A Wealth of (Managed Futures) Common Sense

If you haven’t had chance to check out the work of Ben Carlson over on his blog, “A Wealth of Common Sense,” we highly suggest it. We’ve written about his thoughts and ideas a couple times (here and here) and we couldn’t help but notice the subject of his musings on doing what works for you in his latest post, “The Importance of Intellectual Honesty in the Markets” is of Managed Futures.

“Managed Futures is a trend following strategy that trades futures contracts both long and short depending on the direction of the markets. The strategies are typically diversified across stocks, bonds, interest rates, commodities and currencies and follow a systematic approach. Also called CTAs (commodity trading advisors), these funds got a ton of attention following the 2008 crash because they were one of the few places to earn positive returns when stock markets around the globe sold off anywhere between 35-55%.

I looked at the Credit Suisse Managed Futures Index going back to 2008 and compared it to the annual returns on stocks, bonds and a 60/40 stock/bond portfolio through June of this year:

Asset Class Performance since 2008(Disclaimer: Past performance is not necessarily indicative of future results)
Chart Courtesy: A Wealth of Common Sense

But it wasn’t just his feature of explaining the asset class of Managed Futures, it’s about how investors tend to chase performance, getting in at the highs and out at the lows. As Ben puts it:

“The biggest problem most investors face is that they invest in something like managed futures after they see the impressive results it had in 2008. Then they bail when it falters. Or they change their strategy to a low cost indexed buy and hold approach after seeing how well it’s done since 2009. Once again, many will bail during the inevitable down period.”

Which fits quite nicely with our “In at the Highs out at the Lows” Managed Futures chart.

Managed-Futures-Performance-vs-asset-flow-1024x521(Disclaimer: Past performance is not necessarily indicative of future results)
Chart Courtesy: In at the Highs, Out at the Lows 

Back to Ben Carlson:

“Despite these numbers, I don’t think it makes sense to completely write off (or pile into) a strategy simply because it’s had a poor (or good) run over the past cycle. This is just one fairly short time frame. I’m all about intellectual honesty when discussing the markets. I don’t believe in disparaging someone else’s strategy just because I don’t invest that way. My motto has always been, ‘do what works for you, as long as it helps you reach your goals and allows you to sleep at night.”

We couldn’t have said it better ourselves, but since we’re in the Managed Futures space, we can’t help but take it a step further. We want to add one of Ben’s sentences.

“It’s worth noting that the Credit Suisse index isn’t representative of all trend following strategies, but it does give you an idea about the struggles the space has endured following the crash.”

The fact that the index isn’t representative of all trend following strategies is definitely worth noting, and shows Mr. Carlson is no newcomer to this game. But here’s where things get even a little more interesting. Because not only is the index not representative of all trend following- but trend following is not representative of all Managed Futures. As we talk about in our Managed Futures strategy review every year, there’s also Short Term, Multi-Strategy, Specialty, Agriculture, Spread, and Options strategies.  Not to mention the managed futures-like Global Macro programs. Which is why those who find managed futures ‘works for them’, in Ben’s parlance; may not have found it to be as much of a struggle as the chart suggests.

For instance, in 2013, the Barclayhedge Agricultural Traders sub index was up 5.71%, when the Credit Suisse index was down -2.6%. In 2011, The Barclayhedge Discretionary Traders Index was up +2.75%, while Credit Suisse was down -4.2%. In 2012, the Attain Short Term Fund was up 10.29%% while the Credit Suisse was down -2.9%. {Disclaimer: Past performance is not necessarily indicative of future results}. Of course, you would need a crystal ball to know which of those sub strategies was going to perform each year and which weren’t; but you get the point. Just like small cap stocks can diverge from large cap, or Asian stocks be up while US stocks down; different types of managed futures strategies can, and will (and have), diverge from the poster child trend following strategy. That’s why our Philosophy is to surround a core allocation to trend following with these other strategies to ‘diversify the diversifier’.

How about a Longer View:

Which brings us to a tweet asking for a little more data – something we’re happy to dive into.



