Professional Documents
Culture Documents
In This Issue
Founding Father Q&A
Martin Lueck, president of Aspect Capital and a founder of AHL, talks about last years trades and this years prospects.........................2
Index Track
Insider Talk
Futures Lab
News Briefs
Practitioner Viewpoint
OPALESQUE FUTURES
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OPALESQUE FUTURES
confidence to stay with statistically established trends. What we trade depends on systematic modeling and statistical analysis of data, not gut feeling. The key is to manage the risk very carefully. Our models automatically scale back positions as markets become more volatile. As an example, our equity short positions were profitable at the beginning of the year, but as volatility picked up particularly in September around the Lehman Brothers collapse, we scaled them down even though the trend was continuing. OFI: How did the credit contraction affect managed futures? ML: The liquidity crunch that hit strategies like arbitrage was not a factor for us. We only trade in highly liquid markets. Our leverage is limited to whats inherent in futures contracts. You trade contracts on marginyou might trade $90,000 of gold with a margin of $4,000 but theres no borrowing involved. OFI: Are there opportunities in 2009? ML: My sense is that the global economy is not looking at a return to cheery times any time soon. If 2008 has been a painful year, I believe that theres still more to run and more time to ride many of the trends. Similarly, the fallout from the collapse of the technology bubble in 2000 created opportunities for managed futures for some time thereafter. OFI: What conditions are bad for managed futures? ML: There are two situations when managed futures are likely to perform less well: very sudden reversals of direction and extended periods of calm when there are no trends. In the current environment, however, there are likely to be more trends, whatever the economic prognosis. For instance, if you look at the money governments are printing, you can certainly discern opportunities in interest rates. OFI: A lot of capital left hedge funds last year. What does that mean for managed futures? ML: Id like to think that managed futures will get a larger slice of the smaller hedge fund pie. The strategy has certainly demonstrated its mettle.
OFI: What should people watch for when investing in managed futures? ML: A good manager will be willing to articulate to investors the principles behind the trades. Complex models should not be a barrier. The stigma attached to black boxes is misleading. If anything, its an advantage: the systematic process avoids the vagaries of human emotion and key-man risk. The models, however, have to be continually updated and developed. The landscape evolves all the time, not only in the markets but also in competition with
What we trade depends on systematic modeling and statistical analysis of data, not gut feeling.
traders, for instance. A manager who continues to use the same model without evolving it is a disaster waiting to happen. At Aspect we spend around 75% of our annual budget on technology and research.. Like a pharmaceutical lab searching for innovation, we try to take advantage of changes in market dynamics and find new nuances. Investors need to consider not only a management firms track record but also its investment and progress in research.
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OPALESQUE FUTURES
INDEX TRACKER
2008 Performance
Barclay Hedge
Greenwich Futures
Hennessy MF Index
MSCI EAFE
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OPALESQUE FUTURES
INSIDER TALK
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OPALESQUE FUTURES
FUTURES LAB
Risk/Return Profile
Managed futures add real diversification to a portfolio for several reasons. For one, futures represent potential hedges against such factors as business cycle movements and inflation or deflation risk.
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FUTURES LAB
Also, CTAs often target many markets using multiple strategies. These traders are almost uniquely flexible. Unlike mutual funds, managed futures programs are not limited in what they do. CTAs can buy and sell futures, write or purchase options, and speculate in bull or bear markets. They do not need to pursue a single view as a bull or a bear. A trader in futures markets can nimbly take positions across the world. Foreign exchange and financial index futures allow for global diversification without the need for a fine-grained focus on several thousand stocks or bonds worldwide. Moreover, by their very nature commodities are dependent upon global factors. These characteristics make managed futures diverge from major markets, unlike certain hedge fund strategies. Long/short equity returns, for instance, strongly track the US stock market with a correlation of 93%, whereas this correlation is negative 23% for managed futures (Table 1). What is more, CTA performance is not much related to fixed incomethe correlation is 30%, according to Barclay Hedge. As last year demonstrated, managed futures tend to do well when equity and credit markets slump.
