Rising Interest Rates and Multi Asset Trend Following
The quandary of many a money manager is asset allocation in what will ultimately be a rising interest rate environment. The start of a bond bear market could be coincident with the Fed’s expected increase in rates. The length of a bond bear market might be one year…two years…five years… or even a full retracement over 30 years.
Asset allocation in times of rising rates often focuses on changes in equity sector allocations eg more into technology and healthcare and lessening of fixed income exposure…but that is not the only solution and might be sub optimal allocations.
A white paper by Welton Investment Partners (“Going Up? Where to Find Returns If Rates Begin to Rise”) took a look at annualized returns for each of five investment asset classes during periods of “acute and/or sustained rises in rates.” Welton used “all periods with sustained rises in interest rates of at least 1.5% trough-to-peak” over the period 1970 – 2012. During that 42 year time span, there were six such time periods of acute/sustained rate increases: 1973-74; 1983-84; 1987; 1993-94; 1999-2000. ( (The aforementioned years do not reference calendar periods but, rather, a span of time within those years during which there was an acute or sustained rate increase. )
The five asset classes considered were: equities (both S&P 500 and MSCI World Index); fixed income (both 10 year Treasuries and AAA Corporates) ; and Multi Asset Class Trend Following (Welton’s proprietary Multi Asset Trend Following models).
The winner by a wide margin was Welton’s trend following managed futures models, up an average annualized 12.4% during those periods of rate increases. MSCI World Index was a distant second place at 2.4%. The S&P was flat at .2%. In the red were the 10 year Treasury at -1.4% and AAA Corporate bonds at a whopping -10.4%.
To give investors a better insight into how asset classes behave during periods of rising rates and how Welton’s trend following managed futures were able to deliver a 12.4% gain, Welton broke down the gain of 12.4% into subcomponent gains and offsetting losses.
Gains within the multi asset class trend following came from:
- LONG positions in commodities;
- LONG positions in currencies
- SHORT positions in currencies; and
- SHORT positions in fixed income.
The losses came from
- LONG positions in equity indices
- SHORT position in equity indices and
- LONG positions in fixed income.
Pictorially, the 12.4% net gain is broken down by sector:
Source: Welton Investment Corporation. Reproduced by permission.
The above chart suggests several things. Based on Welton’s multi asset models, managers would want to add the following investment capacities to their asset allocation: go short/long fixed income, go short/long commodities; and go short/long currencies….all in the form of futures contracts. Secondly, the chart suggests that, even during these acute or sustained periods of rising rates, there were trend reversals… it was not all straight up or down. To the extent that investors/managers have the ability to include alternatives in their asset allocations, they should consider multi asset trend following …in addition to equity sector rotation and shortening bond durations and moving to cash; etc.
There are always limitations with studies. One such for this study is that dividend and interest payments were excluded; only the price index for equities and bonds were considered. However, inclusion of these cash inflows would not have bridged the great divide; the performance spread between multi asset and AAA Corporates was approximately 23%. Another limitation is that Welton uses hypothetical for years prior to their multi asset model’s existence and actuals for years when in existence. Also their study speaks to their models only, not to the larger world of trend following CTAs. In fairness, Welton was peeling back the onion skin of sector attribution …something not to be garnered from overall CTA results.
For the curious, Welton will make available a closer look into the specifics of their study.
Best Regards,
Jeannette Showalter, CFA
239-571-8896
Trading Futures and Options on Futures and Forex transactions involves substantial risk of loss and may not be suitable for all investors. You should carefully consider whether trading is suitable for you in light of your circumstances, knowledge, and financial resources. Past performance is not indicative of future results. Opinions, market data, and recommendations are subject to change at any time.