Should We Constrain Equity Exposure in Managed Futures When Stacking on Equities?
Overview
In the context of return stacking, some investors worry about overlapping equity exposure when layering managed futures on top of equity portfolios—particularly when the trend-following sleeve also holds equities. However, this concern is often a byproduct of “product myopia” and “leverage myopia,” where investors judge strategies in isolation or focus on nominal weights rather than portfolio-level exposures. Empirical evidence shows that equity exposure within managed futures programs is not redundant risk but a significant, diversifying return contributor with low correlation to buy-and-hold equities. Constraining this sleeve may reduce both diversification and return potential. A holistic portfolio view is essential for effective stacking.
Key Topics
Managed Futures, Equity Trend Following
Introduction
Return stacking offers a compelling way to do more with every dollar. By layering uncorrelated strategies like managed futures on top of traditional equity and bond exposures, investors can seek improved diversification and more resilient portfolios.
But stacking isn’t without nuance. A common concern arises when managed futures are stacked on top of equities: what happens when the trend program also holds a significant equity position?
In a 100% equity + 100% managed futures strategy, the portfolio may unintentionally double down on equity risk when trends in equities are strong. If those trends suddenly reverse – as they often do – investors could experience magnified losses just when they were expecting diversification. This raises a seemingly intuitive question:
“Should we constrain equity exposure within the managed futures sleeve when stacking on equities?”
On the surface, it’s a reasonable concern. Digging deeper, however, it may reflect more about how we mentally account for portfolios than how risk and diversification actually work in practice.
Missing the Forest for the Trees
This concern is best framed not as a flaw in managed futures, but as a form of myopia: both product myopia and leverage myopia.
Product Myopia: It’s a Portfolio, Not a Product
We tend to analyze investments line by line: this product has stocks, this one has bonds, this one has trend. Stacking challenges that framework because it is a portfolio-level concept.
Consider two theoretical challenges to the previously posed question.
• A conservative investor and an aggressive investor both use the same “100% stocks + 100% managed futures” product to stack managed futures. Would they both want to constrain equity exposure in the trend sleeve?
Leverage Myopia: Two Portfolios, Same Exposure
• Portfolio B: 50% stocks / 33.3% bonds / 16.7% managed futures
These two portfolios have the same relative exposures: Portfolio A is simply Portfolio B with 1.2x leverage. Yet, for most investors, only Portfolio A triggers concern over “stacking too much equity.”
This is leverage myopia: judging risk by superficial weightings rather than underlying exposures. The question of whether to constrain equities in the trend sleeve should be evaluated in the context of total portfolio risk and would apply equally to Portfolio B as it does Portfolio A.
As a whole, this investor myopia is mistaking the performance of one tree for the health of the whole forest. Portfolio construction requires seeing how each piece interacts, not just judging items in isolation.
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Let’s Look at the Data
To further ground our discussion with empirical analysis, we decomposed the return contribution of a representative managed futures trend-following program into five sectors: bonds, equities, energies, metals, and currencies.
Figure 1: Downside Capture-Optimized Stack Allocations
Source: ReSolve Asset Management; CSI Analytics. Calculations by Newfound Research.
With this data in hand, a few key points become clear.
The Sub-Programs Are Uncorrelated
When isolated, the contributory return streams from each asset class category exhibit low correlation to one another. In other words, trend-following in equities behaves differently than trend-following in currencies or commodities. This suggests that managed futures benefits from significant intra-strategy diversification.
Figure 2. Correlation between Sector Contributions
| Bonds | Equities | Energies | Metals | Currencies | |
| Bonds | 1.00 | -0.22 | 0.08 | 0.26 | 0.06 |
| Equities | 1.00 | -0.10 | 0.11 | 0.16 | |
| Energies | 1.00 | 0.08 | 0.07 | ||
| Metals | 1.00 | 0.08 | |||
| Currencies | 1.00 |
Constraining the equity sleeve, then, risks removing meaningful diversification. The reduction in diversification occurs not only because the equity sleeve has low correlation to the other sleeves, but because the risk capital would be re-allocated to the other sleeves, increasing the programs concentration in those sectors.
