Portable Alpha with Managed Futures: A Diversification Overlay

2025-02-25

Overview

This article dives into the mechanics of return stacking with managed futures, illustrating how they have historically performed during market crises and why they may serve as a behaviorally friendly alternative to traditional diversification. By maintaining 100% equity exposure while layering 100% managed futures, investors seek to enhance risk-adjusted returns, reduce drawdowns, and improve portfolio resilience. Learn how this institutional-grade approach allows advisors to offer robust diversification without sacrificing market exposure.

Key Topics

Portable Alpha, Managed Futures, Trend Following, Defensive Overlay

Introduction

Portable alpha has long been an institutional strategy for enhancing returns and improving diversification, but return stacking has made this approach accessible to financial advisors. By maintaining full equity exposure while layering a managed futures overlay, investors can potentially improve risk-adjusted returns without sacrificing market participation. This article breaks down the mechanics of a 100% equities + 100% managed futures approach, highlighting how managed futures can enhance portfolio resilience, reduce drawdowns, and offer uncorrelated return streams. Learn how financial advisors can implement this institutional-grade strategy to build more robust client portfolios.

Enhancing Equity Portfolios with a Managed Futures Overlay

For decades, institutional investors have used portable alpha strategies to improve diversification and enhance risk-adjusted returns. These strategies allow investors to maintain full market exposure while layering additional, uncorrelated return streams on top. Historically, portable alpha was difficult for individual investors to implement due to the complexity and costs associated with hedge funds and derivatives strategies. However, return stacking has now democratized this approach, making it accessible to financial advisors and their clients.

Managed futures, when used as an overlay, offers a compelling way to execute a portable alpha strategy. By maintaining a 100% exposure to equities while adding a 100% exposure to managed futures, investors can include diversifiers in their portfolios without sacrificing core market participation. This allows for enhanced return potential while simultaneously reducing portfolio volatility.

The Role of Managed Futures in Portable Alpha

Managed futures are an attractive choice for a portable alpha overlay due to their low correlation with equities, historical performance during crisis periods, and ability to generate positive returns in diverse market environments. Unlike traditional diversifiers such as bonds, which may experience correlated losses during certain equity drawdowns, managed futures strategies thrive in volatile and trending markets.

Unlike many alternative strategies, managed futures rely on systematic, trend-following models that can take both long and short positions across various asset classes—including equities, bonds, commodities, and currencies—allowing them to profit in both rising and falling markets. This adaptability makes them one of the most effective tools for reducing portfolio drawdowns while maintaining long-term upside potential.

By integrating managed futures as an overlay on equities, advisors can maintain full market exposure while gaining significant diversification benefits. This reduces overall portfolio volatility, enhances resilience, and allows for smoother investment experiences for clients who struggle with traditional diversification approaches.

Historical Performance: Historical Diversification Benefits of Managed Futures

Period S&P 500 Total Return Managed Futures 100% Equities + 100% Managed Futures
2000-2002 -37.6% +40.8% -16.6%
2008 -37.0% +20.9% -23.3%
2022 -18.1% +27.4% +5.0%
Source: Bloomberg. Managed Futures is the SG Trend Index (”NEIXCTAT”). 100% Equities + 100% Managed Futures is 100% S&P 500 Total Return Index (”SPXT”) / 100% NEIXCTAT / -100% Bloomberg Short-Term US Treasury Bill Index (”LD12TRUU”) rebalanced monthly. Past performance is not indicative of future results. Performance is gross of all fees, taxes, and transaction costs. Performance assumes the reinvestment of all distributions. Performance of Managed Futures is net of underlying management and performance fees. Investors cannot invest directly in an index. Performance data is for illustrative purposes only and does not represent actual returns of a specific fund or investment product.

Portable alpha, when applied through return stacking, allows investors to capture the diversification benefits of managed futures while maintaining full equity participation. Historically, this has resulted in improved risk-adjusted returns and reduced drawdowns during market crises.

