Did ‘Risk On’ just sink Managed Futures again?

While the buy-and-hold crowd join the robots in pumping prices up- and then down, and then up and so on – are rejoicing today after stock market gains of 3% and more – managed futures managers may be saying “Not again…”

While not as fully short as they were at the beginning of October, most systematic multi market managed futures programs are still on the short side of the “risk on” assets (stocks, grains, metals, foreign currencies) and long side of the “risk off” assets (USD and bonds), meaning they are essentially betting on a continued ‘risk off’ environment. This has pushed many programs to small gains for December, as evidenced by the Newedge CTA Index up about 1% for the month.

A good portion of those gains will likely be given back after today, unfortunately. This is the same sort of pattern we saw at the beginning of October, when the sharp rally caused losses, and the same stance (although greatly reduced) they had at the end of November.  Both of those ended in less than ideal results (although the November move was more an open trade loss than realized losses), and now today is threatening more of the same.

Being In the holiday spirit, we’re looking for a silver lining here – thinking that maybe another failed move lower means we’re just one step closer to the real move happening. As we’ve explained before, traditional managed futures programs with a trend following type profile are designed to participate in many false breakouts, so that they can be certain of being in the real breakout when it does happen.

While each move may be independent of the ones preceding and following it, they aren’t as independent as a completely random event like the flipping of a coin. In that instance, despite the probability of a coin coming up heads or tails being 50% over many, many flips – the fact that the last flip was heads has no bearing on whether the next flip will be heads. We’re not so sure there isn’t some interdependence in market moves, however. Unlike the coin, the fortunes, hopes, and fears of market participants are interrelated and dependent on what has transpired before, and what they believe that experience means for the future. Those interdependences are infinitely complex, and managed futures managers aren’t trying to find the Da Vinci Code to unlock them – but it isn’t too far of a stretch to think that another trend reversal may mean we’re another step closer to the day/week/month when the trend extends, instead of reversing… is it?

Disclaimer: Past market movements are not necessarily predictive of future moves.

Conflict of Interest Behind Conflicting Testimony?

As testimony on Capitol Hill has continued, MF Global’s collapse has become (if possible) even more dramatic. Corzine’s strategy of pushing plausible deniability in his testimony fell apart with the testimony of the CME’s Terry Duffy, who argues that the law was broken and Corzine knew about it.

At this point, the question has become one of motive- not what Corzine’s motivations might have been as he dipped into those accounts, but whether the resounding indictment is a red herring ploy by the exchange to deflect criticism. One of the articles being passed around today questions Duffy’s testimony with a timid skepticism, though the headline- CME’s Duffy vs MF Global’s Corzine: A question of trust- pushes the idea with all the gusto of a Shakespearean rivalry:

The drama over the meltdown of the brokerage firm MF Global pivots around a clash between two veteran traders who rose from relatively humble roots to the very top of the futures-trading business.

One is Jon Corzine, the firm’s former CEO who just testified in Congress about the mystery surrounding some $1 billion in customer money that vanished from MF Global before it failed. The other is Terrence Duffy, the chairman of CME Group Inc, the huge Chicago exchange where MF Global did most of its trading.

At stake is not only Corzine’s reputation – and whether his career on Wall Street and in politics comes to an ignominious ending – but investors’ trust in Duffy, the CME and the U.S. futures industry, which is largely self-regulated…

A desire to shore up the CME’s image helps explain the forceful and at times personal tone of Duffy’s testimony against Corzine, said federal officials familiar with the matter.

“It doesn’t surprise me they are being so aggressive, they don’t have a choice,” one official said of CME’s handling of the matter. “They have a lot of people who lost money.”

Dennis Hastert, the former Republican speaker of the House who has known Duffy for years and who now sits on CME’s board, says of Duffy: “His reputation, his business, everything he’s ever worked for is on the line.”

Noting that MF Global was one of the largest traders on the exchange, Hastert says “the whole business works on trust, and when somebody breaks that trust, it jeopardizes the system.” Duffy “was not amused by the situation at all,” Hastert added.

