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Managed futures secret weapon: Interest earning Treasury Bills
August 11, 2008
A Wall Street Journal article last week trumpeting the fine returns of Harvard’s endowment fund, which at $35 Billion has been among the best performing institutional investors over the past several years, pointed out an interesting tidbit - that part of Harvard’s success over the past year was due to “plain vanilla [US] Treasury debt”.
The article also mentioned how Harvard remains one of the most aggressive institutional investors in terms of exposure to alternative investments including a hopping 17% in commodities, as well has hedge fund exposure.
While commodities and Treasury debt may sound like the big leagues and only accessible to billion dollar institutional investors such as Harvard, they are in fact two of the cornerstones of the much more accessible managed futures industry.
We can easily see how commodities fit into the managed futures industry; with the professional Commodity Trading Advisors (CTAs) who make up the industry managing client’s money through investments in commodity futures. Many people seek out a managed futures for just that – commodity exposure on both the long and short side.
But managed futures secret weapon, so to speak; is its ability to harness the power of US Treasury debt at the same time it is putting trades on with commodity futures. In short, the secret weapon is the ability to earn both interest and trading returns on the same money.
Most asset classes simply can’t offer this. You can’t buy a house for $500,000 and earn interest on that $500K for example; nor can you purchase $100,000 worth of stock, and at the same time earn interest on that $100K. But in managed futures, you can invest $250,000 in a CTA, and at the same time earn interest on the majority of that $250K.
I would venture to guess that many of you have been told that futures accounts don't pay interest, and have your money sitting there only increasing due to trading gains, with no interest gained at all. It is true that futures accounts generally don't pay interest - but it is one of those half truths my mother used to warn me about. The real truth is that while the account itself can't pay interest - you can purchase US Treasury debt instruments such as T-Bills in the account, and those sure do earn interest.
For all those within ear shot - let me repeat that. You can purchase a T-Bill in your futures account and earn interest on your trading capital. You're either with a broker who has been honest and told you this, or you're not and it may be time for a change (call Attain at 800.311.1145).
Why is this not advertised and more widely talked about in the futures industry? Just follow the money. The clearing firms earn the interest on your money when you don't, then share a portion of that interest back to the broker. It is a large portion of a clearing firm's revenues, and a nice paycheck for the brokers as well. Nobody wants to spoil the golden goose, and Attain is likely to get booed and hissed by the brokerage community for writing it up in a newsletter.
But we have long recommended investors purchase T-Bills to gain a little extra every year, and will continue to do so - as we believe you should make the interest on your money - not us.
How do Treasury Bills work?
Well, first of all - Treasury bills, or T-bills, are short term government debt obligations (meaning bonds). The government issues them every week to cover short term shortages in their cash flow, following the scary logic of you can always pay it back later. Investors lend the government the money for 1 to 6 months, and the government pays the investors back what they lent them, plus interest when the time is up.
The bills are sold at a discount from their face value, meaning you might pay $49,000 for a 180 day, $50,000 T-Bill on January 1st. In 180 days, or roughly six months later on July 1st - the bill matures and you would be paid the full $50,000. The $1,000 difference between the purchase price and face value is the interest you earned.
Some of you might be saying – “So what? I can buy T-Bills in my normal investment account”. Why tie up money buying them in my managed futures account. The answer is the “secret weapon” we spoke of earlier and the good part for futures traders: the T-Bill can be used as margin.
So you don't need to have $100,000 to cover the margin for your investment in a CTA or trading system; and another $100,000 to put into T-Bills. You can use the same $100,000 to both buy T-Bills and cover margin for your investment in a futures program.
That’s right, the T-Bill does double duty – with the clearing firm posting the T-Bill to the exchange on your behalf to cover margin and you earning the interest on it while it sits with the exchange. The clearing firms do build in a little buffer for themselves as a risk precaution, and only allow around 90% of the T-Bill's face value to be used as margin, but that's plenty enough for most investors purposes.
Attain recommends holding 80% of your total account value in T-Bills. This allows for the account to go through its normal fluctuations without having to "bust" the T-Bill to cover margin requirements or because there is not enough cash in the account. "Busting" a T-Bill is little more than selling it back before it matures, which costs a little extra in fees - but you do get back any accrued interest up to that point. (in rare cases, the price you sell it back for could be slightly less than you purchased it for)
As an example, if you have a $100K account, and buy an $80K T-Bill at the discount price of $78,000, you would have roughly $22,000 in cash left in the account. If the CTA or trading system you're invested in had a drawdown of -$25,000, for example; that would leave your cash balance below zero, and the T-Bill would have to be busted to bring the cash balance back into positive territory.
