The Optimal Allocation to Managed Futures

Last Fall, we geeked out on the question that we get asked the most by investors and clients alike, “How much of my portfolio allocation should be dedicated to Managed Futures?” We looked for answers by building two different tables based on an investor’s return expectations for alternatives and based on how much alternatives would help decrease the magnitude of a drawdown.

Another way the investing world finds the optimal allocation to Alternatives is using the Efficient Frontier from Modern Portfolio Theory.  This isn’t Jean-Luc Picard and the Final Frontier – this is the Efficient Frontier where one can calculate the best possible mix of portfolio components to arrive at the highest possible return with the lowest possible risk (as measured by volatility). In plotting all of the different returns and risks of differing portfolio allocation amounts, from 0% in alternatives to 50% all the way up to 100%, you get a curve of the returns and risk of each possible portfolio. The point on that curve with the highest return and lowest risk is the most efficient allocation of assets, known as the Efficient Frontier (see our previous articles on it, here and here).

Then and Now

Back in 2008, the CME Group published their look at the efficient frontier, finding a 20% allocation to Managed Futures and a 40% allocation each to stocks and bonds as the most efficient portfolio allocation splits.

(Disclaimer: Past performance is not necessarily indicative of future results)

But, news flash, asset class returns aren’t stagnant – they go up and down, in and out of favor, and so forth. Meaning the curve after the financial crisis is likely to be different than the one before it. We’ve updated the efficient frontier every year since, to give investors the most recent look, with managed futures having moved from the 20% level to 40%  after the financial crisis, and now down around 35%. Here’s the efficient frontier using data through the end of 2015:

(Disclaimer: Past performance is not necessarily indicative of future results)
Stocks = S&P 500, Bonds = Citi World Bond Index,
Managed Futures = DJCS Managed Futures Index

Now, perhaps more telling than the snapshot as of December, is the best allocation percentage according to the efficient frontier each year going back most of a decade. You’ll see this is a moving target, to be sure, but consider the crazy times we’ve lived through these past 8 years – and the varying fortunes of stocks, bonds, and alternatives (as represented by managed futures). It hasn’t been easy for any of them with the financial crisis, massive bull run in stocks, and 3 year period when systematic trend following strategies struggled; but even so, the optimal allocation has remained relatively stable in the 30% range.

(Disclaimer: Past performance is not necessarily indicative of future results)
Portfolio Makeup 2010-2012: 36% Stocks (S&P 500), 24% Bonds (Citi World Bond Index), 40% Managed Futures (DJCS Managed Futures Index)
Portfolio Makeup 2013-2015: 38% to Stocks, 27% to Bonds, and 35% Managed Futures
Performance begins as in 1994.

Finally, as we’ve pointed out before, you don’t invest in an index, you pick out actual Managed Futures managers, meaning the numbers would surely shift to different portfolio allocations based on that manager’s distinct return profile.  Let us know if you’d like an efficient frontier run on a manager you’re interested in. We’re building a new “Allocator” tool into our new website which will allow you to see how an allocation to a certain manager will change the returns and risk of your overall  portfolio, and can use the tech to run a report for you if interested. After all, that’s what we do.