Managed Futures Today

Contents

Futures Perspective
Investing in managed futures:
For a free subscription, The timing question............................... 4
visit our Web site: Buying a managed futures program in a
managedfuturestodaymag.com drawdown can pay dividends, but there are
many variables to consider.
By MFT Staff

Constructing a managed
futures portfolio ..................................... 8
The basics of allocating to multiple managed
futures programs follows the golden rules of
Editor-in-chief: Mark Etzkorn investing: Know your risk tolerance, diversify,
metzkorn@managedfuturestodaymag.com and perform the necessary due diligence.
By MFT Staff
Managing editor: Molly Goad
mgoad@managedfuturestodaymag.com
Who is minding my money? ...............12
Editorial assistant and CTA registration requirements promote due
webmaster: Kesha Green diligence.
kgreen@managedfuturestodaymag.com By MFT Staff

President: Phil Dorman Strategy Focus
pdorman@managedfuturestodaymag.com Position sizing: Balancing trades
and managing risk ...............................14
Publisher: Balancing the risk of different markets is part
Bob Dorman of the managed futures trading process.
bdorman@managedfuturestodaymag.com By MFT Staff

Managed Futures Performance
Year-to-date returns and assets
under management ...............................18

Commodity Snapshot
Key trends drive bullish move in commodity
Volume 1, Issue 3. Managed Futures Today is pub-
lished quarterly by TechInfo, Inc., PO Box 487 futures markets. .....................................19
Lake Zurich, IL 60047-0487. Copyright © 2010
TechInfo, Inc. All rights reserved. Information in this
publication may not be stored or reproduced in any
form without written permission from the publisher. Key Concepts .....................................19
The information in Managed Futures Today is intended
for educational purposes only. It is not meant to rec-
ommend, promote, or in any way imply the effective-
ness of any trading system, strategy, or approach.
Traders are advised to do their own research and test-
ing to determine the validity of a trading idea. Trading
and investing carry a high level of risk. Past perfor-
mance does not guarantee future results.

2 November 2010 • MAnAGED FuTurEs TODAY

INVESTMENT MYTH NO. 1:

What goes up
must come down.
Not necessarily.

Markets rise and fall, but your investment portfolio doesn’t have to. Managed futures—an
alternative asset class that has achieved strong performance in both up and down markets—
invest across a broad spectrum of asset classes to achieve solid, long-term returns.

For more than a century, CME Group has helped investors and business leaders around the
world manage—and mitigate—their risk. And now we can help you. As the world’s leading
futures and options marketplace, we’re built on a tradition of trust and transparency. Today
firms you’ve known for years are building managed futures portfolios to suit your needs. Ask
your broker or advisor for more information on managed futures.

Learn more at www.cmegroup.com/mf

Futures trading is not suitable for all investors, and involves the risk of loss. Futures are a leveraged investment, and because only a percentage of a contract’s value is required to trade, it is possible to lose more
than the amount of money deposited for a futures position. Therefore, traders should only use funds that they can afford to lose without affecting their lifestyles. And only a portion of those funds should be
devoted to any one trade because they cannot expect to profit on every trade. All references to options refer to options on futures. Copyright © 2010 CME Group Inc. All rights reserved. CME Group is a trademark
of CME Group Inc. The Globe Logo is a trademark of Chicago Mercantile Exchange Inc.

Strategy Focus
Futures Perspective

Investing in
managed futures:
The timing question
Buying a managed futures program in a drawdown can pay
dividends, but there are many variables to consider.

By MFT Staff

Most investors are aware of the dangers of chasing a approach took big risks and experienced sizable
trend or a “hot” market: A big up move attracts lots drawdowns during severe bear-market moves (such
of new buyers looking for more of the same, but at as the one in 2008-2009), since it often bought
some point the market becomes saturated and when while the market continued to fall precipitously.
no more buyers are available, the market tanks. Despite their apparent edge, one of the primary
True, it doesn’t always turn out this way, but by problems with such investment approaches is the
definition the longer any price move has been in psychological challenge of buying something that’s
effect, the closer it is to ending. This is the rea- dropping and holding on to it when it continues to
son many trading models are designed to trade drop.
in the direction of the long-term trend when cor- Just as investors tend to be attracted to stocks
rections occur. For example, the December 2010 that are rising rather than falling, they’re also likely
issue of Active Trader magazine features an article to invest with managers on hot streaks rather than
(“Catching longer-term market swings”) that shows those experiencing drawdowns. This begs the ques-
the results of buying the S&P 500 after the tion: Should you attempt to “time” a managed
appearance of a pattern that includes a relatively futures investment — that is, buy into a managed
sharp (5 percent or greater) sell-off over a brief time futures program that is currently in a down swing,
period. with the expectation that better performance is in
The approach significantly outperformed the mar- the wings?
ket over a two-month time horizon. However, the

