Some
new research on risk parity makes some provocative comments on the risk and
potential value of managed futures in a portfolio. We have cited this
recent work in one of our previous posts suggesting that accounting for skew
can be helpful relative to a risk parity approach focused on volatility.
See Messy markets,
mixed distributions, and skew - Thinking about downside risk. What
was noted with this work is that hedging volatility will not eliminate skew
risk. Volatility diversification or holding negatively correlated
assets can reduce volatility but actually increases tail risks on a
relative basis. There is a floor with skewness diversification because it
is hard to hedge jump risks. Calm or low volatility assets may actually
have higher jump risk.
The
authors in "Risk Parity Portfolio with Skewness"
make an interesting conjecture that managed futures with its low correlation
with traditional assets and its better performance during a crisis can help a
portfolio, but may not solve the risk from skew or short-term jumps in
price.
This
is an interesting comment that is worth exploring in more detail. Put
differently, one may expect that managed futures will do a good job of
diversification when there is an increase in volatility from some macro event.
It may actually perform well during these periods of stress and
higher volatility. The same cannot be said when there is heightened skew
in the distribution of asset prices from jump risks.
My
bias on this conjecture is with the authors. Longer-term trend-following
managed futures managers will not do well during periods of high skew which is
another way of saying high jump risk. This is consistent with the view that
managed futures managers are long long-term volatility and short short-term
volatility. Short-term skew from a jump may not last long enough for
traditional managed futures managers to exploit.
This
conjecture would suggest that high skew periods should not be good for managed
futures. Nevertheless, a possible corollary to this view is that short-term
managed futures managers will actually do better during periods of high skew
when there is jump risk. Their short-term investment horizon may make them
better able to take advantage of jumps which create skew.
This impact of skew on managed futures is
research we will be conducting in the coming weeks. It may have strong
implications with portfolio construction. Longer-term trend-followers should be
matched-up with short-term systematic managers to be able to exploit higher
long-term volatility and shorter-term situations of higher skew.
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