Managed Futures Explained: The Diversifier Most Investors Overlook (Part 1)

Written by John Macy, Financial Coach, MBA, Retirement Income Certified Professional® (RICP)

"Diversification is often called the only free lunch in investing. But what happens when the assets in your portfolio all decline together?"

Most investors diversify with stocks, bonds, and perhaps real estate. While these investments often complement one another, history has shown that during periods of market stress they can all fall at the same time. When that happens, the diversification investors expected may disappear just when they need it most.

Managed futures are one of the few asset classes that have historically behaved differently during many of these difficult periods. Long used by institutional investors, they are now readily available through ETFs and mutual funds.

Unfortunately, traditional diversification — typically represented by the classic 60/40 stock-and-bond portfolio — doesn't always work the way investors expect. In this article we'll explain what managed futures are, how they work, why they can strengthen a diversified portfolio, and how much you might consider allocating.

Why Traditional Diversification Isn't Always Enough

For many years, the classic 60/40 portfolio (60% stocks and 40% bonds) served investors well. Stocks provided long-term growth, while bonds often cushioned losses during stock market downturns.

But investing has evolved.

The bear market of 2022 reminded investors that stocks and bonds can sometimes decline together. Rising inflation and rapidly increasing interest rates caused both asset classes to suffer significant losses. Many diversified portfolios experienced their worst calendar year in decades.

This doesn't mean stocks and bonds no longer belong in a portfolio—they absolutely do. But it does highlight an important lesson:

True diversification means owning assets that respond differently to changing economic environments.

Managed futures are designed to do exactly that.

What Are Managed Futures?

They are professionally managed investment strategies that trade futures contracts across a wide range of global markets. A futures contract is simply an agreement to buy or sell a financial asset (e.g., commodity, stock, bond, currency) at a predetermined price on a future date.

These markets typically include:

• Stock indexes

• Government bonds

• Interest rates

• Currencies

• Commodities such as oil, natural gas, gold, wheat, corn, copper, and livestock

Unlike traditional stock funds, managed futures aren't trying to identify great companies or forecast economic growth. Instead, they attempt to identify market trends, regardless of whether prices are moving higher or lower.

If a market begins trending upward, the strategy may establish a long position to profit from rising prices. If a market begins trending downward, the strategy may establish a short position, seeking to benefit from falling prices.

The objective is to systematically follow trends once they become established.

Academic research has found that trend-following has been effective across a wide range of asset classes (including stocks, bonds, currencies, and commodities), with evidence in some markets extending back more than a century. See this article Time Series Momentum for research demonstrating that trend-following has worked across equities, bonds, currencies, and commodities over many decades.

How Do Managed Futures Work?

Most funds rely on quantitative models rather than human judgment. These models continually monitor hundreds of markets looking for evidence that prices are trending (either upwards or downwards trends).

Consider a few simplified examples:

• Crude oil begins rising steadily over several months. The strategy may purchase oil futures to participate in the trend.

• Treasury bond prices begin falling as interest rates rise. The strategy may establish a short position in Treasury futures (i.e., sell Treasury futures).

• The U.S. dollar strengthens against several major currencies. The strategy may buy dollar futures.

• Gold enters a prolonged decline. The strategy may take a short position until the trend reverses (i.e., sell gold).

The key point is that managed futures don't require stock markets to rise in order to generate returns. Instead, they seek opportunities wherever sustained trends develop.

Because trends occur in many different markets — and sometimes during periods when stocks struggle — trend following strategies have historically behaved quite differently from traditional stock and bond investments.

Consider this analogy: A baseball team built entirely around great hitters may score lots of runs — but it still won't win consistently without good pitchers. Great pitchers are prized for their defensive capabilities but are rarely good hitters. Managed futures play a similar role in a portfolio. They're not there to hit the home runs — they're there to help the team win more consistently.

Why Managed Futures Can Improve a Portfolio

These strategies improve portfolios because they behave differently from traditional investments. In other words, the goal isn't necessarily to earn higher returns than stocks. The goal is to improve how the entire portfolio behaves.

Rather than relying on rising stock prices, they seek to profit from trends across many global markets — including commodities, currencies, bonds, and stock indexes. That means they often respond differently during changing economic environments.