4
Q2 2010 • MAnAGED

Buying drawdowns performance window from 12 to 18 months. The
Two widely referenced studies from the 1990s, one performance was even better: 1,091 profitable vs.
originally published by noted author Jack Schwager 156 unprofitable 18-month periods, a 7:1 ratio.
in his book Managed Trading: Myths & Truths (John One of the limitations these studies acknowledged
Wiley & Sons, 1996), and another from around is that they incorporate some measure of “survivor-
the same time written by commodity trading advi- ship bias.” Because they’re based on portfolios of
sor (CTA) Tom Basso, then of TrendStat Capital CTAs that have survived over the length of the anal-
Management, argued that investing in managed ysis period, the analysis by default is selecting “win-
futures programs during drawdowns was a profitable ners” and doesn’t reflect the performance of those
approach. funds that might have failed during that time.
For example, Basso’s study, which simulated buy- Another recent study by Jeff Malec, CEO and
ing CTAs experiencing three-month drawdowns, founding partner of Chicago-based asset manage-
found the odds were better than 2 to 1 for positive ment firm Attain Capital Management
performance over the following 12 months. Brandon (www.attaincapital.com), incorporated losing CTAs
Langley and Jon Robinson of Robinson-Langley in its drawdown-buying analysis to combat survivor-
Capital Management (www.rlcap.com) revisited ship bias. Malec analyzed the performance of five
the approach earlier this separate CTA portfo-
year (using trend-following
CTAs) and also found it to
Just as investors tend to be lios using different start
dates between January
be successful. Using data attracted to stocks that are 2002 and January 2006,
from three CTA-ranking adding to the invest-
sites, the authors compiled rising rather than falling, ment in a CTA when
a portfolio of 32 trend-
following programs with
they are also likely to invest its drawdown reached
half its maximum his-
at least three-year track with managers on hot torical drawdown. This
records and a minimum of approach outperformed
$5 million under manage- streaks rather than those simply buying and
ment. Negative three-month experiencing drawdowns. holding all the CTAs,
periods were followed by as well as an alternate
profitable 12-month peri- approach that exited
ods 1,393 times vs. unprofitable 12-month periods CTAs when they reached 1.5 times their maximum
only 301 times for a ratio of 4.6:1. Also, both the historical drawdowns, and then rolled the funds into
Basso and Robinson-Langley studies found the another CTA.
opposite approach — selling after big equity run- A subsequent study (www.attaincapital.com/
ups — didn’t provide a similar benefit. (The article alternative-investment-education/managed-futures-
is available at: http://rlcap.com/downloads/RL%20 newsletter/investment_research_analysis/389)
Capital%20-%20Drawdown%20Study.pdf.) Malec’s firm conducted, which used drawdown
Robinson and Langley conducted a similar test duration rather than magnitude, showed that invest-
that replaced the three-month losing period with a ing in a program at its 21-month low point resulted
six-month losing period and increased the forward- Continued on p. 6

MANAGED FUTURES TODAY • November 2010
5 5
Q2 2010 • MANAGED FUTURES TODAY

FuTurEs PErsPECTIVE

in performance over the following 12 months that occur, and changing the subsequent review period
was two times the historical average 12-month per- (two years, five years), will change the outcome of
formance. (Conversely, investing in a program at any historical analysis. These are decisions investors
a 21-month high resulted in performance over the have to work out beforehand.
next 12 months that was only .70 of the average.) And these aren’t the only variables.
The challenge, of course, is being able to apply BarclayHedge.com president Sol Waksman argues
such an approach with real money, which is an the issue of investing in fund drawdowns isn’t as
understandably difficult task for many investors. straightforward as some make it. He points out that
“The success of it centers around being a contrar- one CTA’s drawdown might be a natural function
ian investor and not chasing returns,” Malec says. of the program’s trading style — say, the tendency
“Most [investors] do not of a trend-following
wait for drawdowns; [they] fund to go into a draw-
invest in programs at equity One CTA’s drawdown might down when markets are
highs — likely because wandering in trading
their brains are hard wired
be a natural function of ranges — while another
to avoid something that the program’s trading style, CTA’s drawdown might
causes pain. It’s a rare be a case of a genuine
investor who can look at while another’s might be a breakdown in the trad-
a program at a 21-month ing program.
low and say, ‘That’s the one
case of a genuine breakdown “The question it
I want to get in, instead of in the trading program. really comes down to
the one that has been going is whether the [draw-
up the past two years.’” down] means the
Malec’s study also notes the importance of having wheels are coming off, or just that the system isn’t
a “line in the sand” — a stop-trading point at which designed to deal with the current environment,” he
you will exit an unsuccessful program (see “Track says. “If you know the answer to that question, then
record length” for more information). yes, maybe [a drawdown] is a good time to add to
your investment or to make an investment.”
CompliCations But Waksman also points out investors must con-
Investing in the real world is always more difficult sider the other half of the “timing” equation.
than in a simulated environment. It could be argued “If you’re going to start timing, how do you deter-
the benefit of buying CTAs experiencing drawdowns mine when to get out?” he asks.
hinges upon the ability to proactively identify “qual- Waksman says research he conducted years ago
ity” trading programs that are likely to survive and indicated that from a true investment perspective,
prosper in the long term — as much a challenge for there was little benefit to timing.
an investor as knowing which individual stocks in a “If you’re a long-term investor, it doesn’t really
group are likely to go up or down over the next 12 matter,” he says. “Say you get in at a little bet-
months. ter time. After a few years, what difference does
Using different drawdown definitions (time- or it make whether you had a little bit more or less
depth-based), altering the length of a time-based volatility in the first few months? In the end you still
drawdown, deciding how often reinvestment will need a diversified portfolio.”

