Dear Mr. Market:

What’s your plan for when the stock market goes down? Is this plan the same for when bonds go down? Over the last several years of this bull market we have gradually prepared for this inevitable event by establishing a strategy in advance as opposed to one that is reactionary or emotional.

After reading this article we ask that you do something different the next time the sky is falling. Tell yourself that before the next market crash you won’t have fear, panic, or emotions guide your strategy but rather follow an intelligent plan.

One way to hedge your portfolio against serious drawdowns is by using alternative investments such as Managed Futures. The following five questions are from an interview by US News with Cliff Stanton, CFA and Co-Chief Investment Officer at 361 Capital:

What are the potential benefits of investing in futures?

The primary benefits that managed futures strategies offer are: (1) the ability to generate attractive risk-adjusted returns that are uncorrelated with the staples of most portfolios – equities and bonds, and (2) the potential to provide what is referred to as “crisis alpha”, or positive returns when other assets, especially equities, are struggling. For example, in each of the four calendar years in which the S&P 500 has posted a negative return over the last two decades, the Credit Suisse Managed Futures Index has advanced, most notably in 2008 when it was up 18.3% while the S&P 500 fell 37%.  Managed futures strategies have been a great diversifying asset.

What downsides/risks should investors be aware of?

 Because traditional managed futures funds tend to be highly diversified across equities, fixed income, commodities, and currencies, coupled with the fact that they are afforded the flexibility to take both long and short positions, the downside tends to be significantly less than for equities, but the risks are still meaningful. For example, over the last 15 years, the largest drawdown experienced by the Credit Suisse Managed Futures Index was about 17.5%, which while tough to swallow, pales in comparison to the 51% drawdown suffered by the S&P 500 from November 2007  through February 2009. The fact is, recovering from a 17.5% loss only requires a return of 21%, while recovering from a 51% loss requires a gain of about 100%. The math of a big loss is painful.

If an investor decides to pursue an investment strategy that involves managed futures, what kind of asset allocation should they be aiming for?

The goals of the investor should dictate the overall asset allocation, and in turn, the degree of exposure to managed futures. However, what we know is that having a meaningful allocation (i.e., 10% or more) to managed futures can be quite impactful for the reasons laid out above. And that’s just from a historical perspective that covers a time frame over which interest rates were falling, decade after decade, and thus generating solid returns for fixed income investments. Because bonds not only provided attractive returns, but also tended to be a hedge against equity market turmoil, the need for managed futures wasn’t as great in the past. But what matters in building portfolios today is the future, and we know that after four decades of declining rates, the next 10 years will not be the same, and investors will need to add assets that not only provide diversification, but that also improve upon the paltry return potential of investment grade debt.

What should investors keep in mind when rebalancing a portfolio that includes managed futures?

Rebalancing a portfolio doesn’t require a different approach when managed futures are in the mix. What’s important is maintaining exposure consistent with the asset allocation required to meet the needs of the investor.

How can investors vet managed futures investment options to make sure they’re choosing the right ones? In other words, which factors should they be considering when making a decision?

The devil is indeed in the details, as performance dispersion is much greater within the managed futures space than it is within the U.S. large cap equity category, for example. This is because not only are there many approaches to traditional trend following strategies, but there are also managed futures funds that follow shorter-term strategies, and don’t rely on trends, such as the aptly named, short-term counter trend approach that can be highly effective in choppy markets. Manager selection, properly done, is time intensive and should include both qualitative analyses of the firm, people, philosophy and process, along with quantitative analyses of the strategy’s performance and risk exposures. Investors should focus on identifying a manager’s edge. Is it an intellectual edge? a resource edge? an implementation edge? or a strategy edge?

At My Portfolio Guide, LLC we have implemented strategies incorporating Managed Futures (amongst other instruments) into all of our client portfolios. If the “science” and data behind using these investments doesn’t resonate for you perhaps a visual will be more helpful! Over the past 30 years there have been several major market drawdowns that almost anyone can remember. Here’s how Managed Futures did versus a standard mix of 50% stocks and 50% bonds:

If you’re a visual learner like most people are,  the graphic above should at least grab your eye. If you still need help figuring it all out or want to learn how to specifically incorporate Managed Futures into your portfolio, contact us today!

“A goal without a plan is just a wish.”

–Antoine de Saint Exupery