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6.5 Basics to building Managed Futures portfolios
July 13, 2009
When many people hear the word portfolio, they usually think of their overall investment portfolio, comprised of stocks, bonds, real estate, and hopefully managed futures (if you are still weighing whether managed futures should be in your portfolio, check out our 2008 recap newsletter here).
But ideally, you should have portfolios within your overall portfolio. It isn’t enough to just diversify your overall portfolio amongst non correlated asset classes; you should also diversify within each of those asset classes.
Whether you are a veteran Managed Futures investor or just getting started with Commodity Trading Advisors, the key to long-term success, in our opinion, starts with the portfolio selection process. Unfortunately, that process can quickly turn into a daunting task of analyzing hundreds of programs, doing correlation analysis, and finally creating spreadsheets and formulas to see how the programs you chose work together in a portfolio.
The team at Attain has been putting together portfolios of trading systems and managed futures for years, and know how difficult it can be - not just in terms of choosing the right components, but also in creating the spreadsheets/databases/formulas, etc for analyzing the portfolio. We used to build these portfolios by hand in excel.
But help is on the way, as they say. Thanks in no small part to the many client suggestions, requests, and outright demands we have received over the years – we have created a free online portfolio tool for our current and potential clients on the Attain Capital website, as well as several other tools to help investors build portfolios that work for them.
Subscribers to the Attain website are instantly armed with the following essential tools for portfolio building:
1. Database of 500+ Managed Futures Advisors – Get monthly returns, intramonth DDs, correlation matrices, due diligence information, disclosure docs, & more by browsing through our database of managed futures programs. Click Here to view the searchable / sortable listings. Please note that you will be taken to our “recommended list” including only programs with at least 36 months of data by default and will need to select “Filter By” “All Programs” in the left hand tool bar in order to view more listings.
2. Watchlist – Put systems & CTAs you want to track into a watchlist for easy future viewing.
Click Here to view current mangers you are tracking or to “Add Programs” for future review/analysis.
3. Custom Portfolio Builder –Create & test your own portfolio ideas, combining different trading systems, CTAs, and F/X programs . Click Here to access our online tool for combining multiple managers and evaluating their statistical relationships (i.e correlation, Sharpe, etc).
Now for the fun part – For many investors the process of developing a portfolio simply comes down to optimizing the subcomponents to achieve the highest rate of return on the combined total, with the lowest historical drawdown, and using the least amount of capital. While this sounds good in theory, there is more to building a portfolio than just the numbers in our experience. Beyond the statistical data, there is fundamental data such as which markets/time frames/strategy types, etc. each program represents.
Below are the 5.5 Basic Steps to creating a portfolio which works both statistically and fundamentally.
Step 1: Narrow down your list of possible mangers. Using the above link to our “database of 500+ Managed Futures Advisors” and the filters along the left hand side you can quickly cut down the list using the following tips:
a. Filter by “Recommended”, “Most Searched”, “Recently Featured”, or “All Programs”. If viewing by recommended, you’ll note that we have done some of the leg work described below for you by offering a consolidated list of managers who we have expanded due diligence (including, in most cases, live trading experience with). If you prefer to view the larger list, then select “All Programs”.
b. Adjust the “Period” to show you the manger rankings over the past 36 months. All too often, investors are tempted to use the “All-time” tab which includes mangers who may have as short as 1 month of performance. In our opinion, portfolios should have at their base established managers with at least 3 years of live trading experience. Some larger portfolios could take a chance on a newer manager with 5% to 10% of their portfolio, but it is a higher risk play.
c. All mangers will initially be sorted by Attain’s “Flags”, which are our proprietary quantitative ranking system, with a larger number of “flags” meaning a higher ranking. For more information on the ranking system and criteria - click the following link: http://www.attaincapital.com/attain_answers#cat8. You can re-sort by whichever statistic you wish, and even add stats to the table by using the sort box in the left hand menu or the ‘add to list’ link in the upper right hand corner of the performance table.
d. The default for the main performance page is to not show managed futures programs with minimums greater than $1 MM (let’s face it, not all of us have $10-50 Million to allocate to one manager…why not diversify first), so if you want to view the big boys of the industry, make sure to check the >$1MM check box.
