Evaluating True Diversifiers – Longboard Funds

Evaluating True Diversifiers – Longboard Funds

All true diversifiers are alternatives, but not all alternatives are true diversifiers.

So, we did some research to help investors identify what really belongs in their alternatives allocation. As a result, we’re offering a clear definition of true diversifiers as investment strategies that historically deliver both:

  1. lower risk (through lower correlation in declining markets)
  2. increased returns

We applied this definition to at least 15 years of historical data and 6 true diversifiers emerged.

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Alluvial FundAlluvial Fund performance update for the month ended May 2021. Q1 2021 hedge fund letters, conferences and more Dear Partners and Colleagues, Alluvial Fund, LP returned 5.4% in May, compared to 0.2% for the Russell 2000 and 1.0% for the MSCI World Small+MicroCap . . . SORRY! This content is exclusively for paying members. SIGN UP Read More

True Diversifiers

When evaluating these asset classes for your own portfolio, it is important to consider the environments in which each has historically performed best. Click on each true diversifier to get the highlights, including its return profile, periods of outperformance/underperformance and a snapshot of recent performance:

  • Gold
  • Managed futures
  • MLPs
  • TIPs
  • Treasuries
  • Municipal bonds

True Diversifier: Gold

Gold is similar to cash in that it serves as a store of value. Gold investors receive an added benefit: protection against inflation, or the loss of purchasing power due to currency creation from a central bank. In fact, gold is rare in that it represents the only liquid financial asset that is not simultaneously someone else’s liability. So, it’s not susceptible to destruction through bankruptcy, breach of contract, transition of governmental regime or dilution by printing press. The downside to investing in gold is that it loses value during periods of deflation and can also be subject to shorter term speculative volatility.

Return profile: Since gold does not offer a yield or generate any kind of earnings or cash flow, it serves purely as a store of value. When similar stores of value, such as cash, are stable, gold tends to be stable as well. During times when cash loses value due to inflation, the value of gold is likely to increase—and vice versa when cash gains value to deflation.

Did you know? Gold’s rare ability to store value in a compact, readily transferrable and widely accepted medium has made it the most durable form of wealth, with a track record spanning 5,000 years.

Historical performance

This true diversifier:

  • Outperforms during inflationary periods such as the 1970s and 2000s.
  • Underperforms during periods of price stability and high interest rates such as the 20-year period from 1982 – 2002. Gold also underperforms during deflationary periods, like the commodities deflation from 2011-2015.

Recent performance snapshot: In 2016, Gold emerged from a 4-year bear market during the commodities deflation from 2011-2015. As commodities bottomed in early 2016 inflation increased, causing this recent outperformance. However, if the Federal Reserve follows through on its stated mission of raising interest rates in the coming years, gold prices could face headwinds.

True Diversifier: Managed Futures

Managed futures investments apply a trend following strategy to capture both up and down price trends across global futures markets. This diversified process targets price movements in over 100 commodities, currencies, equities and fixed income markets. Managed futures produces an uncorrelated return profile with positive skew. It produces this return profile by tapping into diverse markets and cutting losing trades quickly while letting winning trades extend. This complements the negative skew associated with traditional asset classes, like stocks and bonds.

Return profile: Managed futures has the potential to thrive during multiple different market environments, including inflation, deflation, economic growth or economic contraction. In fact, historically managed futures has generated positive returns during periods of up and down price movements across asset classes. Since broad-based price trends tend to occur during both inflationary and deflationary periods, managed futures has historically done well during a wide range of economic environments.

Did you know? Trend following strategies have existed in various forms for over 100 years, and today’s style of diversified, rules-based trend following came to prominence during the inflationary 1970s. Historically, these strategies have been confined to a hedge fund format, typically only available to sophisticated high net worth individuals. They started to become available to the retail investor in 2010 via ’40 Act mutual funds.

