Compared to mutual funds, the 30 plus year old managed futures industry is young. Today the industry manages well over $400 billion. Only when well done, managed futures fill a void having no competition. SafeMoneyMetrics® is a multi-purpose risk management service for managed futures sponsors, investors and we hope traders.
Stage One –Advisor Selection
Assume the initial allocation for a private label fund is $1 Million. The general partner and risk manager can be anybody. The following scenario assumes no knowledge of, insight into or personal connections to the managed futures industry. We believe that anyone can access the best this industry offers using common sense and SafeMoneyMetrics®.
Find a data-base of advisors from any web site or futures broker. For example www.iasg.com www.autumngold.com or search the internet.
Another idea is to ask any clearing firm for recommendations.
Verify professional background with the National Futures Association www.nfa.futures.org. Everyone you can legally work with should be registered and have no complaints filed against them.
POINT – do not allow yourself to be manipulated by “proprietary “information that delivered profits to someone else’s account yesterday!
Select a few advisors with reasonable past performance data that accept $1M account sizes or less. Three simple SafeMoneyRatios® are needed to begin any selection process. All information that you need is public and taken from each advisors 13 column track record. You can request the 13 column from each advisor.
- Net Ratio - Defines actual capital at risk relative to volatility of total returns. Formula = Net Realized and Unrealized Trading Profits / Maximum or Average Margin.
- Funding Level Ratio - Defines volatility of returns at the accounts minimum funding level. Formula = Net Realized and Unrealized / Actual Cash
- TR-ROR - The traditional rate of return required by regulations, calculated using the fully funded account size. (Notional Assets). Formula = Net Realized and Unrealized / Notional Assets
The TR-ROR is the least accurate method of evaluating risk/return. It will always cause the most misery if used in current form. Its’ value to SafeMoneyMetrics®™ is a benchmark for correlating other ratios.
WHY? People compensate advisors a management fee on the fully funded account size or Notional Assets – We need to compensate advisors having the greatest level of skill under any given market condition. There is a large difference between trading skill and trending markets. Skill can superficially be qualified by evaluating the three simple ratios defined above, over specified time frames. If we do only that weensy simple task – we are 90% better off.
WHY? – The TR-ROR has no relevance for qualifying or quantifying an advisor’s skill, how much capital is at risk relative to realized returns and volatility under any given market condition! We prefer knowledge of how a really good advisor manages risk under variable market conditions, when they have the most challenges and when they would give up on themselves.
A |
B |
C |
D |
E |
F |
G |
H |
I |
J |
Advisor |
Account Size |
Funding |
Maximum Margin |
Margin $ |
Margin % of Funding Level |
Net Realized / Unrealized |
TR-ROR |
Funding Level Ratio |
Net Ratio |
1 |
$1,000,000 |
$300,000 |
5% |
$50,000 |
17% |
$300,000 |
30% |
100% |
600% |
2 |
$1,000,000 |
$500,000 |
10% |
$100,000 |
20% |
$300,000 |
30% |
60% |
300% |
3 |
$1,000,000 |
$250,000 |
20% |
$200,000 |
80% |
$300,000 |
30% |
120% |
150% |
4 |
$1,000,000 |
$700,000 |
15% |
$150,000 |
21% |
$300,000 |
30% |
43% |
200% |
5 |
$1,000,000 |
$400,000 |
25% |
$250,000 |
63% |
$300,000 |
30% |
75% |
120% |
6 |
$1,000,000 |
$600,000 |
8% |
$80,000 |
13% |
$300,000 |
30% |
50% |
375% |
7 |
$1,000,000 |
$350,000 |
30% |
$300,000 |
86% |
$300,000 |
30% |
86% |
100% |
8 |
$1,000,000 |
$800,000 |
15% |
$150,000 |
19% |
$300,000 |
30% |
38% |
200% |
9 |
$1,000,000 |
$900,000 |
5% |
$50,000 |
6% |
$300,000 |
30% |
33% |
600% |
Advisors 1-9 in the hypothetical table above earned a Traditional ROR of 30% during the time frame used for this demonstration. (Column H). All advisors also have $1M account size requirements. (Column B). If we only had knowledge of those two values, we know nothing and should do nothing.
- Begin with Column C, Funding level. It represents actual cash you can fund your account with.
- Now look at Column F. It represents margin used as a percent of actual cash, or capital you can fund the account with.
- Eliminate advisors 3, 5, and 7 because their margin relative to actual cash is too high. (Column E & F).
- Now eliminate 4, 6, 8 and 9 because their funding level cash relative to required account size is too high. (You can get the same return using less cash.) (Column B & C).
You want the greatest return and lowest risk using least amount of capital. Advisors 1 and 2 are where stage two of our analysis begins.
Information below was originally written for article # 29 Volatility, Illusion or Reality. Traditionally, volatility of return is quantified by the standard deviation of monthly returns over a specified time frame relative to the average return for the same time frame. SafeMoneyMetrics® does not care how volatile returns are from an average for several reasons.
- We use past performance data as a benchmark for determining advisor skill under variable market conditions. SafeMoneyMetrics® monitors relationships between ratios to each other, relative to current market conditions. When specific relationships remain consistent profitability is an expected by-product. Nothing else is possible!
- The exact analysis can also be applied to each market traded by each advisor. Daily analysis for each trader can start with each new client account. Client accounts are analyzed relative to the advisors composite monthly performance for all accounts. Please see Client Risk Management Services.
- Volatility of return on an individual advisor seems less important than capital at risk relative to return for the composite account, then each advisor, then each market traded by each advisor.
- Quantifying an advisors ability to translate unrealized profit into realized return is the major analytical priority of SafeMoneyMetrics®.
