2022 was a fantastic year for showcasing the benefits of adding Managed Futures to the portfolio. Inflation rears its ugly head after 40 years and commodities rip higher during the Ukraine War. Managed Futures, offering exposure to both the long and short sides of return distributions, got you long commodities and short bonds. No other asset class brought you that kind of protection in 2022. Not Gold, not TIPS, not Bitcoin. However, after down single digits in 2023, and another flat to down year in 2024 amid strong stock market results, the naysayers return.

Managed Futures – computers love us! Humans…not so much. Why is that? Take pretty much any sufficiently long Managed Futures track record, or index, run it through asset allocation models and efficient frontiers, the answer is pretty much always the same. Uncorrelated returns, with strong negative correlations in periods of market stress, lowers overall portfolio volatility and drawdowns. The efficient frontier goes up and to the left, improved returns, lower volatility, better portfolio Sharpe. The quants, and CFAs, and nerds all agree…on paper it works. For the seasoned veteran, the RIA, the institutional consultant, holding Managed Futures in a portfolio through time, not so easy with the clients.

Uncorrelated Returns – the human brain is an amazing thing, with a near unlimited storage capacity (~2.5 petabytes), but unlike a computer it does not have the ability to retrieve that data on command. Instead, the brain creates inferences, shortcuts, to aid in decision making. Where there is smoke there is fire…run. If stocks go down, bonds go up (be careful with that one). These inferences rely on built up correlations in our brain, and our brain naturally understands a correlation of 1 (if this happens then that will happen), and a correlation of -1 (if this happens then that will NOT happen). But a correlation of 0 (if this happens then I don’t know)? Financial academia tells us uncorrelated returns add value to a portfolio, computers tell us the same, but the uncertainty of correlation to what we know is hard.

Positively Skewed Distributions – this is the key benefit of Managed Futures, especially when added to a portfolio of negatively skewed investments (stocks, credit). Trend following naturally produces this positively skewed return profile, as it takes long or short positions with a close stop but lets profits run. Trades tend to produce lots of small winners and losers with the occasional big win. Sounds great! But living with it is harder than you think. A positively skewed distribution produces more observations below the mean than above, so on a day-to-day basis can be frustrating waiting for the big payoff. A negatively skewed distribution is the opposite. There are more observations above the mean, and big losses are few and far between. A stock investor can pat himself on the back every day and feel good about his investment, and only has to feel bad about it a few times a decade. A Managed Futures investor must put aside their daily frustration, and know the payoffs will come, and unfortunately there probably won’t be any warning.

Summary – it is the human condition to know what is good for you, but to struggle to do it. It is why the largest story of 2024 may not have been the election, but obesity drugs. So, as we all shift our focus to 2025, evaluate both our diets and investments, know that there is a payoff to sticking to the plan, doing what is good for you. Eat healthy, sleep soundly, and rebalance that portfolio.