Facts That I Think Bloomberg Should Have Covered In Its Managed Futures Story

A recent Bloomberg Markets article by David Evans, “Fleeced by Fees,” raises several valid points but leaves critical “misimpressions,” a word the Evans uses to describe how managed futures is misrepresented to investors.

The primary thesis of the article is that managed futures hides and mis-represents fees to investors while enriching fund managers and eating most investor profits in the process.

While many of Evan’s assertions are correct, perhaps the most serious issue is how the article omits key facts.

For instance, the key fact is that the National Futures Association (NFA), the self regulatory body for the managed futures industry similar to FINRA for equity-based financial advisors, requires that Commodity Trading Advisors (CTAs) and Commodity Pool Operators (CPOs) who offer investments to the public  report performance net of all fees, as is clearly outlined on page seven of the disclosure document reporting guidelines from the regulator.  This document addressing the clarity of CTA investor disclosure clearly states “The disclosure document must include a complete description of each fee the CTA will charge.”

Also omitted from the article was the fact managed futures CTAs and CPOs who offer investments to the public that fall under the NFA regulations are required to report performance net of all fees and commissions – net net.  As outlined on page 12 of NFA disclosure requirements to calculate performance the NFA has a simple standard formula of subtracting the month ending asset value of the account (ENAV) from the beginning net asset value (BNAV).  All fees, commissions and expenses taken out of the investors account during that period of time are factored into the profit loss reporting.

What is missing from the Bloomberg article is any mention of these disclosure requirements, which, if not followed, could lead to the CTA or CPO being banned from the industry.

For its part, the NFA says this information was provided to the Bloomberg reporter in an interview that occurred with multiple people present as witness but Bloomberg never reported the information.

These material facts omitted from the article stands in sharp contrast to Evan’s primary message that fees are hidden and non-transparent in all of the managed futures industry, which is factually inaccurate.  Evan’s fails to make any meaningful distinction between different managed futures account types and varying levels of fees and performance reporting requirements.

While the article is accurate in the assessment that fees in certain investment products offered by Wall Street wirehouses and Broker Dealers are high and gobble up investor profits, this didn’t tell the whole story.  Such non-transparent fees are not the case with all managed futures account types and even some certain managed futures mutual fund providers have a strict policy capping all fees and expenses at 2% and some are even transparent regarding how they operate the strategy.

Most important, had the author dug a little deeper or reported all the information he would have realized you could have substituted the words “managed futures” for “mutual fund” and the article would have been equally accurate.  The issue is the fund product structure adding layers of fees but taking away transparency from the core, a direct managed futures segregated account structure.  While the article paints the entire managed futures as a whole in a negative light, this is not accurate as certain account types not offered by Wall Street wirehouses have very different performance reporting standards than a direct managed futures account, which underlies all the managed futures products.

The Direct Managed Futures Account

In an apparent attempt to paint the managed futures industry with one oblique brush, Evans failed to raise the critical distinction between a direct managed futures account offered by a Futures Commission Merchant (FCM), and the fund structure account types offered by Broker Dealers and wirehouse financial advisors.

What should have been included in the discussion is that all managed futures investments are based on a direct managed futures account held at a FCM that fall under segregated account regulations.  This account type is entirely transparent on a daily basis – investors can even peer into the trades and exact positions the CTA has placed, something unheard of in the hedge fund community – and performance is required to be reported net of every fee, commission and expense.  It is the ideal account type: generally low friction and complete transparency being regulated by an organization with a reputation as playing hard-nosed with those being regulated.  (Some industry executives are on record as calling industry regulators the “Gestapo” and regulators have been accused of being overly aggressive.)

The key point is that once the managed futures account type changes into a fund product, the NFA loses a significant degree of regulatory control over disclosure of fees and performance reporting.

Knowledgeable institutional investors and high net worth individuals typically access managed futures through the direct account or when they access it through a fund product they do so through low fee account structures where all costs are clearly spelled out up front.  The article actually gives an example of this when referring to investors in Winton Capital, but strangely fails to mention the critical difference between a direct managed futures account and the non-transparent fund account with different performance reporting standards.

The Foundation of All Managed Futures Products: The “Direct Account” Structure

In order to distribute managed futures to retail investors, some – but not all – fund products take the transparent managed futures direct account, wrap it in a fund product for distribution to retail investors  while adding hidden fees and expenses and eliminating transparency.  At the core of all managed futures products is the gem of the direct account structure.

The article touches on this very issue by mentioning that pension funds and other institutional investors typically reap the rewards of managed futures, retail investors bear the brunt of fees.  Citing a $1 million investment in Winton Capital, which returned 11.9% during the generally rough 2009-2012 period of time, the article went on to accurately note that a retail investor who invested in a Winton-based fund product from as separate third party product marketer, Altegris, was fee heavy experienced a 10% loss over the same period of time.  The article failed to mention the distinction between an NFA regulated direct managed futures account and a fund product, not regulated by the NFA.

To knowledgeable professional investors and those on the inside of the managed futures industry, this didn’t come as a surprise.  Over the past several years there was a fight between the SEC and the CFTC over disclosure of fees for managed futures mutual funds, with a battle over performance tables inclusive of all fees and expenses vs traditional oblique mutual fund reporting being a key component of the fight.  Again, this battle strangely didn’t make it into the Bloomberg article that was supposedly researched over the course of several months.

BarclayHedge CTA Database: Other Facts Omitted

The article takes on the BarclayHedge CTA Index, accurately noting that CTAs can stop reporting to the index but failing to mention this hedge fund reporting methodology is similar to other hedge fund indexes and reporting services.  The article also fails to mention that once a CTA stops reporting strict rules prevent it from simply starting to report again and other methods are in place to present inaccurate performance reporting.  Failure of a CTA to report to such database reporting services could raise significant questions among professional asset allocators and damage the CTA’s business.  The issue of CTAs stopping reporting is known as “survivorship bias,” yet the Evans fails to address academic study in any meaningful way.  For instance, the survivorship bias rate of the BarclayHedge CTA index is just slightly higher than that of the S&P 500, according to BarclayHedge and confirmed by my 6 year study of the Barclay CTA Graveyard database.

The Bloomberg article also fails to mention that each CTA regulated by the NFA offering investments to the public undergoes an extensive audit.  This includes review of each and every account and confirmation of the publicly reported performance – including checking of how CTA performance is reported to major CTA databases such as the BarclayHedge CTA reporting service.

The article charges that the CMEGroup omits key facts to investors by utilizing BarclayHedge data in its reporting of performance.  Specifically the article says the BarclayHedge database fails to account for fees, but this is inaccurate to a significant degree.  The BarclayHedge CTA Index – and more specifically the Barclay BTop 50 Index – are significantly represented by managed futures direct accounts – well over 60%, according to recent study.  Anytime a direct managed futures segregated account reports performance, this performance is reported net of fees, a critical fact the article failed to mention.  In regards to managed futures study, the BarclayHedge BTop 50 has a much lower survivorship bias rate than does the more general BarclayHedge CTA index, but this was not mentioned.

The article ends by quoting an NFA representative Mary McHenry as saying the regulator doesn’t have a requirement to clearly present how fees have consumed returns over time.  “We don’t have a requirement where they have to present that information.  That would be valuable,” she was quoted as saying.

These statements conflict with the NFA’s own guidelines for performance reporting  and specifically rules 2.29 and 2.36 but also rule 2.13, 2.34.

For its part, the NFA said that the fee performance reporting guidelines were clearly outlined in the interview but these facts were omitted from the article.





Molinero Global Markets Monthly Update

August ended down -2.07%. Our portfolio was well positioned early in August and models increased our risk exposure slowly. However, markets started to move against us while our exposure was fairly high. Our risk management stopped out some positions fast thereby limiting our losses. Core models originated most of the losses while our Short-term model provided some relief. Energy and Metals sectors rallied and impacted our short positions, and were among our worst contributors. Currencies and Equities returns were negative while Bonds were profitable.
Commodities: -1.6%. Disruption of supply and Middle-east increasing tensions over Syria prompted Metals and Energies to rally. Our core models were mainly short and were stopped out. Gold and Nat Gaz were our worst contributors. Ags were profitable and helped mitigate the sector’s loss. Currencies: -0.4%. Our position diversification in Currencies helped during the month; however the Euro correction at the end of the month penalized us. MCM1 gains in this sector were not sufficient to offset losses from the other models.  Equities: -0.4%. Despite the majority of Equity markets correcting in August, our portfolio managed to capture gains in European Equities but these profits did not offset losses in US markets. Asian markets’ contribution was flat. Bonds: +0.3%. While our risk allocation to this sector reduced, all our models managed to capture opportunities and contributed positively to the P&L thanks to their short bond positions. Among them, MCM3 (short term model) was the best contributor in this sector. All maturities were profitable.

To view full performance and details click here: Molinero Capital – Global Markets – Performance Report – 2013-08



What is the capacity of managed futures? Newedge white paper explores the topic

In a recently released strategy note, Newedge researchers Galen Burghardt and Lianyan Liu teamed with Ewan Kirk of Cantab Capital Partners to consider an often discussed issue: Is there a capacity issue with managed futures.  The research team dives deep into issues of futures market open interest relative to a variety of factors, including its flexibility, distribution over various time horizons, as well as examining liquidity and capacity spill-over effects. 

To view the white paper, click here: Newedge_Snapshot_Capacity_managed_futures_industry

As a sidebar consideration, also recognize that managed futures is actually a small percentage of overall exchange volume.  Assuming the average CTA trades 900 round turns per million in assets managed (1,800 contracts, or sides), the overall volume of the managed futures industry is 595,800,000 contracts (sides) traded over a year.  Consider that depending on the year, the CMEGroup trades nearly 2,890,000,000 contracts and is but one exchange.  The FIA reported that in 2012 there were 21,200,000,000 total futures contracts traded.  




Bloomberg asks the question: Are hedge funds for suckers? If they are correlated to the stock market, yes

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.

Best Regards,

Mark Melin,



CTA Interview: Short Volatility CTA Discusses The Ability to Predict Volatility and Risk Management

Below is an interview excerpt for web site members before the article is published in the upcoming Opalesque Futures Intelligence.  Here is a link to a performance sheet of the CTA: Global Sigma  


Recent Pinnacle award winner Hanming Rao is Chief Investment Officer for Global Sigma Plus, a short option trading system in the S&P 500 markets. A Harvard PhD and former SAC Capital and Millennium Partner trader, Dr. Rao engages in what for some is a controversial trading strategy: selling option premium on the S&P 500 futures. 

The strategy works by selling “out of the money” options and collecting a set premium from the option buyer at the time of the trade.  The option buyer is seeking to hedge against a stock market decline and thus pays a premium for the “insurance.”  The pricing of the option premium is dictated based on a number of factors, but most significantly volatility in the markets traded, time horizon relative to expiration and the distance the option is sold from the current market price.  The trade profit is defined by the option premium collected while the primary risk is that the options sold move higher in price and close “in the money.”  A loss example might be selling an S&P 500 put before a market crash and having the value of the put rise significantly afterwards.  The loss on the trade is defined by the difference between the initial option sale price and the now higher closing price of the option. 


Global Sigma Plus has an interesting track record and Dr. Rao is well versed in market strategy, yet the risk management regime has yet to be tested during a period of market crisis.  Past performance is not indicative of future results.  There is risk of loss when investing in managed futures.  This interview does not constitute a recommendation to invest. Performance data supplied by the CTA and was not audited by this publication.

With under $89 million in assets under management, the short option strategy employed by Dr. Rao is known to have a higher average win percentage than trend or relative value strategies, in several studies known to average around 74%.  The analytical value of win percentage in this strategy, however, might be considered a red herring.  As noted in the interview below, risk management – particularly during market crisis – can be significant. Investors analyzing risk in this strategy might do well to consider worst drawdown and downside deviation as clues to risk control, with particular emphasis on drawdown mitigation during periods of rising volatility.  In P (A|B) Method analysis, one benchmark CTA in this category used for comparison is LJM Partners who has a track record dating back 1998, operating during periods of multiple crisis with nearly $200 million in total firm assets under management. We recently caught up with Dr. Rao after his winning the Pinnacle Award for best emerging CTA:


 Mark Melin (MM): Can volatility, a key driver of profit and loss in this strategy, be predicted?  Past study of volatility has indicated that occurrences are randomized.  If it can be predicted, what are you looking at?  Do the variables in your formula have validity?


“Volatility is very mean reverting and range bounded”

Hamning Rao (HR):  Volatility is very mean reverting and range bound.  The average VIX price for the past 20 years has been around 20. In comparison, the S&P500 doubled in value over the last ten years and quadrupled from 1993 to 2013. I don’t know where S&P500 will be for the next 10 years, but it is my opinion the average VIX will most likely still be around 20.


“Many people say stock markets are random. If the market is random, there won’t be fat tails.” 

Many people say stock markets are random. On the other hand, everyone is talking about fat tails. These two things cannot exist at the same time. If the market is random, there won’t be fat tails.

The reason for fat tails, in my opinion, is due to investors herd mentality and risk averse nature of human being. Long term stock market price direction is moved by fundamentals but short term it is a “voting machine.” That is why economists love long term forecasts and technical analysts love short term plays. From technical stand point of view, it is hard to forecast long term movement because there are too many variables. This is more like butterfly effect: there was a butterfly flapping its wing in Brazil, then you had a tornado in Oklahoma City. You may say the butterfly caused the tornado, but they were too far apart and too many things could happen in the middle, it was hard to draw the conclusion. However, the federal agents warned residents 36 minutes before the tornado. So it’s no longer unpredictable when it’s close. Same thing in the financial markets, in summer 2008, most people believed Lehman would survive. However, the Friday before Lehman filed bankruptcy, people knew either Lehman would be bought by another bank or it would disappear. You only have two choices then and the market quickly priced in what would happen next. I could even argue 911 was not random. You had Airlines sold off unusually hard and VIX climbed 11 points to 32 during the 10 trading days before the attack. It was quite a warning already.

: Describe your strategy.

HR: Like many option programs, we also sell options to collect premium. The difference is we may hedge our risk exposure using future aggressively. We try to manage risk on a day to day basis and try to minimize our draw down. We focus on shorter time frame and we can only sell options within 6 weeks to expiration. We also trade very frequently — we traded 20,000 contracts per year per million dollars for 2012 (a high level of trading, which potentially indicates a fair amount of hedging activity). If the strategies work, higher turnover is helpful to minimize draw downs.

MM: Are you 100% discretionary or is there some formula or process you utilize?

We had models and back tests. But trading and execution are discretionary. Compared to futures markets, it is very hard to automate options trading. You had hundreds of strikes and multiple-expiry compare to one single number of underline futures. So far we feel discretionary trading is fine and don’t plan to change it.

MM: What is your edge?

“The only way to distinguish option sellers was when market tanked or had big spikes. It is like what Warren Buffet said: ‘Only when the tide goes out do you discover who’s been swimming naked.’ In order to generate consistent returns over time, you need to focus on risk management.”

