We preface this page with a Thank You
for the progress our industry has made. Special Thank You to Daniel Bruce Stark of D.B. Stark & Co. and Sol Waksman of Barclay Trading Group for allowing me to "beat up" on what they do with love.
Because of a fundamental need for new futures markets, managed futures have evolved as a by-product. Without a need for hedging, futures would not exist and neither would managed futures. The growth of managed futures, is nothing short of miraculous. However, enduring success requires proper application, independent thought and moderation.
Simply stated human skills allow markets to be profitably traded, not statistics! Whether these skills are programmed into a computer driven discipline or used as discretion; quality of mind, consciousness and discipline applied to current market conditions at fair cost are the only basic issues to evaluate. Any statistic can bring us closer or take us farther from measuring this fundamental truth. Inaccurate perceptions or beliefs brought into basic thinking can create a potentially misleading application.
Successful trading begins with talented, honorable people with common sense. Their trading strategy should work under current market conditions. All statistical models are designed to measure this simple fact. There is really not much else to think about!
Be Aware of Statistical "Quirks"
Statistics used for risk analysis and portfolio construction may have variables that are significantly inaccurate when used with managed futures. When Alternative Risk Management (ARM) is integrated into traditional statistical models, most errors and omissions are brought to the surface, reduced, eliminated, compensated for or at least used in proper perspective. If variables cannot be adjusted, compensated for, or if we believe they are harmless, at the very least, you'll be aware that they exist! Below is a very short partial listing.
1) Each CTA compiles their track record differently. CFTC regulations allow different methods of computation, all leading to inherent degrees of distortion. Degrees are related to timing, nature of additions, withdrawals and costs relative to net trading performance. If you are comparing distorted track records of five CTA's, having different costs, and variable methods of performance calculation, how can you get an accurate composite result?
Conclusion/Solution - If any foundation is built with fundamental or inherent variables, the gap between expectation and reality is wider. The potential for unnecessary loss and fear is unknowingly increased. In this application, statistics are taking us farther from truth. Correction requires fundamental uniform calculations and equal costs used within in the analysis. Ask for a pro-forma bringing past data closer to the current reality of your investment.
2) What were market conditions during the time frames being analyzed. Everybody makes money in trending markets. To maintain stability during difficult times requires a high degree of skill. Be sure you are seeking skills that will perform in the future.
3) Remember annualized returns are misleading. A CTA can show 54% calendar year return while your account loses money.
Conclusion / Solution - Ask for the weakness of every positive being presented, and fill the gap. Methods exist that can fill the gap! If each CTA within the study can stand alone under variable market conditions, the study will also hold water. If the CTA only functions when markets trend, integrate a trader using different time frames, markets or strategies (Negative Correlation). Then traditional work is successfully applied to strength already established. Be aware of inconsistencies and build your model with an application of wisdom, rather than blind trust in statistical models!
4) All track records are calculated on net realized and unrealized profits and losses. You are also taxed on both. A track record can have unrealized profits with advisors taking incentive fees. What is left can turn into a realized loss over night, leaving you, the investor with nothing.
Conclusion /Solution- think about structuring your investments, where you take profits with the trading advisor, or at least annually. When your initial capital is at least 50% returned take only half. When your investment is 100% returned reinvest all profits.
Humanity has a tendency to blindly give away power to numbers! THINK BEFORE YOU ACT!
5) Risk vs. ROR between two or more CTA's can be distorted by the commitment to margin used in each program. For example trader A- commits 10% of an account to margin producing a 30% annual return. Trader B uses 20% to produce 50% and trader C uses 25% to return 40%. Using the strongest components of traditional analysis, how can anyone create a rational composite study? Finally who offers less risk?
6) If CTA indexes are used for timing models, benchmark portfolios and comparison studies,
- What is the criteria for index content?
- What is the method of index calculation?
- How does the investment you are considering relate to the index being used?
- Can you actually invest in the index, or duplicate its content?
- Why even consider relating your investment to an index?
- What else is needed to complete a pure model you can count on?
- Are you being taken farther from truth and direct application by the models being employed?
- When a research company says "Our index was profitable for so many years!" What meaning does the statement have to your potential investment?
Stark has the 300 Index. The basic Barclay index is larger. Daniel said his indexes track 80% to 85% of total assets managed within the industry. What percent of total equity managed does the index you are considering represent? Our point is that everything is relative.
Your practitioner's insight, perception and knowledge applied to statistics, rather than raw statistics, contributes to your bottom line.
Contrary to conditioned thought processes! Seeking weakness in anything is strength! Weakness is energy. All weakness when used with wisdom can become great strength - or a positive source of energy!
Conclusion / Solution - for multiple advisor portfolios, select each component on its own merit and weakness. Create a list of assets and liabilities for each advisor and look at both sides. Clean and rebuild basic data to current investment specifications. Obtain in-depth understanding of the accurate relationship between any index being used and your investment. You can then compensate for inherent weakness. Consider greater emphasis on draw down analysis and negatives. Variable draw down analysis offers measurement of an investment's down side. If one can comfortably live with the downside of anything, the good usually follows. Place more emphasis on qualitative analysis, including source of the research.
Do we need benchmark indices because traditional investments use them? If so WHY?
I'd rather create my own idea of success and build on self-defined parameters! If we can build a conservative strategy averaging 20% to 25% annually, why do we need an index? Why do we even care what anyone else is doing! If we want more - we alter the leverage or the strategy. No external measurement is needed to determine my values. This attitude can dramatically contribute to your free time and peace of mind!
In futures dealing with negatives is a positive experience. It's your cake, choose your own ingredients and enjoy!
7) In simplistic terms, in a composite of two or more CTA's a pro-forma would is needed to compensate for fundamental differences.
For example: One CTA had larger than normal draw downs (41%) integrated with above average returns (over 150%). His actual account sizes are $40,000. (Calm down, the weakness was a need for trending markets, which did not arrive last year! If we integrated this CTA into a $200,000 account the commitment to margin, return verses draw down statistics are altered by five.
1) Return 150% / 5 = 30%
2) Drawdown 41%/5 = 8.2%
3) Commitment to Margin 40% /5 = 8%
Tradition NOW perceives our friend as ULTRA Conservative. A CTA selection process may not consider the differences of $40K and $200K account sizes. Ask the Right Questions!
8) There is an iceberg under this tip. Bottom line, if the trader is good, fundamental weaknesses in statistical models don't matter much! We suggest you decide when they matter, rather than allowing the presentation to decide. With time and help of wonderful colleagues, our industry will have more to offer. We might even add definitions of models used, how they can be applied and what their weaknesses are.
We are all blessed with limited perceptions. By integrating the perception of others, risk can be dramatically reduced. We hope the CFTC will consider a regulation requiring research companies and brokerage firms, to disclose inherent weaknesses in all composite presentations and unique solutions for every problem.
Conclusion: Everything created by 'man' will someday outlive its usefulness! Including current statistical applications! Statistics are as valid as the intention and awareness of the person applying them! Remember everything has an opposing side so learn to question!
Aspirin bottles having warnings for people with allergies, Ask that risk analysis provide the same courtesy!