Weekend Reads: Wealth Inequality

Wealth Inequality – (The Economist)

Bigger & Better Advisors – (Investment News)

How Different Sectors of the Market Perform Once the Fed Starts Hiking Rates – (Bloomberg)

How Chicago has used Financial Engineering to Paper over its Massive Budget Gap – (Medium)

Volatility Is Back… Embrace It! – (Wall St. Daily)

We Don’t Know How Often Pilots Commit Suicide – (FiveThirtyEight)

Managed futures can even help an oracle – (Futures Magazine)

March Madness Predictions – (FiveThirtyEight)

Alternative Links: AUM & Performance Chasing

CME:

CME Is Said to Mull Rule Change as Basel Pressure Hampers Banks – (CME Group)

As Silence Falls on Chicago Trading Pits, a Working-Class Portal Also Closes – (The New York Times)

CME says no decision yet on EU wheat contract launch – (Reuters)

AUM & Performance Chasing:

More Global Mandates, Fewer EM Mandates, and Other Changes – (All About Alpha)

Getting in at the High, Out at the Lows – (Attains Alternatives Blog)

Beware of this article: “Buyer Beware With Managed-Futures Funds“ – (MorningStar)

Liquid Alts:

Do Liquid Alts Justify Their Costs? – (Advisor Perspectives)

Short Selling Options:

Selling Volatility Offers Non-Correlated Returns – (Daily Alts)

Options Trading is for (Thanksgiving Turkeys) – (Attains Alternatives Blog)

Bitcoin:

Bitcoin: The Next Asset Frontier? – (TabbForum)

Blast From the Past:

Quant Who Shook the Financial World Tries More Humble Approach – (Bloomberg)

In at the Highs, Out at the Lows

Do you learn from your mistakes? Do your neighbors, colleagues, or the rest of society? It seems that the answer is usually no; and especially no when it comes to the toxic investment cycle of getting in at the highs and out at the lows. We see time after time that this dangerous cycle transcends asset classes, market environments, and Fed chairperson.  We’ve talked before about the dangers of the emotional investment cycle, and after getting the last of the 2014 data on asset flows – we can see Managed futures is the latest case study. Just take a look at the performance of Managed Futures when asset flows are overlaid onto the chart.

Managed Futures Performance vs asset flow(Disclaimer: Past performance is not necessarily indicative of future results)
Source: Barclayhedge CTA Index

People could not have been much more wrong, with outflows of -$63 Billion over the two years ending June 2014, right before managed futures went on to rip off average index gains of +12.32% in the next 6 months. Now granted, those folks who bailed for the exits were looking at being down over the preceding three year period. But it’s not like we’re talking the internet bubble burst. The indices we down about –4.09% over that same time span (July 12 – June 2014). And it’s not like someone didn’t cue Wilson Phillips and say we were at a generational low.

The more troubling sign is that the people didn’t just get in at the bottom – a lot of money got in at the top as well, having poured $44 Billion into managed futures following gains of $7.56% between Jul 2010 and April 2011. What does this mean for the rest of 2015, where money should be flowing into the asset class following an impressive year?  Only time will tell, but we’ve got a feeling this isn’t quite performance chasing at this point. Wait until managed futures puts in a good two to three year stretch – then you’ll see the hot money running for the asset class…. just in time to suffer through a down to flat period.

Meanwhile, those who’ve been invested in managed futures for 10 years or more must just sit back and laugh at the flows in and out, knowing what they know – that it is a mutli-year investment which rewards investors for patience. They know that managed futures is much different than a typical stock market investment. The stock market sees consistent gains interspersed with periods of sheer terror. Managed Futures, in contrast, is consistent frustration/boredom, interspersed with periods of elation when big market trends emerge.

PS –  How big is the Managed futures industry, really? This is something we get into now and again, and just this week MorningStar reported that investors have seen the light, putting $1.4 Billion in Managed Futures Mutual Funds in the first two months of 2015. Now, Mornigstar just tracks mutual funds… not the overall space including managed accounts and privately offered funds. For that, we turn to BarclayHedge, who’s been tracking managed futures assets for 20+ years, and come up with total assets under management by managed futures firms at  $316.8 Billion.

