"Love wishes to be known, completely understood and shared. It has no secrets; nothing that it would keep apart and hide. It walks in sunlight, open-eyed and calm, in smiling welcome and in sincerity so simple and so obvious it cannot be misunderstood." Course in Miracles Text Pg 407
What does "Love" and the above quote have to do with your investment returns?
Self-Love wakes us up to truth that, knowingly or unknowingly many managed futures traders available to the public are sold with superficially misleading advice that could lead to serious loss. The industry also spawns mediocrity unless a bull or bear market adds value in either direction.
We need knowledge, insight and wisdom to position capital that will adjust with "whatever market conditions give us" and we must also avoid "ego driven self-serving advice." Then with our clients, we can peacefully enjoy the other side of life.
"Winning the Losers Game"
To quote Charles Ellis - " Investors who study the realities of investing will be able to protect themselves and their investments from the all to common but unrealistic belief that they can find portfolio managers who will substantially "beat the market." These well informed investors will understand the only way an active investment manager can beat the market is to find and exploit other investors mistakes more often than they find and exploit his and that the manager who strives to beat the market is all too likely to try too hard and be beaten instead1."
To quote Dan Stark - "It has been our observation over the years that successful managed futures investment evolves from positioning clients with a strategic allocation among CTAs enabling them to comfortably remain through draw downs, however be well positioned if and when specific markets change and substantial profit opportunities begin to present themselves."
Notice both viewpoints independent of each other emphasize market conditions and trends with almost none on practitioner skills or strategy related to market conditions.
As proven by physics and true of all people, both professionals will also create investment situations that mirror their particular belief and point of view.
Time and Strategy
Again to quote Ellis: "The single most important dimension of investment policy is asset mix, particularly the ratio of fixed income to equity. Discussions of asset mix have attracted considerable attention in recent years, particularly among pension managers. Their analyses show that over and over again the tradeoff between risk and reward is driven by one key factor TIME. "
"The length of time investments will be held, the period of time over which investment results will be measured and judged, is the single most powerful factor in any investment program." 3
Below is a sample of time windows built with traditional performance data.
Months |
1 |
3 |
6 |
12 |
24 |
36 |
48 |
Best |
22% |
54% |
62% |
72% |
122% |
169% |
198% |
Worst |
-8% |
-6% |
-2% |
2% |
18% |
62% |
84% |
Avg |
2% |
6% |
13% |
27% |
58% |
99% |
148% |
Latest |
-2% |
6% |
2% |
15% |
21% |
62% |
89% |
Notice that with this particular advisor, as time moves forward returns improve and draw downs diminish. This tendency is inherent even with traders having poor performance.
We believe that time related to performance in futures or other derivatives should be quantified relative to the strategy used. Contrary to what Charles Ellis perceives, TIME as an isolated element has NO relevance to performance when evaluating managed futures. Again, remember Einstein and relativity. Nothing lives in isolation. For example: Floor traders may choose seconds, minutes, or hours as their time frame to trade in. Their performance builds for the month using the shortest time available in our industry. Trend following strategies may integrate multiple time frames anywhere from day trading to holding a position for weeks or months. Other trending investments are always in the market over variable time frames, they move from long to short. Their systems are designed to supposedly capture trends. Option spreads can be left on until expiration and traded around. Time in the cycle can be anywhere from weeks to several months. For example, one company we know of positions option spreads to expire in the current month and possibly out 90 to 120 days. Capital committed to each expiration month is weighted according to a proprietary analytical model. Mark said "Over a quarter, if we lose money one month out of three, we know our model is working. More than one losing month in a quarter, would get us to look at what needs to be adjusted."
So time is relevant to strategy, and strategy functions relevant to current market conditions. A strategy can be designed that will adapt to most market conditions, or to dictate under what market condition it will profit from. We prefer the latter. To use a rigid strategy would be parallel to standing in front of an ocean wave and telling it to NOT crash on you! ALPHA does exist folks, when you know how to conduct your search. We cannot eliminate unwanted losses, however we can surely minimize them.
Building from a Causal Level
Remember that with managed futures, large amounts of money under management can lose performance potential. Sometimes, big is not good.
Rather than looking at past performance data let’s consider what causes results relative to the probabilities of markets acting a specific way during the duration of our investment.
WHY? Because we cannot predict trends in any market or sector. Most markets spend 80% of their time in sideways activity with a slight bias to the upside. Even during bear markets lows are higher. (Look at any weekly chart series over time).
If we first determine our needs including time and capital allocation, we can correlate several strategies integrating time needed for the strategy to function. The composite strategy can also compensate for, therefore avoid unwanted losses inherent with each strategy.
Capital can either be weighted or equally distributed. For example if a bull market in a specific sector is tiring we would be well advised to allocate less capital to a long term trending strategy in that sector. Systematic long-term trending strategies have tendencies to get chopped up until the market finds another trend, so we would be increasing our loss potential. We can increase capital allocations to short and medium term time strategies in futures and integrate option spreads that do well in sideways markets taking advantage of time decay.
Capital allocation to each strategy would be determined mathematically and can be rebalanced or shifted as market conditions in specific sectors become more definitive for the specific strategy. In essence you are creating a "Yield Curve Effect."
Tax Issues and Investment Returns
After TAX returns should be an integral part of your investment building process. For investors, futures, options on futures including stock index futures and options are taxed on both realized and unrealized returns at a 60%-40% split. 60% of the return is taxed as capital gains and 40% as ordinary income.
For example: Assume your managed futures account was funded with $50,000. Assume the account has unrealized gains of $9000 on December 31, 2010. You pay taxes on the $9000 gain. If you finally realize the gain at $6,000 in March 2011, since you already paid taxes on $9,000 the $3000 realized loss is reported on your 2011 return. 4
Stocks are taxed on realized gains and dividends. Awareness of TAX implications for managed futures relative to other investments is important. Stock investors need added caution when evaluating managed futures WHY?
Long Term systematic trend following advisors have a tendency to turn very large unrealized profits into very small-realized profits.
Especially when choosing trend-following investments, anyone can graph both realized and unrealized returns to see the stability between them. If differences are volatile we would probably avoid the investment as a stand-alone strategy. If returns are exceptionally good, and we perceive skill rather than market condition was responsible, we may consider integrating another strategy so the composite return potential was easier on the nerves.
Avoiding Losses
Preserving capital is paramount to successful managed futures. Many automated strategies bulldoze their way through choppy markets until a trend emerges that a particular strategy can capitalize on. Unfortunately your capital is chopped up by the bulldozer.
Building from cause rather than past results removes major errors in thinking, belief or habit that can result in massive unwanted losses. As proven by physics truth is consistent on all levels of physical reality. Once we eliminate the cause, symptoms cease to exist.
4 IRS Tax Bulletin #550 - Investment Income and Expenses Marked to Market Rules - Pg 38
3 Ellis - Winning the Losers Game - page 31-35
1 Charles Ellis - Winning the Losers Game page 135