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Timing managed futures entries

September 8, 2008

 

Most investors pore over disclosure documents, interview managers, speak at length with Attain staff on our experience with the manager, what we’ve seen of their trading style, and so on to become comfortable with which managed futures program (or programs) they wish to trade.

But in spending so much time on the “Who to trade”, very few investors consider the “When to trade”. Which begs the question: is the “When to trade” just as important as the “Who or what to trade”? Can timing your entry to a CTA bring better performance than just starting with the CTA right away? And is this especially poignant for CTAs sitting a t new all time highs? Should you just jump into those, or is it better to wait for a pullback? There are a whole lot of questions, and not much literature or research out there on the effects of timing entries.

The rule of thumb amongst most managers when asked about timing the entry into their specific program is to just get in right away, as you may miss out on upside by trying to time the entry perfectly. And indeed, there is an old axiom in the stock market put forward by buy and hold type brokers who believe that you need to be invested in the market constantly, as just a few days of profits can make your whole year. And there are statistics to back this up, showing how portfolios underperform if missing out on the best days.

However, it is also tempting to think of timing an entry into a CTA just right. Getting into the Pere program in January after its 30% DD, and seeing gains of 140% plus after that. Getting into Dighton’s drawdown last April, then seeing gains of around 70% through the rest of the year. ACE, APA Modified, Clarke, and more all have similar stories. Past Performance is not necessarily indicative of future results, of course, and there are stories where the drawdowns just kept going.  

But these opportunities can result in more total profit, as the investor earns not only the difference between the drawdown amount and back to even, they also earn any profits above and beyond the even mark as the program makes new equity highs. For more on investing in drawdowns, please view our old newsletter on the subject here: http://www.attaincapital.com/newsletters/242

But how realistic is it that you could get involved with one of these managers at the exact bottom of their drawdown? Not very. For one thing, the drawdowns can often be quick lived, not giving someone time to get the paperwork filled out, account funded, and so on. But even more difficult is knowing when that drawdown will be coming, and whether or not it is worth waiting for.

If the drawdown is worth waiting for is the big question when considering timing a CTA entry. You may be looking at a CTA like Dighton or Pere and realize that their nice returns come with quite a bit of volatility. And you may think that to avoid some of that volatility, you will look to get involved after the CTA has had a drawdown of such and such percent.

If you expect their worst drawdown to be 50% moving forward, set that as your line in the sand to cease trading the program, and then set a trigger to get involved when the CTA hits a 35% drawdown level – you have in effect moved the max DD for you to just 15%. (50-35).  That makes one of these volatile CTAs much more attractive from a risk standpoint.

But again, what do we give up waiting for that trigger level? Consider the Pere Trading Group program thus far in 2008. Pere is volatile and not for everyone, as Attain and the manager are only too happy to tell you. Imagine a client who, knowing this and wishing to avoid some of that potential volatility and downside, decides in February to set a trigger level of a 35% drawdown to get started. Our imaginary client would still be waiting to get started, and approximately 140% in profits would have passed him or her by. In this case, it seems, it was not worth waiting for the drawdown, as the client in our example gave up over 140% in profits to save 35% in losses.

This led us to pull some numbers and do some testing on what levels make sense, if any, for trying to time an entry into a CTA. We set up our test by looking at the Clarke Capital Management Global Basic program, with its 12+ years of performance history. We can see easily how the overall program performed if an investor started as of Day 1 with the program, but it is more difficult

We split the program’s performance into 12 separate time periods, starting 12 months after the inception of trading (as you need some data on which to base future decisions). These different periods represented 12 different entry points into the Clarke program over the past 13 years, and we were able to calculate what the performance of each period would be if a hypothetical client began trading at the beginning of each period.

We then considered five different entry timing methods based off of end of month drawdown levels. These were as follows:

1. Past Max DD: start trading the program once a new max drawdown (DD) has been hit,

2. Avg DD: start trading the program once the DD is more than the average annual DD of the years preceding each time period (for the time period starting January 1999, this would be the average of the annual DD in 1996, ’97, and ’98).

3. ¼ Avg DD: start trading once the DD is more than 25% (1/4) of the Avg DD explained above.

4. ½ Avg DD: start trading once the DD is more than 50% of the Avg DD explained above.

5. ¾ Avg DD: start trading once the DD is more than 75% of the Avg DD explained above.

The tables and charts in the Chart of the Week section below show the summary statistics of our testing. In general, and as we would expect, the more stringent the rule for entering (such as waiting for a new Max DD), less of the total return was achieved, yet the DD was reduced significantly.  As an example, if waiting for a new max DD which would eclipse the 29.4% DD hit in November 2002, clients would still be waiting, and while saving DDs of 20% on average, they would have missed 123% in profits. This is represented below as achieving roughly 52% of the total profit, while only suffering 50% of the DD experienced by those entering the program “normally” (meaning right away)

On the flip side, there were very promising results when  a hypothetical investor waited for 25% of the Avg DD to get started. In this case, when averaging across the 12 time periods, the average total return was 103% (more) of the total return experienced by starting right away, while only experiencing 92% of the drawdown. That is the goal of timing, and an ideal scenario is achieving an equal amount or more of the profit (over 100% of the total ROR), while suffering less of the drawdown (below 100% of the max DD in that time period).

But what about some of the other levels, such as the /34 of the Avg DD timing. Doesn’t it look pretty good when you only participate in 79% of the DD, but still get nearly all the profit (96%). That may appeal to some more than getting more profit, as many have the goal of reducing risk as much as possible.

And indeed, while we can run statistics and theorize on what levels have performed best for timing - much about timing still does come down to personal preference.

For example, some clients who have made money with other advisors, and have some of the house’s money, so to speak, may be more inclined to start right away and not try to time the entry. With a cushion of profits, missed profits can often be more painful than entering at a bad time and suffering actual losses (probably because those are offset against actual gains).

A client just starting out, however, may have different priorities and feelings about actual losses versus missed profits (opportunity costs). And from what we see, most investors starting out are more comfortable sacrificing possible gains if it saves them from losses right out of the gate. There is just something about starting out on the right foot which lends itself to sticking with the investment through future poor times.

So, in the end, there does seem to be a case for timing entries into CTAs stemming from our real world experience, the data in our past newsletters on investing in DDs, and our testing for this article on Clarke’s Global Basic program. But , admittedly; this testing does not cover all CTA programs, and the type of CTA, their volatility, length of track record, and more all come into play. (For example, we wouldn’t recommend trying to time an option seller, as their make up calls for frequent winning months and rare but larger losing months.)

This means it comes down to your personal circumstances, CTA portfolio, and more.

If you want to guarantee you get the same total return as the program earns over the next x months/years, get in now. Just remember, that also means you will get 100% of any future drawdowns. While if you want some protection, but will be angry if you miss a really big move, consider setting your trigger at a smaller level such as 25% of the average past annual drawdowns. And finally, for those who really want to ratchet down the volatility and drawdowns, consider a more stringent timing such as waiting for a new max DD or using the average DD or 75% of the avg DD.

Want us to look at how timing has performed on a CTA you are interested in, please email us at invest@attaincapital.com or call 800.311.1145 and we’ll be happy to put a report together for you.  

 

- Jeff Malec