Expanding the Diversification Discussion

The effectiveness of diversification depends on an investor’s ability to hold onto diversifiers through all market environments. Many alternative strategies, such as hedge funds or private equity, experience capital outflows during underperformance cycles due to investor impatience and behavioral biases. However, managed futures have consistently demonstrated long-term resilience, offering investors a return stream that does not rely on equity market direction.

A key benefit of return stacking is that investors do not have to sacrifice their equity exposure to introduce diversifiers. This removes a common psychological hurdle—investors do not feel like they are “missing out” during equity bull markets, making them more likely to maintain managed futures exposure over time.

Advisors who implement return-stacked strategies reduce the likelihood of clients abandoning diversification at precisely the wrong time, helping investors benefit from a more stable investment experience over time.

Beyond Traditional Portfolio Construction

Traditional portfolio construction typically relies on a stock-bond allocation for diversification. However, bonds tend to struggle in rising rate environments, leaving advisors searching for alternative diversifiers that do not depend on interest rate cycles. Managed futures, by contrast, have historically performed independently of both stocks and bonds, offering diversification benefits regardless of macroeconomic conditions.
Growth-of-100-in-US-Equities-Bonds-and-Managed-Futures

Source: Bloomberg.  U.S. Stocks is the S&P 500 Index (“SPX”).  U.S. Bonds is the Bloomberg US Aggregate Bond Index (“LBUSTRUU”).  Returns for both U.S. Stocks and U.S. Bonds are gross of all fees.  CTA Trend is the Société Générale Trend Index (“NEIXCTAT”).  You cannot invest in an index.  Returns are gross of taxes.  Returns assume the reinvestment of all distributions.  Past performance is not indicative of future results. Period is 12/31/1999 through 12/31/2024. The starting date is chosen based upon the earliest date data is available for the underlying indexes.

A return-stacked managed futures overlay does not require selling equities to introduce diversification—meaning investors can retain their full stock allocation while still incorporating a proven diversifier that has delivered positive returns in past equity bear markets.

This ability to preserve equity exposure while reducing overall risk makes return stacking an attractive alternative to traditional asset allocation approaches.

Practical Implementation for Advisors

Financial advisors can introduce a return-stacked managed futures overlay through ETFs and mutual funds that integrate equity market exposure with managed futures overlays. These investment vehicles provide an accessible, cost-efficient solution for advisors seeking to implement a diversified portable alpha strategy without the complexity of hedge funds.

By allocating to a 100% equities + 100% managed futures structure, advisors can:

  • Maintain full exposure to the equity market while enhancing portfolio diversification.
  • Add a managed futures return stream that has historically improved risk-adjusted returns.
  • Reduce portfolio drawdowns, helping clients remain invested through volatility.
  • Improve investor behavioral outcomes by embedding diversifiers into a seamless portfolio structure.

Key Takeaways for Advisors

  • Managed futures provide a diversification benefit that has historically improved risk-adjusted returns.
  • Portable alpha with a managed futures overlay enhances equity portfolios without reducing core stock exposure.
  • Return stacking allows financial advisors to implement institutional-grade diversification strategies in an accessible way.
  • The ability to generate positive returns in both rising and falling markets makes managed futures an ideal portable alpha component.
  • Behavioral benefits of return stacking can improve investor retention and reduce emotional decision-making.

Final Thoughts

For decades, portable alpha was considered a strategy exclusive to institutional investors. Today, financial advisors can offer a modernized version by integrating managed futures into a return-stacked portfolio. This approach allows clients to maintain full market exposure while benefiting from the risk-mitigating properties of managed futures.

By embracing a 100% stocks + 100% managed futures framework, advisors can provide a more diversified, resilient portfolio that enhances risk-adjusted returns while helping clients navigate volatile markets with confidence. The evolution of return stacking makes institutional-grade diversification strategies more accessible than ever, offering a compelling tool for advisors aiming to deliver superior long-term client outcomes.

Return stacking represents the next evolution of intelligent portfolio construction, allowing financial advisors to improve diversification, enhance risk-adjusted returns, and provide a more stable investment experience—all without requiring clients to compromise on equity participation.