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Time for Year End Planning/Portfolio Review

December 10, 2007

 

As we enter the final weeks of trading in 2007, it is always worthwhile to put your portfolio in front of the mirror, so to speak - to review the good and bad decisions and investments of 2007, and to also start planning ahead for 2008.

Volatility makes a surprise visit

The first step to examining what was good and bad in your portfolio is to first take a step back and analyze what the overall market environment was like over the past 12 months.

As we look back on 2007 - we know one thing was much different than in years past - volatility. In US stock indices particularly, the slow times of the past five years were replaced with some wild swings we hadn't seen since the tech bubble had burst. Big down moves, and big bounces higher became more and more common, and as they did volatility rose from the historically low levels it seemed to gave been stuck in over the previous 3 years or so. Volatility, as measured by the VIX indicator, averaged just 12.73 over '05 and '06 - but saw spikes to 31 (four times) and 37 in 2007 while averaging 18.52 since March. That's an increase of 45% in volatility.

Beyond this volatility increase, we had some wild moves in traditional commodities like Crude Oil and Wheat which hadn't been seen in years also. Wheat was up over 91% for the year at its highs, and Crude was up 65% as it flirted with the $100 level just a few weeks ago.

Measuring against the Market Environment:

By taking a look at what the overall environment looked like - we can put ourselves in a better position to evaluate each of the components in our portfolio. Without that background information, we may unfairly judge a program's annual performance as poor, when in fact that performance is exactly what we could have expected from such a strategy given the type of market we had.

Investing in managed futures is an absolute return strategy, which means the programs should perform regardless of the environment over the long term - but a poor environment for a program can cause losses in the short term, and we saw that in the various option selling programs which suffered through a few rough spots in 07.

Should we ditch these managers just because they went through a poor market environment? I would say no. They are supposed to do poorly during volatility spikes - because they are supposed to do well during times when there are no volatility spikes. It's hard to have one without the other. And they can do better when volatility is higher, as they are selling bigger premiums. It is not high volatility they do poorly in, but spikes from low to high volatility which cause them problems.

But when reviewing our portfolio and what worked/didn't in 2007, even if we accept that the option sellers were destined to have a poor year with the volatility spikes we saw - we should still look at each in comparison with another, and see who did what given that poor environment. What were the better performers doing different than the others, and can they repeat that relative success moving forward? Did the poorer performers lose more than their counterparts for some specific reason, or are they just that - poorer performers? These are the type of questions we like to see asked.

The market environment works on the positive side too. With markets like Crude, Wheat, and the US Dollar having pretty obvious trends, we should expect managers or programs which are designed to catch such trends to have done just that and seen success in 2007.

Sure enough, we can look at programs like Attain Portfolio Advisors, Dighton, and the day trading system Compass and see that they did as they were supposed to and benefited from the move higher in global volatility.

But if a program is designed to capture volatility and volatility spikes, but didn't' do so in 2007 - it's probably time for a hard look at the program to see what the story is. What is the reason for the under performance?

Reviewing your Portfolio & Looking Ahead:

In reviewing your portfolio, and looking ahead to what you want your portfolio to look like for 2008, we believe the following elements should all be considered.

1. Investment Window - how much time have I given a certain program - how much more time am I willing to give it? Too often investors jump on a hot program, and then jump off of it at the first sign of trouble. This is a sure fire way to accumulate losses instead of gains, as you are continuously getting in at the top and out at the bottom. One way to combat that urge to get in/get out quickly is to set an investment window for each program you invest in. We recommend you give any program at least two years to show you what it can do. As touched on above, managed futures programs should perform regardless of the environment over the long term, but even the best can suffer over the short term due to a poor trading environment for their type of strategy.

2. Strategy Type - Is my portfolio filled with all option sellers? All day trading system? All trend followers? It's important to assign a strategy type to each program in your portfolio to insure you do not have more exposure than you bargained for in any one area. Many investors had way too much trend following exposure back in 2004/2005 - and then ditched it all and loaded up into option selling programs in 2006/2007 just as volatility spiked. These investors would have been better served to have had equal exposure between the two strategy types the whole time.

3. Sub Strategy Type - You may have three option selling programs, but they could each be doing a separate type of option trading. For example, a mixture of FCI (trading commodity options), Zenith (trading mainly Put options), and Ascendant (trading mainly Call options) may not be as bad as it seems on the surface with them all being option selling strategies.

