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  • Jonathan Poyer

Let's Get Wonky: Correlations, Risk Parity and Trend Following

Time to put on your wonky hats for a moment! Our friends at Mt. Lucas have put together a useful and engaging POST.

Before the title scares you off, here are the basics:

In a crisis, some things go down (hello 2022!!!!). Long only strategies do not let you capture that easily. In the past, bonds have worked in portfolios as when yields drop, bond prices go up, which cushions equities. But as we have said previously (here, for instance) equities and bond prices have dropped for 3 consecutive quarters FOR THE FIRST TIME EVER!

In times of BIG crises, asset price correlations move towards 1. What was once independent is no longer so, as correlations move to extremes.

But there are other assets that move as well. Managed futures let you get exposure to more things that are moving. For instance,

  • Crisis In Europe? --- Short the EUR

  • High Commodity Inflation? --- Long Oil

  • Feds Raising Rates? --- Short Bonds and Long the USD

Back to the technical stuff and the folks from Mt. Lucas:

Managed Futures, in a crisis, hones in on the big flows and macro uncertainty that hurts equity markets whether those moves are caused by other markets going up or going down. 2022 is a great example of the need for both long and short exposures. The stock markets prime concerns in 2022 have been soaring commodity prices and collapsing bond prices. Strategies that rely on only the long side are at a disadvantage.

There is no free lunch when it comes to investing, but it is probably wise to have something in the portfolio that can help out when correlations converge and pain spreads out. Managed Futures might be a fit. What is the right allocation??? I will leave that to the experts:)

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