Historical performance: Managed futures has historically delivered mid-single digit returns while maintaining a correlation of approximately zero to the U.S. stock market over long periods of time. It has done well during periods of inflationary growth (mid-2000s), deflationary contraction (2000-2002 and 2008) as well as deflationary growth (2014-2015). The strategy underperforms during periods of relatively price stability, like from 2011 – 2013.

This true diversifier:

  • Outperforms during periods of sustained price trends across multiple asset classes, including both inflationary and deflationary environments.
  • Underperforms during periods of price stability across multiple asset classes, like the noninflationary growth environment of 2011-2013, or during transition periods from deflation to inflation and vice versa.

Recent performance snapshot: This true diversifier experienced gains during the 2014-2015 deflation, but as those deflationary trends reversed in 2016 managed futures performance suffered. The market appears to be potentially shifting into a new regime of higher growth and inflation, which could bode well for managed futures going forward.

True Diversifier: MLPs (Master Limited Partnerships)

Master limited partnerships are publicly traded partnerships, which are unique in their tax treatment as “pass through entities.” This preferred tax treatment shields most of the partnership income from federal taxation.

Return profile: A key feature of the MLP return profile has to do with yields and cash flows. Typical partnership agreements require MLPs to distribute all of their available cash flow to shareholders. This has made MLPs a favorable investment in recent years, thanks to their relatively high yields in a low-rate environment.

Did you know? The first MLP IPO was launched by oil and gas company Apache Corporation in 1981. While the MLP structure has expanded into other sectors over the years, the original formation of MLPs was focused on the oil and gas sector and remains so today.

Historical performance: We use the Alerian MLP as our proxy for the sector. Its performance is closely correlated with the current price, and rate of change in the price of crude oil. This makes MLPs a potential source of inflation protection within a portfolio.

This true diversifier:

  • Outperforms during inflationary periods with rising oil and gas prices.
  • Underperforms during deflationary periods with falling oil and gas prices.

Recent performance snapshot: MLPs followed the sharp price declines in energy markets over the last couple of years, but have since recovered alongside the recent recovery and stabilization in crude oil prices. Further, MLPs appear poised to deliver a potential hedge against a return to inflation in the years ahead if the new administration moves according to the market’s expectations.

True Diversifier: TIPS (Treasury Inflation Protected Securities)

TIPS are U.S. Treasury bonds designed to provide protection against inflation. They provide this inflation protection by adjusting the principle and interest rates of a regular U.S. Treasury bond according to the annual inflation rate, measured by the CPI. Effectively, this causes TIPS to increase in value during periods of inflation, and fall in value during periods of deflation.

Return profile: TIPS will outperform Treasuries when inflation is positive, and underperform Treasuries when inflation is negative (or, in periods of deflation).

Did you know? TIPS were first issued in the U.S. beginning in 1997, and are issued in 3 maturities: 5, 10 and 30-year bonds.

Historical performance: TIPS are similar to Treasuries when inflation is mildly positive or negative, but can potentially deviate in a big way during significant inflationary or deflationary periods. In the 2008 financial crisis, consumer prices crashed along with prices for everything else, causing TIPS to deliver negative crisis alpha compared to the positive crisis alpha that Treasuries provided. There is no data for TIPS performance during the 1970s, but this period of persistently high inflation represents a potential example where TIPS could deliver positive crisis alpha relative to Treasuries.

This true diversifier:

  • Outperforms during inflationary periods with rising consumer prices (measured by the CPI), like the mid-2000s and the initial recovery from the Financial Crisis in 2009-2011.
  • Underperforms during deflationary periods with declining consumer prices (measured by the CPI), like the 2008 Financial Crisis and the deflationary period from 2014-early 2016.

Recent performance snapshot: During the deflationary environment from 2011-2015, TIPS underperformed U.S. treasuries as inflation was negative, thus detracting from TIPS returns. However, the recent uptick in inflation since mid-2016 has caused TIPS to begin outperforming treasuries by a healthy margin for the first time in years.

