Just a couple of weeks ago, we delved into the biggest selling point for managed futures: non-correlation to traditional asset classes. That means that regardless of whether stocks are up or down, managed futures has the potential to make or lose money.

Turns out, all those advisors who have trumpeted diversification within stocks and not outside of stocks are probably wishing they’d bought into managed futures when they had the chance.  As Josh Brown over at The Reformed Broker explained:

The WSJ is out with a story on this summer’s return to hyper-correlation of stocks.  Credit Suisse calls it currently as an 80% correlation for S&P 500 names, higher than the 73% we saw during the panicky peak in 2008.

It’s kind of hard to diversify in a climate such as this, which is why managed futures can be such an excellent addition to a portfolio. Brown points out that, under these circumstances, the jump in correlation is often short-lived, but it is the warning that booms from the Wall Street Journal about the future that becomes an excellent call to diversify now… instead of later.

The big fear for investors is that correlation will remain permanently elevated. While August’s turbulence can be blamed on specific macro issues, correlation levels have trended higher in the last few years. That suggests structural changes may have played a role.

One potential reason is the popularity of exchange-traded funds. ETFs account for more than 30% of volume in U.S. stock markets, compared with just 2% in 2000, Credit Suisse says. It’s reasonable to expect ETF trading to drive correlation higher because many of the vehicles are tied to stock indexes.

If they’re right, and correlation is becoming a structural reality, it’s time to stop deluding yourself into thinking that stock diversification is enough to protect your investments, and start looking for true diversifiers, like managed futures.

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