HR: We think we have a better risk control. Generating returns in an option strategy is the easy part. Everyone knows how to sell options. When market is range bounded, both good traders and bad traders make money. Traders without strong risk management actually will make more money. Like in 2012, the S&P500 index didn’t have a big movement compared to 2010 or 2011, and almost every option sellers made nice profit. The only way to distinguish option sellers was when market tanked or had big spikes. It is like what Warren Buffet said: ”Only when the tide goes out do you discover who’s been swimming naked.” In order to generate consistent returns over time, you need to focus on risk management. We optimized our program based on risk adjusted return instead of maximum return. We hedge our risk aggressively when we have draw downs — since big draw downs are not 0 to 1 switch. Big draw downs always followed by smaller draw downs. So you need cut loss aggressively even when you have smaller draw downs.

MM: What happens when the VIX is at very low levels?  Are their points at which you don’t enter the market?  Do you sit on the sidelines?


“It is very hard to make money when the VIX is low.”

HR: It is very hard to make money when the VIX is low. Obviously if VIX ever went 0, we would close shop since there would be no premium to collect. Our expected return is positively correlated to VIX. When the VIX is higher, we could collect more premium and generate higher returns. We don’t have a set target of returns because this variable. However, since VIX averaged 20 over the past 20 years, we expect 20% returns over longer period of time.

We typically are in the markets. Very occasionally we may be out of the market when realized volatility is higher than implied volatility or when we believe market is going to have a big jump in volatility.

MM: You work on the S&P, are you selling calls and puts or just puts?  How do you determine distance from the money?  Is there a volatility based formula or is it a standard deviation from the market?

HR: We trade both calls and puts. We typically choose options that have around 95% of chance to expire out of money. It is based on volatility.  (It is interesting to note the CTA’s reported win percentage is up near 95%, well above the strategy average of the mid 70% range yet the track record is still only a few years old.)

MM: Describe how you enter positions (with this strategy it is interesting to note if they scale / leg in positions separately or enter the order as a strangle).

HR: We usually sell puts and calls separately instead of selling a strangle. We also spread out our orders and establish positions gradually instead of one big order.

MM: Address your risk controls.  When unexpected volatility strikes, how does the risk management work?  Are you hedging with futures or option spreads?  Do you sell into the back month and roll the position?  What might an investor benchmark relative to expectations when volatility strikes?

HR: When the VIX spikes, we usually short futures to hedge. Sometimes we also buy options to hedge as well. We don’t sell into the back month or roll the positions. We don’t like roll. We are memory-less. We mark to market everyday and use the settlement price as our cost for next day. Our mandate is to manage day to day risk. When you think about a roll to the forward month, you basically refuse to take loss on your positions. We believe that is not helpful in short term trading. Your trading decision should not be affected by your entry point cost.

When Volatility strikes, obviously our existing positions may lose money. But losing money may not be a bad thing because you will gain opportunities (by selling into the volatility spike into forward months) to boost returns the following month.

MM: What’s your margin to equity levels during a normalized market environment and what is the worst case extreme during a volatile market environment?

HR: We normally use 40% margin to equity based on CME SPAN margin and may spike to 80% in rare occasions. This is high compared to other CTA programs. (Editor: by comparison, the average margin to equity for trend traders typically hovers near 15%). One reason is CME imposed higher margin for equity index product compare to other commodities like Currency, Agriculture and Metals even though they have higher volatility. So just looking at margin to equity ratios is not fair for Equity index products.

[Risk Disclosure: Past performance is not indicative of future loss.  Hypothetical past performance, such as modeling performance during previous market environments, is considered to be of lesser analytical value than a CTA’s track record trading client capital.]

Sunrise Capital: The First Half Of 2013 Was A Time For Less Conventional CTA Approaches

Sunrise Capital, a trend following CTA based in California, provided market commentary for the upcomming Opalesque Futures Intelligence (below).  For links to their performance documentation, click here: Sunrise_Evolution_JUNE 2013.

The first half of 2013 proved to be quite tricky for the CTA industry with the Barclay CTA Index down 0.62% (estimate as of July 8th) from January through the end of June. Similarly, other systematic macro indices have lagged far behind the S&P 500 and other traditional investment benchmarks.  However as always, some intrepid CTAs have found ways to deliver compelling returns this year and they are doing so utilizing some unique approaches to systematic trading.

Like many CTAs, Sunrise found quite a bit of trouble in the “risk on/risk off” whipsaws of 2012.  Despite this, Sunrise has rebounded nicely in 2013 and through the end of June, the firm’s new Flagship Program known as Sunrise Evolution is up 14.0% on a net basis.

What has been the key to Sunrise Evolution’s success so far in 2013? Four trades discussed below shed some light on how markets have unfolded over the past six months and how Sunrise has attempted to capitalize on price patterns within these markets differently and, in some instances, more successfully than some of their peers. Moreover, as these four trades demonstrate, diversification remains a powerful defense for CTAs such as Sunrise against even the trickiest of market moves.

The first example of one of Sunrise’s successful 2013 trades stems from a new reality of the global economy:  when China sneezes Australia gets a cold.  Downbeat economic data out of China over the past few months has fueled speculation that the commodities super-cycle is slowing down.  Combine this with China being Australia’s largest trading partner and the outsize role natural resources have on Australian exports and we have a recipe for a sharp retrenchment in the Australian dollar.  Indeed, from a high of over 104 in early April, the market has sharply collapsed down to 91 by the end of June and Sunrise has capitalized on this move.

Generally speaking, trading algorithms that identify strong trend definitions were sure to spot the precipitous drop in the Australian dollar from early April to mid-May.  Starting from mid-May through the end of June however, the pattern shifted from a rather linear descent to a slightly choppier “saw-toothed” decline that appeared to hurt some CTAs but fell right into one of several wheelhouses of the highly diversified Sunrise Evolution Program.  As such, Sunrise was able to ably capture small pullbacks within the larger trend and thereby dampen the volatility that appeared to stymie more traditional trend following approaches.

Another example of a successful 2013 Sunrise trade arises from the sharp gold reversal that has devastated the portfolios of many discretionary “gold bugs” and certain long term trend approaches to the commodity.  From the doldrums of 2008, gold marched from $800 per ounce to what seemed to be continual new heights and hence, the “gold fever” that has characterized many investment approaches since the financial crisis.  Then April happened.  In two days gold dropped $200 per ounce.  The suddenness of the move spooked market participants, leading all to search for reasons for the drop (ranging from inflation numbers to Cyprus’ central bank selling its reserves) and many to flee the commodity altogether.

However savvy CTAs such as Sunrise needed to look no further than the stair-step decline of gold that began in September 2012 to find a compelling justification for building a short position prior to gold’s 2013 collapse.  Indeed, a flexible, longer-looking component of the Sunrise Evolution Program was not deterred by gold’s subsequent run-up of over $125 per ounce from the low towards the end of April.  This proved to be extremely helpful for Sunrise as gold again drifted lower through May and into June and its systematic patience was rewarded on June 20 when gold dropped another $80 in one day, ultimately dropping below $1200 per ounce.  Amazingly, two of the three biggest one-day dollar declines in gold in the past 35 years occurred during Q2 of this year.  While most investors not only missed these shorting opportunities, but also lost significantly on existing long positions, several perceptive CTAs such as Sunrise nailed the short trades by employing flexible models that embrace the concept that under certain circumstances that investors may never understand, gold or any other market can fall even more rapidly than it has risen in recent years.

A third component of Sunrise’s successful 2013 worth examining is its trading approach to fixed income.  Certainly one of the most compelling long term trends of the past several years has been the upward price march of bonds.  The economic implosion of 2008 and a subsequent half decade of stimulus measures by the U.S. and many other governments have sent bond prices and interest rates to places few could have imagined.  With economies around the globe showing signs of recovery, the million dollar question on everyone’s mind in recent months was “when and how will the bond bull market end?”  Every investor, CTAs included, seemed to have different answers to these questions and as demonstrated recently, a manager’s returns over the past several months have been highly dependent upon the accuracy of those answers.

