Diversification is one of the first principles investors learn, but it is also one of the easiest to misunderstand. We are usually taught to diversify by owning more things: stocks from different countries, bonds with different maturities, perhaps some real estate, commodities or other assets. The assumption is that if enough different investments are assembled, the portfolio will become more resilient because they will not all behave in the same way at the same time.
For much of modern portfolio history, stocks and bonds have formed the foundation of this approach. Equities provide long-term growth while high-quality bonds offer stability, income and, in many periods, a useful counterweight when equity markets struggle. It is a sensible structure and there is no reason to abandon it simply because alternatives exist.
The problem is that stocks and bonds, despite being very different assets, usually share one important characteristic: the investor is long. We buy them because, over time, we expect their economic value to increase or because they generate an income stream worth owning. Diversification takes place primarily through the assets we hold rather than through fundamentally different mechanisms for producing returns.
Managed futures introduce another possibility. Instead of asking only which assets should be added to a portfolio, they invite us to ask whether a portfolio might benefit from owning a strategy that behaves differently in the first place.
That distinction becomes particularly interesting when we stop evaluating portfolios only through CAGR, volatility or Sharpe ratios and start paying more attention to something investors experience much more directly: how deeply a portfolio falls, how it behaves while other assets are falling and, especially, how long it takes to recover.
Diversifying the Source of Returns
Managed futures have existed for decades, traditionally through Commodity Trading Advisors, or CTAs, and hedge-fund structures. The name can be slightly misleading because these strategies are not necessarily focused on commodities. They can trade liquid futures and forwards across equity indices, government bonds and interest rates, currencies and commodities, taking both long and short positions. Trend following is one of the dominant approaches within the category, although managed futures encompass more than a single model or trading rule. Academic and industry research has documented time-series momentum across multiple asset classes and long historical periods, while also showing that its strength varies considerably across markets and environments.
A simple trend-following strategy does something quite different from traditional long-only investing. If a market has developed a sufficiently strong positive trend, the strategy may become long. If the trend turns negative, it may reduce that exposure or become short. The same process can occur independently across bonds, currencies, equity indices and commodities.
The important point for a diversified investor is not whether this produces a higher average return than equities. It is that the return-generating mechanism is different.
A global equity fund ultimately depends on companies creating economic value and investors being rewarded for owning them. A government bond depends on contractual cash flows, interest rates and creditworthiness. Trend following does not require an asset to have a positive long-term expected return in the same way. It attempts to capture persistent price movements regardless of their direction. Research on managed futures has consequently found historically low correlations with traditional investments and, in some periods, particularly useful behavior when conventional assets were under stress.
This is a deeper form of diversification than simply adding another ticker to a portfolio. Owning an equity ETF, another equity ETF and a REIT may increase the number of holdings without creating three genuinely independent sources of return. A strategy capable of going long and short across multiple markets operates according to another logic entirely.
That does not mean its correlation with stocks and bonds is permanently zero. Correlations are observations, not promises, and they change over time. The more interesting feature is structural: the strategy is not required to maintain the same directional exposure to the same economic risks.
This distinction helps explain why managed futures sometimes become particularly interesting during prolonged market disruptions. A sudden crash is difficult for a trend-following system because a trend has not necessarily had time to form or reverse. But when inflation, interest rates, currencies, commodities or equity markets develop sustained directional moves, a strategy capable of adjusting its positions can gradually align itself with those trends. Research into crisis periods has found this conditional diversification valuable, although more recent work also cautions that trend following is not a reliable hedge against every drawdown and that outcomes depend on signal horizon and the nature of the crisis.
This is why describing managed futures simply as “uncorrelated” misses much of what makes them interesting. Low historical correlation is the observable result. The more fundamental reason to investigate them is that they are trying to make money differently.
The Metric We Rarely Discuss
Most portfolio comparisons follow a familiar pattern. We calculate annualized return, volatility, maximum drawdown and perhaps the Sharpe ratio. These are useful measures, and abandoning them would make portfolio analysis worse rather than better. But they can also encourage us to reduce an investment journey to a final set of statistics.