6 November 2010 • MANAGED FUTURES TODAY

Track record length
One question many potential managed futures investors
ask is, how long of a track record should a CTA have before
I invest?
some advisors advocate looking for at least two, and
Waksman stresses that managed futures preferably three years of returns; others recommend five
investors must do their due diligence years. But all usually qualify these thresholds with other
and outline their risk and trade goals in criteria such as maximum historical drawdown and assets
advance. under management, among others.
“I think there are two things you need Like the issue of buying on drawdowns, it’s not a cut-and-
to ask yourself,” he says. “Number dried issue. Everything else being equal, of course, it’s dif-
one — and this is before you put any ficult to argue against investing in a CTA with a (successful)
money in — how much are you willing five-year track record vs. one with only a six-month record.
to lose? Where’s the exit? The only time More data means you have more information about the
you can have a rational opinion on that, investment program’s longer-term potential and risk level.
in my mind, is before you’ve made the But in the real world “everything else” is rarely equal.
It is also not difficult to imagine exceptions. For example,
investment.”
what if the program with less than one year of performance
More food for thought: Just as markets
is a new fund launched by an advisor with a longer-term
that have dropped significantly can some-
record of successful funds? What if another new fund is
times drop even more — just ask all the
designed to capture market conditions you believe are
people who bought stocks in July and
emerging?
August 2008 — a negative trend in a CTA
sol Waksman of BarclayHedge says there could be valid
can be difficult to buck. Waksman gives
reasons to invest in a new CTA with a brief track record.
the example of a fund with a compound “Maybe they’re doing something new, and maybe you’re
annual rate of return of more than 20 convinced this new methodology is the wave of the future
percent over more than two decades, but and you’re willing to take a bet on that.”
which for the past four to five years has Also, Waksman notes, in the case of the CTA with a lon-
suffered massive redemptions — on the ger track record, you should consider the more recent per-
order of 90 percent. formance results. “Are the risk-adjusted returns on a rolling
“A rate of return over 20 percent for basis improving or deteriorating?” he says. In other words,
more than 20 years is a remarkable, even if the CTA is profitable overall, has it been on a down-
remarkable achievement,” he notes. ward trajectory for the past two years?
“Does that argue the case that [the fund] “We generally like to see at least five years of track
is going through a rough spot and now record before giving statistical significance to compound
is a good time to buy? Well, maybe, but rate of return, maximum drawdown, sortino ratio (see p.
more people are voting in the other direc- 19 for definition), etc., but we realize that can eliminate a lot
tion. That’s telling you what investors are of talented emerging managers,” says Jeff Malec of Attain
thinking.” Capital Management.
Ultimately, Waksman says, investing is For “emerging managers” (less than five years), Malec
hard work, and investors have to be hon- recommends at least a full year of performance. He then
est with themselves about their goals as adjusts the maximum drawdown based on the track record
well as why they’re making decisions. length to determine the potential stop-out point. For exam-
“The question is, why do you believe ple, the exit point for a CTA with a 10-year track record
this manager is going to continue to pro- would be 1.5 times its maximum historical drawdown, while
the exit point for a CTA with a one-year record would be
vide returns like the ones you’ve seen in
five to 10 times its maximum drawdown. ◆
the past? How are you coming to that
decision?” he says. ◆

MAnAGED FuTurEs TODAY • November 2010 7

Futures Perspective

Constructing a managed
futures portfolio
The basics of allocating to multiple managed futures programs follows the golden rules of
investing: Know your risk tolerance, diversify, and perform the necessary due diligence.

