How I evaluate trend following funds to include in my portfolio
Part 2 of the managed futures trend following series
If you haven’t read my introduction to managed futures trend following, I recommend checking it out here first:
Welcome back to Part 2 of the trend following series!
In this piece, I’d like to share my own process to evaluating which managed futures trend following funds to include in my portfolio as a diversifier to my equities. As I mentioned previously, managed futures trend is arguably the best long term diversifier for equities and can provide an excellent uncorrelated return stream to protect a stock and bond heavy portfolio, particularly in volatile and inflationary times. Today, we’ll explore ETFs and mutual funds that are generally available to most investors on major platforms such as Fidelity, Schwab, E*Trade, and Interactive Brokers.
I want to emphasize that I do NOT think that buying managed futures ETFs and mutual funds is the best way to get trend following exposure. For the most capital efficient exposure, these type of programs are best overlaid on top of a stock/bond portfolio using the assets as collateral for the futures trading in a SMA, or through a high vol private fund like those offered by Dunn or Mulvaney Capital. But since those approaches can have steep minimum capital requirements, it is worth considering more easily accessible ETFs and mutual funds as well.
Here are the key factors to consider:
Volatility
Cost
Universe of assets traded
Track record of the firm
Trend methodology and diversification
Let’s dive into each one:
Volatility is critical as it directly impacts the allocation you need to make in your portfolio in order to move the needle. Think of it this way: if you have a 90% equities + 10% managed futures (MF) portfolio where the equities have an annualized vol of 20% and the MF fund has a vol of 8%, is that going to be enough to really provide a meaningful level of diversification? You’d likely need to have a much higher allocation so that the MF program can improve the risk adjusted returns of the overall portfolio significantly. But rather than selling a lot of equities to buy MF, it makes more sense to simply buy a higher vol MF fund so you can have a smaller allocation to it while still getting most of the benefits. Unfortunately, 40 Act rules prevent these MF ETFs and mutual funds from getting much above 18% vol so that’ll likely be the upper limit for the time being. I target funds in the 15-18% vol range.
Cost is always critical in choosing investment products, but in this case what really matters is the volatility per unit cost. We want as much vol per unit cost as possible. Typically, you’re going to pay upwards of 75 bps for these types of funds so they are not cheap compared to Vanguard index funds which have an expense ratio of 3 bps. The reason costs are higher is due to a combination of active management, dividends on short positions, and interest expense. The cost of financing is typically not a major cost driver as the cash collateral offsets much of it.
Asset universe simply means the set of financial instruments and markets that the fund trades. There is a pretty wide variance here. Replicator funds like DBMF 0.00%↑ may trade a smaller number of markets typically in the 10-25 range while proprietary trend following systems like TFPN 0.00%↑ can trade up to hundreds of instruments and markets including single stocks. I have not observed a significant advantage to trading hundreds of markets vs 50. In general, I prefer strategies which trade the 4 major global asset classes of equities, currencies, bonds/rates, and commodities.
I prefer funds/strategies that have a solid managed futures trend following firm behind them ideally with a decade+ of experience running these types of strategies before, even if it was in a private vehicle. Examples include Man-AHL, AlphaSimplex, Mount Lucas, and AQR.
There is a wide range of methodologies that different funds employ in terms of trend measurement, volatility and risk management, and position sizing. I don’t think there is any one best method though longer term lookbacks and dynamic, volatility dependent position sizing seems to yield better results. What’s more important is diversifying across a few different methodologies as you never know which one will work best in any given year.
Given all of those factors, here are my top 3 favorites:
i) AHLT 0.00%↑ - relatively new ETF offered the well-known firm Man-AHL. Andrew Beer of DBMF 0.00%↑ fame has described this one as a ‘bucking bronco’ because of the higher vol it targets. As of Feb 2025, I have it running at about 18% vol over the last 30 days.
ii) $QMHIX - this is the high vol version of AQR’s managed futures strategy. Great option with a unique methodology that employs economic data in addition to price data for trend following. It also trades over 500 global markets! As of Feb 2025, I have it running at about 18% vol. It’s one of the more expensive options and may not be easily accessible on all platforms.
iii) KMLM 0.00%↑ - Mount Lucas are OGs in the trend following world. This fund tends to run around 15% vol and has a simple but robust trend following system and trades global 22 markets. It does not trade equities.
I hope you found this helpful. If you liked this piece, please do like, leave a comment, and share with a friend!