A new white paper from Forward Management LLC, San Francisco, concludes that diversifying portfolios with managed futures may enable investors to earn better risk-adjusted returns.

That's largely because managed futures strategies historically have maintained very low correlations to stock and bond indexes while producing equity-like returns.

Over the 32-year period ending Dec. 31, 2011, the Barclay CTA Index (a managed futures benchmark) achieved a compound annualized return of 11.16% versus annualized gains of 11.06% for the S&P 500 Index and 8.69% for the Barclays Capital U.S. Aggregate Bond Index.

During that period the CTA Index experienced somewhat less overall volatility and substantially lower drawdowns than the S&P 500. As Forward's white paper relates, the CTA Index showed positive returns during the dot-com crash of 2000-2002 and the financial crisis of 2008, years when the S&P 500 sustained major losses.

Focusing on the past 10 years, through April 2012, Forward reports that a basic 60-40 allocation, stocks to bonds, would have had an annualized return of 5.6% and a standard deviation of 9.5%. Inserting a 10% allocation to managed futures, as measured by a broad index, would have raised returns to 5.9% while dropping the standard deviation to 7.7%. Further improvement, to a 6.1% return and a 6.1% standard deviation would have been achieved with a 20% allocation to managed futures.

If a financial planner decides to use managed futures, is a 10% portfolio allocation adequate? Or is going to 20% worthwhile? "That depends on the return/risk objectives of the portfolio and the existing asset allocation," Forward managing director Norman Mains told Financial Planning. "Assuming that the portfolio is owned by an individual with a moderate investment objective and risk tolerance plus a reasonably well diversified portfolio (say, 60% stocks and 40% bonds), then a 10% allocation to managed futures is a reasonable solution. Individuals with higher expectations and more aggressive allocations would be suitable for a larger allocation, say 20%, to managed futures."

Mains, the author of the new white paper, points out that the number of managed futures mutual funds has "ballooned" over the past five years. "The latest Morningstar data base lists 33 separate mutual funds in this category," he said. "Four of them limit their investments to commodity (or non-financial) futures contracts while the others invest in both financial (stock index, interest rate and currency) and non-financial futures contracts."

According to Mains, those 29 managed futures mutual funds can be broadly categorized as (1) multi-asset index based vehicles, such as the Forward Managed Futures Strategy Fund); (2) vehicles that have developed proprietary rules or judgment-based processes; and (3) vehicles that are conduits for commodity trading advisors (CTAs) or fund-of-CTA-fund vehicles.

"Many, and perhaps most, financial planners have very little understanding of the role and mechanics of futures markets, and relatively little knowledge about managed futures," Mains said.  "The financial media tend to focus on the volatility of commodity prices, giving little attention to the characteristics and benefits of a managed futures program. Many investors do not know of the attractive features of managed futures funds: equity-like returns and a very low correlation to stock and bond returns over time."

Donald Jay Korn writes for Financial Planning.