Here’s what a 60/40 portfolio looks like using Carlson’s same table, with the Sharpe ratio added in to compare the different return and volatility levels (although you know we’re not huge fans of the Sharpe):

Asset Class Ratio Addition of Managed Futures
(Disclaimer: Past performance is not necessarily indicative of future results)
Data = (60/30 MF) is 60% SPY & 40% DJCS Managed Futures Index
Other data from: A Wealth of Common Sense

But as Mr. Carlson said, this is a “fairly short time frame.” What does it look like if we push it out back to the inception of the Credit Suisse index?  And while we’re at it, we’ll be the first to tell you managed futures isn’t meant to replace bonds (although that might not be a terrible idea in a rising rate environment). So what does it look like when diversified into managed futures and Bonds with an allocation of (45% Stocks / 28% Bonds / 30% Managed Futures)? Here you go:

Ratio Two 1994-2015
(Disclaimer: Past performance is not necessarily indicative of future results)
Data: DJCS Managed Futures Index
S&P 500 = SPY Bonds = Barclays Global Aggregate Bond Index

You can see argument for a managed futures allocation in these longer term stats, which speaks directly to Carlson’s main point:

“I don’t think it makes sense to completely write off (or pile into) a strategy simply because it’s had a poor (or good) run over the past cycle.”

For more information on Managed Futures Performance, check out our Whitepaper highlighting the “Performance Profile: Managed Futures

Is Managed Futures Secret Weapon Coming Back?

A long time ago, in a galaxy not so far away – where China was preparing for the Summer Olympics, Kosovo declared independence from Serbia, and Crude Oil was hitting levels at $140; a small band of rebels called short term interest rates were actually whole numbers (like 1%, 2%, and 3%).  That may sound like science fiction to some, but it was real. People could purchase a 1 year T-Bill for say, $97,000, and have $100,000 returned to them 12 months later; compared with the ability to purchase a 1 year T-Bill in 2014 for say, $99,875 ; and get back that $100,000 12 months later.

Fast forward to today – and something exciting is happening in short term rates. We’re not talking science fiction exciting just yet, but there’s significant movement for the first time in years… in short term rates as the world prepares for Ms. Yellen to finally announce an increase in interest rates. Via Zerohedge, we see that the One Year T-Bill has reached rates it hasn’t seen since 2010:

“The US Treasury sold $25 billion of one-year T-bills at an interest rate of 33bps yesterday, the highest since June 2010. It appears the short-end of the yield curve is increasingly pricing in ‘liftoff’ sooner rather than later (and the long-end is responding by rallying – lower in yield – as medium term growth expectations fade) but it raises significant questions about the economic trajectory after the hike (and the ebbing confidence in The Fed).”

Chart 1 Year T Bill(Disclaimer: Past performance is not necessarily indicative of future results)
Chart Courtesy: Zerohedge

Now, trying to 1/3rd of one percent in interest surely isn’t the type of return anyone outside of the money market or commercial paper industry is likely to get excited about. But what if instead of the option of earning 1/3 of 1% (33 basis points as they say in the biz) OR 7.5% on xyz investment, the choice was to earn 1/3 of 1%  AND the 7.5%. AND is certainly more enticing than OR in that scenario.

Managed futures secret weapon, so to speak; is its ability to harness the power of US Treasury Bills at the same time it is putting trades on with commodity futures. In short, the secret weapon is the ability to earn both interest and trading returns on the same money.

What? How can you have two investments at once?  You can’t buy a house for $500,000 and earn interest on that $500K for example; nor can you purchase $100,000 worth of stock, and at the same time earn interest on that $100K.  Turns out managed futures playground of exchange traded futures allows for investors to invest cash into a futures account to invest in a managed futures program, and at the same time earn interest on the majority of that cash.  This works because the futures exchanges and FCMs clearing the trades there allow for T-Bills to be used to cover margin requirements. Bear in mind, futures account margin is not the same thing as stock account margin. Futures account margin is essentially just needing to have a certain amount of money in an account for them to allow you to enter into trades, versus stock account margin where you borrow money to purchase shares.

