Modern Portfolio Theory
Including futures in an investment portfolio reduces volatility while enhancing return [and futures portfolios] have substantially less risk at every possible level of return than portfolios of stocks, or stocks and bonds.
Professor John E. Linter, Harvard Business School.
One would be hard pressed to find a hedge fund prospectus that did not mention Modern Portfolio Theory (MPT). Sure, MPT sounds like academic ivory tower, but MPT is all about diversification and reducing risk.
Modern portfolio theory is standard practice in the smart investor's portfolio. MPT places a non-correlated investment, a predefined percentage managed futures component, into a typical bond and equity portfolio. Risk is diversified away from the bond and equity positions into non-correlated managed futures positions. Higher portfolio returns with a reduction in risk is the end result.
Efficient Frontier Chart
The problem with MPT is explaining that you must take on a perceived risky investment (futures for example) to reduce overall risk. That is like saying you must put a foot out of the airplane to be more comfortable. That can be a tough sell to investors not familiar with the benefits of such thoughtful portfolio refinements.
Modern Portfolio Theory Outside Links
Stocks v. Futures
Stocks and bonds, stocks and bonds. Does mainstream press ever talk of other investments? Today's self described experts treat stocks as an investment without alternative, yet trading in currency markets dwarfs stock trading. Everyone needs stocks and bonds, but is that enough in today's global markets?
Contrary to popular opinion, futures markets are more than Las Vegas casinos. Adding futures to your portfolio of stocks and bonds has been shown to be a net plus over the long term. Several studies reveal that a stock and bond investment portfolio with a 10-30% mix of futures over a decade or more increases returns while reducing risk.
