Managed Futures: A Primer

This trading strategy, that goes long or short on futures contracts for a variety of assets depending on their momentum, has some promise as a unique, uncorrelated asset stream with a positive expected return. Here’s a primer that considers whether managed futures have a place in RP portfolios.

This is part 1 of the exploration of managed futures. Click below for Part 2 which is a close look at DBMF, the preferred way to invest in this asset class
Preferred Asset for Managed Futures: DBMF
If managed futures are going to be included in a RP portfolio, what’s the best asset? My vote is for DBMF, which has had solid returns and low correlation to stocks and bonds in its short history. Proceed with caution for this asset though, because of that very short history.

For Ray Dalio, the “Holy Grail” of investing is a portfolio made up of multiple, uncorrelated asset streams. He has talked about finding fifteen such streams, but this has always seemed a stretch, as I’m only up to six in my portfolio: stocks, bonds, commodities, gold (which you could easily count as a commodity), cryptocurrency, and directly-owned real estate (so not REITs, which I include with stocks). Then there is volatility, the fine art market and maybe farmland, none of which I have invested in yet, but that would only be 9.

Enter managed futures. Briefly, this is a trading strategy that goes long or short on a wide variety of futures contracts in order to make money as those contracts continue on their trend. Approaches can be either systematic, based on proprietary trading algorithms, or discretionary, based on active guessing about what to invest in and when.

Managed futures are a bit odd because the key with them is not what you are investing in, but how. The exact type of futures contract is of secondary importance - these are often for different commodities, but they don’t have to be as you could use this strategy on foreign currencies, bonds, equities, and even cryptocurrencies. It’s a highly technical strategy that was pioneered by hedge funds, and has mostly remained confined to the world of professional investors. As DIY investing has evolved, however, this strategy has become more and more accessible and importantly, cheaper to execute.

The great promise of managed futures is that their decent returns may be uncorrelated with both stocks and bonds. Since the strategy can involve going long or short, it is not necessarily tied to the market or the economy doing well or badly, but can adjust to find profit in a variety of assets and time periods. Over the past three years, for example, the IMGP DBi Managed Futures Strategy ETF (ticker: DBMF) has had basically zero correlation with US stocks, International stocks, and Long-term Treasuries (-.05 to VTI; -.09 to VXUS; -.15 to VGLT). Meanwhile it has had an annualized return of 15.4%. That combination of non-correlation with great return has piqued my interest, for sure.

Questions remain, though. The current avenues for investing in managed futures are not very old, and so time will tell if those returns can be maintained and whether it will remain non-correlated. Other managed futures ETFs (like WTMF and FTF) have been around somewhat longer, but have not performed very well, leading us to ask if DBMF is doing something fundamentally different or if it has just luckily captured lightning in a bottle.

Additionally, it is an active strategy that carries higher expense ratios than just about everything else in my portfolio. The fees are explicable, though, since doing this on your own would be incredibly time consuming: you’d need a way to identify trends in hundreds of different futures markets, and then every time you made a decision you’d have to input a complicated system of stop and limit orders to define entry and exit points. Hopefully, with more competition in the space, fees can come down.

The managed futures strategy is intriguing, but I remain skeptical. Things that sound too good to be true always are (almost always?). I do think there is enough to them to warrant inclusion in a test portfolio, so I’ve changed the commodities strategy in the RPC Growth portfolio to now be split between PDBC and DBMF. Instead of the portfolio aiming for 15% in PDBC, the allocations will now be 7.5% for both PDBC and DBMF. Let’s see how DBMF performs, and whether its volatility patterns differ from PDBC and the other assets.

For more on managed futures, here is what I've found in terms of the best resources:

Best video explanation of managed futures:

Quick overview from Investopedia:

An Introduction to Managed Futures
Their inverse correlation with stocks and bonds make these investments worth getting to know.

Risk Parity Radio featured the IMGP DBi fund (DBMF) in two episodes, employing the “Stein Process” (ten questions to ask and answer about any investment possibility) to give it a closer look. Although the specific focus is on this ETF, you'll get a sense of managed futures in general:

Finally, the splash pages for the four managed futures ETFs on the market now. Stay tuned for part 2 of the exploration of managed futures where I'll go into DBMF more specifically and contrast it with the others: