It’s late 1987. Institutional investors had just lived through the debacle of October 19, when the stock market collapsed, driven down by an idiotic idea … portfolio insurance. Shortly afterward, we had our first meeting with Rusty Olson, CIO of Eastman Kodak’s pension plan. Regardless of what you think of Kodak’s business acumen at the time, the pension plan was a star. Rusty was in the process of turning over every rock in the financial marketplace, looking for diversification for his very aggressive portfolio. He found us. We pitched him on the idea of managed futures as the ideal diversifier. Liquid, leverageable, and systematic. He loved it but with a caveat. We proposed a multi-manager managed account. But he, and his consultant, had no way of knowing how we were doing relative to some benchmark … there was no benchmark at the time. So we built one — the MLM Index. To my knowledge, it was the first rigorous, price based measurement of the risk premia available to futures traders.
2025 has been fascinating to watch through a macro lens. The Trump administration is seeking to reshape policy in ways that will reverberate for years to come. Trading relationships, defense priorities, tariffs, fiscal policy, monetary policy, immigration policy and the regulatory landscape are all on the table. Many of these directly impact the markets in which we operate. Last quarter started in the messiest of fashions, ‘Liberation Day’ setting tariffs based on trade deficits rocked the stock market and was swiftly paused in favor of ‘The Art of the Deal’ over the next few months. Stocks recovered, the contours of deals started to take shape and soon we had the One Big Beautiful Bill signed. Tax cuts were extended and investment tax credits were increased. Deficit arguments abound, most of which read like political talking points dressed up as economics. Are we talking about baselines vs current law or current year? Counting tariff revenue? Are we ascribing a growth multiplier? Our take on the macro aggregate is that deficits are not getting materially and hastily slashed so the accounting identity that public deficits become private profits still holds and growth is OK. Under the surface though there are some big changes in the composition of spending, especially when coupled with the new AI Action Plan. There is a broader discussion to be had on the role of the government in setting industrial policy and picking winners that is best saved for a glass of wine. However, they aren’t kidding calling it a ‘Big’ bill (‘Beautiful’ may be a stretch) but take the time to go through it, the answers to the test are in there. Money for defense and a desire to lead in AI.
Ask any self-respecting trend follower what kind of market environment favors their strategy, and you’ll get the usual suspects: volatility, uncertainty, macro and geopolitical stress, inflation, deflation, recession. But here’s the thing—those are just the conditions. The real driver? Signal versus noise. Trend needs signal.
In 2022, the signal was deafening: inflation fears, war in Ukraine, and ultimately, realized inflation. Since 2023? More like a symphony of noise. Just look at U.S. rates: 10-year yields dipped below 3.5% in April ’23 on recession fears… then hit 5% by October on “higher for longer.” They slid below 4% in Jan ’24 (soft landing), bounced to 4.5% by April (higher for longer again), dipped back under 4% in September (post-Yen carry unwind, recession vibes), then shot above 4.5% in Jan ’25 (pre-inauguration pro-growth Trump trade), and—you guessed it—dropped back under 4% in April (DOGE, tariffs, not pro-growth but outright recessionary).
At Mount Lucas we run both discretionary macro and systematic Managed Futures strategies.
While macro outlooks are useful for understanding Managed Futures returns, they aren’t very predictive (the “following” part of trend following). However, rule of thumb, they tend to do well when volatility increases in macro markets.
Managed Futures picks up a risk premium from hedgers on both sides of the markets, that risk premium shifts with uncertainty.
We have a new administration coming in shortly that sees volatility as a feature for negotiating leverage and has big macro policy goals.
These policy goals run directly through the macro instruments we trade – bond yields, currencies and commodity markets.
Investors need exposure to these macro markets to help diversify traditional investments.
Where do we see sources of volatility relative to the markets we trade?
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.
We speak with a diverse range of investors—domestic and international, institutional and retail, alternatives-focused and equity-centric. Typically, they have a variety of questions and concerns driving their current thinking. However, in recent weeks, there’s been a singular focus: the return of President Trump. It’s remarkable how much of a Rorschach test he has become.
For macro topics like inflation or growth, we usually see a fairly narrow range of opinions—around 10-15% of people expecting slightly lower inflation, 10-15% anticipating it to be a bit higher, with most clustered near the target, expecting the status quo. Currently, not a single person thinks we are in a state of equilibrium. On one side, 50% believe we’re headed for runaway inflation fueled by exploding deficits, Fed pressure, eroding confidence in the USD, and soaring commodity prices due to global turmoil. The other 50% foresee a deflationary crisis spurred by the deportation of 10 million immigrants, a $2 trillion reduction in the federal budget, and a rampant USD disrupting emerging markets and driving commodity prices down. Adding to this uncertainty, President Trump, the world’s largest one-man volatility machine, has teamed up with perhaps the only person who could rival him, Elon Musk. Volatility squared.
These factors, among others, have realigned market assumptions, significantly increasing the likelihood of problematic inflation or deflation over the next twelve months. Investors face a FLATION complication.
The past few years have seen large moves in global yields. To (very briefly) recap, at the end of 2018, US 10-year yields were around 3% on the heels of recent rate hikes. Late in 2019, the escalation of trade tensions between the US and China led the Fed to enter a mid-cycle course correction taking yields down under 2%. The pandemic at the start of 2020 prompted emergency cuts everywhere and moves to record low yields close to 0.5%. Yields started rising again as the economy reopened, and as inflation reared its ugly head in 2022 global central banks found themselves behind the curve. The US 10-year touched 5% for a hot second in late 2023 before falling to 4% at year-end. Rates bounced around in 2024 as markets grappled with several rounds of “the Fed needs to cut” to “rates will be higher for longer.” Now, inflation near target and the balance of worries has shifted from the inflation to questions of soft landings and slowdowns.
We’ve highlighted a few times on this blog on how trend following can be helpful in portfolio construction with its ability to access a diverse set of markets as well as both sides of the return distribution (long and short) in those markets. Diversification is driven by both of those features. 2022 saw bond prices fall and commodity prices rise as inflation, war and interest rates rattled through the global economy and asset markets. The ability to get short exposure to bonds and the Japanese Yen as interest rates rose, coupled with long positions directly in the commodity markets that stoked inflationary fears, enabled trend following allocations to cushion traditional portfolios of stocks, bonds and credit. Direct exposure to the factors hurting traditional portfolios is a key benefit of trend following, as well as its adaptability in different environments. Indeed, in previous difficult periods for traditional markets the opposite exposures were the most helpful – long bonds and short commodities in the GFC were the right positions for trend to take.
On the commodity side in particular, we have long thought that owning commodities as a long only investment was a mistake, and that due to human ingenuity and product substitution prices would go down in real terms over time. The short side is too important to ignore. This can be true in financial crises like 2008/09 when crude oil dropped some 75%, but also in quieter times. The risk premium in Managed Futures comes from taking on risks producers and consumers want to shed, making participation on both the long side and short side necessary. Commodities are particularly useful as they are much less correlated to each other than something like bond markets. Crude oil, grains, softs and meats all have their own cycles driven by their own unique drivers and supply/demand curves. Current grain markets are a good example.
In 2022 grain markets spiked upwards as the Ukraine war directly impacted the wheat market. Prewar, Ukraine harvested some 33m tons of wheat as one of the larger global producers. Prices of US wheat had been trending higher through 2021 and were sitting around $8/bushel; by May they were 50% higher at $12/bushel. Wheat competes for acres with corn and soybeans, as farmers optimize a planting mix in part based on market prices. If wheat – which grows like a weed – is trading 50% higher than usual some acres shift to wheat and away from corn and soybeans, reducing expected crop sizes, pushing those prices higher. Long only caught that move. The best cure for high prices though is high prices, and possible crop shortages and fears of the same can be solved with a couple of good harvests. As those fears and shortages abate, prices fall again. This is what we have seen in 2024. Planting conditions were perfect, the growing season weather has been perfect. Seed technology and farming advances keep improving. Record yields for corn and soybeans this year. What happens when high prices meet record yields? Lower prices. It’s times like these you need your shorts.
Source: Bloomberg, Mount LucasSource: Bloomberg, Mount LucasSource: Bloomberg, Mount Lucas
This is an excellent piece from JP Morgan Asset Management and GIC. It presents a different framework for institutional investors looking to diversify away from traditional portfolios, making the case that portfolio starting points play a large role in where you should end up. The paper starts by classifying hedge funds by their risk/return profiles, with Managed Futures strategies going into the Loss Mitigation sub-group. They then examine the optimal allocations to the sub-groups and show that standalone hedge fund allocations should be different than hedge fund allocations that are being integrated into 60/40 portfolios. They conclude a few important things:
Correlations
First, they note that hedge funds classified as Managed Futures, Commodities and Macro have lower equity correlations while Equity, Event Driven and Credit are more correlated to stocks.
This is one of the beauties we see in Managed Futures and Macro and why they work so well in broader portfolios. The economy is cyclical, so fixed income and stock markets inherit that cyclicality. Commodities are rarely in equilibrium, cycling between oversupply and undersupply. Traditional portfolios are dominated by long exposures, which rely only on the right-hand side of a return distribution. Managed Futures and Macro are one of the few places where you can get access to the short side of a return distribution, the down part of a cycle. The other factor that drives the lower correlations – commodities and currencies are just more different from each other than equities are from each other. Sugar is nothing like cattle and nothing like silver or natural gas – completely different supply/demand pictures. While individual companies have their own fundamentals, sales cycles and market wide multiples drive a large part of valuation. The economic cycle is a common factor.