Many investors, including many CTAs, held fast to massive long bond positions as 2012 turned to 2013 and have not been quick to unwind those positions, even as Bernanke’s comments have spooked markets and strongly suggested that the end of the trend is neigh.  However Sunrise, through the more diversified and dynamic approach of Sunrise Evolution, much earlier in 2013 began to not only aggressively unwind its long positions but also, take on short bond positions in some of its models.  Therefore, when the bond tides really began to turn sharply in May and June and lengthy trends began to deteriorate across the entire yield curve, many firms were squarely in harm’s way while others like Sunrise, were not.

Much like gold, the end of the trend in bonds has been fast, violent and in many cases as harmful to investors as the preceding uptrend was helpful.  CTAs like Sunrise with models that spotted the early stages of this violent downward price move in the months and weeks prior to the Bernanke comments of June 19 were well positioned to profit from the massive sell-off that ensued.  CTAs and discretionary traders that did not pick up on these clues suffered mightily as evidenced by the top bond management funds which in many cases have just posted their worst quarters on record.  In sum, it’s clear that volatility has returned with a vengeance to the bond market and the operative question for any CTA going forward is how their models are calibrated to deal with this new fixed income reality.

Lastly, it is worth examining equities, an area where, after enjoying profits from January through April, Sunrise took some lumps in May and June.  Specifically, like most CTAs and most investors generally, Sunrise benefitted mightily from the raging bull equity market that originated a few years ago but truly launched in earnest with the turn of the calendar to 2013. Indeed, print a six-month, one-year, or two-year chart of the S&P and the trend is inescapable: up and to the right with a particularly strong burst in early 2013.

With the S&P closing at an all-time high of 1669.16 on May 21 and many global equity markets following suit, both longer and shorter term aspects of Sunrise Evolution thrived on equities through the middle of May. Moreover, due to some unique innovations in their new flagship, Sunrise was at times better able to calibrate and focus its stock positions and when needed, de-couple U.S. markets from non-U.S. equity markets, which have at times demonstrated far less strength and far more volatility than their U.S. counterparts.  In addition, certain components of Sunrise Evolution wisely pocketed much of the equity profits they had achieved in the earlier months of 2013 and thus as certain markets (particularly those in Asia and Australia) began to sharply retrace, Sunrise had much less to lose than many competing CTAs and did not appear to suffer as much damage as others from the volatility as Q2 unfolded.

Since mid-May however, equities have presented challenges that have confounded even more diversified trading approaches such as that of Sunrise.  The first trouble spot arose in Japan, when the Nikkei experienced intraday swings of over 1000 points two days in a row as the index ultimately fell 3000 points on the back of a rising yen and questions about the efficacy of “Abenomics.”  These moves went suddenly and swiftly against a well-established trend and invariably caused Sunrise and other CTAs to give up some of the gains they had made in earlier months.  Next, questions about the health of the Chinese economy sparked concerns about global demand and negatively affected stock markets in East Asia and Australia—again bucking an established trend and forcing profit givebacks by CTAs such as Sunrise.  Finally, the same June 19 Bernanke speech that spurred on the tremendous shorting opportunities in gold and fixed income shocked equity markets and drove them violently backward in such a way that losses were inevitable for just about any CTA approach, including that of Sunrise Evolution.

The net result of all of this was a significant giveback in equities by Sunrise in both May and June. Yet despite this, Sunrise Evolution nonetheless found a way to record slight overall portfolio gains in both months.  How was this so?  The answer lies in the power of a diversified trading approach, an approach that in Sunrise’s case allowed the firm to neatly offset all of its equity losses with big gains in other sectors and markets as highlighted by the trades discussed above.   Therefore, in the case of CTAs such as Sunrise Capital Partners at least, the first six months of 2013 suggest that the winning strategy may be a more broadly diversified and more nimble trading approach that is not scared to take some profits and that even in the face of a few massive long term trends, keeps eggs spread across many baskets such that it is not as dangerously exposed to the damages that can come from sudden, violent reversals to such trends.

News Analysis: CFTC Files Aggressive Charges Against MF Global CEO Jon Corzine and back office executive Edith O’Brien

(Below is an early peak at an article in the upcoming Opalesque Futures Intelligence)

By Mark Melin

On June 27 the Commodity Futures Trading Commission (CFTC) filed civil charges against MF Global’s CEO Jon Corzine and assistant treasurer Edith O’Brien in what can only be considered an increasingly bizarre incident.

Citing a lack of appropriate supervision, the CFTC suit most importantly points to what knowledge, if any, Mr. Corzine and Ms. O’Brien had regarding questionable asset transfers that are documented to have come from customer segregated accounts.  If knowledge of illegal asset transfers can be proven and the case is criminally prosecuted the actions could be punishable by up to ten years in jail.  Without re-iterating fine detailed work of NFA board member and Commodity Customer Coalition founder John Roe, the essential concept is pretty simple.

Mr. Corzine asked if the questionable fund transfers were “enough to be in compliance” and Corzine received a “no” answer. 

The height of CFTC evidence against Mr. Corzine  may center on a recorded phone call between Mr. Corzine and an un-named MF Global treasury employee.  To paraphrase, Mr. Corzine asked if the questionable fund transfers were “enough to be in compliance” and Corzine received a “no” answer.

In another recorded conversation, Mr. Corzine appeared to display knowledge of the asset transfers and their origin from customer accounts, according to published reports.  “We have a money management account at Chase, if my memory serves me,” Mr. Corzine told the employee. “Yeah, it’s the JP Morgan Trust account, but that’s cash seg for clients — it has nothing to do with greasing our wheels for Chase to move,” the employee said, referring to the customer segregated funds.

In addition to recorded conversations making the case clear, there is documented evidence, both in the public domain and yet to be published, that show warnings were given regarding the questionable if not illegal nature of the asset transfers.

After the firm’s bankruptcy and in Congressional testimony Mr. Corzine said he did not involve himself with asset transfers and claimed repeatedly not to know where the money went.  US Congressman Michael Grimm (R-NY), a former FBI Financial Fraud investigator, has called on the Department of Justice to charge Mr. Corzine with perjury.

Will criminal charges be filed against MF Global executives?

DoJ Charges Not Forthcoming According to Press Leaks

Throughout the investigation, curious press leaks occurred from those close to or directly involved in the DoJ investigation. As former Futures Magazine editor Dan Collins notes, just as the heat was turning up against Mr. Corzine leaks from investigative sources quickly claimed “There is no evidence of criminal wrong doing.”

Leaks from those close to the DoJ investigation began occurring as early four months after the MF Global incident and appeared to serve the purpose of diminishing the public demand for an investigation.  National mainstream media reports seldom questioned the leakers despite documented criminal evidence to the contrary in the public realm.

“I find this anonymously sourced article to be one which lacks an appropriate level of professional skepticism,” Hilary Till, a policy advisor at the Heartland Institute, said in a statement.  Editors at several national media outlets are documented to have withheld reporting damming information in the MF Global incident. “An informed observer would have preferred for (the article) to also have explored the credible evidence that Mr. Corzine perjured himself before multiple House and Senate Committees as evidenced by numerous recorded phone calls prior to MF Global’s bankruptcy referenced in the civil complaint by the CFTC, and as summarized by Rep. Michael Grimm (R-N.Y.).  Of note is that Rep. Grimm is a former FBI agent who had been tasked with investigating financial crimes and a current member of the House Financial Services’ Committee.”

DoJ’s criminal division did not respond when asked if an investigation would take place surrounding leaks in a purportedly highly confidential criminal case.