One downside to holding T-Bills in your futures account is that the clearing firms have made it nearly impossible for you to read your statements accurately when you hold a T-Bill. Depending on the clearing firm, they either list the Bill's face value or 90% of the face value, even though the actual value is the purchase price, plus any accrued interest to that date - and they don't include any of the T-Bill's value in your liquidating value or cash balance. For first time buyers of T-Bills looking at their statements the next day, it’s as if they lost $50,000 in the day following the purchase of the T-Bill - as the totals they are used to looking at don't reflect it.
And one other important note for those investors having their accounts professionally managed. You don't want to purchase a T-Bill in the account the advisor in managing. The interest earned will increase the value of that account, and you don't need to be paying the advisor 20% of the profits due to interest, just pay him or her on the profits due to their trading.
Attain solves this by holding an investors total cash balance in a master account, then purchasing T-Bills in that account and allocating out to CTAs through related sub accounts.
And finally, if you have a broker telling you that you can only purchase a T-Bill on the margin excess in your account (which is sometimes just 30% to 70% of the account), don’t believe it. Again, 90% of the T-Bill can be used for margin, so the truth is you can purchase bills above the amount of margin excess you hold.
So why not earn an extra couple basis points on your account balance. They don't require huge accounts to do so - anything above $30,000 or so is a good starting place. T-bills can be used as margin, they can be busted in a day's notice and turned liquid, and they are considered to be the most secure and safe investment in the world. In short - start using your money to make money - start holding T-Bills in your futures account.
The charts below show the hypothetical growth of $100,000 invested in T-Bills over the past 15 years (no risk sure looks nice when charted, doesn’t it), and the comparison of the compounded growth of $250,000 invested in the Clarke Global Basic program on its own, and again with 80% of the balance rolled into 180 day T-Bills every 6 months. You can see that the T-Bill account earns nearly $200,000 more over the past 10 years !
PS - The ability to post US Treasury Debt instruments such as T-Bills also opens up the ability to do Capital Protection plans in a managed futures account; where the discount amount of a zero coupon amount is only put at risk, insuring that even if that amount is lost, the account’s principal will be intact when the bond matures. You can read more about this technique in a past Attain newsletter here: http://www.attaincapital.com/newsletters/238
PPS - If you're asking what if I hold my account in Euros, Pounds, Yen, or others, unfortunately T-Bills must be purchased in US dollars, but for large investors with balances of $1 Million or more - Attain has secured clearing arrangements in which Euro Bunds or Bobls can be held in the account in the same manner as US T-Bills.
IMPORTANT RISK DISCLOSURE
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Sizable market movements were again evident in several commodity sectors during the past week; with the activity in the U.S. Dollar catching the most attention. The U.S. Dollar rallied +3.28% to levels not seen since late February, with the Euro -3.65% suffering the most as the European Central Bank kept rates steady. The ECB also stated that further rate hikes could be a thing of the past, especially with economic conditions in Europe slowing down and inflation sector prices showing sign of further retreat. For the week other currency futures like British Pound lost -2.78%, Japanese Yen shed -2.30%, and Swiss Franc dropped -2.97%
The metals added to downward momentum from the previous week on lower inflation concerns. The mentality seemed to accelerate due to the gain in the U.S. Dollar which was again more evident in the industrial metals with Silver -12.50%, Palladium losing -10.98%, and Copper falling -8.97%. Platinum –5.89% and Gold -5.85% followed the lead of industrial metals.
The U.S. Dollar gains also sparked another round of selling in the energy complex. Crude Oil lost -7.02%, RBOB Gas shed -6.49%, and Heating Oil lost -8.09%. Natural Gas again found added pressure due to lighter demand than expected summer demand due to cooler temperatures and ended the week down -12.26%.
The grain and food sectors were mostly lower last week with activity in the grains being the main feature as they lost more risk premium due to U.S. Dollar gains, but also a continued favorable weather scenario which will in all likelihood increase production despite early season flooding problems. Soybeans lost -13.62%, Corn shed -11.52% and Wheat ended down -3.62%. Most sectors in the food arena followed suit as Cocoa lost -10.39%, OJ was down -4.83%, Sugar fell -4.14%, and Coffee lost -3.21%. The livestock sector again posted higher results as Lean Hogs gained +8.42% on continued strong foreign purchases and Live Cattle ended up +1.76% on tighter U.S. supplies.
