ReturnStacked put up a new paper a couple of weeks ago about leveraging up to add alternatives. An important building block to their work and products is not removing equities or fixed income to make room for the alternatives. As I was making my way through, I had the following thought about what a huge allocation to managed futures would look like with very little in equities and no bonds.
On testfol.io, the KMLM managed futures ETF can be backtested to 1987 via however they simulate certain tickers. You can see where managed futures helped and where it was a drag but that's not the most interesting way to look at it.
The worst year for the two portfolios that are 60% managed futures with no bonds was 2002 when Portfolio 1 was down 12.31% as you can see and Portfolio 2 was down 11.68%. Yes, plain vanilla 60/40 was down less that year but if you agree with me about bonds, then we cannot rely on bonds the way we used to to offset large equity declines.
Looking at the year by year bar chart, out of 39 full and partial years, I count 12 years where Portfolios 1 and 2 were far, far behind 60/40. Lagging in some random year by 5 or 6% ok, but as one example of what I mean, in 2017 both 1 and 2 were down less than 1% while 60/40 was up 14%. Portfolios 1 and 2 lagged badly three years in a row recently; 2023, 2024 and 2025.
The point is that anyone looking for a portfolio that resembles what 60/40 used to do when bonds were a one way trade have a decent chance of doing so without the unreliability of bond duration or the variable of adding leverage. Over the very long term, the portfolios with 60% in managed futures tracked closely to 60/40 without duration risk.
Adding a ton of managed futures is one way and while it can probably work, as we've looked at countless times, there will be long periods of anguish here and there.
Another approach we've looked at many times has been barbelling the 40 with a lot in very boring, steady fixed income with a small slice into riskier income niches. The idea being that if something terrible happens in the risky slice it won't wreck the portfolio.
Portfolios 1 and 2 are 90% FLOT which is very plain vanilla. Portfolio 1 puts the risky sleeve in TLT which would have been a poor choice and Portfolio 2 puts the risk sleeve in catastrophe bonds which would have turned out to be a good choice. The 10% in TLT would have lagged the 10% in cat bonds but TLT did not blow anything up.
The returns for Portfolios 1 and 2 are not killing it by any means but that is not the object for what goes into the 40 or whatever percentage you use to offset equities, make that reliably offset equities. Also you can see FLOT yielding nothing for a long time and then turning up in 2022 as it finally started to pay out.
This is simply an example of how to size risk into a portfolio. Having 10% in cat bonds probably isn't inviting doom but is a little heavier than I'd want to go. As we have looked at countless times, there are enough higher yielding segments that take different kinds of risk to get some yield, reduce volatility and diffuse risk without extending duration which many pundits are saying it is now finally time to do. Unfortunately a lot of them said the same thing at 4% and at 3%.
I have no idea what interest rates will do. If you've been reading this blog for a while you know I'm not trying to predict something, this is about avoiding something.
The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.
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