Congressman Grimm’s call for DoJ perjury prosecution, as well as other troubling MF Global issues impacting the stability of markets and the US economy, has yet to be reported by certain mainstream media.  These include questionable manipulation of the SEC’s Edgar database that hid risk in MF Globlal’s bond offering  and appears not to be properly investigated, according to public documentation.  Institutional investors including struggling pension funds lost close to $400 million as the bonds were worthless months after being issued.  Throughout the MF Global case documented information of a potentially criminal nature was in the public domain and admitted into the Congressional record; a CFTC commissioner called for an investigation into certain issues on national TV, yet no known investigation of the issues has occurred and the major media remained mostly silent.  When the media fails to report interesting issues brought up by a former FBI Fraud Investigator turned Congressman and CFTC commissioners who consistently spoke out on lack of investigations and potentially criminal behavior damaging US markets, it weakens the brave efforts of well-meaning regulators, politicians and law enforcement officials.  Or is that the point?

What Is The Holdup at DoJ?

With leaks from official sources involved in the investigation claiming the “case was cold” as early as 4 months after the crime scene was established, one might wonder why, approaching three years after the incident occurred, DoJ has yet to close the case?  ”All the relevant information is well known and documented,” said one source with knowledge of the asset transfers, speculating the DoJ could simply let the statute of limitations expire in 2015 rather than issue a legal opinion that would require it to ignore key facts in the case.

 ”The CFTC was tired of waiting for DoJ to act,” a high ranking regulatory official was quoted as saying.

“The CFTC was tired of waiting for DoJ to act,” a well known Wall Street journalistic source told me, quoting a high level regulatory official in a remark that failed to make the published story.  (Both sources have independently confirmed these statements via e-mail but their identities will remain confidential.)

“In light of all of the other scandals in this administration, dropping charges against Mr. Corzine) does raise a question about tainted prosecutorial discretion for this former Democrat governor of New Jersey,” said Michael Warder, Vice Chancellor of Pepperdine University.  “Attorney General Eric Holder adds to a growing list of, at the very least, politicized judgments.”  Mr. Warder himself joins a list of three legal professors, one a former SEC enforcement attorney, to question the lack of DoJ prosecution and investigation.  As best can be determined, comments from these highly respected legal minds has yet to appear in any mainstream business publication or on any traditional US television network.

Corzine Responds

Mr. Corzine’s attorney, Andrew Levander of Dechert LLP, called the lawsuit “unprecedented.”

In regards to the “unprecedented” claim made by Mr. Corzine’s attorney, author and Bloomberg View Columnist William Cohan points out in an article titled The Wall Street Spin Machine Mobilizes for Corzine the charges were not unprecedented.  In 1988 the CFTC charged former CME chairman Brian Monieson with failure to supervise.  It is unknown if Mr. Levander really meant to say charges had never been filed against the Wall Street political elite and thus were “unprecedented.”  When asked to clarify his position Mr. Levander’s office did not respond.

MF Global Legal Connections

In addition to retaining Dechert, while Mr. Corzine was CEO at MF Global, the firm was a legal was a client of Covington and Burling prior to the October 31 bankruptcy.  Additionally Covington and Burling was appointed by the MF Global debtor’s bankruptcy trustee, former FBI director Louis Freeh, for involvement in insurance matters on April 12, 2012.  At Covington and Burling white collar defense lawyers included US Attorney General Eric Holder and former DoJ criminal division head Lanny Breuer, but Mr. Corzine was not an individual client of the law firm, according to a spokesperson.

After exiting DoJ Mr. Breuer went back to work at Covington and Burling where he was reported to receive $4 million per year.  Publically embracing his role in white collar criminal defense, Mr. Breuer lists as a legal specialty navigating “corporate crisis” and “Congressional investigations.” Following the financial crisis of 2008, questions were raised regarding Mr. Breuer’s criminal division and its investigation of MF Global and Wall Street’s political elite when important markets and the economy at large have been damaged. Members of Congress called for an independent prosecutor in the MF Global investigation.  Mr. Breuer was subject of journalistic reports that led to questioning a lack of Wall Street investigations at the DoJ.  This includes a PBS Frontline report where Mr. Breuer discussed not fully investigating certain criminal activity of powerful bank financial interests as well as a 60 Minutes piece that revealed the DoJ failed to question several bank executives in the 2008 derivatives led stock market crash, including the Countrywide Financial chief fraud investigator said to have information on fraud at the firm.  Mr. Breuer resigned from the DoJ after appearing in the Frontline piece and was head of the DoJ criminal division during the MF Global investigation.

The timing of Mr. Breuer’s resignation was not relevant to the Frontline piece airing, according to a spokesperson for Mr. Breuer.  “It is patently absurd to assume there was a connection between Mr. Breuer’s resignation and the Frontline piece,” said Rebecca Carr of Covington and Burling, authorized to speak on Mr. Breuer’s behalf.  “Mr. Breuer had been preparing to leave DoJ for months and the timing was purely coincidental.”

Ms. Carr indicated it was the US Attorney’s Office in the Northern District of Illinois (Chicago) who was in charge of investigating Mr. Corzine and not DoJ’s criminal division, citing this article in Futures Magazine.   Although sources close to the DoJ investigation had indicated it was the US Attorney’s office in the Southern District of New York (New York City) that investigated Mr. Corzine and separate sources had indicated former US Attorney in Chicago Patrick Fitzgerald was “uncomfortable” with the DoJ investigation, Ms. Carr said it was not the DoJ’s criminal division making final decisions regarding criminal prosecution of Mr. Corzine but rather DoJ attorneys in Chicago.

Defending Mr. Breuer’s tenure at DoJ as tough on corporate crime, Ms. Carr cited increased enforcement of the Foreign Corrupt Practices Act, the $4 billion fine against British Petroleum, the most Medicare fraud “takedowns” in US history and the most extraditions from Mexico in a single year.  While she cited the $1.25 billion fine paid by the UK-based bank HSBC for laundering drug money for cartels and Iran, critics  have called this settlement weak in light of the fine represented a small portion of the bank’s yearly profits and the damaging nature of the money laundering clients.  There are no documented criminal cases brought against Wall Street’s major banks despite the significant negative societal impact of the 2008 stock market meltdown.


The Confusing Case of Edith O’Brien

The CFTC charges brought up issues that are confusing for many inside observers of the case.  In particular, it appears as though MF Global assistant treasurer Edith O’Brien, who was interacting directly with Mr. Corzine on the asset transfers, appears to industry observers to have known the transfers were questionable if not clearly illegal before they were made.

“I don’t want to take anyone down with me.”

The CFTC suit notes that Ms. O’Brien failed to copy her colleagues on an email with details of one questionable asset transfer because “I don’t want to take anyone down with me,” she said on a recorded line.  If Mrs. O’Brien assumed the transfers had the potential to take people down, why did she execute what appears as a known illegal asset transfer?  Did she believe the case would not be investigated and she would not be subject to prosecution due to her affiliation with powerful Wall Street political players?

The Real Damage is to the US Financial System

The most significant crimes are those that damage public markets and the world economy.  It may be an old school thought, but the crimes that damage the economy should be investigated hardest.  Currently, however, we have a system in place where those who speak out in defense of markets – regulators, political leaders, law enforcement and journalists –  receive little support or are punished by those official entities entrusted with defending markets and providing a check and balance against powerful players abusing the system.

If one were to plot the demise of the economy, the concept of free markets and democracy, it might start by punishing those who stand in defense of justice and free markets.

Can the Magic of Hope and Change Happen?

While the political winds that have gripped this investigation from the start seem to favor the cover-up route, an optimist might consider that change has been occurring.  The wheels of justice can be slow but might just get it right in the long run.