Finally, stock Index futures also reacted to the stronger US currency on ideas yield potential will improve versus other foreign venues. This was especially evident as the sector turned away bad earnings news from both Fannie Mae and Freddie Mac to post strong weekly gains. Dow Futures led the way with a gain of +3.37%, followed by S&P futures that added 2.58% and the NASDAQ which ended +1.50%. The small caps also posted gains with the Mid-Cap +1.43% and Russell finishing the week +1.07%
Contrary to many market participants consensus that August was going to see a slow down in market volatility; a slow down has been far from the reality after the first week of trading and is having an impact on the option trading mangers. The top performing manger thus far has been LJM Partners who is ahead +1.23% to start the month. Their trading involves a complex strategy of selling both puts and calls on the stock index futures and is ahead +30.70% for the YTD though July. LJM has been running live for client accounts since 1999 with an annualized return of 32.15% and maximum drawdown of 46.54%.
On the downside of this month’s volatility, FCI has an open trade loss of approximately -7% heading into today's market action. As with most option selling strategies, they are subject to volatility spikes in individual markets causing for quick negative spikes against the portfolio - substantial moves in markets like Soybeans, which has fallen over 15% so far in this month, are examples of moves that can cause for quick volatility spikes. Coming into August FCI was ahead 17.77% for the year.
Other option trading estimates for August are as follows: ACE Investments +0.91%, Cervino Diversified Options +0.33%, Cervino Diversified 2x +0.70%, Cervino COP -0.27%, Crescent Bay PSI -0.90%, Crescent Bay BVP -3.02%, Diamond Capital flat, Rathiel +0.49%, Zenith Index +0.42%, Zenith Diversified +0.39%, Zephyr Aggressive +0.69%, Zephyr Moderate +1.87%.
With all of the volatility in the grain and agriculture markets we'd also expect to see some swings with these mangers as well. Thus far Chicago Capital is leading the way with returns of +0.84% as they work their way back into the black for the year - the program was down -0.36% through July. Elsewhere, Rosetta is ahead +0.5% while the NDX suite of strategies are down -2.8% (Abednego) and -5.02% (Shadrach) to start the month. Looking ahead, tomorrow is the first major crop report of the year and promises to provide some excitement in the above markets...stay tuned to next weeks update to see how the mangers faired.
The first week of August last week saw many of the trend following and other multi-market managers which struggled in July thanks to the quick and somewhat drastic sell off across many commodity markets; start to rebound.
Most of the open trades which caused the July losses have now been closed out and new positions are being established as new trends emerge in the marketplace. So far in August nearly all of the multi-market CTA’s tracked by Attain are in the black including Clarke Capital Management which has jumped out to impressive August gains thus far.
The Clarke Capital Global Basic program has been this month’s top performer with estimated returns of +16.78%. The manager has opened several short positions in the foreign currencies; which has proven proficient thus far as the US Dollar has reached its highest level since February. The Clarke Global Magnum program has also done well so far this month with estimated returns of +8.01%.
Other managers with positive returns in August include Robinson-Langley Capital Management +3.86% est, Long Term Trading Navigator +2.64% est, Attain Portfolio Advisors Modified Program +1.66% est, Optimus Capital Mangement +1.58% est, Attain Portfolio Advisors Strategic Diversification Program +0.81% est, Dighton Swiss USA +0.21% and Hoffman Asset Management +0.12% est.
Other notable programs include DMH Futures Management which is flat so far in August and Northside Trading which is down -3.29%.
With equities bouncing back for the majority of the week, there were plenty of opportunities for day and swing trading systems to capitalize on the renewed strength in the stock market.
Starting with the day trading systems, BounceMOC eMD entered long on Tuesday and Friday for a total of +$820 for the week. This is the type of market environment that rewards patient Bounce investors- a long recovery from oversold market conditions. Look for the Bounce systems to continue their winning ways in the coming weeks if the market continues to “bounce” off of its lows.
Elsewhere in day trading; BetaCon 4/1 ESX jumped into the action on Tuesday and came out of the day with a winning trade of +$485.23. Waugh eRL had one winning trade on Monday offset by a losing trade on Friday for +$48 for the week. Finally, Compass SP finished the week just under the breakeven mark at -$164.80 on two trades.
Moving over to the swing programs, Bounce eMD was up +$465 on a closed trade basis, and also was holding onto a profitable long trade heading into the weekend. Ultramini ES lost -$7.50 on a pair of trades from Tuesday and Wednesday. Signum EBL and TY both saw small increases in open trade equity on their long positions. Tzar eRL added to open trade equity on its long trade while the NQ and ES lost on their short positions. Tzar NQ has been holding short for over a month while the ES just reversed short early last week. Mesa Notes continues to hold short since the end of July. SeasonalST ES entered long on Friday and was holding its position heading into the weekend.
Long-term systems have started to enter short in various foreign currencies such as British Pound and Euro Currency and long in the Dollar Index. There have also been new short entries in metals, grain and energy markets as they continue their slide.
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.