Consider two portfolios that ultimately generate similar long-term returns and experience similar maximum drawdowns. One recovers from its worst decline within eighteen months while the other remains below its previous peak for four years. Their traditional summary statistics may look reasonably similar, but living through them would be a very different experience.
Recovery Time measures that difference.
A drawdown tells us how far we fell. Recovery Time tells us how long we had to live there.
For an investor with a sufficiently long horizon, the difference might appear irrelevant in a spreadsheet. In real life it can matter enormously. A prolonged underwater period overlaps with retirement decisions, withdrawals, job changes, unexpected expenses and, perhaps most importantly, the investor’s willingness to remain committed to the strategy.
This is where adding a structurally different return source can become more interesting than simply optimizing the portfolio’s average return. If an alternative strategy occasionally generates positive returns during periods when traditional assets are experiencing sustained losses, the benefit does not necessarily need to appear as a dramatically higher CAGR. Its contribution can instead appear in the path followed by the total portfolio.
Research into trend-following overlays provides a useful example. Work by Rattray, Granger, Harvey and van Hemert examined the behavior of traditional stock-bond portfolios during crises and argued that mechanical rebalancing can actually worsen some trending drawdowns because it repeatedly buys the falling asset. Their research found that an allocation to trend following could introduce positive convexity that helped counter this behavior.
That does not translate into a universal rule saying that a particular allocation to managed futures will cut Recovery Time by a particular percentage. Portfolio tests can indeed show very substantial reductions in recovery periods in some historical samples, including results approaching a halving under certain constructions, but those numbers are highly dependent on the assets, starting date, allocation, trend strategy, fees and rebalancing assumptions being tested. They should therefore be treated as evidence of a mechanism worth studying rather than as an expected future result.
The important observation is more modest and, in my view, more useful. If part of a portfolio has the ability to generate returns from trends that are independent of the direction required by its long-only holdings, the portfolio acquires another potential route out of a drawdown.
That matters because recovery is not determined only by what caused the loss. It is determined by what happens afterwards.
A portfolio composed almost entirely of long risk assets may need those same assets to recover before the portfolio can return to its previous high. A portfolio containing another return mechanism may not be completely dependent on that sequence. The diversifier does not need to eliminate the loss to be useful. It only needs to contribute differently enough, at the right times, to alter the path.
This way of thinking also changes how we judge the success of an allocation. If a managed-futures strategy produces a lower long-term return than equities but meaningfully reduces the duration of difficult portfolio periods, calling it a failure because it lowered CAGR slightly would miss the reason it was included. Conversely, adding it simply because a backtest produces a prettier Sharpe ratio would be equally superficial.
The relevant question is whether the portfolio becomes more resilient in a way that matters to its owner.
The Problem With Owning Something That Actually Diversifies
There is an uncomfortable consequence of genuine diversification. A strategy that behaves differently from the rest of the portfolio will inevitably spend periods looking wrong.
This sounds obvious, but it is one of the hardest aspects of alternative strategies to tolerate.
Imagine a long equity bull market accompanied by relatively quiet bond and currency markets. Equities rise year after year while a managed-futures allocation produces mediocre returns, suffers whipsaws or simply goes nowhere. After several years, the comparison becomes increasingly unpleasant. The equity allocation has compounded beautifully while the diversifier appears to have consumed capital that could have been invested in the obvious winner.
At that point, selling it can feel entirely rational.
Yet a diversifier that consistently rises alongside equities would probably not provide much diversification when equities eventually encounter a prolonged adverse environment. The periods in which the strategy looks unnecessary can therefore be connected to the very characteristic that makes it potentially valuable.
This is not merely theoretical. Trend following has experienced extended disappointing periods. Research published before the pandemic discussed a significant managed-futures drawdown and materially weaker performance during the preceding decade relative to its longer history (Babu and colleagues, You Can’t Always Trend When You Want). The strategy did not stop being trend following; the market environment simply offered fewer sustained trends that its models could exploit.
That history is important because managed futures should not be marketed as permanent crisis insurance. They can suffer during rapid reversals and range-bound markets, and a sudden market collapse may occur faster than models can adjust. Academic reviews have also warned that CTA databases and indices can contain biases and that evidence for performance persistence after fees is not uniformly strong.