The CFTC’s move to charge Mr. Corzine was relatively bold.  As a member of a small but powerful Wall Street elite who appear to have operated without any checks and balances, Corzine is at least being logically questioned for the first time by a regulatory agency with a history of standing in defense of markets.  (Think about former CFTC Chairwoman Brooksley Born who bravely confronted the improper derivatives design and lost her job as a result; or former CFTC Chairman William Rainer who fought for logical derivatives regulation in the bruising Enron battle.)

If at trial the CFTC brings out evidence so loud and clear, and the political winds change relative to protecting powerful Wall Street actors ahead of critical markets, then we might see action.  Change doesn’t happen overnight.  It was only a few years ago even debate regarding Glass-Steagall was repressed in DC and certain media circles and now there could be a vote in Senate on the issue.  But perhaps a more significant milestone might be found in recent revelations from the DoJ’s RMBS working group. The group is considering fighting sophisticated financial crimes with simple yet effective bank fraud laws against knowingly providing false information to a financial institution.  This is a crime for a reason.  The fact DoJ is looking to more aggressively enforce the law in areas that damage the US economic engine is a post-Lanny Breuer positive that caught the attention of Frontline producer Nick Verbitsky.

As Frontline demonstrates, the media can have a positive role at helping clean up a mess that has generally led to distrust of the system.  Hiding the problem and not reporting significant issues is not a method to engineer confidence, because most cover-ups are eventually discovered.

MF Global In Proper Perspective

The ultimate sin in the brokerage industry is to convert customer funds for the firm’s own needs.  PFG’s Russ Wasendorf Sr. and fraud at Peregrine Financial Group (PFG), discussed in the last issue of OFI, illegally converted customer segregated funds for his own purposes and received a harsh 50 year prison sentence.  The week preceding MF Global’s October 31, 2011 bankruptcy, the firm is documented to have converted customer funds for its own purpose of covering a house margin call.

Knowingly converting customer funds for the brokerage firm’s needs and having a reasonable idea those funds would not come back to customers is clearly illegal, if that is what occurred.  The impact of this violation of the sanctity of the customer segregated funds concept resulted in spinning direct segregated account into the most significant crisis of confidence in derivative industry history.  Resulting changes in regulatory protections from MF Global and PFG requiring confirmation of bank balances, proposals for an insurance fund and a “C level” written sign off for large asset transfers, among other regulatory protections have, ironically, made the segregated account significantly more secure.  Yet questions regarding the failure of DoJ to properly investigate and prosecute actions that have so damaged derivatives markets relied on for commodity price stability will likely continue.

“MF Global’s unlawful use of customer funds harmed thousands of customers and violated fundamental customer protection laws on an unprecedented scale,” said Steve Stanek, a research fellow at the Heartland Institute and managing editor of Budget and Tax News. “Edward Snowden, who recently leaked information on the massive spying being done against Americans by the National Security Agency, is looking for a place to give him asylum. I suggest he seek asylum on Wall Street, where the right business and political connections are enough to stop all criminal prosecutions.”

Altegris Publishes White Paper on Trend Following

The feature article in the next Opalesque Futures Intelligence is a white paper from Altegris.

Below is a sneak peak at a recent interview for web site members and a link to the Altegris white paper:

Two Minutes With Matt Osborne of Altegris

Investors who bought into the uncorrelated, liquid alternatives managed futures message have been disappointed recently, noted Matt Osborne of Altegris Advisors, co-author of the recently released white paper “Is the Trend Your Friend?”  Written with Lara Magnusen, a director at Altegris, the white paper studies the long term performance characteristics of managed futures and perhaps most significant explains the beta market environment that contributed to managed futures relative under performance. 

 Mark Melin (MM): How important is an understanding the market environment in terms of setting appropriate performance managed futures expectations?

Matt Osborne (MO): It’s critical.  Understanding not only the current environment as well as having a historical framework is key to developing a long –term perspective.  All asset classes go through cycles, ensuring investors understand these cycles helps investors to better understand the diversification benefits of managed futures as well as manage their performance expectations.

MM:  On a historical basis trends have always been a component of market environments.  How important is the mean reversion aspect of trends appearing and not appearing in markets.  Winton’s David Harding is quoted as saying: “Trends come and go and we can’t predict when they will come next, but we know they will come.”  Could managed futures be set for a period of mean reversion?  IE: is the strategy “due” for a resumption of trends?

MO: Mr. Harding is correct; we can’t predict.  Based on experience, however, I think trend following managers are potentially poised to capitalize on future breakout movements in the markets. We witnessed significant market reversion post May 22nd – when Bernanke hinted that QE tapering was on the horizon.  It appears as if we may be moving from a mean-reverting phase of prior years to a trending phase–providing a ripe environment of opportunity for trend followers over the remainder of 2013.

MM:  In the white paper, you mention markets “Whipsawing between risk-on and risk-off environments constrains trend persistence.”  What will it take for this type of non-productive trend following environment to change?

“When will things improve? A bedrock principle of managed futures is that they simply require persistence of trends—in either direction—in order to potentially deliver strong returns.”

MO: We’ve essentially had a perfect storm for trend following managers. Thankfully, the damage has been minimal in our view vs. drawdowns in long only asset classes.   When will things improve? A bedrock principle of managed futures is that they simply require persistence of trends—in either direction—in order to potentially deliver strong returns. We’ve seen some signs of increased price persistence already.  The true catalyst could be a number of things, from increased volatility, a persistent rise in interest rates, to less government intervention in financial markets.

MM:  With the potential for the Fed to pull back from manipulating the yield curve, does this have potential for market trends to re-emerge?  What has been the impact of QE on the managed futures industry at large?

“With tapering potentially on the horizon, you can see by just looking at a chart of the 10-year, that trend looks to have reversed.   QE has also hurt trend followers because it has created a domino effect of global deleveraging.” 

MO: QE has both helped and hurt.   The Fed bond buying program has helped interest rate trends, pushing yields to historical lows – creating the ultimate “don’t fight the Fed” trend.  With tapering potentially on the horizon, you can see by just looking at a chart of the 10-year, that trend looks to have reversed.   QE has also hurt trend followers because it has created a domino effect of global deleveraging.  As various countries essentially manipulate their currencies, FX markets have become increasingly choppy and difficult for trend following managers.  In general, I think as the Fed and governments become less involved in introducing new or continuing existing policies, it will create the potential for trends across markets to re-emerge – since markets will rely more heavily on historical market drivers and not having to try and navigate and interpret what certain policies mean and don’t mean and the impact those policies may or may not have.

MM:  Altegris is known as traditionally allocating assets heavily in the trend following category.  There is no doubt it is the most predominate strategy with a valid beta market environment.  What degree of value, if any, do you find in relative value or volatility strategies not dependent on the market environment of price persistence?

MO: There is a great deal of value; these strategies take a different approach to finding alpha, the merits of which is a much deeper discussion.

MM:  What is the difference between a trend and momentum strategy?

MO: Not everyone may answer this same way, but in our view, momentum strategies are a type of trend strategy that is seeking directionality.  They are agnostic as to whether markets have momentum on the downside or upside.

MM:  What’s the key point, the drop dead line, you want people to take away from this report?

MO: We want to acknowledge that it has been challenging for managed futures managers and those invested in managed futures.  At the same time, we hope that readers understand that no one can time a market’s top  and bottom perfectly—and those who maintain  a long-term allocation to managed futures, in our view, have the opportunity to experience the most  complete range of potential benefits offered by the strategy.

