Managed Futures and the Kiss Effect, or, Who's Afraid of Pricey Markets?

Abstract

Recent developments have not only driven numerous financial markets to record highs, but also significantly increased the correlations between various asset classes. Following one of the longest bull markets in history, current price levels and the co-movement behaviours of traditional asset classes suggest reduced expected returns and diversification benefits in the future. The question, therefore, is whether there exist investment strategies that still provide an attractive risk/return profile and consistent diversification benefits. The hypothesis and aim of this paper is to demonstrate that the unambiguous answer is yes! The risk premia of as well as correlations between asset classes are time varying, and strategies that dynamically adjust to changing attractiveness and co-movements are able to harvest positive returns in various market environments. However, these strategies inherently need to be highly liquid in order to allow for dynamic exposure management. One type of alternative strategy that combines liquidity with adaptiveness is a managed futures strategy. Accordingly, this paper elaborates on the differences in the risk/return profiles of traditional balanced mandates and a long-short risk-balanced CTA strategy. It shows that the latter is not only well suited to withstand adverse bond or equity market conditions, but it may even find attractive return opportunities in turbulent times. We call this the king in stress scenarios (KISS) effect of long-short managed futures strategies. This robust and diversifying risk/return profile is mainly attributable to its broad and adaptively weighted investment portfolio, as well as the possibility of taking on short positions.