Combining Risk-Managed Equities and Managed Futures
Do you need risk management for equities in a diversified portfolio?
November 2024. Reading Time: 10 Minutes. Author: Nicolas Rabener.
SUMMARY
- Combining equities and managed futures has been an attractive combination
- Applying a trend following overlay for equities has generated mixed results
- The attractiveness depends largely on the outlook for equities
INTRODUCTION
In a recent research article (read What Equity Factor Is Best Combined with Managed Futures?), we analyzed what equity style is optimal for combining equities and managed futures, which are also known as CTAs. Intuitively, the most correlated equity factor, ie momentum, should be least attractive for a combination portfolio, and the most negatively correlated factor, ie value, the most attractive.
However, this neglects that the performance of equity factors has been quite dispersed over the last two decades and the difference between theoretical long-short and practical long-only implementations. Investors also need to decide whether they prefer to focus on returns, Sharpe ratios, or drawdowns.
For example, combining value stocks and managed futures, proxied by the SG Trend Index, with equal-weighted allocations generated the highest return in the period from 2006 to 2024, however, this combination portfolio has experienced one of the larger maximum drawdowns, likely as cheap financial stocks underperformed significantly during the global financial crisis in 2009. In contrast, combining low volatility stocks with managed futures generated the highest Sharpe ratio and lowest maximum drawdown.