The diversification case therefore requires a certain psychological agreement with the strategy. The investor must be prepared to tolerate periods when it contributes very little precisely because the objective is not to maximize its standalone return relative to the S&P 500.
This is where portfolio construction becomes more behavioral than mathematical. It is easy to own diversification in a backtest because twenty years of returns appear simultaneously on one screen. It is much harder to own it sequentially, waiting through several disappointing years without knowing whether the environment in which the strategy becomes useful will ever arrive.
There is another complication. Managed futures strategies are not interchangeable. Different managers use different markets, trend horizons, volatility targets, position-sizing methods and additional signals. Some funds are relatively pure trend followers, while others incorporate broader systematic macro techniques. The words “managed futures” describe a family of strategies, not a single return series.
That makes implementation more difficult than buying a global equity index and accepting market returns.
From Hedge Funds to an ETF
One of the reasons this subject has become more relevant to ordinary investors is that strategies once associated primarily with hedge funds and institutional portfolios are increasingly available through liquid investment vehicles.
DBMF is an interesting example, not because it represents the only way to implement managed futures, but because its design illustrates a different approach. Rather than attempting to reproduce every trade made by individual CTA hedge funds, its strategy seeks to infer the aggregate exposures of leading managed-futures funds and replicate those exposures efficiently using liquid futures. The manager describes the objective as capturing similar underlying CTA signals while reducing some of the implementation costs associated with traditional hedge-fund structures.
This does not make an ETF equivalent to owning a collection of hedge funds, and replication inevitably introduces its own model and tracking risks. It does, however, demonstrate how alternative return mechanisms are becoming available without requiring investors to enter traditional hedge-fund structures.
For a Chill Capital investor, that development is interesting for reasons that have little to do with making a portfolio more sophisticated.
The objective should never be complexity for its own sake.
A portfolio containing fifteen different strategies is not necessarily more diversified than one containing three. The useful question remains whether each component introduces something that the others genuinely cannot provide. If the answer is simply another variation of equity beta, additional complexity may accomplish very little. If the answer is a structurally different source of return with a plausible economic rationale and sufficiently low dependence on the portfolio’s dominant risks, then the conversation becomes more interesting.
Managed futures deserve consideration within that second category.
The Chill Perspective
Traditional diversification begins with assets. Managed futures encourage us to think one level deeper and diversify the mechanisms through which returns are generated.
That does not make them essential for every portfolio, nor does it make the traditional stock-and-bond structure obsolete. It simply exposes a limitation in the way diversification is often discussed. Two assets can have different names, different cash flows and different places in a portfolio while still depending heavily on favorable long-term market direction. A strategy capable of moving between long and short positions across several unrelated futures markets introduces a different dependency.
For me, the most interesting way to evaluate that difference is not to ask whether adding managed futures maximizes CAGR or produces the highest Sharpe ratio in a historical optimization. Those questions can be useful, but they risk turning a diversifier into another performance product.
The more revealing questions concern the journey. What happens to the portfolio when its traditional sources of return struggle together? Does the alternative component remain genuinely independent when diversification is needed rather than merely displaying a low average correlation? Does it reduce the depth or, perhaps more importantly, the duration of the periods spent below the previous portfolio high? And can the investor tolerate owning it through the long stretches when its purpose is difficult to see?
Recovery Time is particularly useful because it connects portfolio mathematics with actual experience. This perspective also connects to How to Think About Risk Beyond Just Numbers. Wealth does not exist only at the beginning and end of a backtest. Investors have to live through everything in between. A portfolio that spends less time recovering may provide a form of resilience that a slightly higher terminal value fails to capture, particularly for someone approaching the stage when capital must begin supporting real life.
Managed futures cannot guarantee that outcome. They will not protect against every crisis, and there will be environments in which they disappoint. The research itself gives us good reasons not to turn them into another investing miracle. But their ability to trade different markets, in different directions, according to a different return mechanism makes them worth studying for a reason more fundamental than recent performance.
Perhaps the most useful evolution in diversification is therefore not endlessly expanding the number of assets we own. It is understanding what actually makes each part of the portfolio earn money, and then asking whether those mechanisms are sufficiently different to keep the whole system from depending on the same version of the future.
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