Bloomberg Vomits Alternatives

We couldn’t resist this Bloomberg headline the other day:  “Classic Cars, Lean Hogs and Duchamp Art Lead Alternative Investment Ranking”  Cars, Hogs, and art… and an alternative investment ranking – this was going to be interesting.

Except the ranking is little more than the trailing 36 month returns – without mention of the volatility, drawdowns, or any other risk to the investments.  And the so called “Alternatives” in the article seems to be an odd mish mash of returns for whole investment categories like Private Equity with its 100s of Billions of Dollars invested alongside the returns for single stamps from 1867 which gos for around $400.

Throw in a few Ferraris, REIT indices, some Bordeaux wine, Soybean Meal futures, and Hedge Funds; and it’s like Bloomberg vomited alternatives all over the page.

Conventional_1

Conventional_2

Exotic_1(Disclaimer: Past performance is not necessarily indicative of future results)
Tables Courtesy: Bloomberg

Now we get it, looking at exotic property or ideas is a lot more fun to read about then say risk adjusted ratios (what real alternatives folk geek out over), but to compare investing in wine and fast cars to Private Equity and Hedge Funds seems a bit off the mark to us. For one, there is perhaps $1 Billion worth of capacity in some of the ‘exotic’ investments put up on the page, while some of the hedge funds listed manage many billions.  It’s not quite fair to compare the return on a $400 stamp or $1,000 bottle of wine with the Trillions invested in the hedge fund and private equity space. One is attainable to a handful of people in the world, the other to millions. It’s sort of like comparing the Yankees win/loss record for the year with Phil “The Power” Taylor’s darts record.

Oh well… the tables are pretty and it’s fun to see how much some of those ‘exotics’ returned. Who knew?  Self storage REITs were the place to be. We’ll take the ‘under’ on that happening over the next three years.

As for their line about alternative investment (now they’re talking the whole world of them…) underperforming the S&P – that is another case of apples and oranges, although not for the reasons outlined above, with both return streams available to the masses.  Alternatives are oranges to stocks apples because “Hedge Funds Don’t Care if They’re Underperforming the S&P.”

Do we still need to do this? A Trend Following Rebuttal

We’ve been known to help straighten out some wayward journalists from time to time, and our friend Michael Covel pointed out just such a journalist in need of some help last night via twitter:

Now, Michael could be accused of drinking the trend following Kool-Aid a little too much at times, but there’s worse things to be passionate about, that’s for sure. And we don’t think Noah Smith is actually attacking ‘trend following’, despite the article’s headline and conclusion that “the trend is your friend till the bend at the end.”

Mr. Smith appears to be warning investors from taking on hidden risks in exchange for consistent gains, and cautioning against chasing performance. Mr. Smith appears to be telling investors in his ‘Investing’ column on Bloomberg View – to steer clear of the selling deep out of the money options. He is teaching us not to fall for the put-option fallacy, where investors get lulled into a false sense of security right before things blow up. He trots out examples of this fallacy in the mortgage backed securities bust in 2007, hedge funds in the 1990s and early 2000s, and Japanese workers (??).

The rub for Covel and ourselves is… He is warning against selling volatility. He is warning against booking small, consistent gains in return for the possibility of large future losses. But he conflates those warnings with “Trend Following,” seemingly not aware that Trend Following does the reverse. Trend Following is a LONG volatility strategy, which books small, frequent losses in exchange for the possibility of large future gains. It is quite literally the exact opposite of what is described in Noah Smith’s article.

The proof is in the past three years. The proof is in 2007 and 2008.  If trend following were falling for the put-option fallacy – the returns would be a LOT better the past three years, but it’s been a skinny few years for trend following. See here, here, or here. Those selling volatility (ignoring the big risks of the past) are the ones making money, as can be seen in the short VIX ETF (XIV) or plain old $SPY.  And what about 2008?  What about when the hidden risks came flying to the forefront?  How do you explain Trend Following’s outperformance during that time, Noah?

We suggest taking a short trip through a few blog posts and our educational materials on Trend Following, and maybe reading one or two of Covel’s excellent books on the subject, maybe rewriting the article.