Why Past Performance of a Conventional (60-40) Portfolio Is NOT Indicative of Future Performance

By Mike Dever / Brandywine Asset Management

For the past 31 years[i], a conventionally-diversified portfolio consisting of 60% stocks and 40% bonds has provided investors with satisfying returns of +10.80% annually. This was the result of both stocks and bonds advancing strongly throughout that period. Better yet, stocks and bonds complimented each other nicely.  When stocks returned +19.35% annually from the market low in 1982 to its peak in August 2000, bonds lagged somewhat (although still returning a substantial +10.34% annually). But in the period from the 2000 market peak to the 2009 market low, while stocks declined a sharp -43.51%, bonds balanced that with a strong +61.78% rally. More recently, both stocks and bonds have advanced, with the 60-40 portfolio gaining an annualized +15.36% from the market low in March 2009 to May 31, 2013.


The past 31 years was an unprecedented period for a 60-40 portfolio; one that wasn’t seen prior. In fact, as I wrote in my best-selling book, Jackass Investing: Don’t do it. Profit from it., “all of the real stock market returns over the past 111 years can be attributed to just an 18 year period – the great bull market that began in August 1982 and ended in August 2000. Without those years the real, inflation-adjusted return of stocks, without reinvesting dividends, was negative.”


Unfortunately for investors, the 60-40 results of the past 30 years aren’t likely to repeat in the near future. Here’s why not.


Return drivers for U.S. equities


There’s an ethos among equity investors that stocks provide an intrinsic return. This ethos is rooted in a depth of academic research that identifies an equity “risk premium” as the source of stock market returns. The equity risk premium is the “theory” that equities are destined to produce greater returns than less risky investments such as corporate bonds, simply because they ARE riskier.


In fact, the “research” supporting the equity risk premium is actually not research at all but merely an observation – an observation that over the past couple of centuries stock returns outperformed bonds. Then a postulate, the risk premium, was created to support that observation, which in turn was “proven” by the observed data. As you could likely surmise from the obvious circularity of the postulate and proof, this is wrong. The risk of investing in stocks has nothing at all to do with their returns. As I show in Jackass Investing, stock market returns are driven by three primary “return drivers”.


In the book’s first chapter I show how over the long term stock market returns are dominated by corporate earnings growth, and in the short-term (less than 20 years) by the multiplier (the “price/earnings” or “P/E” ratio) people are willing to pay for those earnings. The chart displaying this is reproduced here[ii]:

Effect of Earnings Growth and People’s Enthusiasm on Stock Prices

In the second chapter I display the fact that historically, dividends have provided 48% of the total return from U.S. equity investing over the period 1900 – 2010[iii]. (In most of the studies presented in my book and in this article, I use the S&P 500 total return index which includes dividends.)


Knowing this, these were the three dominant return drivers that contributed to the stock market’s +11.88% annualized return over the past 31 years:


  1. 6.16% of the annual return was driven by the average annual profit growth of 6.16%
  2. 3.19% of the annual return was the result of the increase in the P/E ratio from 10 in 1982 to more than 23 at the end of 2012 (using the cyclically-adjusted P/E (“CAPE”) presented by Robert Shiller in his book Irrational Exuberance[iv])
  3. 2.53% of the annual return was due to the dividend rate starting the period at an historically high 6.24% in 1982 and averaging 2.53% throughout the period

Going forward, if the P/E ratio reverts to its long-term average of 16.4, corporate profits grow at their historical average of +4.70%, and dividends increase at the same rate as corporate profits (and the dividend payout ratio increases to its long-term average), stocks will appreciate at just 7.05% per year over the next decade. Here’s the arithmetic.


Future returns from U.S. equities


To determine the likely return for the S&P 500 over the remainder of this decade we need three primary inputs:


  1. The rate of earnings growth for the companies underlying the index,
  2. The most likely P/E ratio people will pay for those earnings at year-end 2020, and
  3. The dividend yield for those stocks during the period.

Let’s look at each of these in turn.


Return contribution from earnings growth


Since 1900, the nominal (before inflation) average annual growth rate for companies in the S&P 500 has been 4.7%. Over the same period the average annual inflation rate has been 3.04%. For purposes of our projections I will assume these two variables continue at the same rates into the future. While I understand there are many people who expect a substantial increase in inflation, historically, that has also resulted in an increase in the nominal (before inflation) return for the S&P 500. So if that were to occur, while the nominal return from the S&P 500 would likely increase, the real (after inflation) rate of return would, on average, remain around the historical level of 1.7%. Because of this, I project the annual return contribution from earnings growth, between 2012 and the end of 2020, will be +4.70%.

Return contribution from investor sentiment


There are a variety of methods used to calculate the price/earnings ratio of a stock or stock index.  The method I will use in this article is CAPE (“Cyclically Adjusted Price Earnings Ratio”), the ratio popularized by Robert Shiller in his book Irrational Exuberance. CAPE compares the S&P 500’s current price to the 10-year average of earnings. This has the benefit of smoothing earnings volatility to reduce the short-term impact of events such as the 2008 financial crisis. Over the past 113 years, CAPE has ranged from a low of 4.46 (in the depths of the Great Depression) to a high of 48.94 (at the peak of “dot-com” hysteria in 1999). The average CAPE over that period has been 18.63.


As of year-end 2012 CAPE stood at 23.37. Part of the reason the rate was above the long-term average was because the 10-year average earnings value used in the calculation was depressed by the effects of the Great Recession of 2008. In order to make the CAPE value in 2020 appear less elevated (compared to the long-term average) than it appears today due to the Great Recession, I will continue to walk forward the earnings average of the prior 10 years from 2013 through 2020, assuming average earnings growth based on the long-term average of 4.7%.  This results in a growth rate of 6.8% for the 10-year earnings average from 2013 through 2020.


As a result of the combination of the increase in the 10-year average of profit growth and CAPE reverting to its long-term average, I project the annual return contribution from investor sentiment, between 2012 and the end of 2020, will be ‑0.73%.


Return contribution from dividends


The dividend yield on the S&P 500 at year-end 2012 was approximately 2.20%. This represents a dividend payout ratio of 36%. This figure is quite a bit lower than the 113 year average of 59%. If the payout ratio reverts to its long-term average, this will boost the dividend yield over the remainder of this decade. As a result of this, and assuming that dividends grow at the same rate as profits, which is 4.7% per year, I project the annual return contribution from dividends, between 2012 and the end of 2020, will be +3.07%.

Calculating the S&P 500 total return


We’re now left with a simple arithmetic problem to determine the projected average annual return for the S&P total return index, between 2012 and the end of 2020.


This is the sum of the contribution from each of the three return drivers:


Earnings Growth:             +4.70%

Investor Sentiment:       – 0.72%

Dividends:                           +3.07%

Total:                                     +7.05%

Future returns from bonds

For the past 31 years the Barclay Aggregate Bond Index averaged annualized returns of 8.43%. Unfortunately, the two primary return drivers that contributed to that performance are both destined to provide much lower returns in the future. They are:

  1. The capital appreciation provided as the high interest rate of 13% that prevailed at the start of the period declined to just over 1% today,[v] and
  2. The average yield of 5.74% on the 5-year Treasury note over the period.


With the Barclay Aggregate Bond Index now yielding just over 2%, and the U.S. Treasury 5-year note yielding 1.05%, the likely return from bonds over the remainder of this decade should be similar to the current yield on the Barclay Aggregate Bond Index, which, as represented by the iShares ETF (AGG) is 2.43%.

Calculating the Return on the 60-40 portfolio


In summary then, based on the above straightforward analysis, from year-end 2012 through year-end 2020 we can expect the following return from a conventional 60-40 portfolio:


Stocks (60%):                     7.05%

Bonds (30%):                     2.43%


This is less than 1/2 the return earned over the past 31 years and approximately 1/3 the returns produced since the Great Recession low in March 2009. As I pointed out at the beginning of this article, 60-40 has always been a risky proposition; returns are earned in a “lumpy” fashion. Without the tailwinds of low P/E, high dividend yield and high interest rates, in the future those lumpy returns will be earned in relation to a lower trendline of overall performance. Also, while these projections are based on a sound analysis of the return drivers powering the 60-40 portfolio’s performance, they are certainly not absolute. Already, in the first 5 months of the 8-year projection period (January 2013 through December 2020), the 60-40 portfolio has gained more than 5%, twice that expected from these projections.