Equity Trend Has Been a Major Return Contributor
We can see from Figure 1 that trend following in the equity sector has, historically, been one of the biggest contributors to total managed futures performance. Removing it – or constraining it – could meaningfully reduce the strategy’s expected return.
In other words, equity exposure in managed futures isn’t just risk – it’s return. Due to the long/short nature of the program, this contribution can be positive in both positive equity environments (Figure 3) and negative equity environments (Figure 4).
Figure 3. Quarterly Return Contributions in 2013
| Bonds | Equities | Energies | Metals | Currencies | |
| 3/31/13 | -1.59% | 5.06% | 0.06% | 2.81% | -0.07% |
| 6/30/13 | -1.96% | 0.71% | -0.94% | 1.21% | 3.19% |
| 9/30/13 | -1.27% | 2.09% | -0.27% | -1.30% | -1.81% |
| 12/31/13 | -0.06% | 8.63% | -0.64% | 2.02% | 0.39% |
Figure 4. Quarterly Return Contributions in 2008
| Bonds | Equities | Energies | Metals | Currencies | |
| 3/31/08 | 0.67% | 1.40% | 2.48% | 1.43% | 3.49% |
| 6/30/08 | -0.16% | 4.12% | -0.49% | -0.22% | -1.51% |
| 9/30/08 | 1.29% | -3.14% | -1.17% | -0.58% | 0.60% |
| 12/31/08 | 1.51% | 1.02% | 1.24% | 0.82% | 2.07% |
Equity Trend ≠ Buy-and-Hold Equity
Here’s perhaps the most critical point: even though trend programs trade equity futures, they behave very differently than long-only equities. The correlation between the equity trend program and the S&P 500 is often low or even negative. Why? Because trend can be short, or flat, or flip directions rapidly. Its exposures are adaptive, not static.
Over the full period, the contribution of the equity sector to trend program returns only had a correlation of 0.34 to buy-and-hold equities. This slightly positive correlation is a byproduct of the fact that equities, on average, went up over the period and therefore trend, on average, was slightly positive.
Figure 5. Cumulative Excess Returns of Equity Program and S&P 500 (Scaled to Identical Volatility Levels)
Source: Bloomberg; ReSolve Asset Management; CSI Analytics. Calculations by Newfound Research.
Given the dynamic nature of returns to the equity trend sector, investors would be better off thinking of this sleeve as an idiosyncratic portfolio diversifier rather than simply “adding more equity risk” to portfolios.
|
Bonds |
Equities |
Energies |
Metals |
Currencies |
B&H Equity |
|
|
Bonds |
1.00 |
-0.22 |
0.08 |
0.26 |
0.06 |
-0.40 |
|
Equities |
1.00 |
-0.10 |
0.11 |
0.16 |
0.34 |
|
|
Energies |
1.00 |
0.08 |
0.07 |
-0.08 |
||
|
Metals |
1.00 |
0.08 |
-0.06 |
|||
|
Currencies |
1.00 |
0.03 |
||||
|
B&H Equity |
1.00 |
Conclusion: Don’t Blindfold Your Diversifiers
Constraining equity exposure in a managed futures program because it’s stacked on top of equities may feel conservative, but it risks kneecapping one of the strategy’s most important strengths over the long run.
Managed futures are designed to be opportunistic. Sometimes that means holding equities when they trend. Other times, it means going short or shifting entirely to other asset classes. If we handcuff the strategy out of fear of doubling down on equity risk, we may reduce its ability to protect in times of stress and its ability to deliver in times of trend.
The solution isn’t to neuter the diversifier. The solution is to design portfolios holistically: accounting for exposure, risk, and behavior across the entire portfolio, not just within a single sleeve.