With 2011 coming to a close and 2012 just around the corner, it’s only natural to start contemplating your New Year’s resolutions. While the traditional resolutions that come to mind are often personal (better fitness, less stress and more philanthropy are some of the most common if you ask the government), we urge you not to neglect financial contemplation as you outline your goals for the dawning year.
To be fair, after the way the markets have behaved this year, the thought of delving into your investment portfolio may be cringe-inducing, but, as they say, “No pain, no gain.” It’s years like this that really picking apart your portfolio is crucial. Take a look at your investment portfolio, its performance, its balance, and what you’re hoping to accomplish with it over the next year. Unsure of where to start in this fiscal self-examination? Here are a few questions to kick things off:
1. What is my Investment Window? How much time have I given a certain program (investment strategy) – 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. We wrote earlier this year about how this disconnect between expected and realized performance results in a vicious “in at the top/out at the bottom” cycle that can deliver swift losses to the foolhardy investor. For managed futures in particular, we advise a minimum investment period of 2-3 years if you’re going to have proper context for program performance evaluation. Using this as a filter- how is your portfolio doing?
2. How diversified am I? Is my portfolio filled with all option sellers? All day trading systems? All trend followers? If you’re an Attain client, you’ve probably been warned away from such imbalances, but these questions are important as you recalibrate for the new year. We just broke down 2011 managed futures performance by strategy type last week, and viewing your portfolio through the lens of those strategies can help you make informed decisions about how balanced your strategy exposure may be within your portfolio, which may help hedge against a year where one particular strategy struggles. For instance, 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 in 2008, then flopped back into trend followers in 2009 just as they struggled and option sellers shined. These investors would have been better served to have had equal exposure between the two strategy types the whole time.
3. What Markets am I exposed to? Which do I want to be exposed to? 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, as investors are usually much more exposed to stock indices than they think. After a year that has been as risk on/risk off as 2011, it may seem silly to even worry about which markets you’re in; they were all swinging on every headline out of Europe, anyway, right? Even though this may be the case, there’s much more to analyzing market exposure. What kind of liquidity do these markets have? How volatile were the moves made there? Which markets ended up yielding the most profits for you, and- most importantly- why? Were you missing out on more favorable trading conditions in other markets, and, if so, were the movements in that market a product of new developments or fluke-ish events? Understanding these answers may help you better understand the risk within your portfolio, and give you insight as far as how it could be better managed.
4. What are my 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 decisions during a stressful drawdown. The problem is that, while we may understand when sitting at equity highs that drawdowns are a part of investing in managed futures, and often (though not always) come up in a cyclical manner, once that drawdown actually hits, we have a bad habit of morphing from a rational investor into a panicked, frenzied mess. It is much better to make decisions regarding your stop trade levels today, with a clear head, on what you will do when a certain program gets to a certain level than dissolve into pieces alongside your account statements in the heat of the moment.
5. What does my overall portfolio look like? Your managed futures portfolio likely doesn’t exist in a vacuum, and it pays to make sure it can play well with others in your portfolio. If you’ve allocated a large chunk of your risk capital to a long-only commodity fund, like GLD, you may not want to be allocating to a program that may increase your long exposure during critical times. For most investors, your main concern will be making sure you’re not overexposing yourself to stock market performance, which may mean avoiding option sellers that will suffer when stocks sell off and volatility spikes. The bigger picture question may have to do with your overall asset class allocation. We’ve written in the past about the updated “Efficient Frontier”- arguing that balancing your portfolio between stocks, bonds and managed futures with a 40%-20%-40% split, respectively. Does your portfolio fit within these parameters? Could it benefit from a shift?
As we said, these questions are only a start, and should not be considered exhaustive as you sit down to analyze the current state of your investments. But that’s the nice thing about asking questions- they often lead to even more questions. The end goal of asking these questions should be the development of your New Year’s Financial Resolutions for your portfolio- what comes next? What programs are on my shopping list? How do I measure my success- especially as it pertains to process?
More questions than answers? Maybe… but when it comes to investing, we think you should ask as many questions as possible; an informed investor is often the more successful one.