In some ways, the logic here makes sense. Duffy and the CME find themselves in a perilous position. If Corzine was doing something fishy, to what extent are they liable for not catching it? It had crossed our minds that the CME would be feeling the heat in all of this, especially with the industry anger over their initial reaction to the MF Global collapse. But would that heat be enough to compel them to such tactics?

We’re betting no.

For starters, testifying in front of Congress is not for the faint of heart. Not only is your testimony broadcast to the world, but a misstep carries major legal repercussions, providing a disincentive to try to lie. This doesn’t mean that people don’t perjure themselves. If Duffy is right, that means Corzine already has. The difference here is what’s at stake. At this point, Corzine’s entire life has imploded; he has nothing left to lose. Duffy, on the other hand, would have a long way to fall if disgraced, and would leave himself and the CME open to potential civil legal action if the testimony had been fabricated.

Second, the CME has historically been very careful about what they’ll say and when they’ll say it. They carefully curate and guard their reputation, as one would expect when dealing with such a massive financial entity. This sort of disciplined message development is what drew the ire of so many in the days following MF Global’s filing for bankruptcy. Those calling the CME for comment or explanation found themselves quickly turned away; no one was about to say anything until they could do so with certainty. Ignore Duffy’s risk in this mix- the CME’s board and communications department would not have stood behind Duffy’s testifying if they didn’t have that certainty.

In our minds, this perspective makes more sense than the vindictive testimony angle- particularly when you consider the numbers. One might expect that November would have seen a drop in trading volume as MF Global, one of  the largest FCMs in the business, froze up billions in client trading funds, or as a result of concerned investors who hadn’t been directly impacted by MF Global pulling out of the markets. We certainly expected  the CME’s volumes to be down, and have been monitoring volume on a weekly basis looking for a trend to this effect. Turns out, that has not been the case.

You’ll notice that November saw some drops in equity index trading, energies and forex. You’ll also notice that, despite these drops, volume year to date is up across the board. In other words, the CME isn’t seeing a massive drop in business that’s compelling them to throw Corzine under the bus. This doesn’t mean that the CME doesn’t have more long-term concerns, nor does it mean that confidence in the system hasn’t been shaken. We’re just not seeing an immediate compulsion for recklessness, which, given the risk-oriented nature of our industry, definitely has us leaning towards believing Duffy over Corzine.

The Risk in What’s Being Risked

One of the managers we work with, Dean Hoffman of Hoffman Asset Management, has an interesting piece up on his blog today. As he points out, there are thousands of CTAs for an investor to choose from when they start investing in managed futures, and dozens of statistics you can reference as you sort through your options. Some of these are metrics you’ll find us frequently referencing on the blog, such as max drawdowns, length of drawdown and risk ratios like Sharpe, Sortino and Sterling. However, as Hoffman points out, these statistics, no matter how excellent, are going to fall short of what many think they can do:

What investors want (or should want) is excellent risk adjusted performance, but in my opinion, the standard performance measures only succeed at hindsight reporting. Those same measures perform miserably when trying to predict future risk adjusted performance.

In other words, metrics of evaluation for CTAs relate to past performance, which (say it with us, now) is not necessarily indicative of future results. In fact, Hoffman provides some pretty interesting charts which pretty effectively confirm this idea. What was most interesting to us, however, was his reliance on a metric which, in our opinion, is not often enough considered in the evaluation of a CTA: their margin-to-equity ratio.

The margin-to-equity ratio indicates what percentage of a CTA managed account is posted as margin, on average. Essentially, it tells us how much money they have tied up in margin at any given point in time relative to the nominal investment amount. For example, if you have a $1,000,000 nominal investment in a CTA, and the margin requirement on that account is $100,000 – the margin to equity on that account is 10% (100k/1mm).  Note that it is on the nominal amount, so if you have $200K traded as $1 million through the use of notional funds, and the same $100k in margin , the ‘official’ margin to equity is still 10%, even though it would be 50% on a cash basis.

Hoffman concludes:

…margin-to-equity ratios can be an excellent way to predict future drawdowns. Empirical data show us that higher margin usage leads to higher average and maximum drawdowns. Also, unlike returns and drawdowns, margin-to-equity ratios are fairly easy to predict.