At the end of the day, the exchanges and FCMs want you to have collateral to act as a buffer against any moves against your positions in the future. So they can take money from those who lose money on a trade to pay those who made money on it. That’s what the exchanges do. The good news – they view T-Bills and cash essentially the same. So you don’t need to have $100,000 in cash to act as collateral; and another $100,000 to put into T-Bills. You can use the same $100,000 to both buy T-Bills and cover margin for your investment in a futures program. That’s right, the T-Bill does double duty – with the clearing firm posting the T-Bill to the exchange on your behalf to cover margin and you earning the interest on it while it sits with the exchange.

Now, the clearing firms do build in a little buffer for themselves as a risk precaution, and usually only allow around 90% of the T-Bill’s face value to be used as margin, and those fees and haircuts made it a breakeven (to losing) proposition when 1 year interest rates were at 0.10%. But with the potential gain 3 times that now… it’s starting to make sense again. And should we get back to the 1% to 3% environment, it’s a must have for any serious investors. Who doesn’t want an extra 100 to 300 basis points per year tailwind.

PS – For those investors having their accounts professionally managed. You don’t want to purchase a T-Bill in the account the advisor in managing. The interest earned will increase the value of that account, and you don’t need to be paying the advisor 20% of the profits due to interest, just pay him or her on the profits due to their trading.

PPS – The exchanges also allow certain stocks to be used as collateral. So if you loath to sell that Apple stock, but like the managed futures value proposition – there’s ways to use your stock as collateral in much the same way as T-Bills. Call us for more information on how that works (312-870-1500).

Have They Convinced You Commodities Are Dead Yet?

If you had a dollar for every article about how horrible commodities have been performing, well.. you’d be rich (or have about as much as if you had shorted said commodity markets).   The past few weeks have seen Gold drop below 2010 prices, WTI Crude drop back below $50, and Sugar hit fresh 4 year lows.  The result? The long only commodity indices taking it on the proverbial chin…

Here are just a couple headlines and charts associated with the articles:

Are We Nearing Peak Commodity Hatred?

Pragmatic Capitalism Commodities Chart(Disclaimer: Past performance is not necessarily indicative of future results)
Chart Courtesy: Pragmatic Capitalism

Commodities: The Great Bear Market

Economist Commodities(Disclaimer: Past performance is not necessarily indicative of future results)
Chart Courtesy: The Economist 

Global Growth Worries Pummel Commodities

WSJ Commodities Charts(Disclaimer: Past performance is not necessarily indicative of future results)
Chart Courtesy: Wall Street Journal 

There are 100s of Commodities Out There:

With headlines like these, you would never know that Canola Oil is at all time highs, Cocoa is at four year highs, or that Natural Gas has barely been moving this year while Crude Oil has been rocking and rolling.  Turns out, there’s 100s of different commodity futures markets out there – and more than 30 liquid ones beyond just Gold and Crude Oil.  All of these commodities are broken down into five main sectors:  Energy, Metals, Grains, Softs, and Livestock., which is about the order in which people think about commodities.  We all know Oil is a commodity, and Gold is sort of the commodity poster child, even though it acts a bit more like a currency at times.  But you’re deep in the weeds when you start to think of Cocoa or Cattle as commodities.

Commodity Index WeightsChart Courtesy: Barchart

The people who created product around commodities are no dummies, structuring commodity indices around such popularity (at times based on actual metrics like percent of global production value), with a heavy slant towards energy and metals, with the Coffees and Cattles of the world essentially being left behind. The chart above is a little old, from a 2010 BarChart article, but the point remains – there’s more than one way to track “Commodities” via an index. Here’s how the various indices have performed over the past 60 months, highlighting just how different these indices move.