By MFT Staff

Once you have decided to add managed futures to “The primary objective is to provide a return
your investment portfolio, the next step is to build stream that is uncorrelated to traditional asset
a sub-portfolio of CTA (commodity trading advisor) classes such as equities and fixed income,” says
programs. There are more than 1,000 CTA programs John FitzGibbon, managing director of Lighthouse
available, and selecting the right mix of CTAs is Partners, a fund-of-funds manager with $4.5 billion
necessary to achieve your investment objectives. At under management. “When you think about periods
this stage it is very important to work with an expe- like 1998, 2002, and 2008 (see Figure 1) — the
rienced managed futures portfolio advisor. most stressful periods in the markets — managed
We spoke with numerous portfolio managers and futures provided positive returns and dampened
there was consensus on the basic steps to integrat- volatility in investors portfolios.”
ing managed futures into a portfolio. All agreed the Portfolio managers emphasize that investors need
first step is to set realistic objectives for the role of to view managed futures as a long-term invest-
managed futures in the portfolio. ment. “The returns in managed futures can come
in short bursts, and then there are
Figure 1: BArClAy CTA index vs. s&P 500 (ThrOugh July 2010) often extended periods of side-
The Barclay CTA index has returned more than the S&P 500 over the past ways movement or even a draw-
30 years, and it has done especially well during times of financial stress, down, so an investor needs to be
such as 2000-2002 and 2008. patient,” says Matt Osborne, man-
aging director of Altegris Advisors,
an alternative investment advisor
with $2.7 billion under advise-
ment. “Investors need to view
managed futures on a minimum
three-year time frame.”
“Managed futures are about
where the investment portfolio
is going to be three to five years
from now,” says Walter Gallwas,
president of Attain Capital
Management, a firm specializing
Continued on p. 10



You’re already
diversified.
Check again.

Stocks and bonds are a staple of a diversified portfolio, but are they enough? True diversi-
fication means investing in assets that have low correlations with traditional asset classes
like stocks and bonds. Managed futures offer this type of diversification.




FuTurEs PErsPECTIVE

in managed futures through individually managed of its future price. Spread traders exploit differentials
accounts. “It’s not about where corn is going to be between markets such as corn vs. wheat or between
after the next corn export report.” different delivery months of the same commodity.
Individual market specialists are CTAs who focus on
diversifiCation a specific market segment such as grains, energies
Just as the purpose of managed futures is to diversify or interest rates. “Typically the non-trend-following
an investment portfolio, the CTA programs chosen segments are non-correlated with each other and
must be diversified within the asset class. Portfolio non-correlated with the trend-following compo-
managers highlight four criteria of managed futures nent,” Osborne says.
programs necessary to get the right mix of CTA trad- The third level of diversification is the time frame
ing programs. on which a CTA trades. The time frame is basically
The first level of diversification is to invest in the average length of time the CTA is in a trade.
CTA programs that trade different markets. Futures Trading time frames are either short-term (10 days
offer exposure to a wide range of markets, such as or less), medium-term (11 to 30 days) or long-term
energy, grains, foodstuffs, currencies, interest rates, (more than 30 days), although it is common for
and equity indexes. “The different markets give you long-term trend followers to hold a position for six
some diversification right off the bat because they months to a year or more. By investing with CTAs
don’t necessarily move in tandem with each other using different time frames you have the potential
or other assets,” FitzGibbon says. to take advantage of short, medium and long-term
The second level of diversification is to combine market moves. For example, short-term traders tend
trend following and non-trend following CTAs. to outperform long-term traders in choppy, sideways
Trend followers try to profit from long-term trends markets but long-term traders can capture huge
in the markets, such as the natural gas downtrend moves when markets go into long-term trends.
in Figure 2. Note that trend followers, like all CTAs, Investors should work with their advisor to choose
can be either long (profit in rising markets) or short CTAs that diversify the managed futures allocation
(profit in declining markets). As previously men- across markets, trading styles, and time frames. “You
tioned, managed futures are a long-term investment: could achieve diversification with as few as seven
The sizable trends in natural gas occurred on aver- or eight managers, or as many as 30,” FitzGibbon
age every 67 weeks and lasted for an average of 38 says. “Our Lighthouse Managed Futures Program
weeks. It is also interesting to note that large trends currently has 23 CTA managers diversified across
in natural gas and many other commodity markets trend-following programs, short-term trading pro-
occurred in 2008-2009 when the equity markets grams and fundamentally based programs. The
lost nearly one-half their value. fundamentally based programs are predominantly
“The non-correlation benefit of managed futures specialists in their markets such as metals, energy,
(to equities and fixed income) is primarily driven grains, livestock equity indexes and financial
by the trend-following managers,” Osborne says. futures.”
“That’s not to say that non-trend strategies aren’t
great and can’t be integrated into a portfolio. We risk level
believe they should be, but the predominance is It is an old adage in futures trading that rewards and
trend following.” risks are always balanced. If a CTA is producing
Non-trend following CTAs include short-term trad- large percentage gains, it is probably also incurring
ers, fundamental traders, spread trading and indi- large drawdowns (the percentage of the portfolio
vidual market specialists. Short-term traders often lost before it regains its former peak value). A man-
try to profit from brief reversals of the long-term aged futures portfolio advisor will have measures of
trend or trading off the news and events of the day CTAs’ risk-adjusted returns, such as the Sharpe Ratio
or week. Fundamental traders use the traditional and Sortino Ratio (see p. 19 for definitions), that
supply and demand for a commodity as a predictor will help investors chose a portfolio of CTAs with