–    ‘Trend Following’ whitepaper

–   Here’s a Guy Managing $25 Billion with Trend Following

–    100 years of Trend Following

–    Covel’s Books:

o  Trend Commandments

o  The Little Book of Trading

o  Trend Following

o  The Complete TurtleTrader

–    Our series on how a trend following trade works:

Anatomy of a Trend Following Breakout – Crude Oil

Crude Trends and Cursing your Manager 

Anatomy of a Trend Following Trade – the Short Side

Anatomy of a Trend Following Trade – the Short Exit

Anatomy of a Trend Following Trade – the Journey

Until then, on behalf of all the trend followers out there, we’ll echo Michael Covel’s sentiment.

“Please get a clue.” 

 

Here it is, the Big Sell Off… has been Wrong the past 169 Times

In case you missed it, the Dow was down around 300 points yesterday to bring the index into negative territory for the year (just a handful of days after hitting a new intra-day and all time closing high) – spiking the Vix 27% and no doubt bringing a bunch of worrisome headlines around the financial world today along the lines of:

Here it is… this is the big one = Marc Faber followers

Eureka! Volatility is back!  = Managed Futures & Global Macro managers

Stocknado = Josh Brown

We’ve been due for a pullback  = such and such asset management co.

Relax, it’s all in your mind = Barry Ritholtz

The easy thing to do today is write about how this shows just how scary stocks can be… We’ve surely done it before (here, and here). To talk about how and why you should be diversified (here), and to talk about this could be the start of a move lower as evidenced by a few chart patterns (divergences in the Russell and MidCap). But every time we’ve done that for the past 5 years, we’ve been wrong.

Every dip like this over the past five years has been little more than that – a dip. It hasn’t been the start of the next big bear market. It hasn’t been the crash we’ve been waiting for and the return of big volatile swings. It’s usually been one off. A quick bout of selling in the otherwise boring day after day slow grind higher, leading to those complaints about there being no volatility.

Consider the numbers since the lows in March of 2009. Since then the S&P has experienced a single day loss of -1% or more 169 times, -1.5% or more 88 times, and -2% or more 52 times (with about 45% of all of those happening in 2009 and 2010). That’s not a whole lot of days out of the 1,300+ days the market has been open, but it’s not all that  rare either. These days happen. But what concerns us more than the fact that they happen, is what typically happens after them. What’s the average return of the S&P  1 day, 30 days, and 90 days after experiencing a -1% loss or greater?  That’s the type of question we’re interested in.  Turns out – buying the close on such a day the past 5 years has been an excellent strategy.

Day After Returns(Disclaimer: Past performance is not necessarily indicative of future results)
Data = Since March 2009

The average next day performance after a big down day (loss of more than 1%) has been about three times the average daily performance (.25% versus .09%). Talk about BTFD… (look it up). We’re told as young investors to be very careful trying to catch the falling knife, but this has been more like catching a falling balloon, untying it, and watching it zoom higher.

Who knows what today, the next month, and next 90 days will bring. Is this drop a falling balloon unable to do any damage, or the proverbial falling knife which might cut your hand off? We won’t pretend to know – but we’re sick of treating every one of them like the falling knife. They won’t all be dangerous to catch… and indeed they’ve been anything but for the past five years. “This time is different” is notoriously wrong, and to say this sell off is any different from the other 160 or so we’ve seen in recent memory would be stretching it.

One of these times it will be different, and long volatility strategies such as managed futures and global macro will be waiting – but the odds here likely favor another bounce higher and new all time highs on the horizon for stocks.

PS – Mr. Market – this is an attempt at some reverse psychology. We really do want some volatility and down moves, not a return to the slow crawl higher… We’re hoping a nod to the likelihood this amounts to nothing may in fact make this time different. 

 

Can You Time the Market Without Crying?

We’ve all seen pictures like this one from Putnam showing how bad of an idea it is to miss the 10 best days in the stock market

Missing the Best DaysChart Courtesy: Putnam

But we read an interesting post on trying to time trading systems (that’s like timing market timing) that seemed to approach this in a bit more logical way. You see – it doesn’t make much sense to talk about missing the 10, or 20, or 40 best single days in the stock market. Most market timers aren’t trying to avoid a single bad day,  and get back in the next day. Most are looking at things like Price to Earnings ratios and the rest are trying to avoid bad periods… not just bad days. Plus, nobody is that unlucky trying to time the market that they miss just the 10 best days over a few decades. On the flip-side, nobody is that lucky that they would magically miss the worst market days over 10 to 20 years, only to get right back in the next day.