Step 2: Once you have filtered the main database and found some intriguing managers, step 2 is to build a “Watchlist” inclusive of a wide range of mangers. Every investor has her favorite way of evaluating possible investments – whether it’s to simply select the top performer, lowest drawdown, highest Sharpe ratio, etc., and that is a good place to start building the portfolio (but not advisable for finalizing a portfolio selection)
While the above is a valid initial step, the real value is adding mangers with a wide range of investment philosophies trading across multiple markets, time frames, and models. To determine a mangers basic investment philosophy you can view the program profile of each manager listed on the site by clicking on each mangers name and then selecting View / Program Profile”. For example, Mesirow Financial Commodities Absolute Return Strategy, the top ranked manager in the recommended list over the past 36 months, is described in their profile here: (http://www.attaincapital.com/managed_futures_rankings/profile/1514) as short term discretionary traders. If you have questions on any manager listed on our website or seen elsewhere please feel free to e-mail us at firstname.lastname@example.org for a more detailed description.
Whenever you find a manager you would like to add to your watch list, simply check the box next to the manager’s name and then select “Add to Watchlist” at the very bottom of any table you are viewing. Another way to add a manger is to select “Add to Watchlist” below the monthly performance table when reviewing an individual manager.
As a quick tip – Do not discriminate between mangers that have higher minimum investments than you are considering allocating…Remember Managed Futures offer the unique advantage allowing investors to create their own leverage through the use of notional funding. To learn more about notional funding here is a link from our website: http://www.attaincapital.com/attain_answers.
Step 3: Take a step back and consider the risk of the programs you are looking at, thinking how much capital are you willing to LOSE. Most people concentrate on how much money they can MAKE when building a portfolio, but we find that concentrating on the potential downside before considering the upside is a better approach.
This step requires some soul searching, and nearly all investors overestimate the amount of money they are comfortable losing during a drawdown phase. Most people aren’t comfortable losing any money, so it is a bit of an odd thing to consider how much you want to lose (you don’t want to lose anything!), but this step helps to keep your portfolio size under control.
For each manager you are considering, ask yourself if you are willing to lose an amount equal to their Max DD times 1.5. A further exercise is to consider whether you would be willing to lose an amount equal to the sum of the Max DD for each component of the portfolio. That is unlikely to happen thanks to managers doing different things, but the probability is still greater than zero.
Step 4: Determine each manager’s “True Minimum”. What do we mean by true minimum? Simply put, in Managed Futures, investors don’t have to actually invest the stated minimums for each program; as the technical amount to trade a program (the margin usage) is usually only 10% to 20% of the total amount the manager recommends as a minimum. Thus there is the listed minimum for each program, and a smaller (usually 1/3 to ½ of that amount) true minimum, which is all the investment technically requires. We view the true minimum of each program as the average margin use + the historical maximum drawdown amount. Going back to our December 22nd, 2008 newsletter will help clarify this topic, and give you an initial list of “True Minimums” to work from: http://www.attaincapital.com/managed_futures_newsletter/311. The true minimum is an important concept, because it opens up the possibility of trading 5 managers with minimums totaling $3 Million with just $1 Million in cash. This ability to leverage your capital across managers is obviously very appealing to some investors, but it should not be considered apart from Step 3 = considering the risk.
Step 5: Finally, the last step is to build and evaluate your portfolio. Now that you’ve narrowed your list of managers by adding them to your Watchlist, determined your risk/ reward goals, and calculated each managers true minimum, it is time to build the thing and see how it looks.
When reviewing your portfolios, also take a minute to review the correlation analysis below the monthly performance tables. Correlation is a statistical measure of the relationship between each of the sub managers, and varies from -1.00 to +1.00. A high reading 0.50 to 1.00 means two investments will tend to move together (winning when the other wins, and losing when the other loses), while a larger negative reading 0.50 to -1.00 means two investments will tend to act in opposite ways (winning when the other loses, and losing when the other wins). Ideally we’d like to see the underlying components offer correlations right in the middle of this range (between 0.4 and -0.4). Too high and you aren’t getting diversification, too low and you’re just spinning your wheels with gains in one program being offset by losses in another. We want each program to perform independently.
