PIMCO Trends: Managed Futures: Seeking Diversification and Returns
Managed futures strategies have historically delivered attractive returns over the long run with low equity correlations. Yet not all funds have consistently delivered positive returns in periods of sudden “crisis volatility.”
Managed futures strategies have produced positive returns during sustained equity market downturns, but not all funds are designed with the agility to generate “crisis alpha” during periods of sudden volatility. Matt Dorsten, co-portfolio manager of the PIMCO TRENDS Managed Futures Strategy Fund, and Christopher Santore, product strategist, talk with Mike Connor, product strategist, about how funds differ in their objectives and design.
Q: What are reasonable long-term objectives for managed futures strategies?
Dorsten: Managed futures strategies use systematic trend-following to pursue a valuable set of objectives: positive returns over long holding periods, diversification through negative equity correlation, and crisis alpha through positive returns across periods of sustained market volatility.
Over the long-run, trend-following strategies have delivered returns that are similar to equity markets, with lower volatility and a negative correlation to equities, attracting allocations from investors seeking diversification from equity risk (see Figure 1).
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Q: How have investors used managed futures?
Santore: After performing well through sustained equity market drawdowns (see Figure 2), trend-following has gained popularity in risk-mitigating allocations alongside traditional defensive investments such as government bonds and equity put options.
We believe that trend-following offers investors a compelling value proposition as a strategy that can capitalize on market volatility. In 2020 for example, trend-followers seized opportunities from both long and short positions across asset classes as portfolios adapted to crisis conditions in the first quarter, followed by a risk asset rally in the second half of the year. Looking forward, we believe trend-followers are well-positioned to continue meeting expectations, and encourage allocators seeking equity diversification to focus on strategies specifically designed to emphasize diversification.
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Q: What market environments tend to be best for managed futures?
Dorsten: Trend-following portfolios have historically performed best during periods of elevated market volatility, when equities tend to struggle, and when investors value diversifying strategies the most. Trend-following thrives during periods of market volatility by building larger positions as persistent trends develop, producing an inherently diversifying distribution of returns that often performs best in the most volatile market conditions. In particular, equity sell-offs have often been productive environments for trend-following as persistent equity declines drive risk reducing behavior across asset classes, creating more potential trends to follow.
However, not all managed futures strategies have successfully navigated recent bouts of market volatility, such as the fourth quarter of 2018 and the first quarter of 2020, suggesting that some managed futures strategies may either include non-trend strategies that are less consistently defensive, or may allow for more long equity risk that can degrade the equity diversification potential. By contrast, The PIMCO TRENDS Managed Futures Strategy has remained focused on trend-following, with a steadfast commitment to equity diversification as a primary objective.
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At PIMCO, our TRENDS Managed Futures Strategy seeks an enhanced return potential in higher-volatility markets through a number of design features, including:
- Emphasizing short- to medium-term trend signals that have historically outperformed across equity drawdowns,
- Imposing a conservative limit on the maximum equity beta, and
- Trading a broad and diverse investment universe selected to enhance return potential rather than maximize capacity.
Our results in Figure 4 demonstrate the value-add of such a disciplined approach, resulting in more consistent diversification and performance over the long-term. Our strategy has consistently generated strong returns across volatile markets – such as in the first quarter of 2020 and in fourth quarter of 2018 – and generated more muted positive returns in low volatility risk-on environments such as 2017.
Q: How does PIMCO TRENDS target an enhanced diversification profile?
Santore: At PIMCO, we’ve enhanced the diversification potential of our strategy by capping equity beta to limit the potential long equity exposure of the portfolio without sacrificing return potential. This is possible because, counterintuitively, there’s a surprisingly weak relationship between the equity positioning of trend-following strategies and subsequent returns. In practice, limiting the maximum equity beta of the trend-following portfolio reduces the size of positions with positive equity betas when the portfolio would otherwise exceed the limit. This effectively embeds a dynamic sizing feature by allowing the portfolio to have larger potential positions when it offers more potential diversification benefits. Of course, this can cause the strategy to miss out on some potential returns from long equity positions that an unconstrained portfolio with a higher equity beta would capture. But for allocators seeking equity diversification, our research shows that the short-term trade-offs of limiting long equity exposure are worthwhile over the long-term.
Q: How does PIMCO TRENDS target crisis alpha through positive returns across market crises?
Dorsten: Negative average equity correlations have historically enabled managed futures to provide strong positive returns during sustained equity market sell-offs. Briefer equity sell-offs, however, have resulted in mixed outcomes across managed futures funds. Yet even during brief and moderate equity declines (exceeding 10%), PIMCO TRENDS Managed Futures Strategy has, since its inception in December 2013, delivered consistently positive returns that have outperformed the SG Trend Index.
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PIMCO TRENDS Managed Futures Strategy prioritizes crisis alpha (i.e., generating positive return during periods of high financial stress) partly by emphasizing relatively fast-moving trend signals designed to adapt quickly to changing market conditions. During the March 2020 COVID-19-induced market crash, for example, moving quickly to net short equity exposure was critical in driving positive returns, as slower signals missed out on some of the decline (see Figure 5 below). And while moving quickly introduces higher turnover and potentially more exposure to sudden market reversals, we’ve calibrated our trend-signal speed to prioritize potential performance in equity sell-offs.
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Q: What should investors expect from the PIMCO TRENDS Managed Futures Strategy going forward?
Santore: Going forward, we expect our defensive-oriented trend-following strategy to continue to seek to deliver on our long-term objectives: positive returns over long holding periods, diversification through negative equity correlations, and crisis alpha through periods of sustained market volatility. Investors must understand that not all managed futures strategies share these objectives and make the same trade-offs in strategy design. Accordingly, we advise allocators to focus on the role managed futures strategies are meant to play in their portfolio. Allocators prioritizing defensive characteristics may choose different strategies than allocators seeking to maximize returns in an equity rally.
At PIMCO, we believe that managed futures allocations can have the most positive impact during volatile market conditions and have designed our strategy with clear objectives in mind.
Learn more about PIMCO TRENDS Managed Futures Strategy Fund.
- Trend-following thrives during volatile markets, particularly as persistent equity declines drive risk reducing behavior across asset classes, creating more potential trends to follow.
- PIMCO TRENDS has consistently generated strong returns across volatile markets and produced more muted positive returns in low volatility risk-on environments such as 2017.
- PIMCO TRENDS prioritizes defensive characteristics. Our objectives are long-term positive returns, diversification through negative equity correlations, and alpha through periods of sustained volatility.
Portfolio Manager, Quantitative Strategy
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