… lower margin-to-equity ratios, correlate to superior risk adjusted performance.

In summary, we believe that to help prevent serious drawdowns and get superior risk adjusted performance that one is better off with managers who have low margin-to-equity ratios than with managers who have high margin-to-equity ratios.

While the conclusions drawn here are certainly worthy of contemplation, the word that jumps out at us is “predict.” It appeals to the most basic inclination of an investor- the desire to effectively see into the future and determine returns before allocating funds. Unfortunately, despite what the data in this piece may suggest, we don’t agree with Mr. Hoffman’s crystal ball theory.

The data analyzed here in regards to margin-to-equity comes from the Barclay Hedge database. The listed margin-to-equity ratios found for a program there are not calculated levels, but are submitted to the database by the managers themselves. Given that, while they give a rough idea of the average margin-to-equity ratio for each program, they aren’t necessarily reflective of actual margin-to-equity ratios. And unfortunately, CTAs rarely keep this statistic up to date in the various performance reporting databases. While they will update their monthly performance regularly, other information in the database can become a little stale, especially since updating that information is not a requirement for continued listing in the database.

Investors can always ask a manager about past margin-to-equity levels (and indeed, if a manager can’t provide a detailed report on their margin usage – that’s a red flag from a due diligence standpoint), but even here, the ratio can change substantially depending on the market environment. In fact, in our experience, this ratio, for most managers, ends up being fairly fluid, fluctuating between 10-30%, as managers engaged in profitable trades will often have higher margin allocations than they would at another point in time. The moving target here means that, unless you’re monitoring the margin-to-equity ratio for all of these programs in real time, the relationships you find between their ratios and performance are tenuous at best.

We’re not saying margin-to-equity ratios aren’t an important consideration; we use it regularly in our analysis of CTAs. It’s just that the metric should be more specific – with the low, average, and maximum margin to equity levels reported – not just a single number that we’re left to interpret (though it’s likely the average level). Much like the Sharpe ratio and max drawdown and other metrics, the margin-to-equity ratio is not a magic bullet when it comes to CTA evaluation. It’s only in the context of a myriad of other statistics that it has value, and, much to the chagrin of investors everywhere, it still can’t predict the future.

Weekend Reads

It’s been a week of conflicted feelings. On one hand, the economic data coming out of Europe actually looks positive for once, and even the statistics being tossed around stateside don’t look awful. On the other hand, the durability of these numbers is yet to be seen, as many of the indicators we’ve come to rely on lose a little bit of traction when the markets continue to swing dramatically. Then there are those new poverty numbers… and they aren’t pretty. But it’s been a long week, so we won’t drag this out any longer. Here are some weekend reads to keep you busy until Monday morning…

  • A new meaning for ‘Risk On’ (Bloomberg)
  • 50 Economic Stats You’re Probably Not Ready to See (Zerohedge)
  • Great curation of content on the late Christopher Hitchens (Reformed Broker)
  • YTD stock market returns by country (Bespoke)

And just for fun…

  • Hey, look- the Home Alone house is for sale! (AOL)
  • This is what happens when you give kids a bad Christmas present (Youtube)


In the ongoing effort to keep our technological infrastructure on the cutting edge, Attain will be installing a new communications system this afternoon. We will have our numbers forwarded to alternate lines, but there is a chance that between 3 PM CST and 10 PM CST today our telephone system may be down. If you need to reach us for the remainder of the day, please feel free to contact us via a direct email or via invest@attaincapital.com. Thank you for your patience and understanding.

Great Expectations, Legal Drama, and Continued MF Global Investigations

It’s time to get excited! They found the missing MF Global money!

Hate to burst your bubble, but you may want to wait a minute before you jump for joy. Here’s the background…

CFTC Commissioner Jill Sommers, who was put in charge of conducting the MF Global investigation after Gary Gensler recused himself due to his personal connection with Corzine, came out yesterday and said that they were far enough along the trail that they know where the money went. Now, it’s a matter of figuring out which transactions were legitimate and not.

