This analytical process introduces time tested concepts from hedging, common sense and a never ending search for truth that has a way of eluding all of us.
" Everything you have taught yourself has made your power more and more obscure to you. You know not what it is, nor where. You have made a semblance of power and a show of strength so pitiful that it must fail you. For power is not a seeming strength, and truth is beyond semblance of any kind. Yet all that stands between you and the power of God in you is but your learning of the false, and of your attempts to undo the true" A Course In Miracles Text Page 275.
Standards for Advisor Acceptance
Our foundation for advisor selection is based on analysis that includes realized profits relative to capital at risk and cost of money over a specific time. "Internal Benchmarks" are also used. Profits are evaluated for each market, each market relative to other markets within the strategy, the composite relative to current market conditions and the "internal benchmark." The difference between the "internal benchmark" and current profitability represents only one element of the work.
What is and Why Use Internal Benchmarks?
We created the "internal benchmark" application. It represents a standard defined and previously delivered by the advisor. Similar to sports, each athlete competes only with his personal best. The benchmark is used to monitor a standard relative to current reality and future potential.
For Example: Assume we contract an advisor that delivered between 20% and 35% annually over several years. Without wasting energy processing information that we have no control over such as how the strategy was built, will it function in current market conditions and numerous other factors I won't bore you with; we can track current realized profits relative to capital at risk within any market and time frame. If current results deviate from the predefined "internal benchmark", either up or down, decision rules trigger specific actions. Choice of actions could include, distributing profits, adding capital, leveraging or de-leveraging the account and possibly changing the advisor.
It is important that the benchmark be internal to the strategy, rather than something external to it. WHY?
Universal Law, also physics1 proves that when fear is removed from any situation, strength is automatically increased. There is nothing to do but release fear (remove blocks). Nature does the rest! Because each advisor defines their benchmark, increased comfort allows for a higher quality of decision to evolve. We are not only kinder, but we strengthen the position of all participants.
Comparing ourselves to someone or something external to our highest potential (benchmark) weakens us because it goes against the power of nature. Any external human comparison is interference that causes misery in many areas of life. If we can teach this to others, the planet will change in an hour.
An Oak tree need not compare itself with
an Elm tree to know its’ own splendor as an oak tree.
The 51% Rule for Foundation Building
To accept any advisor and maintain a long-term relationship we ask for and monitor the following.
- 51% of all markets traded have to be profitable.
- 51% of all trades within each market have to be profitable.
- Profits have to exceed losses by at least 51% for each market traded.
- 51% of the initial margin required for each market is the maximum capital at risk on each trade.
- 51% of all markets traded at any time need to be profitable.
Profits have to exceed losses of the composite portfolio by at least 51% at any one time.
Acceptable Variables: The above scenario maintains optimum balance and stability. Profitable deviations from our optimum, offered by the marketplace may include 35% profitable markets, 45% profitable trades and profits exceeding losses by 65%. Other combinations are also probable.
To accommodate what the marketplace offers, without compromising our standards we ask that if any one or more of the six variables is under 51% that another or others be over 51% by three times the difference.
For example: If a strategy has 45% profitable trades rather than 51%. We require that the profit to loss ratio on each trade be 69%, three times the difference between 45% and 51%.
WHY? Balance - although a strategy may be profitable, it may indicate excessive capital wasted to achieve profits, relative to an alternative. Also because of imbalance within the inter-dynamics, I also perceive unwanted potential liability. WHY?
Nature always seeks optimum balance. When any one element is out of balance nature will release or express the energy to rebalance. In managed futures that aspect of Universal Intelligence or release of energy will manifest as capital loss.
How did we build the monitoring system?
We began by establishing a foundation of past performance for each advisor related to the initial six 51% parameters. This also becomes an internal benchmark for each strategy. Continuing analysis requires tracking realized trades for each market. Realized trade information is translated into a rate of return based only on capital at risk, cost of money and time.
A constant $1000 Unit represents current market conditions. The rate of return on each trade is added to a second $1000 Unit. Data points are not compounded. The difference or basis between the flat $1000 Unit and the rate of return becomes one foundation for analysis. Too many trades below the $1000 relative to the benchmark is revealing.
How is Information Used?
Over time a weekly or monthly table of basis differences becomes a valuable tool for decision making. It compliments draw-down analysis with a more accurate method of defining capital at risk relative to rate of return.
Multiple Applications Become Possible
- The reliability of Value at Risk and other traditional analysis is increased because the rate of return calculation used in the standard deviation is based on return relative to capital at risk and cost of money.
- As the basis difference narrows (profitability becomes less, we are in a draw-down) a good time to add capital if the decision to keep the strategy remains.
- As differentials widen we can distribute profits (profitability increases).
- During a period of narrowing differences, look at each component of the composite to efficiently locate the weakness.
- We have immediate access to useful information and heightened awareness to which part of the strategy relative to current market conditions needs to be adjusted
- Useless information is eliminated, so quality of decisions is increased.
- Compounded $1000 Unit values can be calculated for presentation purposes without severe distortion of truth.
- Data is easily applied to traditional applications of risk analysis.
- An abundance of data over a short period of time increases the quality of risk management.
- If data is gathered weekly, time is contracted and risk control is increased. We can also benefit by using advisors having shorter formal track records. WHY? Many good advisors are missed early on because 36 data points (three years) is needed for prudent analysis.
- Data can easily be reformatted for research purposes.
- Early warning reveals itself in trade evaluation and correlation analysis for each market and to the internal benchmark; rather than monthly rate of return calculations, draw-down analysis and relationships to benchmarks external to the strategy, which are all misleading.
- Correlation analysis using realized returns relative to capital at risk offers an impeccable foundation to compare and integrate multi-advisor investments.
- Finally, by correlating realized results with traditional month end ROR that includes both realized and unrealized. The differential between both data points can prove to be useful.
Look at Client Risk Management at http://www.safemoneymetrics.com
1 Professor David Bohm - Unfolding Meaning Page 117