Trend Following (Managed Futures): The “Crisis Alpha” That Saved Portfolios in 2022
Trend Following (Managed Futures): The “Crisis Alpha” That Saved Portfolios in 2022
๐ WHO THIS IS FOR (Prerequisites)
- Required Profile: Investors seeking “Uncorrelated Returns” to hedge against prolonged bear markets or inflation shocks.
- Primary Objective: Crisis Alpha (Generating positive returns specifically when Stocks and Bonds are falling together).
- Disqualifying Factor: Investors who cannot tolerate “Line Item Risk” (Trend Following can underperform for years during flat/choppy markets).
โ ๏ธ STRATEGY ELIGIBILITY CHECK
Trend Following is psychologically difficult because it often loses money in calm markets (The “Insurance Premium”).
- โ๏ธ Vehicle Selection: Must choose between ETFs (1099 Tax Form, No K-1) or Mutual Funds/LPs. (K-1s complicate tax filing).
- โ๏ธ Allocation Sizing: Typically requires 10-20% of the portfolio to move the needle during a crisis. (5% is too small to hedge a crash).
- โ๏ธ Whipsaw Tolerance: Can you hold a strategy that loses small amounts repeatedly (false breakouts) while waiting for the “Big Trend”?
- โ๏ธ No Forecasting: You must accept that the strategy ignores news, earnings, and macro logic. It follows price only.
*Warning: Trend Following is NOT “Market Timing.” It does not predict; it reacts.
EXECUTIVE SUMMARY
- The Problem: In 2022, Stocks fell -18% and Bonds fell -16%. The classic 60/40 portfolio failed because correlation went to 1.
- The Solution: Trend Following (Managed Futures) creates a “Long/Short” portfolio across Commodities, Currencies, and Rates. It profits from divergence.
- The Mechanics: If Oil is going up, it buys Oil. If Treasuries are falling, it shorts Treasuries. It rides these waves until the trend breaks.
- The Result: In 2022, while the S&P 500 crashed, the SG Trend Index (a benchmark for CTAs) was UP ~20%+. It provided the liquidity to rebalance when everything else was burning.
Trend Following is the “Fire Department” of investing. You pay a small cost (fees/whipsaws) during peace time to ensure you have a massive payout when the city is on fire. According to Team BMT Analysis, it is the mathematically optimal partner for a Risk Parity or 60/40 portfolio. Source: AQR Capital / BarclayHedge
- Benchmark: SG Trend Index (Representative of major CTA performance).
- Comparison Asset: S&P 500 (US Large Cap Equities).
- Crisis Definition: Periods of significant equity drawdown (>20%).
- Performance Data: Historical returns during major market stress events (2000, 2008, 2022).
- Rebalancing: Assumes the strategy is held as a permanent allocation, not traded in and out.
Performance During Major Crises (Crisis Alpha)
| Crisis Event | S&P 500 Return (%) | Trend Following Index Return (%) |
|---|---|---|
| Dot Com Bubble (2000-2002) | -45.0 | 28.0 |
| Global Financial Crisis (2008) | -50.0 | 20.0 |
| Inflation Shock (2022) | -18.0 | 25.0 |
*Chart Note: Trend Following exhibits “Convexity” during crises. The worse the market crash (especially extended ones), the stronger the trend tends to be, leading to higher returns for CTAs.
Structural Comparison Matrix
*Why Managed Futures behave differently from Stocks.
| Feature | Buy & Hold (Stocks) | Trend Following (Managed Futures) |
|---|---|---|
| Philosophy | Convergence (Betting on Growth/Earnings) |
Divergence (Betting on Price Momentum) |
| Direction | Long Only (Profits only when market rises) |
Long & Short (Profits in both directions) |
| Asset Class | Equities / Bonds | Commodities / Currencies / Rates / Equities |
| Best Environment | Low Inflation, Steady Growth | High Inflation, Market Crises, Extreme Trends |
*Operational Note: Trend Following is often called “Divergent” because it harvests profits from markets moving away from equilibrium.
How it worked in 2022:
- The Bond Rout: As the Fed hiked rates, bond prices crashed. A 60/40 investor lost money on bonds.
- The Trend Signal: CTAs detected the downtrend in bonds early. They went “Short Treasuries.”
- The Result: As bonds kept falling, the Trend Followers made massive profits on the short side, offsetting the losses in their equity portfolios. This is “Crisis Alpha.”
โ BOUNDARY CLAUSE: Structural Limitations
- The “V-Shape” Recovery: Trend Following is slow. If the market crashes fast and rebounds fast (like March 2020), the strategy gets whipsawed (Sells the bottom, Buys the top) and loses money. It needs sustained trends.
- Fee Drag: Managed Futures strategies involve active trading and complexity. Expense ratios are typically higher (0.75% – 1.5%) than passive ETFs. You are paying for the “insurance.”
๐ค DECISION BRANCH (Logic Tree)
IF Portfolio = 100% Equities (Aggressive):
โข Input: You want max growth and ignore volatility.
โข Output: Skip Trend Following. It will likely drag your returns during bull markets.
IF Portfolio = Balanced (Preservation Focus):
โข Input: You fear a “Lost Decade” or Inflation/Stagflation.
โข Output: Allocate 10-15% to Managed Futures (e.g., DBMF/KMLM). This provides the “third leg” of diversification beyond Stocks and Bonds.
“Diversification is the only free lunch.” But true diversification requires assets that zig when others zag. Trend Following is one of the few strategies that has historically zagged reliably during financial storms.