We apply a standard deviation to SafeMoneyMetrics® data, as one measure of risk. A correlation and relationship between the Realized and Volatility Ratio is established to evaluate volatility of unrealized account value relative to realized profits. ( See chart below).
The data table below represents the average minimum and maximum of three ratios from inception of trading through the end of October 2010. The advisors maximum loss was negative 23.84% only on capital at risk. That means he never lost more than 24% of the capital used for trading purposes. That capital only represents a specific portion of the total account size! When that information is integrated with Stage One analysis – we have a benchmark for future performance –
Oct -10 |
Realized Ratio |
Volatility Ratio |
Net Ratio |
Average |
18.28% |
-0.09% |
18.27% |
Minimum |
-23.84% |
-7.83% |
-23.84% |
Maximum |
200.96% |
7.99% |
200.96% |
The chart below analyzes relationships between the SafeMoneyMetrics® realized, volatility and net ratios. Volatility measures capital at risk relative to open trade equity on unrealized positions. The green realized (profitability) parallels the blue net ratio (difference between realized and volatility).
Data below zero represents negative returns. Negative returns are quantified as a percentage of capital at risk. For example, imagine that margin requirements are used for each market as a foundation for the capital at risk formula. In this instance the advisor’s maximum loss was under 25% of the margin requirement, NOT the entire account value. The analysis can be applied to a composite multi-advisor portfolio, each advisor, then each market.
Stage Three Time Windows
Time windows quantify a time frame in which the portfolio can comfortably deliver quality. Many people lose money because their time expectation of what a trader can do is unrealistic. Because past returns can never be duplicated; analyzing quality of return and skill under most market conditions can prevent unwanted losses. Also an investor’s objectives may be mismatched for a particular advisor – in those situations everyone loses.
Realized |
3 Mo. |
6 Mo. |
9 Mo. |
12 Mo. |
Average |
17.88% |
16.99% |
15.02% |
14.02% |
Minimum |
-9.05% |
-3.93% |
-1.15% |
-0.47% |
Maximum |
80.16% |
56.27% |
37.95% |
29.48% |
|
|
|
|
|
Volatility |
3 Mo. |
6 Mo. |
9 Mo. |
12 Mo. |
Average |
0.06% |
0.03% |
0.03% |
0.03% |
Minimum |
-2.61% |
-1.30% |
-0.88% |
-0.66% |
Maximum |
2.66% |
1.33% |
0.89% |
0.67% |
|
|
|
|
|
Net |
3 Mo. |
6 Mo. |
9 Mo. |
12 Mo. |
Average |
17.94% |
17.02% |
15.05% |
14.05% |
Minimum |
-9.05% |
-3.93% |
-1.13% |
-0.47% |
Maximum |
80.16% |
57.12% |
37.90% |
29.45% |
Time windows solve all three problems because they offer a rational performance expectation giving clients a comfort zone to live with. Specifically: Short term traders should show profitability sooner rather than later. Assume you are a buy and hold investor, working with day traders might drive you over the edge! Longer term trend following traders may be a wiser choice for you. If you are fundamentally selective when picking stocks, systematic (auto-pilot), diversified traders that lose money is 23 of 27 markets traded may not work well for you!
Stage Four – Capital Allocation
Details and variations on other themes will be offered in subsequent articles – for now you probably have enough to think about – Superficially – after we determine the strongest ratios for individual advisors, capital is allocated between two or more advisors until the mix optimizes the most beneficial composite ratio.
Specifically – greatest risk is defined by the relationship between a maximum Volatility and minimum Realized Ratio. Think about it. High volatility and low profitability is not healthy! A multi-advisor portfolio should reduce maximum risk demonstrated by the relationships between those two ratios. The combination should offer less risk than any single advisor used in the portfolio.
Once maximum risk is quantified, upside potential is optimized. Upside is represented by the maximum realized and minimum volatility. (High realized profits and low volatility.) Finally, most of the time investments do nothing. Our nothing time is minimized. Nothing is represented by the middle ground of realized to volatility – For example – a low volatility and flat or negative realized ratio represents nothing.
The composite investment should prove less time doing nothing than either advisor can offer alone.
Stage Five – Investment Monitoring
Client Risk Management is used when an investment begins trading. Information from the daily equity run is used to create SafeMoneyMetrics® ratios. Carefully look at the CRM PDF demo at the Client Risk Management web page. Monthly advisor data used to build the portfolio continues to be updated and analyzed. It then represents the “internal benchmark” used to compare with the investment.
When imbalances in the composite realized to volatility ratio are perceived (relative to the benchmark) – SMM evaluates each advisor within the mix. Custom analysis includes each market traded by each advisor. The weakness is easy to locate. Advisors can be notified or capital reallocated. Decision making rules are built into the analysis.
Traders have opportunity to constantly evaluate trades relative to current market conditions and their own performance. The value of this process is worth an entire article because it strengthens people and lowers fear. Every client has a personal SafeMoneyMetrics® workbook. The system uses excel and produces pdf reports. The file can also be used to create client presentations. Finally each client workbook, serves as a valuable component of the compliance process.
SafeMoneyMetrics® “raises the bar” for advisor selection and building multi-advisor portfolios. More important it’s an exceptional self-monitoring research and marketing strategy for traders, at no added cost. Over time advisors with high ratios will grow in numbers, equity under management and happy clients.
Futures and Options on Futures are designed to manage risk, create stability and preserve wealth. Markets are only created to manage volatility and risk of the related cash markets. Managed futures are a by-product of the markets fundamental purpose and should only be considered within a similar context of risk management. We believe that beyond modest returns and increased stability that nothing more or less should be expected from the investment.
Always Wishing You Profit and Peace of Mind