This is certainly good news, and an improvement over the complaints about bad bookkeeping that we were previously hearing from the CFTC. That being said, there are a few things you need to think about:

1) They know where the money went- that doesn’t mean they have it.

The comments made by Sommers indicated that they now have a clear picture of the transactions that were made. She did not say that they had located the funds in an account, or that they had recovered the money, which, if it were the case, would definitely have been blasted out as a victory cheer from every corner of the earth. This development, unfortunately, does not give us any indication of when (or if) that money will be available to the clients.

2) They don’t know where all of it went, though.

Sommers may be confident that they now have the full story, but CFTC Commissioner Bart Chilton is not. Shortly after Sommers’ comments came out, Chilton tempered expectations of how much money had been accounted for, saying “Based upon the most up-to-date information available, I do not have confidence that we know where all the money went.”

3) They’re still figuring out if these transactions were legitimate or not. If not, well…

It’s been made clear that, assuming they do get their hands on any amount of the missing money, it will not be distributed until the nature of these transactions is fully understood. This is the part that makes us nervous. We’re hoping everything works out, but some have speculated that those funds could have been transferred from an American bank to an international subsidiary in order for MF Global to skirt regulations on rehypothecation and get access to extended lines of credit.

Such a transfer may happen regularly for an FCM such as MF Global, making the movement look routine on paper, but it’s that rehypothecation component that could cause an issue. Should it be determined that this was the case, it’s likely that we’ll be watching a complex financial legal battle over whether those funds are now the property of the lien holder (i.e. the bank to which the collateral was pledged) or the MF Global client- pitting individual investors against big financial institutions once more. Anyone else think this sounds like 2008?

Further reading: Reuters

Top 10 Lessons Learned in Managed Futures – 2011

The year is ending, which means the blogosphere is gorging itself on end of year reflections- especially top ten lists. Being managed futures folks ourselves, we’re all about riding the trend, so we figured, why not hop on this one? Instead of looking at specific moments or trades or programs though, we decided to recommit to the goal of education by presenting the top 10 lessons learned in the managed futures space. Some of these are things we already knew, but were reminded of, while others constituted a swift kick to the shins. Perhaps it has not been the best year ever for managed futures, but it certainly was an informative one.

10. Just because you pretend you’re an authority doesn’t mean you are.

This year has been ripe with missteps by the financial media. From confusion to gross over-simplification to willful dissemination of inaccurate information, the facade of authority granted by a byline has lost its luster. We were so irritated we actually dedicated an entire newsletter to covering ways to properly curate your financial news selection.

9. The Volatiltiy/Trading System relationship came unwound….

Generally speaking, people tend to assume that volatility and trading systems work well together. This is typically a fair generalization, but as the performance of Strategic has aptly demonstrated over the course of 2011, not all volatility is created equal, and the choppy markets have taken their toll on many a beleaguered trading system this year. Even the application of specific filters failed to create an entirely favorable result. The hope is that 2012 will bring more favorable trading conditions.

Disclaimer: Past performance is not necessarily indicative of future results.

8. Timing is everything.

Poor Dighton Capital. A bold bet on the direction of the Swiss Franc earlier this year made a lot of logical sense, but the markets would have none of it. Dighton blew up, losing 32% for the month before all was said and done (Disclaimer: Past performance is not necessarily indicative of future results), and days after getting out of the ill-fated trade, the Franc decided to cooperate as the Swiss government intervened…. As the old saying goes…timing is everything

Disclaimer: Past performance is not necessarily indicative of future results.

7. Nothing is impossible.

Remember that one time we thought American politicians would actually use the debt ceiling as a high stakes game of chicken? Remember that one time where they proved us wrong and made utter fools of themselves? Remember that one time S&P decided they’d had enough of the shenanigans and downgraded the impervious United States of America- eliminating its previously untouchable AAA credit rating? Yeah- that happened. Despite all the hot air from all corners of the investing world, the impossible occurred- humbling for all parties involved (if only for a moment). And since we’re already talking about it…

6. The trend is your friend- until it isn’t.

The trend over the year had been a strong one to the upside in a slew of markets. For a while there, the trend was giving managed futures a nice little performance boost. With stocks sort of hit or miss, it was looking like a good year for managed futures… and then it was the beginning of August. And everything reversed. In a very big way. Trend followers did what they were supposed to- they took the loss. Doesn’t mean it wasn’t a bitter pill to swallow.

