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If Consistency is Key...

August 27, 2012

 

In an age of struggling pension funds, it’s common to hear commentators and spectators in the world finance joke, “Anyone who can find a way to guarantee 7% annual returns will raise a trillion dollars by the end of the year.” Realistic? Absolutely not- unless you’re buying into some sort of scam- which, to be clear, we don’t advise.

That being said, this goal isn’t unique to the world of pensions. Both individual investors and RIAs seem to be in constant search of that silver bullet investment- the one allocation that will guarantee them a life of luxury. In a world absent of such possibilities, the request we get most often is for consistency. If they can’t get a magical 7% return, can they at least get returns they can count on?

This is still a request without a perfect answer, especially in a world where past performance is not necessarily indicative of future results. After hearing the question for about the millionth time, though, we began to wonder- just how consistent has this past performance been in the managed futures space? How, exactly does it stack up to what we’ve seen out of finance’s favorite child- the stock market? We ran the numbers, and what we found may just surprise you.

Battle of the Indices: Managed Futures v. Stocks

Let’s be as clear as possible. Financial indices are not infallible representations of asset class performance. Whether it’s the S&P 500 or, our index of preference in the managed futures space, the Newedge CTA Index, there are limitations. They’re both going to have survivorship and selection bias. Both fail to represent all of the investment opportunities within their respective asset classes.

That doesn’t mean they’re useless, though. Just as there are tens of thousands of individual stocks, there are thousands of individual CTAs. Not all options in both classes are worthy of investment. Trying to track the data on all of these options is likely a futile endeavor. But indices allow us a snapshot, if you will, of performance within an asset class. It’s not a panorama, but it can still give us an idea of what we’re looking at, which is why, despite their faults, indices continue to be a point of reference in financial analysis.

So we took a look at the rolling returns of both the Newedge CTA Index and S&P 500 over 12, 24, 36 and 60 month windows of time from January 2000 to July of 2012. We then measured what percentage of time achieved results greater than 0, 5%, 10%, 20% and 30%. For example, if we looked at 100 different 12 month windows (that isn't 100 years, it is xx years, as each subsequent month creates a new 12mo window), and 50 of those windows were positive, and 50 were negative, we would find the index was positive 50% of the time across 12 month windows. The point of the experiment was to look at what percentage of the time you’d have achieved certain results had you held an investment in each asset class for a given amount of time. Here’s what we found in terms of positive results:

DISCLAIMER: PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS

Generally speaking, managed futures fares pretty well here. In the each window, they beat out stocks in terms of generating a larger percentage of overall positive returns and positive returns over 5%. When the return figure thresholds get higher, stocks start to beat out managed futures, particularly in the shorter timeframes. But when the investment timeframe is longer, stocks increasingly lose their edge. This is significant because we typically recommend holding managed futures investments for at least 3-5 years.

These performance figures are only significant when held side by side, though. Afterall, 10% returns over five years aren’t all that exciting, even it has happened 100% of the time since 2000. The reason it does matter is because those kinds of results only happened about 30% of the five year windows for the S&P 500. Not all that impressive, is it? Again, past performance is not necessarily indicative of future results, but this is certainly food for thought.

To be fair, though, there’s more to investing than positive returns. We’d be remiss to not also consider the downside of things. So we ran the numbers, using the same parameters, for negative results within the same windows of time:

DISCLAIMER: PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.

Here is where we separate the mice from the men, so to speak. See, managed futures may not, in every time period, trounce stocks on the positive side, but they have demolished them on the downside. If you could have mustered allocations to the components of the Newedge CTA Index at any point in the past ten years for ANY two, three or five year period, you would never have seen losses greater than -5% total. Stocks can’t touch that stat with a ten foot pole.

Impressive? Sure. But realistically, you can’t invest in a CTA index. So what happens when you look at the same kinds of figures on a program by program basis?

The Investable Breakdown

To look at things from an investable perspective, we turned to the metric that we value most in the Attain offices- our ranking system. As a refresher, we firmly believe our ranking system to be the most thorough in the industry, and most representative of quality managed futures investments. We measure each program offering managed account access in our database across eleven different metrics related to return, risk, correlation levels, ease of access (minimum account size) and length of track record. Within these categories, risk is given more emphasis to avoid biasing things towards those programs with higher all-time compound rates of return.

We also time-weight the statistics, evaluating each metric across 1, 3, 5, and 10 year time periods in addition to the full length of the program's performance. This focus on performance and risk control across time frames insures that great returns far back in a program’s track record don’t skew their ranking, and, likewise, that newer programs who haven’t "lived through the tough times" don’t dominate the rankings (as they earn scores of 0 for any period they weren’t active – i.e. the 10yr period for a program with just 6 years of track record).

These rankings, which we represent generically with a score of one to five flags in the database on our website (one being poor and five being tops), are tallied up on a semi-annual basis in our popular rankings newsletter, but on a daily basis, we prune these rankings down even further to include only programs for which we’ve done full and in-depth qualitative and quantitative due diligence. Within this list, we use rankings to guide our allocation strategies. So when it came time to evaluate consistency of performance in managed futures on an investable basis, we could think of no better grouping than the top managers we recommend ourselves- the five flag stars of the recommended list.

However, even here, we felt the need to do a little trimming- not for performance amplifying purposes, but for balance. P/E Investments, for instance, has three program variations with five flag rankings on our recommended list. That didn’t really create the kind of balance we were looking for in this exercise, so we took the original program version whenever there were multiple five flag programs from the same manager on the list. That brought the grand total to nine programs for consideration- a cross-section of traditional trend followers, agricultural traders, short-term traders, currency traders and specialty programs- all of whom we would invest with.