When building multi-asset optimized portfolios, being able to maintain the low or negative correlation throughout regimes and having a positive expected rate of return is the holy grail. The investing world witnessed this in 2022 as the long since forgotten phenomenon called inflation ran through stock and bond portfolios like a bad lunch. Managed Futures? Kept the negative correlation and provided positive returns; it is generally a regime agnostic strategy. More details in this piece. The times it struggles are during periods of particularly low macro volatility, typically quite good for traditional assets that prefer the stability of cash flows and abhor the instability of crash flows, which Managed Futures craves.
The chart from the piece that highlights the performance in equity drawdowns is also important – while Managed Futures is generally uncorrelated most of the time, in stress periods it has been negatively correlated and produced positive returns.
The chart below illustrates the remarkable consistency Managed Futures has shown during equity drawdowns relative to other alternative investments. This is a fairly high hit rate for Managed Futures and Macro strategies, certainly compared to Event Driven, Credit and Equity strategies.
The second conclusion that jumps out is that optimal allocations to underlying hedge fund strategies are very dependent on whether there is a broader portfolio concern in the background. Standalone hedge fund portfolios will likely want more exposure to stocks and credit than hedge fund portfolios that are being built to complement or diversify broader portfolios that already contain equity and credit. We completely agree. Equity and credit portfolios are generally thought to be negatively skewed. In our view, the right thing to do when adding hedge fund exposure to an existing portfolio is to look for strategies that can be negatively correlated, aim at the highest positive skew possible, and then rebalance fairly aggressively.
For many investors, Managed Futures are a portfolio element, slotting into broader portfolios. As we built our Managed Futures strategies over the years we have stayed investor focused, always keeping the broader portfolio goals in mind.
Over the past couple of decades many public pensions have reduced public equity exposure in favor of private equity, private credit, real estate and fixed income. The volatility laundering debate notwithstanding, if one believes they have less equity beta, then having a Managed Futures strategy that takes equity exposure may be a fine decision. If one has a portfolio that is already heavy public equity, then skipping additional long equity exposure inside the Managed Futures strategy may be more appropriate. It is the same with volatility targeting positions. In a standalone hedge fund allocation that is optimizing solely for that portfolio, volatility targeting positions may be a fine thing to do. We are not against it in all circumstances – our view is that where you stand depends on where you sit. If you sit with a large equity portfolio that doesn’t volatility target itself, you likely want a Managed Futures strategy that doesn’t volatility target either. In that world, one should optimize for the broader portfolio and make decisions that most help the whole. We have written more on that skew maximizing approach here.
Some quick background on the macro. Let’s look at the potential impact on a Trump re-election if he does what he is talking about on tariffs. Roughly speaking to set the stage, in President Trump’s first term he placed a set of duties on Chinese products in the America First economic policy to shrink the trade deficit and rebuild the U.S. manufacturing base. The world generally operates under large multilateral trade deals; he wanted to move to more bilateral deals and renegotiate the large deals. Exit TPP, redo NAFTA for example. Tariffs were planned/enacted on a variety of goods imports across finished products and raw materials: steel, washing machines, solar panels, flat screen TVs, batteries and many more Chinese goods in response to IP theft. Retaliatory measures from partners ensued, escalations etc. At the same time, he leveled lots of (correct) charges of currency manipulation by trading partners. Short version that underpins President Trump’s thinking – countries that keep their FX weak increase the attractiveness of their products at the expense of others, cause large trade surpluses, encourage overproduction/under consumption in the country with weak currency and underproduction/overconsumption in the strong currency country. In single product basic terms – if China keeps its currency very cheap it makes washing machines produced there unfairly cheap vs those produced in the U.S. Over time it is the currency naturally strengthening that should close that gap – keeping it weak on purpose as China does/did prevents that natural correction. When you zoom out to the macroeconomic level – the important part is China’s currency manipulation leads to not just exporting cheap washing machines but exporting unemployment from China to the U.S. as manufacturing jobs slowly leave the country due to U.S. products being unnaturally uncompetitive. Clearly it is impossible for all countries to run trade surpluses, someone must run the corresponding deficit, so the practice is damaging. At the same time, Trump discouraged companies from moving production overseas with reduced tax incentives via BEAT and GILTI, reduced domestic corporate tax rates, and used the bully pulpit to shame those that did. Some deal making ensued.
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