Investors who are seeking an alternative method to diversify a portfolio in these troubled times can consider a managed futures exchange traded fund strategy.
In the recent webcast, Can a Managed Futures Strategy Come to the Rescue as Stocks and Bonds Struggle?, Gerald Prior III, chief operating officer, and senior portfolio manager at Mount Lucas, pointed out that by participating in the futures markets, a managed futures portfolio acts as an important market participant, accepting that price risk and providing liquidity to commercial interests. The primary benefit of investing in managed futures is the mitigation of portfolio risk through an uncorrelated asset class. Furthermore, during periods of market stress, managed futures have historically shown greater potential for negative correlations. Institutional investors may employ an active futures manager for a variety of reasons. However, investors of all types may use managed futures to diversify risks in a portfolio that does not already consist of derivatives.
To access the managed futures market, investors can look to something like the KFA Mount Lucas Index Strategy ETF (KMLM) from KFAFunds, a KraneShares company. The underlying index, or KFA MLM Index, tracks the performance of Mount Lucas’ managed futures strategy. The index is meant to reflect the return available to managed futures investors through an efficient passive trend following algorithm. The Mount Lucas team trades futures contracts derived from the value of various commodities, currencies, and government bonds, Prior explained.
Prior argued that the KFA MLM Index has the potential to outperform during periods of price instability and dislocation. The index is also meant to exhibit lower volatility than the broader market during such periods, providing a meaningful diversification impact.
The KFA MLM Index implements a trend-following algorithm to signal the inception of significant price dislocations. Inputs to the algorithm (trends) include market prices and their respective long-term moving average based on these trends, the index takes long or short positions depending on the direction of the price dislocation. Trend signals are executed in small increments over several days, lowering the overall market impact. The index is designed to capitalize on sustained price dislocations in futures markets, Prior added.
The KFA MLM Index has also exhibited negative correlations with US equity and bond markets during both bull and bear market periods.
“That is what makes it so valuable as an addition to any portfolio. In times of high uncertainty, this long/short process of managed futures tend to do very well,” Snowy Ding, investment strategist at KraneShares, said.
“What also jumps out at me here is the asymmetrical nature of the index,” Ding added. “So really, you can almost think of this as insurance when the market is rallying, this tends to be flat but when the market does go south, you can rely on this to be up exponentially too.”
Ding argued that tracking the KFA MLM Index may reduce both risk and drawdown when used as a complement to a traditional 60% stock and 40% bond portfolio. Allocating as little as 10% may yield risk-adjusted performance benefits.
Financial advisors who are interested in the managed futures strategy can watch the webcast here on demand