Managed futures have been a topic of much discussion and interest for advisors this year as the crisis alpha generators ride the waves of volatility and market drawdown, providing opportunities for a noncorrelated return stream to equities and bonds for portfolios. KFA Funds, a KraneShares company, hosted a recent webinar on trend following and their fund, the KFA Mount Lucas Index Strategy ETF (KMLM), that featured Gerald Prior III, COO and senior portfolio manager at Mount Lucas Management LP, as well as Clint Sorenson, CFA, CMT, and co-founder of WealthShield. It was hosted by Snowy Ding, CFA and investment strategist for KFA.
Managed futures take long and short positions on several asset classes — commodities, currencies, fixed income, and equities — based on models of how the assets are actually performing right now. They are often called crisis alpha generators because they traditionally have performed well when markets have done very poorly, such as the Global Financial Crisis and the Dotcom Bubble, a pattern that we are experiencing once more in 2022.
Having managed futures within a portfolio can help to hedge and account for the negative performance of equities or bonds over times of volatility and market drawdown. Prior explained that holding a managed futures fund like KMLM can help to smooth out some of that volatility and create better performance opportunities for a portfolio because they “crash up” at times when markets are “crashing down.”
Image source: KFA webinar
“I think the most important thing you see here, because of this sort of positively skewed event during this crisis is that you’re able to hold your equity position,” Prior said. “At the end of the day, for an advisor working with clients, it’s a lot easier to convince a client to hold onto their equities when you have something like this buffering the portfolio.”
Managed Futures Provide Mathematical Optimization
Sorenson finds great appeal in managed futures because it’s akin to “being in harmony with the market… kind of the realization that you’re trading the present moment, if you will. It’s about being aware of price movements, about being aware of what markets are doing, and then taking positions based on a rule set and following those rules with discipline.”
“It was not about being right or wrong: it’s about making money,” Sorenson explained.
Managed futures draw a line in the sand of sorts between the investing approach of what is behaviorally optimal and what is mathematical optimal, believes Sorenson, because of the purely mathematical and rules-based approach that managed futures adhere to.
“Every time we’ve done studies and mean-variance optimization, or trying to optimize the portfolio, especially for downside deviation, trend following ends up getting the 100% portfolio weighting when you don’t put any constraints on it,” Sorenson explained. “The reason why is because it is a very mathematically optimal approach to managing money, especially when you’re considering limiting max drawdown while improving compound annual growth rates.”
Investors however, particularly in the U.S., tend to carry a strong aversion to ambiguity, preferring to invest in what they can identify with and tried and true investments that have performed well over the last decade, such as the S&P 500, or the Dow Jones. Having a large allocation to something like managed futures can be a difficult sell for clients long-term, Sorenson said, because oftentimes they don’t look like the performance of the more familiar exchanges.
“Finding a portfolio that you can stick with is super important,” explained Sorenson. “We like to allocate a minimum percentage to trend following, call it 10% because it’s got to be meaningful enough to the portfolio but then we want to really work from that client’s independent behavioral constraints to figure out how much we can kind of push it to be a core allocation because we do believe that trend following should be a core portfolio allocation.”
Invest in Managed Futures With KMLM
The KFA Mount Lucas Index Strategy ETF (KMLM) from KFAFunds, a KraneShares company, invests in futures contracts in commodities, currencies, and global bond markets.
KMLM’s benchmark is the KFA MLM Index, and the fund invests in commodity currency and global fixed income futures contracts. The underlying index uses a trend-following methodology and is a modified version of the MLM Index, which measures a portfolio containing currency, commodity, and global fixed income futures.
Futures contracts in the index include 11 commodities, six currencies, and five global bond markets.
The index evaluates the trading signals of markets every day, rebalances on the first day of each month, invests in securities with maturities of up to 12 months, and expects to invest in ETFs to gain exposure to debt instruments.
KMLM carries an expense ratio of 0.90%.
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