True Diversifier: U.S. Treasuries (medium-to-long term duration)

U.S. Treasury performance depends primarily upon the interest rate environment. During periods of rising interest rates, treasuries (of medium-to-long duration) incur losses on their principle, as the discounted cash flows decrease in value relative to the market’s higher rates. Conversely, during periods of falling interest rates Treasuries can gain value as the discounted cash flows become worth more relative to the market’s lower rates. This increase in value can occur regardless of whether the economy faces inflation or deflation, growth or contraction.

Return profile:  U.S. Treasuries have experienced a nearly uninterrupted bull market for the last 35 years as interest rates have steadily fallen from a high of more than 15% in 1982 to less than 3% today (on 10-year Treasuries). This marked the inverse environment of the previous 35-year period where bonds underperformed during the post-war era from 1946 – 1982.

Did you know? The secular decline in interest rates for the last 35 years is a key reason why a traditional 60/40 stocks and bonds portfolio has historically worked well for investors. Further, the ability for central banks to lower interest rates during periods of economic crisis has enabled bonds to provide valuable crisis alpha within a portfolio. This means bonds could fail to replicate this type of portfolio buffer in a rising interest rate environment—something most investors have never experienced.

Historical performance:

This true diversifier:

  • Outperforms during periods of deflation with falling interest rates, or inflation with falling interest rates.
  • Underperforms during periods of high inflation with rising interest rates.

Recent performance snapshot: Interest rates started moving higher in the summer of 2016, and accelerated after the presidential election. As a result, U.S. Treasuries have entered long-term downtrends for the first time in years. Many have been anticipating a reversal in the bull market of the last 35 years toward a potentially long lasting bear market, caused by a secular rising interest rate environment.

True Diversifier: U.S. Municipal Bonds

MUNIs act very similar to Treasury bonds, as outlined in the above section, except with fewer returns and less crisis alpha, or diversification value. Municipal bonds are also more susceptible to default risk compared to treasuries, because municipalities do not have the option of creating money to repay municipal debts.

Disclosures and Definitions

Past performance is not indicative of future performance.

Index performance on this page was sourced from third party sources deemed to be accurate, but is not guaranteed. All index performance is gross of fees and would be lower if presented net of fees except for the SG Trend Index, which is net of fees. Investors cannot invest directly in the indices referenced in this blog.


True Diversification: Investment strategies that have historically provided investors with at least 70% of the return of traditional 60/40 stocks and bonds portfolios while having less than .30 bear correlation to traditional 60/40 stocks and bonds portfolios.

(MLPs) Alerian MLP TR: The index measures the performance of energy segment U.S. equity securities. It is a composite of the 50 most prominent energy Master Limited Partnerships (‘MLPs’). The index is calculated using a float-adjusted, capitalization-weighted methodology.

(TIPS) Bloomberg Barclays Gbl Infl Linked U.S. TIPS TR: The index measures the performance of rule-based and inflation-protected securities issued by the U.S. Treasury. It is a subset of the Global Inflation-Linked Index (Series-L).

(Muni Bonds) Bloomberg Barclays Municipal TR: The index measures the performance of USD-denominated long-term tax exempt bond market, including state and local general obligation bonds, revenue bonds, insured bonds, and pre-refunded bonds.

(U.S. Treasuries) Bloomberg Barclays U.S. Treasury TR USD: The index measures the performance of US Treasury (notes and bonds) which are U.S. Agg eligible, i.e. maturities greater than or equal to 1 year, min amount outstanding 250MM.

(Managed Futures) SG Trend Index: A leading benchmark for tracking the performance of a pool of the largest managed futures trend following based hedge fund managers that are open to new investment. The SG Trend Index is equal-weighted and reconstituted annually. The SG Trend Index is formerly known as the Newedge Trend Index.

(Gold) S&P GSCI Gold Index: a sub-index of the S&P GSCI, provides investors with a reliable and publicly available benchmark tracking the COMEX gold future. The index is designed to be tradable, readily accessible to market participants, and cost efficient to implement.

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