To be entirely fair, there was going to be some skew toward consistency in using these rankings to select managers to look at, as the rankings themselves favor consistent performance. That being said, if the goal was to look at investable programs, this was a skew we were comfortable with.

We’ll tell you this much- there was approximately zero risk we did a one or two year performance breakdown of these programs in this newsletter. This had nothing to do with the numbers (they were pretty attractive, truth be told), and everything to do with healthy investment habits in the space. We try, at every turn, to discourage investors from “trading” in and out of CTAs. If there isn’t a really compelling reason to get out of a program (and no, a drawdown is not necessarily a compelling reason- see here for why), then we advise sticking with a program for a minimum of three years, so that’s where we started. Given that the programs in question all had varying lengths of track record, we also made sure to note what the number of periods in question was for the analysis to be fair. The results were so good, we almost didn’t share them:

DISCLAIMER: PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.

* Indicates QEP Only Program. For further explanation, click here. Programs selected were 5 flag programs on Attain's recommended list. Where more than one program per manager existed, the original was analyzed.

Yes, you read that correctly. Had you invested in any of these programs, in any of the enumerated three year periods in their track record, at least 95% of the time, you would have generated positive returns. The bulk of the time, you’d have seen results far greater. What level of greatness those results would have reached would have depended largely on your risk tolerance. Covenant Capital has some of the more impressive results in this table relative to the size of their track record, but they are also a far more volatile program than the 2100 Xenon Fixed Income Program, for instance. It’s about what you can stomach in the in-between. And track record length is important. Global Ag may have a perfect batting record across those percentage buckets, but that’s only over nine separate three year periods. Context is everything.

But what happens when you extend the investment period to five years- outside of some programs losing relevance due to a shorter track record? Again, we hesitated to show the results, but they are what they are:

DISCLAIMER: PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS

* Indicates QEP Only Program. For further explanation, click here. Programs selected were 5 flag programs on Attain's recommended list. Where more than one program per manager existed, the original was analyzed.


If we didn’t have the ability to vet these track records, we wouldn’t believe it ourselves, but the numbers don’t lie. Covenant Capital, in particular, is noteworthy. Over 120 different five year investment windows, the returns were over 30% in every single case. The average five year return? A whopping 135%. For those of you seeking that magical 7% annual result for pensions, programs like Covenant may be as close as it gets.

But again- past performance is not necessarily indicative of future results. And again- we’d be remiss to not look at the potential downside. But therein lies the rub. We could have rendered tables in the same fashion as we did for the positive returns in these timeframes, but you’d be looking at a lot of zeroes. In fact, in three and five year time windows, for all of these programs across the entirety of their track records, only one- 2100 Xenon- had more than a goose egg in the negative returns column- and none of those instances were greater than -5%.

Does that make managed futures the mythical silver bullet on an investable basis? Absolutely not. Does that mean they don’t suffer volatility? Of course not. And this is where consistency analysis falls short. Not only is past performance not necessarily indicative of future results, but when you consider managed futures in the proper timeframe, this sort of consistency analysis doesn’t adequately reflect the heartache of the drawdowns in between.

To give a more balanced picture, here’s an idea of what that heartache can look like:

DISCLAIMER: PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS

* Indicates QEP Only Program. For further explanation, click here.

It all comes back to risk tolerance. Covenant may have some pretty impressive positive performance statistics when it comes to consistency, but could you stomach nearly two years of losses to reap the rewards? Global Ag, as we highlighted last week, has had some stellar days of late, but could you deal with -20% being accrued in a little over a year to benefit from that?

These are questions you have to answer before you invest- consistency be damned.

Conclusion

We understand that drive for the silver bullet investment. It’s part of the reason we never stop working at improving our process. But as they say- no pain, no gain. There is no magical, lossless investment out there- only due diligence and decision making based on solid information and with respect to the individual investment goals and risk tolerance of the investor. Consistency evaluation alone doesn’t tell the whole story, especially when past performance is not a crystal ball. But if consistency is important to you, managed futures, held relative to all the important factors in play, is, in our opinion, more than worthy of your consideration. 

 

IMPORTANT RISK DISCLOSURE


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Feature | Week In Review: The Slow Creep Turns Negative

Last week the indices continued to follow the August trend of low volatility, low volume, and little movement – although unlike the week before, the trend was a slow creep downward. A slightly steeper fall on Thursday was erased by a nearly equal bounce up to cap off the week, leaving the Dow down -0.69%, the S&P 500 down -0.38%, the Nasdaq down -0.04%, the S&P Mid-Cap 400 E-mini down -0.69%, and the Russel 2000 E-mini down -1.15%. In bonds, US 10-year notes gained 0.81%, and US 30-year bonds gained 1.71%. In currencies, the US Dollar was down -1.28%, the Japanese Yen was up 1.06%, the British Pound was up 0.76%, the Euro gained 1.60%, and the Swiss Franc rose 1.59%.


Metals posted significant gains last week, in part due to violence and unrest plaguing several South African mining operations. All of the metals hit new 3-month highs except for Copper, as Gold gained 3.30%, Silver gained 9.35%, Copper was up 1.87%, Platinum rose 5.52%, and Palladium gained 7.78%. In energies, Crude was down -0.50%, Heating Oil rose 0.57%, RBOB Gasoline was up 1.67%, and Natural Gas lost -0.63%.

In grains, Corn was up 0.47%, Wheat fell -0.80%, and Soy was up 5.21%. In meats, Live Cattle was down -0.66%, and Live Hogs fell -5.02%. In softs, Cocoa fell -1.84%, Orange Juice once again displayed its whiplash-inducing nature, as it gained 19.62% on the week, Cotton rose 2.61%, Coffee fell -0.18%, and Sugar lost -2.97%.

 

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.