1. Diversification

The greatest benefit of managed futures isn't necessarily higher returns—it's different returns.

Over long periods, managed futures have generally exhibited relatively low correlation with both stocks and bonds. That means they often move independently from the rest of a portfolio. Adding assets with low correlation can improve a portfolio's overall risk-adjusted returns even if the new investment earns returns similar to other asset classes.

2. Potential Protection During Major Market Declines

Systematic trend following strategies have sometimes performed particularly well during extended bear markets because (unlike stock funds) they can benefit from persistent downward trends in just about any market.

This characteristic has led some researchers to describe managed futures as a source of "crisis alpha" — returns that have historically been strongest during periods when traditional portfolios face their greatest challenges.

While there are no guarantees that this pattern will continue, it helps explain why many institutional investors have long included managed futures as part of diversified portfolios.

3. Reduced Portfolio Volatility

A smoother investment journey can be just as valuable as higher long-term returns.

If managed futures perform differently than stocks and bonds, they can help reduce overall portfolio volatility and, in some cases, lessen the severity of portfolio drawdowns.

For investors approaching retirement — or already retired — smaller drawdowns can be particularly valuable because large losses early in retirement may permanently reduce the sustainability of a retirement portfolio. This challenge is known as sequence of returns risk, a topic I've discussed in previous articles.

4. Broad Exposure to Global Markets

Most investors own only a small slice of the world's investable assets. Managed futures strategies, by contrast, often trade hundreds of markets across many countries and asset classes. That broad opportunity set allows them to pursue returns in places that traditional stock and bond funds simply don't access.

Research at a Glance

✓ Historically low correlation with stocks and bonds

✓ Positive performance in many major bear markets

✓ Improved Sharpe ratios in numerous portfolio studies

✓ Lower portfolio drawdowns

✓ Trend-following documented across more than 100 years of market history

What Does the Research Say?

Fortunately, we don't have to rely on theory alone. Managed futures have been studied extensively by academics and investment researchers for more than three decades, and the findings have been remarkably consistent: Adding a modest allocation to these strategies — typically 10% to 20% in many research studies— has historically improved portfolio diversification and reduced overall portfolio risk (see for example this article on Understanding Managed Futures by AQR).

Perhaps the most compelling finding is what happens during difficult markets. AQR's long-term research found that trend-following managed futures have historically generated positive returns during many of the worst equity bear markets (see Demystifying Managed Futures by AQR), including 2000-2002 and 2008, helping offset losses elsewhere in a portfolio. Numerous portfolio studies have also found that adding 10% to 20% managed futures to a traditional stock/bond allocation historically increased risk-adjusted returns (measured by the Sharpe ratio) while reducing portfolio drawdowns and overall volatility (see Managed Futures: Understanding a Misunderstood Diversification Tool by Alpha Architect). No strategy works every year, and these strategies can go through long periods of disappointing performance, but the research consistently suggests they have been one of the most effective diversifiers available to long-term investors.

Comparison from 3 Difficult Historical Periods -- Trend Following Index vs. S&P500 Total Return

Theory is helpful — but investors ultimately care about results. The charts below show how managed futures performed during three of the most challenging market environments of the past 25 years.

Comparison from 3 Difficult Historical Periods -- Traditional 60/40 Portfolio vs. Diversified 50/30/20 Portfolio

In the following chart the Traditional 60/40 Portfolio is composed of 60% S&P500 Index and 40% Aggregate Bond Index Fund (AGG). The Diversified 50/30/20 Portfolio is composed of 50% S&P500 Index + 30% Aggregate Bond Index Fund (AGG) + 20% Managed Futures Trend Following (SG CTA Index).

These historical examples help explain why many investors view managed futures primarily as a diversification tool rather than a return-enhancing investment. During difficult market environments, they have historically helped offset losses in traditional stock and bond portfolios.

Of course, managed futures don't provide protection in every market decline. They work best when markets develop sustained trends, which is why investors should expect periods of disappointment. Their value comes from their long-term contribution to a diversified portfolio — not from outperforming every year.

Common Misconceptions

Managed futures are often misunderstood, so it is important to clear up a few common myths.

Myth #1: Managed futures are just commodity funds.