TABLE 1
25% Stocks1 25% Bonds2 50% Managed Futures3 Standard Deviation: 10.76 Compound Annual Return:
Jan 1, 1980 - Oct 31, 2008 1. Stocks: S&P 500 Total Return Index 2. Bonds: Lehman Long-Term Treasury Index 3. Managed Futures: Barclay CTA Index
11.41%
39% Stocks1 39% Bonds2 22% Managed Futures3 Standard Deviation: 9.33 Compound Annual Return:
10.88%
50% Stocks1 50% Bonds2 0% Managed Futures3 Standard Deviation: 11.18 Compound Annual Return:
10.42%
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futures) presents an investor with the greatest risk and lowest return. A portfolio comprising 39% stocks, 39% bonds and 22% managed futures offers the best combination of return and risk. Countless investors might have been spared at least some of the financial destruction they endured in 2008 had they seen fit to allocate a small portion of their investment capital to this sector as a hedge against just the type of economic tsunami were experiencing. Indeed, the term hedge applies to this asset class much more accurately than it does to a hedge fund strategy like long/short equity or even distressed debt investing.
No Fat Tails
There is a common misconception that futures-related investing is a form of speculation and hence poses high risk. If anything, the opposite is true for the industry as a whole. While individual CTA programs can have large drawdowns, as a group they have a remarkably stable profile compared to almost any other asset class over the past decade. In a performance scorecard for both traditional and alternative investments from 1998 through 2007, futures returns are remarkable in being persistently positive and avoiding extremes (Table 2). One expects the worst and best performers to vary from year to year, but some asset classes show up frequently in either category. Thus commodity index returns often move from the very top of the ranking to the very bottom from one year to the next. There is a sharp contrast in this respect between the commodity index and managed futures, despite the commodity component of CTAs. Managed futures are never at the bottom of the ranking. Neither are they at the top. Through the market cycles, managed futures come out consistently in the middle of the distribution.
NOTES * From 2000 through 2007. Source: HedgeFund.Net Strategy Focus Report: Asset-Based Funds, March 10, 2008. ** 10-year period ending December 31, 2007. Source: Barclay Hedge.
A study published by the Chicago Mercantile Exchange concluded that for a 20-year period ending in 2008, portfolios with up to 20% of assets in managed futures yielded as much as 50% more returns than portfolios consisting only of stocks and bonds, with comparable risk. The graph below shows that a traditional portfolio (50% stocks, 50% bonds, and no managed
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FUTURES LAB
Unlike equities or the commodity index, managed futures as a whole does not yield more than 30% a year although individual managers can make very high annual returns in some conditions but neither does it lose money. It stays within a
TABLE 2
relatively narrow band, ranging from 3% to 18%. In view of this history, CTAs stayed true to form during the 2008 storm. Far from adding to the danger, managed futures acted as a hedge.
Ten Years Markets Comparison* Best and Worst Performers vs. Managed Futures
Year Best Worst MF**
1998
Commodities (-)35.8%
10.2%
1999
REITs (-)6.5%
11.3%
2000
Commodities 49.7%
18.3%
2001
REITs 15.5%
Commodities (-)31.9%
3.3%
2002
Commodities 32%
3.2%
2003
Currency (-)14.7%
4.5%
2004
REITs 30.4%
Currency (-)7%
14%
2005
Commodities 25.6%
Bonds 2.4%
7.6%
2006
REITs 34%
Commodities (-)15%
5.8%
2007
Commodities 32.7%
REITs (-)17.8%
10.7%
* Source: From a scorecard prepared by Rydex Investments. Managed futures is represented by the Standard & Poors Diversified Trends Indicator, leveraged equity is S&P 500 leveraged 150% daily, commodities are represented by the Goldman Sachs Commodity Index, currency is the US dollar index, and REITs returns are from the National Association of Real Estate Investment Trusts. ** An asset class performance comparison for 2008 is on p. 2.
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NEWS BRIEFS
CME Reports Big Volume Changes
CME Group, the large futures exchange, says trading by members went down 21% from the third to the fourth quarter. It attributes the drop to extreme volatility in key contracts and normal seasonal slowdown as well as the credit crisis. Large hedge funds, one of the customer segments CME reported on, reduced trading volume by 32% and now account for 8% to 9% of the overall volume. But certain markets saw rapid growth in 2008, in particular E-minis, energy and metals products. Electronic trading continued to gain market share.