There’s just one little problem, those numbers include the world’s largest hedge fund ($220 Billion Bridgewater).  And they include Winton. Now, we agree that Winton should be included, even if David Harding dropped an ‘f bomb’ in the Financial Times claiming they’re not a Managed Futures firm, just weeks before winning the Managed Futures Pinnacle Award last year.

For those who might want to see what the industry is looking like without Winton & Bridgewater inflating the numbers, here’s our try and stripping them out. While that downward sloping curve may send some of you running for the hills, this is exactly the sort of dis-interest those looking to get out of the toxic ‘in at the highs, out at the lows’ cycle should welcome.

Asset Flows of Managed Futures ex bridgewater winton(Disclaimer: Past performance is not necessarily indicative of future results)
Source: Barclayhedge CTA Index

DISCLAIMER: The stats herein discuss the growth of assets under management both from new money invested and gains/losses on past money invested. It is not intended to portray performance of the asset class.

 

February’s Best By Performance

While one month’s performance is no way to judge an investment that has 3 to 5 year cycles, a glance at who’s doing well in the different environments month to month can be a useful data point at times. Here’s the top managed futures performers (by return only) for the month gone by:

Note: These programs are not necessarily recommended by Attain. For a list with much more thought behind it – check our semi-annual rankings (updated February 2015).

 (Disclaimer: past performance is not necessarily indicative of future results. Programs listed consist of those with at least a 3 year track record tracked by Attain Capital Management for investment by clients via managed accounts and do not represent all available programs in the managed futures universe.  The Max DD represents the worst drawdown of all time for the listed programs).

Managers and ProgramsFeb. RORMax DDMin. Invst.
Brandywine -- Symphony Preferred (QEP)10.76%-38.11%1,600,000
Pacific Capital Advisors -- Vanguard9.48%-11.39%100,000
Bayou City Capital (QEP)9.26%-80.35%100,000
Boston & Zechiel -- ACTS Aggressive 7.85%-62.40%100,000
LJM Partners -- Aggressive Program Writing (QEP)6.22%-63.83%500,000
Diamond Capital -- Enhanced S&P 6.11%-10.82%150,000
Goldman Management -- Stock Index Futures (QEP)5.17%-5.08%300,000
JKI Futures -- Etiron 2X Large Prop. 5.03%-37.27%1,000,000
Ramsey Quant Systems -- RQSI (QEP) 4.79%-31.66%5,000,000
ITB Capital Advisors -- Time Value Trading (QEP)4.00%-40.49%1,000,000

(Disclaimer: Past performance is not necessarily indicative of future results)

 

Making the Case for New Managers

“Only invest with managers with 5 year track Record”

“Don’t invest in a program with less than $50 million under management”

“Make sure your investing with someone who’s ‘been there’ before”

A lot of investors out there (including us at times: here and here) have some hard and fast rules when it comes to selecting managers for their alternatives portfolio. Indeed, this is why the large keep getting larger (see Winton recently surpassing $30 Billion, Bridgewater over $100 Billion, and Nassim Taleb’s rant on the futility of trying to play at this game where winners take all). Last time we checked, the breakdown of large versus small managers looked something like this:

David vs. GoliathData Courtesy: Attain Post “So You Want To Be A CTA

At a certain point in an investors filtering and due diligence, only one or two names remain.  If you want a program with a 10+ year track record, performance profile of x, staff of at least y, in house compliance, legal, etc. etc. – your list starts to dwindle in a big hurry, leaving just the largest players who have been around for a long time. Turns out asset raising is as much of a winner take all game as ride share apps and search engines.

But are these investors missing the forest for the trees (albeit redwoods), so to speak?  Are they doing themselves a disservice by only going with the old hands? Is there a case to be made for the new guys on the block?  Turns out there most certainly is – from a pure performance standpoint.

We took a look at our culled database of 600+ managed futures programs going back into the 1980s to find out just how ‘new programs’ perform compared with older programs, plotting the average performance by year of track record across hundreds of programs. This shows the average performance of each program in its first 12 months, its next 12 months, the 12 after that, and so on and so forth until looking at the 10th year (12 month period) of track record for those programs which go out 10 years plus.