10 Q2 2010 • MANAGED FUTURES TODAY
November 2010 • MAnAGED FuTurEs TODAY

Figure 2: lOng-Term Trends in nATurAl gAs
Like many commodity markets, the natural gas market exhibits trending
periods followed by non-trending, choppy price action. Long-term trend
risk-reward ratios commensurate followers tend to profit in uptrends and downtrends while short-term trad-
with an investor’s risk tolerance. ers profit when no clear trend exists.
(See “Looking beyond return”
in Managed Futures Today, May
2010.)
“The first conversation we like
to have with a client is about risk,”
Gallwas says. “If a client says he’s
comfortable with 20-percent risk,
we’ll look at managers who have
a 10-percent drawdown, where
we’ve given the program room to
exceed its historical risk.”

due diligenCe
As with all trading, it is imperative
for an investor to do his home-
work. Working with a portfolio advisor can make Using the example of natural gas from Figure 2, a
this process easier. trend-following CTA probably would have had stel-
“A typical mistake investors make is to be wooed lar profits through the first half of 2006, been flat
by the return profile of a CTA without doing full and or down for the remainder of 2006 and all of 2007,
complete due diligence on the manager,” Osborne and experienced renewed profitability from the
says. “Investors overweight a performance assess- large uptrend in the first half of 2008 and the huge
ment instead of looking at the experience of the downtrend for the rest of 2008 and the first three
people involved and their process in terms of run- quarters of 2009. (Remember, CTAs can profit from
ning a business. We’ve seen many great traders both rising and falling markets, so profitability is
whose businesses failed because of lack of opera- determined by the size and breadth of the trend, not
tional discipline and infrastructure.” its direction.)
“Our due diligence process can take six to nine According to FitzGibbon, a common error is “to
months,” Gallwas says. “We try to quantify opera- invest in a trend-following program very late in the
tional risk as much as possible. Is it a one-man cycle and then watch the program go into a signifi-
band out of his basement? Is he building an infra- cant drawdown. [Investors] buy the top and effec-
structure? There are a lot of times we like the per- tively sell the bottom.” He adds: “It’s probably easier
formance of a CTA but operationally he just doesn’t to know when to get on the train than it is to know
know what he’s doing, and we’re not willing to take when to get off.”
that risk on any manager.” While there are myriad details in constructing a
However, the biggest mistake investors make, managed futures portfolio, the basics are pretty sim-
according to the portfolio advisors we spoke with, ple: Set realistic objectives and know your risk toler-
is chasing the hot, new CTA. “It’s human nature to ance. Think long-term. Diversify you CTA portfolio
assume that what happened in the past will per- in terms of markets traded, trading styles, and time
sist into the future,” FitzGibbon says. “But when it frames. Do as much due diligence on how a CTA
comes to allocating to trend-following managers, it’s runs his business as you do on his returns. Don’t
not uncommon that their best-performing periods chase the hot, new CTA. Finally, work with an expe-
are followed by their steepest drawdowns.” rienced managed futures portfolio advisor.◆

MAnAGED FuTurEs TODAY • Q2 2010
MANAGED FUTURES TODAY • November 2010 11
11

Futures Perspective

Who is minding
my money?
CTA registration requirements promote due diligence.

By MFT Staff

The financial crisis of 2008-2009 left many investors every CTA must pass the National Commodity
asking “Who exactly is managing my money?” With Futures Examination, often referred to as the Series
the explosion in new financial products over the 3 Exam.
last decade, many new money managers were not The Series 3 Exam uses 120 questions to test
registered with any government agency or industry applicants’ knowledge of futures trading theory and
self-regulatory organization. The Dodd-Frank Wall practice and market regulation. Experienced traders
Street Reform and Consumer Protection Act now are advised to devote 40-50 hours studying for the
requires many of these new financial product man- exam, while newer traders will need to study more
gers to register. than 100 hours to pass the exam.
However, registration is nothing new in the man- During registration, CTAs are required to provide
aged futures industry; it’s been required since 1983. extensive background information about their busi-
Your commodity trading advisor (CTA) must be ness, including: the listed principals of the firm, and
registered with the Commodities Futures Trading which of the principals holds more than 10 percent
Commission (CFTC), the government agency that financial interest in the firm; the business address
oversees futures trading, and be a member of the and contact information of the CTA; whether the
National Futures Association (NFA), the futures firm has been involved in any regulatory actions,
industry self-regulatory organization. In addition, NFA arbitrations or CFTC reparations; and the his-
tory of the firm’s NFA status.
nFA BACkgrOund AFFiliATiOn sTATus inFOrmATiOn CenTer The NFA makes all the information
available in an easy-to-use web format
called the Background Affiliation Status
Information Center (BASIC) portion
of its website at www.nfa.futures.org/
basicnet/welcome.aspx.
“The best investor protection is inves-
tor education,” says Larry Dyekman,
NFA director of communications
and education. “All investors should do
The NFA’s BASIC system makes it easy to find registration information extensive due diligence before making
about CTAs, CPOs and futures trading firms. any investment.” ◆