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PRACTITIONER VIEWPOINT
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Fund Hazards
Thats not all. Fund structures have other risks, not related to investment strategy or markets, that separate accounts do not have. There is redemption risk, as became glaringly apparent in 2008 because of the huge net outflows from hedge funds. When a large portion of a funds investors ask for their money at the same time, the liquidation of portfolio positions causes unexpected losses that can lead to further redemptions, further losses and so on in a downward spiral. Funds usually attempt to prevent this problem by limiting redemptions to certain periods or in some cases not allowing redemptions until the withdrawal requests can be matched with available assets.
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PRACTITIONER VIEWPOINT
With an individually managed account, by contrast, there is no effect from other investors leaving the program. An investor looking to cash in her investment merely has all of the positions in her separate account liquidated and the cash sent to her. There are no duration or asset mismatches to deal with. There is also transparency risk to consider. An example is the blowup of Amaranth hedge fund two years ago. The fund lost around $4 billion trading natural gas futures. It was supposed to be diversified yet was concentrated in a simple bet on natural gas price spreads. Investors did not know how concentrated Amaranths portfolio had become because there was no transparency. Funds lack transparency by design because managers typically concerned about their strategy being imitated or taken advantage of do not want the public (and competitors) to be able to see whats happening in the portfolio. Individually managed accounts, on the other hand, are set up in a way that allows you to see everything that is going on in your account day by day. This insures that there will be no big surprises like 80% of your account turning into a bet on the price of natural gas. If something strange is going on, you will be the first to see it. It is one thing to lose money because a manager traded poorly or market conditions were adverse, quite another to lose because a manager did not match investment duration with redemption structure, put all the money into one huge bet, or committed fraud. Due diligence aims to identify non-investment risks so that you can separate those from trading risks. Separately managed accounts achieve that goal, whereas due diligence can fail to do so, as we saw in the spectacular Madoff affair.
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Futures Advantage
Now, proponents of funds may say that while individually managed accounts are great, the minimum necessary to have an advisor manage your specific account is too high. The fund structure, they might say, is the only way for smaller investors to get access to trading strategies which may require hundreds of millions of dollars of capital. They do have a pointyou cant do merger arbitrage, statistical arbitrage, or private equity deals with an individually managed account unless you have around $100 million in the account. An insistence on having your own account would keep you out of plenty of very good hedge funds. But most good hedge funds have too high a price tag anyway. Perhaps if you cant afford to do it in your own account, you shouldnt be looking at that type of investment in the first place. That brings us back to managed futures and individually managed accounts. Unlike hedge funds with their large minimum investments, there are quality managed futures programs where you can invest using an individually managed account with minimums as low as $50,000such as Clarke Capital Management. With managed futures you get affordability and the protection of individually managed accounts. The protection means you dont have to worry about the fraud, redemption and transparency risks associated with funds. The manager does not have access to your money, other investors redemptions dont affect individual accounts and you can see all the trades put on for you. Bad things can still happen in an individually managed account, of course. A manager could put on trades inappropriate for the agreed-upon strategy, say. But such problems can be identified early on, before they progress. That way, you wont learn from news headlines that your investment is wiped out due to fraud or positions you had no idea you were in.
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OPALESQUE FUTURES
TOP TEN
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34.7%
7.8%
20.3%
131%
Global Diversified
17.5%
76.5%
Schindler Trading
17.4%
-30%
MS4
Futures Truth CO
15%
50.9%
13.3%
60%
12%
6.5%
12%
7.7%
Options
ArborVitae Capital
11.6%
13.7%
10.8%
44%
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PUBLISHER Matthias Knab - knab@opalesque.com EDITOR Chidem Kurdas - kurdas@opalesque.com ADVERTISING DIRECTOR Denice Galicia - dgalicia@opalesque.com EDITORIAL ADVISOR Tim Merryman - tmerryman@opalesque.com CONTRIBUTORS Bucky Isaacson, Frank Pusateri, Pavel Topol, Ty Andros, Walt Gallwas.
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