Tradition & History
In the early 80’s Harvard Professor Dr. Litner created a primary study on the value of managed futures. We believe it was the first study conducted by any university. Te University of Massachusetts built a division dedicated to alternative investments. The Universities worked closely with major US exchanges. In the early 80's Barclay & DB Stark were seeds relative to the prominent data base forces that they have evolved into. Barclay, works in conjunction with Universities, Exchanges, Institutions, Banks and the media. Sol Waksman / Barclay founder has co-authored work published in Derivatives Quarterly. Stark & Barclay Indexes have become "benchmarks" referenced throughout media and industry like Dow Jones. Software services now integrate managed futures databases into their services. A distressing thought we'll address in subsequent articles. Their research has been cited in numerous books, including Schwaeger's first book on managed futures called "Managed Trading" Myths and Truths. Barclay, Stark, & MAR and now other data base services are to futures what the S&P & Dow Jones is to stocks. The world “believes” that all managed futures indexes are benchmarks for evaluating managed futures investments. Unintended inaccurate beliefs are a serious cause of unforeseen losses.
It is imperative to understand what tradition cannot and will never do!
Blind Trust = High Risk
The first index ever originated was the Dow Jones. Charles Dow created the DJIA to time stock purchases. Index content is comprised of the daily closing price of public companies. Managed futures indexes are comprised of monthly rate of return data. They basically index trading talent applied to markets, NOT market prices. Managed futures indexes are widely used as benchmarks to evaluate performance of non-related investments. There are serious differences in content and application. For details read WHY you benefit from SafeMoneyMetrics. Blindly following any analysis without thinking for yourself will usually cause unforeseen losses.
Use of managed futures should parallel a carefully designed and executed hedge strategy. The futures markets originated to offset risk of related cash markets. Never deviate from that intended purpose. Well designed managed futures strategies can offset the volatility and risk of any traditional risky portfolio.
Although teaching people that prudent application of managed futures can parallel the concept of hedging, it is negligent & misleading to imply that managed futures resemble even a derivative of hedging. They are a risky speculative strategy that can offset the potential risk of other risky strategies. Managed futures are not even an investment. You are giving money to someone that you believe has talent to make money trading the markets.
Responsibility
As investment professionals, we have a colossal responsibility. Our decisions, based only on our beliefs have a ripple effect to and through the environment. Avoiding managed futures because of personal fear is NOT a responsible decision. Traditional investments may become more unpredictable and volatile. Contrary to your perception of "normal," I am second generation and grew up with member firm status in the hedge industry. To me, designing a futures strategy requires equal energy to eating breakfast. Although we have opposing beliefs, both belief systems result in creating the physical reality that we are each comfortable with.
Accurate Thinking = Positive Results
A hedge strategy is constructed by defining risk and objectives associated with a company's cash market needs. ONLY then are futures used to stabilize or reduce price risk associated with the strategy. Success is quantified by integrating the composite results of both cash and futures positions. This is the ORIGINAL and ONLY economic purpose of futures. Managed futures are a by-product or indirect application emanating from ONE fundamental purpose.
Stocks and bonds are instruments used to raise capital for company growth. Again without fundamental economic need, both would be non existent. Mutual funds and other traditional investments exist ONLY as a by-product of the fundamental economic purpose of stocks and bonds. All markets would be non-existent without a fundamental economic need, NO market was EVER established so you can speculate. Markets founded upon a basic need for economic stability have evolved into investments with potential to produce a similar form of stability for investors.
Managed futures and alternative investments parallel that traditional path and hold their place of honor within a spectrum of economic opportunity for appropriate investors.
We believe anything less than a 'holistic' approach to managed futures is speculation, rather than healthy management of risk. We suggest that you recognize the difference before approaching these markets. -
A Trading Manager Selection Process
Trading Manager work begins with data categorized by account size, market sector, standard deviation, time windows, rolling 3,6,9, & 12 month returns, draw down analysis, and other variables or statistical models. The process backs into building a composite strategy. For example, a client has $500,000 choosing a 25% annual return with a 10% draw down. The work may begin by equating client preferences with a data base selection process. Analysis of current cost, market conditions and timing for entering the investment is all included. Allocation among traders offering greatest potential with least amount of risk is evaluated. After a thorough due diligence is applied to the selection process, the industry provides impeccable presentations defining future probabilities based on past data. All that is humanly possible gets done. However history of poor performance has proven it is never enough!
Quality of Mind Applied to Tradition = Positive Results
Traditional thought evaluates data. Alternative Risk Management ( ARM) begins with evaluating cause. Trusting the end result of raw data especially when profitable is foolish. Your evaluation should begin with a process of how returns were achieved. The quality of a human mind interacting with a market, at reasonable cost is the ONLY & BASIC cause of results. Successful trading and performance evaluation can only result from someone's ability to evaluate shades of gray within a black and white environment.
Poor marketing or lack of prudent fundamental education is a major cause of unnecessary losses in our industry. When client capital is managed, quality of client understanding enters the risk equation.
Tradition /Indexes & Benchmarks
Managed Futures have grown using indexes that parallel tradition. Used for trend, correlation & performance analysis managed futures indexes cannot usually be replicated for investment or used as a benchmark portfolio.
Investments 4th Edition by Sharpe defines a Benchmark Portfolio as a portfolio against which the performance of an investor can be compared for the purpose of determining investment skill. A benchmark portfolio represents a relevant and feasible alternative to the investor's actual portfolio and in particular, is similar in terms of risk exposure."
D.B Stark CTA index is an equity based index of 300 trading advisors. Stark fund index was 200 partnerships. Barclay CTA index currently tracks over 530 programs. Track records must begin at 4 years for inclusion. These indices are frequently MIS-USED to market a managed futures strategy. The sponsor parallels strategy past performance against the index. The marketing application is unknowingly negligent and misleading.
By attempting to parallel traditional measure of performance evaluation, the industry may have followed an agenda having no useful foundation for evaluating managed futures investments.
Anything taking us farther from truth is usually cause for unnecessary loss.
Consider an Alternative
- How does an index or benchmark relate to my investment?
- Does using any index offer greater profit potential?
- What is gained by comparing any investment to external measurements?
- What kind of index can be useful to my situation?
- How clean and relevant is used in the index?
Integrate simplicity, common sense, and direct evaluation techniques to what tradition teaches. You'll give yourself unparalleled opportunity.
Article #7 Managed Futures – Investment Profiles for Risk Management is also useful.
This tip of an iceberg is designed to stimulate your independent thought. Integrate what you know into what is offered. Blind acceptance of anything, let alone managed futures or any alternative investment can lead to unnecessary difficulty that is easily avoided.