V.8:1 (9-13): Enhancing index stock portfolios with futures by Donald L. Jones and Timothy L. Walsh

Enhancing index stock portfolios with futures by Donald L. Jones and Timothy L. Walsh

The benefits of diversification are well known: most investment managers diversify by including bonds and cash in a stock portfolio already diversified across many industry groups. Less well known is the fact that managed commodity futures portfolios are an attractive diversification candidate that can lead to a disproportionately large increase in return while simultaneously reducing risk. Thus, stock portfolio managers, regardless of their degree of risk-aversion, should consider futures to improve the return-risk tradeoff of their portfolios.

Researchers and professor John Lintner combined the results of 15 futures managers from mid-1979 through 1982 and demonstrated that futures returns and volatilities were greater than their stock counter-parts. Our research using one managers' returns for 1974 through mid-1985 demonstrated that adding 10% futures to and index stock portfolio (with an imputed 4% annual dividend), would have doubled the average net return while reducing the worst-year loss by 300% (from –25.7% in 1974 to –7.2% in 1981). Extending our database through March 1989, we can now examine the effect of futures on an index portfolio for returns broken down annually, quarterly and monthly. These annual returns provide an overview that not only extends, but confirms the earlier results.