Portfolio diversification is the one true “free lunch” of investing, where you can achieve both greater returns and less risk. But, as can be seen by its reliance on just four return drivers, the conventional 60-40 portfolio does not provide true portfolio diversification. When those four return drivers underperform, as is indicated by the projections in this article, performance will suffer. True portfolio diversification can only be obtained by increasing diversification across dozens of return drivers. I give examples of a truly diversified portfolio in the final chapter of my book, and am pleased to provide a complimentary link to that chapter here:  Myth 20. While some people may prefer to gamble on a less-diversified 60-40 portfolio, as my book shows, in the longer-term, true portfolio diversification can lead to both increased returns and reduced risk.






By:          Michael Dever



About the Author:

Michael Dever is the CEO and Director of Research for Brandywine Asset Management, an investment firm he founded in 1982. He has been a professional investor/trader since 1979 and has experience in stocks, managed futures, commodities, mutual fund timing, market neutral equity, and long/short equity. He is also the author of “Jackass Investing: Don’t do it. Profit from it.”, an Amazon Kindle #1 best-seller in the following “investment” categories:  Commodities, Futures, and Mutual Funds

[i] From the market low at the end of July 1982 through May 31, 2013.


[ii] Michael Dever, Jackass Investing: Don’t do it. Profit from it. (Thornton: Ignite Publications, 2011).

This study uses linear regression analysis to determine the degree to which variance in the S&P 500 Total Return Index over various holding periods (1, 2, 5, 10, 20 and 30 years) was explained by the changes in nominal earnings and changes in P/E. A 10 year average was used to represent both the nominal earnings and the “E” in the P/E in order to reduce the impact of economic cycles. The regression analysis included three separate regression calculations for each holding period. The first regression measured the goodness of fit for changes in average earnings versus S&P total returns. The second regression measured the goodness of fit for changes in the P/E versus S&P total return. The third regression includes the two parameters, average earnings and P/E, versus S&P 500 total returns. Since linear regression assumes orthogonality of the independent variables, that assumption was tested on all of the holding period data. The Percentage change in the nominal earnings versus the P/E ratio had R2 values ranging from 2% to 6% across all holding periods, suggesting the two regression parameters are mostly independent of each other. Furthermore, the two parameter regressions were found to explain greater than 93% of the variance in the S&P 500 total return over each holding period. Since nearly all of the variance in the S&P 500 return is captured by the two parameter regression I normalized the R2 result from each of the single parameter regressions to 100% for use in Figure 3. The use of the single parameter R2 to measure the explanatory power of the S&P 500 total return for the two regression variables is an approximation. The subtle (<6%) correlation between the independent variables and the synergy that occurs for the two-variable regression requires cautious interpretation. The results shown in the graph display an estimate of the relative contribution of the change in earnings and the change in P/E towards the change in the S&P 500 returns.

[iii] Annualized return of S&P 500 TR index 1900 – 2010: +9.51%. Annualized return of S&P 500 w/o reinvesting dividends: +4.92%. Contribution of dividends = (9.51 – 4.92) / 9.51 = 48%.


[iv] The cyclically-adjusted P/E (“CAPE”) used by Robert Shiller in his book: Robert J. Shiller, Irrational Exuberance (Princeton: Princeton University Press, 2000, 2005, updated). Data used in Shiller book and for S&P 500 Total Return performance available at: http://www.econ.yale.edu/~shiller/data/ie_data.xls. Retrieved February 14, 2011.


[v] This was the rate on the 5 year U.S. government bond. Five years is used as that is the approximate average duration of the Barclay Aggregate Bond Index.

[1] From the market low at the end of July 1982 through May 31, 2013.


[1] Michael Dever, Jackass Investing: Don’t do it. Profit from it. (Thornton: Ignite Publications, 2011).

This study uses linear regression analysis to determine the degree to which variance in the S&P 500 Total Return Index over various holding periods (1, 2, 5, 10, 20 and 30 years) was explained by the changes in nominal earnings and changes in P/E. A 10 year average was used to represent both the nominal earnings and the “E” in the P/E in order to reduce the impact of economic cycles. The regression analysis included three separate regression calculations for each holding period. The first regression measured the goodness of fit for changes in average earnings versus S&P total returns. The second regression measured the goodness of fit for changes in the P/E versus S&P total return. The third regression includes the two parameters, average earnings and P/E, versus S&P 500 total returns. Since linear regression assumes orthogonality of the independent variables, that assumption was tested on all of the holding period data. The Percentage change in the nominal earnings versus the P/E ratio had R2 values ranging from 2% to 6% across all holding periods, suggesting the two regression parameters are mostly independent of each other. Furthermore, the two parameter regressions were found to explain greater than 93% of the variance in the S&P 500 total return over each holding period. Since nearly all of the variance in the S&P 500 return is captured by the two parameter regression I normalized the R2 result from each of the single parameter regressions to 100% for use in Figure 3. The use of the single parameter R2 to measure the explanatory power of the S&P 500 total return for the two regression variables is an approximation. The subtle (<6%) correlation between the independent variables and the synergy that occurs for the two-variable regression requires cautious interpretation. The results shown in the graph display an estimate of the relative contribution of the change in earnings and the change in P/E towards the change in the S&P 500 returns.

[1] Annualized return of S&P 500 TR index 1900 – 2010: +9.51%. Annualized return of S&P 500 w/o reinvesting dividends: +4.92%. Contribution of dividends = (9.51 – 4.92) / 9.51 = 48%.


[1] The cyclically-adjusted P/E (“CAPE”) used by Robert Shiller in his book: Robert J. Shiller, Irrational Exuberance (Princeton: Princeton University Press, 2000, 2005, updated). Data used in Shiller book and for S&P 500 Total Return performance available at: http://www.econ.yale.edu/~shiller/data/ie_data.xls. Retrieved February 14, 2011.


[1] This was the rate on the 5 year U.S. government bond. Five years is used as that is the approximate average duration of the Barclay Aggregate Bond Index.

Managed Futures Account Type Categorization

There is much discussion regarding account type options.  The first place to begin understanding is categorizing the account type.  While many categorization opinions exist, I organize account type in three categories based on their regulation, distribution channel and primary investor type.


“Direct” or individually managed accounts are regulated by the NFA, CFTC and are available through Futures Commission Merchants (FCMs) and Introducing Brokers (IBs).  These account types are typically utilized by individual investors and more sophisticated institutional investors.  Investors in these accounts range across the map and are not necessarily restricted based on their net worth or level of sophistication.


“Traditional” Hedge Fund / LP / Pool structure.  These managed futures accounts are regulated by the NFA and CFTC but also may be regulated by the SEC and FINRA depending on their distribution.  These funds are typically distributed through sophisticated asset managers, family office professionals, investment banks and an elite group of registered investment advisors.  Many times these funds are for Qualified Eligible Participants – highly sophisticated investors – and contain exemptions that do not require disclosure documents nor auditing by the NFA.


Mutual Fund / ETFs. These accounts are primarily regulated by the SEC / FINRA but also regulated by the CFTC.  They are available through general wirehouse financial advisors and mainstream RIAs.  Investors in these low minimum investment accounts range are not restricted based on their net worth or level of sophistication.


While account type is important, understanding the benefits, legal protections and disadvantages of each account type is more significant.