Diversifying a Portfolio
Unfortunately with the world economy continuing to experience the fallout from the sub-prime debacle as well as the retail consumer holding back on spending, the stock market is weathering a challenging period.
One of the tenets of modern portfolio theory, as developed by Nobel prize-winning economist Professor Harry M. Markowitz, is that more efficient investment portfolios can be created by diversifying among asset classes with low to negative correlations. Adding a managed futures fund to a portfolio of traditional stocks and bonds has the potential to reduce risk and improve performance.
Combined with the credit problems for the average consumer and business owner and a recession officially started in December ’07, and you have a formula for a very difficult stock market going forward.
Even any bullish stock analysts, if you can find one, are predicting that any sustained upward move of the stock market will be a long and drawn out process with meager single digit returns for many years to come.
We believe in the strongest of terms that this is a time for "Extreme Caution." Now is the time to heed the wisdom of Modern Portfolio Theory and properly balance and diversify a stock portfolio with a non-correlated asset class like managed futures and options.
1. Potential to Lower Overall Portfolio Risk
The main benefit of adding managed futures to a balanced portfolio is the potential to decrease portfolio volatility. Risk reduction is possible because managed futures can trade across a wide range of global markets that have virtually no long-term correlation to most traditional asset classes. Moreover, managed futures funds generally perform well during adverse economic or market conditions for stocks and bonds, thereby providing excellent downside protection in most portfolios.
Correlation of Selected Asset Classes
Security type |
Managed futures |
Bonds |
U.S. stocks |
|---|---|---|---|
Managed futures |
100.00 |
0.30 |
-0.23 |
Bonds |
0.30 |
100.00 |
-0.29 |
U.S. stocks |
-0.23 |
-0.29 |
100.00 |
(Based on a 10-year period ending December 31, 2007. Managed futures: Barclay CTA Index. Bonds: Lehman Brothers Long-Term U.S. Treasury Index. U.S. stocks: S&P 500 Total Return Index. Source: BarclayHedge, Ltd.)
2. Opportunity to Enhance Overall Portfolio Returns
While managed futures can decrease portfolio risk, they can also simultaneously enhance overall portfolio performance. The following chart illustrates that adding managed futures to a traditional portfolio improves overall investment quality while also potentially reducing risk. This has been substantiated by an extensive bank of academic research, beginning with the landmark study by Dr. John Lintner of Harvard University, in which he wrote, “...the combined portfolios of stocks (or stocks and bonds) after including judicious investments ...in leveraged managed futures accounts show substantially less risk at every possible level of expected return than portfolios of stocks (or stocks and bonds) alone.” (Source: John Lintner, “The Potential Role of Managed Commodity Financial Futures Accounts (and/or Funds) in Portfolios of Stocks and Bonds,” Annual Conference of Financial Analysts Federation, May, 1983.)
Optimum Portfolio Mix, January 1987 – February 2008
(Managed futures: CASAM CISDM CTA Equal Weighted. Stocks: MSCI World. Bonds: JP Morgan Government Bond Global. Source: Bloomberg.)
Read a more detailed analysis of this study. Whether you access the link or not a detailed hard copy will be mailed to you when you request our Free Investors Kit.
Also, read The Benefits of Managed Futures (PDF).
There is no guarantee that adding Managed Futures and Options to a Stock/Bond portfolio will increase performance or reduce risk. Before investing the CTA's disclosure document must be read and signed. A break-even analysis will be supplied to you as to what point your account would break even in the first two years, net of all costs. The before mentioned studies and statistics in no way purport to be representative of the entire universe of commodity trading advisors.
Next: Choosing a CTA