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Strategy Focus

Position sizing: Balancing trades
and managing risk
Managed futures programs use more than stop orders to
control risk and create more consistent performance.

By MFT Staff

While many newer investors often treat Managed futures programs similarly “weight”
different assets identically — buying the positions in different markets based on contract
same number of shares of different size, price levels, and market environment to make
stocks, for example — one of sure risk and profit potential is distributed appro-
the distinguishing charac- priately across the portfolio. This relatively simple
teristics of professional concept, while seemingly removed from the
portfolio managers “Xs and Os” of triggering trades, is nonethe-
is knowing that vary- less one of the most important risk-control
ing position size is an tools managed futures funds have at their
integral aspect of their business. disposal.
If a managed futures program is
designed to diversify across all Comparing markets
liquid U.S. futures, for example, it Let’s look at three futures markets, crude oil (CL),
cannot simply buy or sell the same wheat (W), and the E-Mini S&P 500 (ES). One crude
number of contracts in all markets. oil contract represents 1,000 barrels of oil (42,000
Trading one T-bond contract is not gallons) and is quoted in dollars per barrel, making
the same as trading one natural gas a $1.00 change in the price of crude worth $1,000.
contract. At a trade price of $75.00, a single contract’s value
is $75,000.
One wheat futures contract represent 5,000 bush-
els of the grain and is quoted in cents per bushel,
which means a 1.00-point (1-cent) price change is
After all, if a stock worth $50. At a trade price of 650 6/8 cents
portfolio manager wanted
equal exposure to two stocks, one trading at
$20 and the other trading at $30, he wouldn’t pur- (650.75) a wheat
chase the same number of shares of both of them: contract has a value of $32,537.50.
he’d by one-and-a-half times as many shares of the Finally, the E-Mini S&P 500 contract has a value
$20 stock as the $30 stock, because then he would of $50 times the contract’s price, and each 1.00-
own equal dollar amounts of both. Other factors, point move in the contract is worth $50. With the
such as the difference in volatility between the two, market trading at 1025.00, a contract’s value would
would also be a factor. Continued on p. 16



A higher return
means higher risk.
Maybe.

It’s a bedrock principle of investing. Or is it? You can reduce risk and increase returns by
adding managed futures to a portfolio of stocks and bonds.




sTrATEGY FOCus

TABle 1: COnTrACT And PriCe-mOve vAlues
Min. price
Contract Point (1.00)
Contract size Price fluctuation Tick value
value value
(tick)
Crude oil 1,000 barrels 75.00 $75,000.00 $1,000.00 .01 $10
$50*futures
E-Mini s&P 1025.00 $51,250.00 $50.00 0.25 $12.50
price
1/4 cent
Wheat 5,000 bushels 650.75 $32,537.50 $50.00 $12.50
(0.25)
Futures contracts have different sizes and volatilities, which can often make apples-to-apples comparisons difficult.