Also, of particular interest, is the difference in investment styles between the managers. One of the biggest issues investors face is over optimization within their portfolio, as people tend to like to go with the investments style that’s producing returns right now when constructing their portfolios.
For example, if we went back in time to January 1st 2007 and chose to build a portfolio based solely on the programs which had performed best over the past 36 months (highest Sharpe ratios), it’s more than likely that many of us would have selected a portfolio composed of all option selling mangers.
For those who didn’t read our newsletter last week (http://www.attaincapital.com/managed_futures_newsletter/340), such naïve portfolio construction would have resulted in terrible performance over the next two years. Meanwhile, a portfolio which included underperforming multi-market systematic managers would have done quite well as volatility spiked.
Fast forward in time to January 1st 2009, where most investors putting together portfolios were making the same mistake in reverse, including only the mutli-market systematic programs which performed well in 2008 at the expense of programs which should do well if volatility subsides. While not drastically bad, many multi-market systematic programs have fallen short of their 2008 return levels, leaving the portfolios of many underperforming. These two real world examples should drive home the point that it is best to diversify your managed futures portfolio, getting exposure to as many different strategy types as your capital level can support. Have some systematic, some discretionary, some option sellers, some spread traders, and some single market specialists.
Step 5.5: Realize that you have put together your portfolio with the benefit of hindsight. There is a lengthy risk disclaimer accompanying the portfolio performance reports which explains that while the results of CTAs within a portfolio actually happened in client accounts, the portfolio as a whole may have never traded together, and thus should be considered hypothetical in nature. Pay this disclaimer more than the normal lip service. You may have the best looking portfolio in the world when you’re done, but an exact repeat of its components zigging while the others zagged exactly as they did in the past is highly unlikely. To overcome this portfolio over-optimization, we recommend finding a program on our site that you think is terrible; and adding it to the portfolio. This will allow you to stress test the portfolio in a way, and see what would have happened if one of your selections “blew up”.
Step 6: The last tiny step is to be patient in the portfolio start up process. It may seem best to get the portfolio running right away, but we recommend investing a smaller amount on day one and holding off on the full target investment until your target programs enter drawdown phases. While your portfolio may be slightly overweight to one group of mangers in the first 1-3 months we firmly believe in the power of investing in Drawdowns (see June 8, 2009 newsletter: http://www.attaincapital.com/managed_futures_newsletter/331).
There have been countless studies and white papers done on portfolio management, and while the above just barely scratches the surface (we could go on and on discussing when and how you should rebalance your portfolio, correlation analysis, stress testing, and so on), we hope to have relayed the importance of utilizing the right tools to build a portfolio that fits your parameters.
Armed with the above steps, we encourage you to login to the Attain website and take the time to construct your own portfolio of managers. If you are already trading a portfolio, use our tools to evaluate your current holdings. Perhaps two managers are more highly correlated than you would like? If you have not used our portfolio tool yet, what are you waiting for? Take the time to educate yourself on the range of mangers and their relationship to one another, then go wild and build a portfolio that is right for you. It’s free to use, and anyone at Attain is ready and able to answer any questions you have. If you would like an online demo of how to use our portfolio tool please give us a call at 800.311.1145 or 312.604.0926 or e-mail us at email@example.com.
- Jeff Eizenberg
IMPORTANT RISK DISCLOSURE
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Most markets seemed to want to go lower last week as concerns about economic recovery and nervousness ahead of quarterly earning kept market participants uneasy during the past week. The headline news was the weaker consumer sentiment as the latest reading dropped to levels not seen since the March figure when the financial sector was just starting to turn the corner. For the fourth consecutive week U.S. equity index futures ended with a mostly softer tone with Russell 2000 futures -3.88%, Mid-Cap 400 futures -3.80%, S&P 500 futures -2.13%, NASDAQ futures -2.02% and Dow Futures -1.89%.
Energy futures featured another round of weaker activity on growing negative economic concerns which sparked fears of lower demand. The nervousness of lower demand seemed to run industry wide with announcements of refinery shutdowns by major oil players due to poor profitability. The news seemed to shake confidence even more as the shutdowns will lead to more supply on an already burdened situation. For the week RBOB Gasoline futures ended -11.32%, Crude Oil futures -10.34%, Heating Oil futures -9.97% and Natural Gas futures -6.78%.