It makes much more sense to us to talk about what missing the best streaks of days looks like. The best 10 and 30 days periods, for instance. That would be a lot more interesting; to see how bad/good you would have been if you picked the exact wrong/right time.

Here’s what we found:

(Note: These figures do not represent actual trading, and were not taken from real experiences)

Missing the Best Trading Days

Missing the Worst Trading Days(Disclaimer: Past performance is not necessarily indicative of future results)
(Note: The figures and charts above are an example and do not represent actual trading)

In our opinion, the better argument for not trying to time would go something like this:

Trying to time the market?

  • If you’re incredibly smart, or lucky, or both – missing the worst 10 day streak would save you 549%
  • If you’re incredibly dumb, unlucky, or both – missing the best 10 day streak would cost you 212%
  • If you’re somewhere in between smart and dumb and have average luck – you’ll likely not miss anything… with missing the average 10 day streak resulting in 4%

We’re not sure if this supports timing or not – but it sure seems a better way to talk about it, rather than the more prevalent narrative about the big danger of missing the best 10 days in the stock market – like they come one right after the other or you’re the unluckiest person on the planet.  The whole thing is kind of silly anyway – as it is backwards looking, and would need to be completely thrown out the window if the next 30 years were the negative image of the past 30 years, with stocks returning –70% over the span. If that happens, then timing would do no good, again – it would be better to not be involved at all…

 

 

Performance of 40 Futures Markets Mid-Year

We’ve officially made it half way through the year, meaning those who did well will likely be mentally doubling their first half success in imagining where their year will end, while those who struggled will act like a weekend golfer making the turn – saying ‘ok, let’s turn it around now… let’s get it done on the back nine’.

Without further ado, the front nine scores across 40 different futures markets courtesy of Finviz:

Futures Performance 2014 Q2(Disclaimer: past performance is not necessarily indicative of future results)
Chart Courtesy: Finviz.com

Some of our thoughts:

• 65% of the markets are positive of the year, down from 75% last quarter.

• Corn and Wheat went from number 4 & 8 on the leader board last quarter, to a negative performance on the year thanks to an ongoing multi-month down trend.

• Coffee and Hogs continue to hold their position as the top commodity performers. However, coffee is down considerably (-19%) from its 2014 highs, while hogs have been hitting new highs.

• Nikkei is the only stock futures index that remains negative of the year

• CHF, CAD, USD, and EUR are almost unchanged on the year

• The S&P 500 & the 30 Year Bond’s YTD performance are almost identical.

 

Why Hedge Funds Don’t Care if They’re Underperforming the S&P

With the S&P 500 showing triple digit returns since the financial crisis, we’ve noticed there have been more and more publications denouncing hedge funds as under performing the S&P 500. We even got in on the trend too, but in a slightly different way than most.

The problem with saying hedge funds are underperforming the S&P 500 is that the grand majority of them aren’t even trying to beat the S&P 500 in returns, for any set period. They are trying to deliver better risk adjusted returns than the stock market, but that doesn’t make for as good of a headline. “Hedge funds post .026 better Sharpe ratio over trailing 36 month period” just doesn’t have that ring to it.

The problem is, as more and more hedge fund like products make it into so-called ‘liquid form’ via a mutual fund or ETF or the like; more and more everyday investors will be able to access them, and more and more websites and other portfolio tools which compare performance to stocks by default will be serving up the S&P 500 as the benchmark for the Alternative Funds performance. It turns out more than a few people are picking up on this apples and orange comparison, with Joe Light from the Wall Street Journal weighing in recently with his article “How Do You Measure the New ‘Alternative’ Funds?

“If a fund intentionally hedges its exposure to stocks, it isn’t really fair to say that the fund did well in 2008 or poorly in 2013, says Jonathan Boersma, head of professional standards and a benchmarking expert at the CFA Institute. The problem is that it wasn’t really designed to beat the S&P 500 during up markets in the first place.”

So what should investors in Alternatives benchmark their investments against? Mr. Light has two key factors to look at before attempting to compare a hedge fund to anything.

“The first step: Figure out what you might have invested in instead. Another yardstick: What does the fund manager say his ultimate goal is?”