Source: Finviz; Date: August 4th, 2011; Disclaimer: Past performance is not necessarily indicative of future results.


5. The trend is your friend – until it isn’t (part 2)

Picture this- it’s getting to the end of September, managed futures programs have steadily initiated short positions in ‘risk on’ markets while takig long positions in ‘risk off’ markets – enjoying their best gains of the year as things start looking better for managed futures. They had readjusted to the downtrend, and managed futures programs were looking to gain momentum once more. Cue Columbus Day and then an October which simply went up, up, and up some more across nearly all assets, reversing the just initiated trends in most cases. Suddenly, everything was reversing all over again, and managed futures programs were watching their August nightmares replay with an autumn backdrop. This market surge came at the worst possible moment, making it exceedingly difficult for the asset class to recover in time for positive YTD performance to become an option.

Source: Finviz; Date: October 10th, 2011; Disclaimer: Past performance is not necessarily indicative of future results.

4. Europe is a little bit crazy.  

By a little bit, we mean a lot. The debt crisis is in full swing, but the solutions being proposed are a little less than awe inspiring. Staring down a loose conglomeration of drastically different nations with stark differences in their financial circumstances, the solution to the laborious pile up of debt seems to be… to take on more debt? This move has made the Euro trade a volatile one, with a dizzying ascent in the beginning of the year followed by an incredulous dive back down. Year to date, the Euro is down just over 2%, and managed futures has thoroughly enjoyed shorting it on the way down.  But the Euro hasn’t been the only market impacted. The back and forth nature of the debt negotiations- with each day bringing a new complication or reason to celebrate- fostered an erratic risk on/risk off atmosphere that waged war on the trends managed futures typically looks for… though it looks like one might finally be emerging as the year comes to a close.

3. Ratings agencies are still dumb.

In 2008, the world saw exactly how dim-witted credit rating agencies could be, with the crumbling banking titans certified as AAA right up until the moment the house of cards collapsed. 2011 witnessed continued reminders of this, as agencies kicked their downgrading efforts into overdrive… even if only in threats at times. An attempt to make-up for mistakes of years past? Maybe… but then again, by their standards, MF Global wasn’t considered junk until the day they actually filed for bankruptcy.

2. Option Sellers are still susceptible to swift losses- just in case you forgot.  

Dighton Capital wasn’t the only CTA to take a hit this year; around the same time as their implosion, option sellers were struggling as well. The poster boy for this spiral was FCI, which finished off August down a whopping 51.35% (Disclaimer: Past performance is not necessarily indicative of future results). As we covered at the time, these kinds of losses are the risk you run investing in option selling strategies. You may see small, incremental gains over an extended period of time that provide added value to your portfolio, but if there’s a volatility spike going the wrong way, you could give it all back- and then some- which is why we suggest avoiding becoming Taleb’s turkey through an option selling gain protection strategy.

1. Now is the time for industry unity.

MF Global opened up a lot of eyes. Many didn’t realize the liberal permissions included in 1-25, or the threat of rehypothecation bids gone bad. The assumption was that, in order to get anywhere in this industry, you had to have the same kind of respect for the sanctity of sacred accounts that the clients who depend on them do. Thanks, Corzine, for proving us wrong.

While the disaster has deeply impacted both former MF Global clients and the rest of the industry, it has also prompted the industry to come together in the name of reform and progress. The CME and NFA in particular- initially criticized for their woeful response to the scandal- have stepped up to the plate, attempting to not only remedy some of the issues we discovered in the days following the bankruptcy following, but solve other deficiencies before they have a chance to cause problems. The industry has never been louder, more united or more proactive. While we all could have done without the drama, the upside here is that we’re going to come out stronger on the other side. Here’s hoping that next year sees a continuation of this trend in particular, and a healthy, prosperous year for all of us.

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