Avg Perf Track Record(Disclaimer: Past performance is not necessarily indicative of future results)

You can see a definite downward sloping curve, showing that programs do very well in their first year, great but somewhat less well in year two, and worst and worse until year 8, when there is a bit of a move back to normal levels.

What is going on here?  First and foremost is a bit of backfill bias. What is that? Well, when managers submit their programs to the database in hopes of raising money, they rarely do it after posting three years of negative returns. The more usual pattern is for a manager to start out, have success, and then submit their program’s performance to the databases, “backfilling” the data to their first month of trading.  This creates very good looking first years of returns, as the poor first years were never submitted in the first place. They never became official ‘managers’ and never got into the database for us to analyze at a later date (what’s called survivorship bias).

But there’s more than just the bias issues happening here, because even if we ignore the first three years of track record – the same pattern exists:

Avg Performance Track Record 2(Disclaimer: Past performance is not necessarily indicative of future results)

So there must be something more than just backfill bias – which, by the way, is not more than 18 months in our experience, on average. That something else could be what the MJ Blog, (unfortunately, it’s not Michael Jordan’s blog) calls Structural Alpha. That’s what we’ve referred to as smaller managers being able to access markets like Corn and Cocoa and the rest which the Billion Dollar plus managers can’t because of position limits and market impact (i.e. when they want to exit, their size moves the market so much as to hurt their position). Speaking of market impact, or slippage as it is known in the systematic trading world, here’s our old visual from this post on the extra large managers trying to exit a trade.

New Picture

Protecting vs. Performing. Which leads us to the final answer here, which is established managers making a natural transition to asset protectors versus asset performers. This is a bit of a cliché and there’s more than a few high profile big firms which still swing for the fences. But more often than not, the normal performance profile for managers is higher returns and higher volatility in the early parts of their track record. There’s a few reasons for this, including manager naivete at their outset, where they simply didn’t know as much as they do now in terms of risk control, the known unknowns of risk, and operational efficiencies. You know the old saying… if I’d known then what I know now.

There’s also the simple math of risk reward. When young and starting out, just like in many endeavors, it is well worth the risk to be a little more aggressive in order to make a name for yourself, in a sort of ‘better to have loved and lost then never have loved at all’ type game. But as you get more successful, as you become ‘married’ to a track record and large number of assets – the risk/reward shifts. Sure, at a base level you have to keep performing. Nobody’s going to stick with you forever if you’re not. But the risk shifts from a risk of not ‘making it’ to a risk of losing what you have.  As an example, if you lose -20% in a month, you might lose 50% of your assets. If you lose -20% over three years, you might lose 5% of your assets.

The big institutional investors may argue it isn’t worth the risk for them to take a chance on a new manager. Now, they are often talking career risk there, why take a flier on a new manager when you can get most of the return with an established manager and not risk operational issues, big reversions to the mean, and so forth which might cost them a job. And for 5% to 10% of their portfolio – they are probably right.

But for the smaller, more nimble investor who is after better risk adjusted performance – and doesn’t have a job to worry about losing, and is doing more than 5% in alternatives;  is avoiding the perceived risk of less sophisticated operations, a smaller staff, and more worth the trade off in performance? Can you actually get the better performance outlined above by trying out “new talent.”  We sure think there is a case to be made for the new manager. And an even stronger case for the new manager who makes it through a due diligence process where many of the operational issues that are a perceived risk can be removed as an issue. And an even stronger case for the new manager who isn’t really new – who instead is a disciple of an established manager, of a trading desk at a bank, and so on. We know a few names, if interested.

There are risks to new managers – but most of them are identifiable, and thus able to be addressed.  And the risk is mirrored by defined advantages to new managers. So if you’re in need of a little something extra. If in need of a diversifier to your diversifier, a satellite strategy to your core managed futures holdings, there are worse things you could do than looking at a new manager. Sign up here to be notified of new managers and funds which become available through our industry relationships.