Once you know what’s under the hood of your hedge fund, and know the ultimate goal, there are many possibilities for a proper benchmark.

1. Measure against 0 

Most hedge funds market themselves as “absolute return” vehicles, being able to make money in many different economic environments; and in the strictest sense of that phrase – the benchmark to use would be the 0% line. A positive gain. This is the sort of benchmarking a lot of investors do unknowingly, saying if the investment is making money (is up >0), it is doing well, and if not – it’s under performing – no matter what the stock or bond markets are doing.

2. Hedge Fund Indices

What about a hedge fund index?  Yes, there are such things, and while they are plagued with complaints of survivorship, backfill, and other biases – they appear to act quite well as a benchmark for alternative investments in… you guessed it – hedge funds. We prefer the DJCS Hedge Index, which just happens to have multiple sub-indexes covering Emerging Markets, Event Driven, Long/Short Equity, Global Macro, and Managed Future; just to name a few.

3.  Managed Futures Indices

You’ll see that managed futures is one of the listed hedge fund indices, and for those in the space we specialize in – it is more than a fair comparison to measure up your alternative investment in the managed futures space to the various managed futures indices. While they differ month to month and have different compositions, we’ve found the average of them to be quite consistent with the actual gains and losses seen in actual managed futures accounts of our clients. It’s also worth noting that there are sub indices here as well – where you can dive down and compare different styles with the short-term trader index, ag index, and trend following sub-index.

4. Commodity Index

It’s hard to get too far down the alternative investment spectrum without running into commodities – and comparing your alternative investment (especially if it is a commodity heavy managed futures investment or energy fund or the like) to one of the original alternative investments makes a lot of sense.  You can get more granular here as well, with indices on energy, agriculture, and so forth – just be careful you’re not looking at an index of energy companies.

Now, comparing an investment to an index which is most similar to the strategy or you investment seems logical enough, but even then your investment is likely to be much more volatile (both on the upside and downside) than the index due to the index gaining the advantage of a smoothing effect by combining many managers. This makes it important to normalize the performance in some manner, which is where risk adjusted ratios come in:

1. Sharpe Ratio 

The most popular risk adjusted ratio is the Sharpe. The Sharpe Ratio measures return over volatility. But as we’ve discussed, the largest issue of using volatility of returns, and more technically the standard deviation of returns, is that using such a calculation assumes a normal distribution of returns.

2. Sortino Ratio 

Then there’s the Sortino ratio, which measures risk over both the upside and downside volatility.

3. Mar and Calmar Ratios

The Mar and Calmar Ratios measures Compound ROR over Max DD.

4. Sterling Ratio

The Sterling ratio is slightly different, which measures Compound ROR overage the average drawdown, instead of max drawdown.

And just how do hedge funds look against the S&P when considering their normalized behavior – their Sharpe ratios? As joked about earlier – when you plot the rolling 3 year Sharpe ratio of Hedge Funds and the S&P 500, there isn’t the same sexy headline of hedge funds underperforming the S&P 500. They’ve been about the same lately, after being handily ahead for the better part of the 2000′s.

3 Year Rolling Sharpe Ratio(Disclaimer: Past performance is not necessarily indicative of future results)
Data: Hedge Fund = DJCS Hedge Fund Index SPY = S&P 500 ETF via Yahoo Finance

 

So the next time there’s an article claiming Hedge Funds (or other Alternative Investments) as underperforming the S&P 500, realize they are telling you that the Filet tastes meatier than the Salmon. The Salmon is half the calories and half the fat content… if it doesn’t taste as meaty – that’s usually on purpose.

The Russell 2000: The Chicken or the Egg?

All eyes in our office tomorrow will be looking at Russell 2000 futures after shooting right up to down trend line today.  While some have been calling for the S&P and Dow to confirm the down move seen in the Russell, there now exists the very real possibility the Russell will rally to make new highs to match those two, instead of the other way around.

The 1130 level (today’s close), 1140 level (the next resistance on the down trend), and the 1150 level (the mid April bounce highs) will all be key levels to watch in the saga which is small cap stocks…

Russell Trend Lines
(Disclaimer: Past performance is not necessarily indicative of future results)
Chart Courtesy: Finviz

Who will catch up to whom?? Stay tuned….