4. Markets - Do I have exposure to Crude Oil, Wheat, etc.? Do I want exposure to those markets? What markets is my exposure in? Am I overexposed in any one sector? These are all great questions to ask of yourself, and the answers very well may surprise you. Investors are usually much more exposed to stock indices than they think.

5. Stop Trade Levels - Drawdowns can and will happen in the future. Do you have a plan, written down, on what you will do when the drawdown hits for one the components in your portfolio? It is important to set a stop trade level for each of the programs in your portfolio, so you don't make emotional based decisions during a stressful drawdown. It is much better to make the decisions right now, with a clear head, on what you will do when a certain program gets to a certain level.

Conclusion:

As you can no doubt read between the lines above - diversification is key. Not just in markets, but also in strategy type. The old school method of diversification within managed futures was to diversify between markets - but we've seen over the past several years that diversifying between long and short volatility programs can go just as far, if not further in smoothing out your equity curve.

It is also important to remember that the best performing portfolio over the past 3,5, 10 years or whatever you're testing is in most likely hood not going to be the best performing one over the next 3 years. No one wanted to include long volatility programs such as trend followers in 05, and 06 - but those programs did a great job absorbing the sting of some short option programs in 07.

The markets are ever changing, and no one knows what 2008 will bring. But we should expect the unexpected, not fear it, and make sure we are spread out between as many market and strategy types as possible. So work with your Attain broker to review what has happened, and where you can go from here. A little bit of planning now could pay a lot of dividends in the future.

- Lisa Smith

 

Chart of the Week: November Performance Summary (top 10 CTAs/Systems)

CTAs (Past Performance is not necessarily indicative of future results)			Trading Systems (Hypothetical Model Accounts)
CTA Program	Nov 2007 Return	Min Invest. (000s)	Trading System	Nov 2007 Return	Min Invest. (000s)
CKP Finance Associates - LOMAX Program	12.0%	100	Rayo Plus DAX (cg)	36.9%	30
Ascendant Strategic1	7.6%	100	RT-Viper YM	25.3%	10
Crescent Bay - PSI Program	5.0%	10	Tzar ES	25.1%	30
CCM Millennium Program	3.0%	2000	Signum TY	21.2%	30
Zenith Resources - Diversified Option Program	3.0%	35	BetaCon 4/1 ESX	14.1%	5
ACE Investment Strategists	2.8%	50	Waugh ERL	11.6%	10
Cervino Capital - Diversified Options	2.4%	50	Ultramini ES	11.1%	15
Raithel Investments - Target Volatility Program	2.0%	100	Signum EBL	9.4%	30
Zephyr Asset Management (Aggressive)	1.7%	100	Bounce Swing EMD	8.9%	10
Financial Commodity Investments Program	1.6%	100	BounceMOC EMD	8.9%	10

 

 

Important Risk Disclosure

The CTA % returns above are reported from the managers directly, or an estimate of monthly performance based off of accounts being managed by the listed managers at Attain. Managed commodity accounts can subject to substantial charges for management and advisory fees. The above numbers include all such fees, but it may be necessary for those accounts that are subject to these charges to make substantial trading profits in the future to avoid depletion or exhaustion of their assets. The regulations of the Commodity Futures Trading Commission (CFTC) require that prospective clients of a CTA receive a disclosure document when they are solicited to enter into an agreement whereby the CTA will direct or guide the client's commodity interest trading and that certain risk factors be highlighted. The disclosure document contains a complete description of the principal risk factors and each fee to be charged to your account by the Commodity Trading Advisor (CTA). This document is readily accessible at this site using the “Disclosure Document” link above. The system % returns above are hypothetical in that they represent returns experienced in a model account. The model account rises or falls by the exact single contract profit and loss achieved by clients trading actual money pursuant to the listed system's trading signals on the appropriate dates. The hypothetical model account begins with the initial capital level listed, and is reset to that amount each month. The % returns reflect inclusion of commissions, fees, and the cost of the system. Commission and fee cost = # of monthly trades * $50.00. The monthly cost of the system is subtracted from the net profit/loss prior to calculating the % return. 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. THESE PERFORMANCE TABLES AND RESULTS ARE HYPOTHETICAL IN NATURE AND DO NOT REPRESENT TRADING IN ACTUAL ACCOUNTS.