As most investors know, periods of heightened stock market volatility have the ability to wreak havoc on a portfolio as well as a sound night’s sleep. During these volatile periods, many investors choose to withdraw a portion of their investment and sit on the sidelines waiting for the markets to stabilize. Unless you happen to be an expert at market timing, reducing your investment allocation severely minimizes any potential upside.
First, let us take a look at volatility and its impact on stock market performance. The five year chart below illustrates the volatility of the S&P 500 (in blue) along with the performance of the S&P 500 (in green) side-by-side:
Over the last five years, there have been frequent periods of 100% increases in volatility with the most dramatic increase coming in late 2008, when volatility spiked to +400%. As you can see, when volatility spikes, it has typically resulted in negative performance for the stock market. In the coming weeks and months, with the uncertainty of the Euro zone crisis and the potential impact it may have on the U.S. economy, volatility may continue to rise.
While many investors use the wait and see approach during times of increased volatility, some choose to re-allocate portions of their equity portfolio into their other traditional assets. While this method may seem sound, most traditional assets are correlated to one another. Thus their re-allocation to another traditional asset class is still tracking the movement of the equity markets to some extent.
Often less explored, is the use of alternative assets, specifically managed futures to help reduce portfolio volatility while retaining the opportunity for non-correlated gains. The combination of today’s technology coupled with the wide array of Commodity Trading Advisors available, makes it relatively simple for any investor to find an advisor that suits their individual risk tolerances and potential performance expectations. While diversifying a portfolio using managed futures can be done at any time, it becomes an excellent alternative to simply “sitting on the sidelines,” during extremely volatile periods. Another benefit investors typically discover, is that managed futures can also provide non-correlated returns during times of stagnancy in the equity markets. Using the same time period as the above chart, the chart below shows the performance of the S&P 500 side-by-side with the NewEdge CTA Index (a common benchmark used to measure managed futures performance).
*Data compiled from NewEdge CTA Index monthly performance and S&P 500 Monthly performance.
S&P 500 performance has a range of +11.00% to -16.00%, while the range of the NewEdge CTA Index has a range of +5% to -5%. While you may notice slight directional correlation between the two during certain periods, it is easy to see that the performance of the S&P 500 is much more volatile than the performance of the NewEdge CTA Index.
It should be noted that the points mentioned above are not guaranteed outcomes. Investors should analyze managed futures the same way they would analyze any investment, which is why it is important to understand the ways in which the claims made above hold merit – the primary reason being diversification. As an alternative asset class, managed futures offer diversification from traditional assets – stocks, bonds, and real estate. Beyond asset class diversification, managed futures have the ability to add non-correlated alpha to an investor’s portfolio. This non-correlation of managed futures to traditional investments is one of its most unique traits, and a key reason why many investors consider adding them to their overall portfolios.
While all this may seem daunting to those new to managed futures, the process is not difficult. As with most things, the key is to take that first step and increase your knowledge of the investment. Being proactive is critical to being a successful investor in this era. The old “buy and hold” mantra is great if you are Warren Buffet, however it does not always work out for the rest of us. A few key decisions to minimize losses and maximize gains during obvious times can make a world of a difference to both your bottom line and your health.
Florida Branch Manager
Disclaimer: Please use the above material strictly for educational purposes. Past performance is not indicative of future results. Futures trading involves substantial risk of loss. By no means is this newsletter offering any investment advice or suggesting to make any trade recommendations. Please consult an aiSource advisor prior to opening any managed futures accounts.