be $51,250. Table 1 summarizes these values, along trade, and more than twice the size of the wheat
with the value of each contract’s minimum price gain.
move (tick). To “equalize” the trade signals across markets the
Let’s say a trading system bought both all three manager needs to know how many contracts each
contracts yesterday on the close at these prices, of wheat, crude oil, and the E-Mini S&P 500 should
and today these markets all gained .86 percent. be traded to produce equivalent profits. A quick
The money manager’s trading system is based on way to do it is to calculate the ratios of the dollar
the idea that all trade signals are of equal impor- gains in the E-Mini S&P and wheat to the gain in
tance and each one should have the same weight oil, which is used as the baseline contract because
in the overall portfolio — a common feature of it had the largest gain.
many long-term managed futures systems. However, Table 3 shows the crude oil gain was 1.47 times
because of the differences between the sizes of the size of the E-Mini S&P gain and 2.31 times
these contracts, Table 2 shows their dollar gains for the size of the wheat gain, which means the dol-
the day are very different, even though all of them lar values of the day’s gains would be equalized if
made the same percentage price gain for the day: the manager traded 2.31 wheat contracts and 1.47
The dollar gain for the crude oil trade was almost E-Mini S&P contracts for every oil contract. Because
50 percent larger than the gain for the E-Mini S&P that’s impossible, the numbers have to be rounded.
Rounding the ratios to the
TABle 2: sAme mOvemenT, diFFerenT resulT nearest integer would result
Prev. close Today’s close % gain $ gain in buying one E-Mini S&P
Crude oil 75 75.65 0.86% $650.00 contract and two wheat con-
E-Mini s&P 1025 1033.92 0.86% $445.88 tracts for every oil contract.
Although the final column in
Wheat 650.75 656.41 0.86% $283.08
Table 3 shows a reduction in
The dollar gains in these three markets are quite different, even though they all the wide disparity between
rallied by .86 percent overnight.
the between the wheat profit
and the other markets’ gains,
TABle 3: BAlAnCing TrAde siZe 1 there is still a relatively sig-
Ratio / nificant difference between
$ gain (Rounded) New $
# contracts crude oil and the E-Mini S&P.
Crude oil $650.00 1.00 1 $650.00 The positions can be bal-
E-Mini s&P $440.75 1.47 1 $440.75 anced even more accurately
Wheat $281.25 2.31 2 $562.50 by increasing the number of
crude oil contracts traded
Comparing the sizes of the dollar gains indicates how many contracts of each are
necessary to balance the portfolio. and further refining the


TABle 4: BAlAnCing TrAde siZe 2
Ratio /
$ Profit (Rounded) Actual $
# contracts
ratios. For example, if the sys-
Crude oil 2 $1,300.00 2 $1,300.00
tem purchased two oil contracts
instead of one, the profit the E-Mini s&P 2.95 $1,300.21 3 $1,322.25
next day would have doubled Wheat 4.62 $1,299.38 5 $1,406.25
to $1,300. Table 4 shows nearly Further refining the number of contracts produces more balanced results.
the same dollar profit would
have been achieved by trading a manager could use the average daily percentage
2.95 E-Mini contracts and 4.62 wheat contracts — change over a certain period (for example, 20 days)
double the ratios from Table 3. Because these new as a simple volatility measure and adjust the number
ratios are much closer to whole numbers, when of contracts traded as this figure changes.
rounded the result of trading five wheat contracts Instead of showing the percentage price change
and three E-Mini S&P contracts for every two crude for a single day, Table 5 shows the average daily
oil contracts results in fairly comparable dollar change for the past 20 days. (Note: The absolute
results between the different markets, as shown in value of price changes would be used, since we are
the final two columns. The balance between markets concerned with the total amount of price move-
could be further refined by continuing this process, ment, not its direction.) In this case, the markets’
depending on the how much capital the manager different volatilities would result in different average
has to allocate. dollar gains than those from Table 1. Here, the ratios
between the crude oil, E-Mini S&P, and wheat con-
faCtoring in volatility tracts become 1 to 2.14 to 6.87 or, when rounded,
The previous example showed how positions in 1 to 2 to 7. The final column shows trading seven
different futures markets could be made more com- wheat contracts and two E-Mini S&P 500 contracts
parable based on one day’s trading activity and for every crude oil contract produces fairly compa-
identical percentage moves in the three markets. Of rable dollar results. As in the previous example, the
course, in reality market conditions are constantly contract ratios could be refined further as desired.
changing and trades are being opened and closed at
different times, which makes the position-balancing ConsistenCy and risk management
process much more dynamic. Although position balancing might seem like a rela-
Although related futures contracts (such as dif- tively unimportant aspect of trading, it is actually an
ferent stock indices) may often make similar-sized integral part of any futures portfolio manager’s risk-
moves from day to day or week to week, most mar- control process: Managing the size and volatility dif-
kets have different volatility levels, which means ferences between different futures contracts creates
position sizes will need to be adjusted on a regular a stable trading framework and more-consistent and
basis as market conditions change. For example, predictable performance results.◆

TABle 5: AdJusTing FOr vOlATiliTy
20-day avg. % gain Avg. $ gain Contract ratios (Rounded) New $
Crude oil 1.26% $945.00 1.00 1 $945.00
E-Mini s&P 0.86% $440.75 2.14 2 $881.50
Wheat 0.42% $137.50 6.87 7 $962.50
Based on the average daily percentage price changes over the past 20 days, seven wheat contracts and two E-Mini
S&P contracts will result in comparable dollar results.

MAnAGED FuTurEs TODAY • November 2010 17

Managed Futures Performance

returns turn bullish into fall
Managed futures in the black through September, agricultural funds lead the pack.