Activity in metal futures was also a victim of economic worries not only in the U.S., but abroad as some indicators pointed to weaker than expected conditions. The headlines sparked another rounds of position squaring in the sector that has been the base for inflationary and growth expectations. For the week Platinum led the way down -7.27% followed by Palladium -6.86%, Silver -5.78%, Copper -6.86% and Gold -1.98%.
The Commodity and Food sectors was a fairly mixed affair last week with grains again seeing heavy pressure on ideal growing conditions in the U.S., along with news that export demand may have seen its peak for the year according to the USDA. Activity in livestock was mixed as Lean Hogs advanced on improving market internals and Live Cattle declined from weaker cash and product prices. Soft commodities were mixed, although OJ posted an impressive rally on ideas dry conditions in South America could hamper production. Crop risks also boosted price activity in both Cocoa and Cotton. For the week OJ ended +17.81%, Cocoa +6.05%, Lean Hogs +4.13% and Cotton +2.36%. Weaker products were led by Coffee -2.98% followed by Sugar -1.85% and Live Cattle -1.74%.
Currency futures activity again led to the Japanese Yen advancing against the balance of the complex as perception of more stable economic conditions in Japan versus the rest of the major global economies sparked flight to quality support. News from the U.K. of no further plans to induce more economic stimulus sparked pressure in the continentals. For the week the Japanese Yen ended +3.46 and the U.S. Dollar index futures eked out a +0.06% advance. The British Pound -1.26% led the decliners followed by Euro currency -0.42% and Swiss Franc -.26%. The rate sector posted a nice rally last week sparked mainly by the weakness in other areas most notably the stock market with 30-year Bonds +1.63% and the 10-year Notes +1.68%.
Option-trading managers continued their high level of performance in the first week of July after standing tall in June. Once again, the top performer thus far in July has been FCI; however this time it is the original Option Selling Strategy (OSS) leading the way with estimated returns of +1.96%. OSS historically sells options further out of the money than its sister program CPP (which also includes long option protection at times).
Other Option Trading estimates are as follows: ACE Investment Strategists +0.75%, Cervino Diversified +0.54%, Cervino Diversified2x +0.75%, Crescent Bay PSI +0.37%, Crescent Bay BVP +1.36%, FCI CPP +0.80%, and Raithel Investments +0.22%.
Specialty mangers are off to a mixed start in July with Rosetta Capital leading the way +2.26%. Rosetta is hoping that this trade is the start of a revived trading environment for their program which has been relatively inactive vs. prior years. Elsewhere, Emil Van Essen Spread Program is ahead +0.56%, NDX Abednego is down -1.07%, and NDX Shadrach is down -1.69%.
Multi-Market managers faced turbulent waters right off the bat in July with energies, grains, and soft commodities all falling drastically during the first two weeks of trading. Many managers came into the month bullish on energies and grains along with some long soft (sugar, cotton, coffee) positions as well. Perhaps more frustrating than the losses is that commodities continue to have a very high correlation to the stock market. This has made trading very difficult for managers and systems who expect commodities to trade on their own and have a few degrees of separation from the stock market.
Despite the difficulties some multi-market managers are performing very well this month. Leading the pack is Integrated Managed Futures Global Concentrated program est. +2.15% for the month. Integrated has outperformed their peers for the last month and a half and aren’t showing any signs of slowing down soon. Hoffman Asset Management has also survived July so far at +1.53% est., followed closely by Clarke Capital Global Mangum at approximately +1.23%. Other managers up for the month include Clarke Global Basic +0.60% est., and Dominion Capital Management +0.41% est.
Managers that have struggled in July include Mesirow Financial Commodities Absolute Return -0.09% est., Mesirow Financial Commodities Low Volatility -0.01% est., DMH at -0.25% est., Futures Truth MS4 -0.29% est., Futures Truth SAM101 -0.32% est., APA Strategic Diversification -1.80% est., Lone Wolf Investments -1.97% est., Robinson-Langley -2.74% est., and APA Modified -5.50% est.
