Here is a link to the latest issue of Opalesque Futures Intelligence: OFIJulyFinal
The recent Bloomberg Businessweek cover story, Hedge Funds are for Suckers, was interesting, as is increasing push back from those in the traditional equity-dominated investment world towards the notion of “alternative investing” becoming mainstream.
The cover story is interesting not because it is wrong – to the contrary, it is probingly accurate in many meaningful ways. Specifically, too many hedge funds exist that are highly correlated to equity markets and beg the question: why not just invest in a stock index ETF? But that’s not entirely the point. The article is interesting because of the introspection it caused.
There are many differences between the NFA regulated managed futures industry and the traditional hedge fund community, some good, some less than positive. As someone who speaks with both managed futures and equity-based hedge funds, these conversations very different. With managed futures funds, I can get right to the point and typically get answers quickly. They questions I ask managed futures funds points to key regulatory differences in investor protections:
1) Have you had your performance independently audited by the NFA? This is a significant benefit of managed futures. The NFA conducts not only audits of performance and the reporting of that performance to the major databases, but also performance follows a fund manager’s track follows them. Despite recent issues with PFG and confirmation of bank balances, the auditing of performance and investor protections this organization offers is noteworthy.
2) What is your beta performance driver? Understanding the macro market environment is key to proper correlation. The vast majority of larger hedge funds are equity-based hedge funds, correlated to the stock market by nearly .80, and the macro performance driver is typically economic strength and a rising stock market. In managed futures, correlated near 0.20 to equities, the lowest correlation in the alternative investing universe, the beta performance drivers are completely independent. A true hedge.
When a manager understands their beta exposure it means they have figured out the strategic underpinnings of how markets and managed futures investments work. It’s not just about understanding the math, but also understanding how things work and why they perform as they do. In this vein, make sure to read work from Altegris in this issue starting on page 5 as their analysis of managed futures performance during various volatility regimes and market environment of price persistence is spot on.)
3) Where is your alpha? What is your edge? When you ask this question, don’t lead but rather watch to see how much they disclose regarding risk management and how the actual algorithm / strategy works. Focus on risk management. Have they provided enough information so as to determine how the program might model during various market environments? Look at the interview with short volatility CTA Global Sigma Plus in this issue. Dr. Hanming Rao’s comments on predicting volatility and focus on risk management are interesting, but it is critical to determine how risk regimes operate during times of crisis.
4) What is your AUM, length of audited track record and what type of investors have supported your firm? (In both equity-based hedge funds and managed futures, sustainability and business operational issues are important; it’s just that the math is a little different. With AUM information – including asset inflows and outflows – provides reasonably strong indications as to the potential for a business risk as much as a trading risk. In managed futures typically funds with $50 million AUM are self sustaining without the need to overreach in generation of performance fees, while those in the evolving stage, just over $100 million in AUM, can be interesting because they are growing with a sustainable revenue flow yet not to large to lose a nimble and manageable market footprint. In this regard, consider the RPM developed theory that, like a growth stock, managed futures funds might be most productive once they have graduated from an emerging to the evolving manager. After this stage, the theory holds that performance can either stagnate or re-invigorate when the CTA hits the mature stage. This conceptually mimics a recent study from the Tabb Group that showed mid-sized equity hedge fund managers outperformed peers. In addition to AUM and experience levels, it is also important to recognize the investor type the CTA focuses on because this points to business operational issues. Once a CTA reaches over $50 million in AUM, they need to be clear about their path to growth. Is the ideal investor type a sophisticated institution such as a plan sponsor or family office? A manager in this realm likely has a business operational structure and risk management process in place. There is an appropriate account structure and distribution channel for this type of product. Or is the offering targeting retail through traditional equity-based financial advisors or the separate introducing broker channel? Each path to the investor has different regulatory regimes, offering types, risk modeling and investor protections / benefits.)
So is Bloomberg Businessweek wrong? No. There are way too many hedge funds highly correlated to the beta in the stock market. Investors should open their eyes to different beta exposures and focus on performance / correlation during times of crisis. After all, isn’t uncorrelated performance the point of hedge funds?
In this issue other interesting items to note include Andreas Clenow and his new book, Following the Trend. In particular Mr. Clenow makes observations about differences in win percentage and risk management between trend and counter-trend approaches that is thought provoking. After this we have interesting market commentary from Efficient Capital, Sunrise and Brandywine Asset Management.
I hope you find this issue useful. Feel free to reach out with comments.
DISCLOSURE: These are the opinions of the author and may not have considered all risk factors. Nothing on this web site should be construed as an individual recommendation, talk to your independent advisor. The author and Opalesque may have relationships with those people they cover in the publication. Mr. Melin provides a full disclosure of his business relationships to regulators and certain eligible participants who engage him in consulting projects. Managed futures investing involves risk and there are no guarantees of safety or future performance being implied. Managed futures can be a risky investment. This web site and its content is subject to the terms of the web site. Risk Disclosure and terms of web site are available here: http://www.uncorrelatedinvestments.com/templates/Disclaimer.html Performance information received on this site is provided by third parties and deemed reliable but there is no guarantee relative to same. Performance reporting sources and quality assurance techniques may include, but are not limited to: disclosure document, CTA self reporting, brokerage firm reporting, consultant reporting, spot checking other reporting databases; nonetheless no guarantee of accuracy or implication performance verification or auditing is being made by the publishers. The CTA Database is a project separately managed from www.uncorrelatedinvestments.com.