Commodity Index ETF Bear Market
(Disclaimer: Past performance is not necessarily indicative of future results)

It’s not Whether it’s going Up or Down, it’s by How Much

Which brings us back to our little slice of the world in Alternative Investments.  You can read how Commodities aren’t all that Alternative in a recession in our ‘Truth & Lies in Alternative Investments’ whitepaper, and the charts above showing the big impact of energy in most commodity indices drives that point. If the S&P 500 has a large portion of companies in energy sector, and energy is a large portion of the commodity indices – does it follow that a large portion of the S&P is tied to commodities?  Food for thought.

Thing is – while economists and shipping companies may care how much of a country’s GDP is energy versus Cotton farming; giving value to a value weighted commodity index  is something alternative investment managers don’t really care about.

They just want a commodity market – any commodity market – to be moving more than average. We can all grasp how the stock market is more than just the Dow Jones Industrial Average. There are outliers to the upside like Netflix and Apple, outliers to the downside, and everything in between, forming an average; and creating room for ‘stock pickers’ to be able to pick the winners and pan the losers to add value.  Professional Alternative Investment managers working in the commodity space take a similar approach, albeit highly systematic and risk controlled as compared to the stigma of a “stock picker.” The commodity pros aren’t just investing in Commodities going up or down – they are looking for the outliers inside of the commodity complex. They are looking for the Netflix of commodities, or Enron on the downside.

So don’t cry for those in commodity futures when the Wall Street Journal waxes on about the big bear market in commodities. We may be crying if it is a slow crawl downwards interspersed with lots of fits and starts, or cheering it down if it’s a significant move in one direction over a few weeks to months.

For an in-depth understanding of how a long/short commodity strategy works, click here.

For a performance comparison of the Commodity Index ETFS vs. managers actively trading the ups and downs of the commodity market, click here.

An Alternative Way to view Diversification

We’re living in a post 2008-2009 financial crisis world. Investors and advisors alike know that having your eggs all in one basket could land you in some hot water (especially if it’s the arguably broken 60/40 portfolio). The reason being, one single person or group isn’t able to call what’s going to be the “best” asset class (by performance only) in any given year.

Enter the ever so popular diversification quilt, which essentially ranks each asset class top to bottom over the past 15 years. The issue, of course, is that although they include 10 asset classes, they really don’t include alternative investments, specifically Managed Futures. The latest to release a chart like this is Business Insider.


As you might remember, we took the liberty of changing around the “quilts” published by Bloomberg back in September by adding Managed Futures to the mix. The second issue with the quilt table is that these “quilts” are all on the same axis level. For example, if an investment was the worst performer of the year and still up 2 or 3 percent, it would look the same as an investment that came in last at a -10% on a different year.

Which got us thinking how different would the table look if we spread out the investments so that the performance range would be visible? This is what we got.

P.S – Looking at each asset class on its own fluctuates year to year, is just one way to look at volatility. So, so we connected the dots of the largest performance range (Emerging Markets), Managed Futures, and the smallest performance range (Cash).

(Click here for a better view)

Diversification Chart Past 15 Years Logo

(Past performance is not necessarily indicative of future results)
Large Cap = S&P 500
Small Cap = Russell 2000
Intl Stocks = MSCI EAFE
Emerging Markets = MSCI Emerging Markets
REIT = FTSE NAREIT All Equity Index
HG Bond = Barclay’s U.S. Aggregate Bond Index
HY Bond =BoAML US High Yield Master II
Cash= 3 Month T Bill Rate
AA = Asset Allocation Portfolio
(15% Large Cap, 15% Intl Stocks, 10% Small Cap, 10% Emerging Markets, 10%  REIT,
40% HG Bond

Insights from Alternatives Best in Boston

In our best efforts to inform and educate investors about Alternative Investments, we set off to Boston last week to talk alternatives. We had a great turnout, which prompted discussions and questions regarding fund structure, the return drivers of alternatives, and how to deal with upcoming market uncertainty.

For those that missed it, here’s a recap of the live tweeting of the event.

P.S — One of the unexpected bonuses of the event was seeing all trucks and set of the upcoming Ghostbusters movie. Sadly, there was no Kristen Wiig sighting.

Panel Two