The past forty years has been a spectacular period for the 60/40 portfolio. Equities continued to hit new highs, interest rates drifted lower and lower with low price inflation. Under the backdrop of low macroeconomic uncertainty, goods have been plentiful and easily accessible, and supply chains have worked in an efficient manner around the world. This entire narrative changed in 2020 when the world faced a global pandemic. Since then, inflation has hit its highest year-over-year number in 40 years, and scarcity, supply chain issues, and general disruptions have plagued once streamlined and globally integrated businesses. Since February 2022, geopolitical issues surrounding the war in Ukraine only further exacerbated the situation.
Going forward, inflation and the potential for rising rates are themes that will be important. Figure 1 plots the year-over-year consumer price index changes alongside 10-year and 2-year yields. From this graph, we can see how extreme levels of CPI have moved ahead ofprevailing interest rates. Although it is hard to say how extreme the changes in markets will be there is one thing that seems to be certain – the range of outcomes for dffferent asset classes is large and there is little consensus.
US Consumer Price Index (CPI) Year-Over-Year and US 10-Year and 2-Year Note Yields
Figure 1: Changes in the year-over-year Consumer Price Index (CPI) and the U.S. Treasury 10-Year and 2-Year Note yields from June 1976 (inception of the 2-Year Note) to March 2022. Source: Bloomberg, AlphaSimplex.
To examine the impact of macro uncertainty on different asset classes, we consider a multiasset definition of macro uncertainty based on an aggregated measure across equities, fixed income, currencies, and commodities. To proxy a measure of uncertainty, we use the implied volatility for each asset class aggregated and risk adjust for each asset class as different asset classes have ranges in levels of uncertainty. Figure 2 plots macro uncertainty from 2005 to present. From this graph, we can examine the extreme periods of macro uncertainty (either low or high) and rising or falling uncertainty. The low or high uncertainty is defined as the top 30% or bottom 30% absolute level of uncertainty. Rising or falling uncertainty is measured trough to peak or vice versa for different periods (marked in arrows in the graph).
Macro Uncertainty (aggregated)
Figure 2: Macro Uncertainty from December 2005 to March 2022. Macro uncertainty is the aggregated implied multiasset volatility across equity, fixed income, currencies, and commodities. High vs. low macro uncertainty is defined by the absolute level where top 30% is high and bottom 30% is low. Rising and falling periods of uncertainty are defined by peak to trough periods. Source: Bloomberg, AlphaSimplex.
Trend Likes Both Low and High Uncertainty
Figure 3: Performance of equity, fixed-income, currency, and commodity markets and the SG Trend Index during periods of low and high macro uncertainty based on monthly performance from December 2005 to March 2022. Past performance is not necessarily indicative of future results. Source: Bloomberg, AlphaSimplex.
Navigating the Extremes: Managed Futures in Good Times and Bad Times
Table 1: Asset class and trend-following performance during periods of rising and falling macro uncertainty. Data from 2005 to 2021. Past performance is not necessarily indicative of future results. Source: Bloomberg, AlphaSimplex.
From both Figure 3 and Table 1, it seems that trend-following strategies tend to like both low and high macro uncertainty and they seem to work well during periods of rising uncertainty. Since macro uncertainty is a general term, we can examine some of the extreme environments, both high and low, and see how asset classes and trend-following strategies perform. To do this, we consider their performance during extreme periods of inflation surprise, both high and low, as well as during rallies and crashes for each asset class. We choose to consider inflation surprise given the current macro environment using the Citi Surprise Index.1
Figure 4 plots the return for different asset classes and trend following during very low or very high inflation surprise. From this chart, we can see that during this period equities and bonds like both low and high inflation surprises, while commodities and currencies prefer higher inflation surprise. Trend following is positive during both low and high inflation surprise.
Macro Drivers: Inflation
Figure 4: Performance of different asset classes and trend following during periods of very low or very high inflation surprise based on monthly performance from December 2005 to March 2022. Past performance is not necessarily indicative of future results. Source: Bloomberg, AlphaSimplex.
Portfolio Benefits of Managed Futures
Figure 5: Asset class performance for equity, fixed income, currency, and commodity markets with trend-following performance during rallies and sell-offs for each asset class based on monthly performance from December 2005 to March 2022. Past performance is not necessarily indicative of future results. Source: Bloomberg, AlphaSimplex
Given that trend-following strategies have tended to like macro uncertainty during the period analyzed in this study in terms of navigating extreme moves in markets, there were generally benefits to adding the strategy to a traditional investment portfolio during this period. To demonstrate this, Table 2 lists extreme environments and the performance impact of adding trend following to a traditional 60/40 portfolio. Across extreme environments, trend following tends to increase overall portfolio returns and improve risk-adjusted returns.
Table 2: Portfolio benefit during extreme macro environments from December 2005 to March 2022. Past performance is not necessarily indicative of future results. Source: Bloomberg, AlphaSimplex.
Given recent geopolitical events, increased levels of inflation, and the push towards rising rates, there is also an increase in macro uncertainty. Investors may expect extreme moves in a number of markets as they navigate the impact of these changes. To examine the impact of macro uncertainty, we use a multi-asset class measure of macro uncertainty and find that during the period analyzed in this study most assets prefer periods of low macro uncertainty and very few like high or rising macro uncertainty. Trend-following strategies, when compared with traditional asset classes, seem to like both high and low macro uncertainty, and particularly prefer periods of rising macro uncertainty. As a result, we further examine the performance of traditional assets during extreme periods (both rallies and sell-offs) and periods of high and low inflation surprise. Over a range of extreme environments, trend April 2022 followers tend to find opportunity during the extreme periods where some traditional assets tend to sell off. This observation demonstrates the value of diversification both during extreme periods and during periods of high macro uncertainty. Put simply, for good or for bad, extreme periods drive more persistent trends. When these trends are captured as part of a trend following strategy, they can provide diversification to an overall portfolio.
2 During this period, the prevailing trend in bonds has been upward. In this period, it is not surprising that all bond sell-offs have reverted. This has not been the case year-to-date in 2022.
Past performance is not necessarily indicative of future results. Managed Futures strategies can be considered alternative investment strategies. Alternative investments involve unique risks that may be different from those associated with traditional investments, including illiquidity and the potential for amplified losses or gains. Investors should fully understand the risks associated with any investment prior to investing. Commodity-related investments, including derivatives, may be affected by a number of factors including commodity prices, world events, import controls, and economic conditions and therefore may involve substantial risk of loss. The illustrations and examples presented in this document were created by AlphaSimplex based on unaudited data and methodologies. Accordingly, while the underlying data were obtained from sources believed to be reliable, AlphaSimplex provides no assurances as to the accuracy or completeness of these illustrations and examples. The views and opinions expressed are as of 3/31/2022, and may change based on market and other conditions. There can be no assurance that developments will transpire as forecasted, and actual results may vary. All investments are subject to risk, including risk of loss. This document has been prepared for informational purposes only and should not be construed as investment advice. AlphaSimplex is not registered or authorized in all jurisdictions and the strategy described may not be available to all investors in a jurisdiction. Any provision of investment services by AlphaSimplex would only be possible if it was in compliance with all applicable laws and regulations, including, but not limited to, obtaining any required registrations. This material should not be considered a solicitation to buy or an offer to sell any product or service to any person in any jurisdiction where such activity would be unlawful.
Publication: April 2022.
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