While commodities are part of many managed futures fund strategies, most managed futures funds also trade stock indexes, government bonds, currencies, and interest rates.

Myth #2: They're trying to predict the market.

Most managed futures strategies don't forecast where markets will go next. Instead, they react to trends after they emerge using systematic rules.

Myth #3: They're only for hedge funds.

Historically that was true. However, in recent years several relatively low-cost ETFs and mutual funds have made managed futures accessible to individual investors.

Myth #4: They always make money when stocks fall.

Not necessarily. Managed futures perform best when markets develop sustained trends. Sharp market reversals or choppy, sideways markets can be challenging for many trend-following strategies.

Risks Investors Should Understand

Like every investment, managed futures come with tradeoffs.

Performance Can Be Cyclical

Managed futures often experience long periods of disappointing performance.

When markets lack clear trends, returns may lag stocks and bonds for several years.

Investors need patience and discipline to stick with the strategy through these periods.

Returns May Look Strange

Because managed futures trade many different markets, their returns often seem disconnected from the financial headlines. They may post gains during difficult years for stocks — or lose money during strong stock markets. That's exactly what makes them useful diversifiers, but it can also make them psychologically difficult to own.

Expenses Are Higher

Managed futures funds generally cost more (i.e., have higher expense ratios) than broad stock index funds because they're actively managed and require sophisticated trading systems. Fortunately, retail costs have fallen significantly over the past decade as competition has increased.

They Aren't a Magic Bullet

Managed futures shouldn't replace a diversified stock portfolio. Instead, they should complement it. Their role is to improve diversification and potentially reduce portfolio volatility and risk — not to outperform stocks over every time period.

Why Don't Target-Date Funds or Balanced Funds Include Managed Futures?

Because managed futures can underperform traditional investments for many years at a time, most conventional balanced funds and target-date funds have chosen not to include them, despite their diversification benefits.

How Much Should You Allocate?

There isn't a single "correct" allocation. The appropriate amount depends on your goals, risk tolerance, and the rest of your portfolio. That said, many diversified portfolio studies have examined allocations in the 5% to 20% range.

As a general guideline:

Allocation	Possible Use
5%	Introduce additional diversification with minimal impact on overall portfolio behavior and performance.
10%	A meaningful allocation that may improve diversification while remaining easy to maintain.
15%	Suitable for investors who place a higher priority on reducing portfolio volatility, risk, and drawdowns.
20%	More appropriate for investors who strongly value diversification and understand that managed futures may underperform traditional assets for extended periods.

Rather than asking, "How much return will managed futures generate?" a better question is:

"How much could they improve the resilience of my overall portfolio?"

That shift in thinking helps explain why institutional investors often evaluate managed futures differently than traditional asset classes.

The Bottom Line

Managed futures aren't designed to outperform stocks or replace a traditional stock-and-bond portfolio. Their role is different: to provide diversification when traditional investments struggle.

For investors approaching retirement — or already living off their portfolios — that additional resilience can make a meaningful difference. Sometimes the most valuable asset in a portfolio isn't the one that earns the highest return — it's the one that's still working when everything else isn't.

Like any investment, managed futures require patience. They will experience periods of disappointing performance, and there will be years when you'll question why you own them. But history suggests that maintaining exposure through those difficult periods has been an important part of realizing their long-term diversification benefits.

Now that we've covered why managed futures deserve consideration, the next question is which fund should you choose? In Part 2, we'll compare the leading managed futures ETFs and mutual funds available to individual investors, discuss the strengths and weaknManaged Futures Explained: The Diversifier Most Investors Overlookesses of each, and explore which funds may be the best fit for different types of investors.

Wondering whether managed futures could strengthen your retirement portfolio?  Every investor's situation is different, and the right allocation depends on your goals, risk tolerance, and overall investment strategy. If you'd like personalized guidance, I'd be happy to help. Schedule a complimentary introductory consultation or learn more about my retirement planning and investment coaching services at FlourishingPath Financial Coaching.

Author:  John Macy, MBA, RICP®

John Macy is a professional financial coach and the founder of FlourishingPath Financial Coaching. With over six years of experience as a financial coach, John helps pre-retirees and retirees design resilient portfolios and income streams for their next act. Read his full story here.