In short-term stock index trading, Paskewitz Asset Management Contrarian 3X Stock Index stands at -2.74% est. and MSLO -0.03% est. month to date.
It was encouraging to see stock and bond volatility pick up last week but you wouldn’t know it from the trading system results, day trading systems in particular. More often than not, the market would gap higher or lower in the overnight session, get all the programs trading in one direction and then reverse course at some point in the session to trim advances/declines to a minimal amount. The swing programs fared better than the day trading systems, but still weren’t anything to write home about.
Beginning with the day trading systems, Compass SP was the only system able to keep its head held high +$200 for the week. Other results were ATB TrandyBalance v2 Dax-295€, Rayo Plus Dax -415€, Viper II ES -$545, Clipper ERL -$750, Waugh ERL -$1,035.12 and ATB Welcome v2 Dax -2,070€.
Moving on to the swing systems, Jaws US 400 was shining star +$1,829.37 for the week followed by Waugh Swing ES +$582.50 and AG Mechwarrior ES +$165. Ultramini ES had two trades for -$785 for the week.
IMPORTANT RISK DISCLOSURE
Futures based investments are often complex and can carry the risk of substantial losses. They are intended for sophisticated investors and are not suitable for everyone. The ability to withstand losses and to adhere to a particular trading program in spite of trading losses are material points which can adversely affect investor returns.
Past performance is not necessarily indicative of future results. The performance data for the various Commodity Trading Advisor ("CTA") and Managed Forex programs listed above are compiled from various sources, including Barclay Hedge, Attain Capital Management, LLC's ("Attain") own estimates of performance based on account managed by advisors on its books, and reports directly from the advisors. These performance figures should not be relied on independent of the individual advisor's disclosure document, which has important information regarding the method of calculation used, whether or not the performance includes proprietary results, and other important footnotes on the advisor's track record.
The dollar based performance data for the various trading systems listed above represent the actual profits and losses achieved on a single contract basis in client accounts, and are inclusive of a $50 per round turn commission ($30 per e-mini contracts). Except where noted, the gains/losses are for closed out trades. The actual percentage gains/losses experienced by investors will vary depending on many factors, including, but not limited to: starting account balances, market behavior, the duration and extent of investor's participation (whether or not all signals are taken) in the specified system and money management techniques. Because of this, actual percentage gains/losses experienced by investors may be materially different than the percentage gains/losses as presented on this website.
Please read carefully the CFTC required disclaimer regarding hypothetical results below.
HYPOTHETICAL PERFORMANCE RESULTS HAVE MANY INHERENT LIMITATIONS, SOME OF WHICH ARE DESCRIBED BELOW. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN; IN FACT, THERE ARE FREQUENTLY SHARP DIFFERENCES BETWEEN HYPOTHETICAL PERFORMANCE RESULTS AND THE ACTUAL RESULTS SUBSEQUENTLY ACHIEVED BY ANY PARTICULAR TRADING PROGRAM. ONE OF THE LIMITATIONS OF HYPOTHETICAL PERFORMANCE RESULTS IS THAT THEY ARE GENERALLY PREPARED WITH THE BENEFIT OF HINDSIGHT. IN ADDITION, HYPOTHETICAL TRADING DOES NOT INVOLVE FINANCIAL RISK, AND NO HYPOTHETICAL TRADING RECORD CAN COMPLETELY ACCOUNT FOR THE IMPACT OF FINANCIAL RISK OF ACTUAL TRADING. FOR EXAMPLE, THE ABILITY TO WITHSTAND LOSSES OR TO ADHERE TO A PARTICULAR TRADING PROGRAM IN SPITE OF TRADING LOSSES ARE MATERIAL POINTS WHICH CAN ALSO ADVERSELY AFFECT ACTUAL TRADING RESULTS. THERE ARE NUMEROUS OTHER FACTORS RELATED TO THE MARKETS IN GENERAL OR TO THE IMPLEMENTATION OF ANY SPECIFIC TRADING PROGRAM WHICH CANNOT BE FULLY ACCOUNTED FOR IN THE PREPARATION OF HYPOTHETICAL PERFORMANCE RESULTS AND ALL WHICH CAN ADVERSELY AFFECT TRADING RESULTS.