2010
2010
index sePT. Thru 2009 2008
yTd*
Through the end the third July
quarter, managed futures pro- Barclay CTA Index 1.94% 2.49% -0.98% -0.10% 14.09%
Agricultural Traders Index 2.94% 7.33% 2.57% -1.40% 9.95%
grams were in bullish terri-
Currency Traders Index 0.78% 2.91% 2.70% 0.91% 3.50%
tory for the year, according to
Fin./Met. Traders Index 0.94% 2.86% 0.84% 0.60% 10.35%
data from BarclayHedge.com. systematic Traders Index 2.34% 2.68% -1.50% -3.38% 18.16%
With approximately 90% of Diversified Traders Index 3.24% 2.42% -3.10% -3.61% 26.55%
funds reporting on Oct. 21,
* Through September, with approximately 90 percent of funds reporting.
the Barclay CTA index was up
2.49 percent as of Sept. 30,
reversing the -0.98 percent return
posted at the end of July.
Although discretionary, diversi-
fied, and systematic programs
all turned around their previ-
ously negative returns, the mar-
quee move was made by the
Agricultural Traders index, which
was up 7.33 percent on the year,
far outpacing the other sector indi-
ces.
Among the indices that made
the transition from red to black,
the Diversified Traders index
made the most impressive move,
reversing a -3.1 percent return
at the end of July to a 2.42-percent gain through diversified commodity trading advisors (CTAs), as
September. well as those focusing on the most-trending sectors
Strong, sustained moves in many physical futures, (e.g., financial/metal traders).
including metals, foodstuffs, grains, and some finan- The Barclay CTA index represents more than
cial futures (particularly interest-rate futures) likely 500 U.S. futures fund managers. Updated industry
contributed to gains among trend-following and returns are available at www.barclayhedge.com. ◆

managed futures asset growth continues
Financial/metals programs see biggest increases in Q2.

Managed futures assets under management (AUM) the year, up 2.85 percent from the previous quarter
increased for the fifth consecutive quarter in Q2 and 13.17 percent more than Q2 2009.
2010, according to data from BarclayHedge.com. Perhaps driven by big moves in the metal futures,
Total AUM for U.S. managed futures programs and especially the record-setting move in gold (GC),
increased to $223.4 billion in the second quarter of the BarclayHedge Financial/Metal Traders sector


Commodity Snapshot

Commodities at highest levels in two years
Commodity indices challenging resistance in late October.

The summer rally noted in the
previous issue of Managed
Futures Today followed through
into October, as commodity
indices tested their 2010 highs
and pushed to their highest lev-
els since October 2008.
As of Oct. 22, the Rogers
International Commodity Index
TRAKRS (RCT), which gauge
the performance of global phys-
ical commodity markets, had
pushed slightly above the year’s
high (above 24.00), a gain of
more than 20 percent from the
June low. After a brief correc-
tion in August, the index rallied
almost without interruption into
mid-October before
consolidating. sizable profits.
Gains were driven by some record-setting moves Financial futures: In addition to notable moves
in metals (gold set a new record high above $1380/ in physical commodity futures, U.S. interest rate
ounce in October, but silver and copper posted futures (T-bonds and T-notes) continued to rally into
even larger gains on a percentage basis), along with October, approaching near-record levels set in late
continuations of major uptrends in grains (especially 2008, while a sharp sell-off in the U.S. dollar con-
corn, which recently replaced wheat as the most tributed to big downtrend in the U.S. dollar index
bullish market in the sector) and select soft com- futures (DX)
modities (sugar and cotton). since June and
Natural gas (NG) continued to diverge from a a similar up key Concepts
mostly range-bound energy sector by extending its move in the
Sharpe ratio: Average return
massive downtrend — a move that has provided Euro FX futures divided by standard deviation of
trend-following futures fund managers with (EC). ◆ returns (annualized).

Sortino ratio: IR – RF StD(NR)
increased AUM by nearly 5 percent — more than twice as much as
the next-largest gain, which occurred in the Systematic Traders sector. Where:
Currency and agricultural programs were the only sectors to see IR = Investment’s return (typically
net outflows in Q2 (-2.13 percent and -17.11 percent, respectively), the annualized return)
the latter sector’s decline somewhat ironic given the big trends that RF = The risk-free return
unfolded in grains in 2010 and the industry-leading returns of agricul- StD(NR) = Standard deviation of
tural managed futures funds in recent months. Overall, Systematic and the investment’s negative returns
Diversified programs (and there is overlap between the two) continue (typically annualized)
to maintain the highest AUM) levels. ◆

MANAGED FUTURES TODAY • November 2010 19


Smart money
sticks to stocks
and bonds.
Not anymore.
A simple switch to your portfolio can help you outsmart the smart money. Investors who
add managed futures to their portfolios can achieve strong performance in any kind of
economic environment. Be it a bull or bear market, managed futures generate strong, long-term
track records.




Managed Futures Today

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