by Tyler Resch, Portfolio Manager, IASG

A common theme among my prior newsletters and something I am constantly discussing with my clients is the need for diversification in your managed futures portfolio. There is substantial uncertainty in the market right now and although the Presidential election is behind us, investors seem to have as many if not more questions than before. October proved to be a volatile month, November has thus far shown to have the same potential, and there is little reason to believe we will have much of a break in December. This brings me back to efficient portfolio construction and some of the ways you can analyze your current allocations or future portfolio considerations.

IASG has a proprietary tool referred to as the Blender that allows you to build hypothetical portfolios of Managed Futures programs and review important statistical data to help you asses risk, correlation, and potential return. The Blender tool allows you to input CTA programs, define the trade levels, and review a properly weighted performance composite of the programs you have chosen. An allocation chart is generated based on your portfolio weightings to help give you a visual representation of how diversified you are among CTAs and where you are potentially over or under allocated. A performance graph is also produced that helps demonstrate at what historical times the portfolio may have struggled as well as when it outperformed. This allows you to pinpoint a deficiency and work to understand what was going on in the market at that time and then look to supplement the portfolio with a program that excels in similar markets.

The Blender tool also helps you understand the correlation between the programs within your portfolio as well as the portfolio’s correlation to major US and international indices. A common goal among my clients is to be as uncorrelated to the S&P as possible. With the Blender, you can actually quantify this correlation and shape this figure by altering your allocation levels and which programs are included in the portfolio. The potentially more vital correlation analysis the Blender creates is the correlation of each program to one another within your portfolio. The goal of course being that the correlation between your managers be as low as possible so that when you do have a CTA experience a draw down the others are able to help you weather that and manage your downside risk.

Furthermore, a complete statistics work up is compiled for your review. Important statistical indicators are concentrated in three different areas of focus: risk, reward, and volatility. With this information you are able to more clearly see what your worst loss, average loss, and loss frequency over the course of your hypothetical track record would have been. You can of course also view your compounded annual rate of return, standard deviation, and annualized Sharpe ratio. An additional capability available to you is the opportunity to take these statistics and review them side-by-side with the same statistics of the major Index of your choice. I am particularly inclined to do this with the S&P to help demonstrate how a Managed Futures portfolio would affect the overall performance of my investor’s traditional portfolio.

These are only a few of the tools within the Blender and a very broad overview of how they can be utilized. For instance if you were looking for a Trend Follower with a non traditional approach, you could create a Blend consisting of some of the big name Trend Followers and then add other Trend Followers to assess the correlation between them. Going into the end of the year with a new year around the corner is the perfect time to take a look at your current allocations or review a potential first time investment and see if the risk/reward makes sense for you. If you would like some guidance while utilizing the Blender or would like to discuss some candidates to potentially include in your portfolio, I am happy to help. For questions regarding this article, a specific CTA or Managed Futures in general, please feel free to contact me by phone (312) 913-9603 or email at tresch@iasg.com.

HYPOTHETICAL PERFORMANCE RESULTS HAVE MANY INHERENT LIMITATIONS, SOME OF WHICH ARE DESCRIBED BELOW. THERE ARE FREQUENTLY SHARP DIFFERENCES BETWEEN A HYPOTHETICAL COMPOSITE PERFORMANCE RECORD AND THE ACTUAL RECORD SUBSEQUENTLY ACHIEVED.

ONE OF THE LIMITATIONS OF A HYPOTHETICAL COMPOSITE PERFORMANCE RECORD IS THAT DECISIONS RELATING TO THE SELECTION OF TRADING ADVISORS AND THE ALLOCATION OF ASSETS AMONG THOSE TRADING ADVISORS WERE MADE WITH THE BENEFIT OF HINDSIGHT BASED UPON THE HISTORICAL RATES OF RETURN OF THE SELECTED TRADING ADVISORS. THEREFORE, COMPOSITE PERFORMANCE RECORDS INVARIABLY SHOW POSITIVE RATES OF RETURN. ANOTHER INHERENT LIMITATION ON THESE RESULTS IS THAT THE ALLOCATION DECISIONS REFLECTED IN THE PERFORMANCE RECORD WERE NOT MADE UNDER ACTUAL MARKET CONDITIONS AND, THEREFORE, CANNOT COMPLETELY ACCOUNT FOR THE IMPACT OF FINANCIAL RISK IN ACTUAL TRADING. FURTHERMORE, THE COMPOSITE PERFORMANCE RECORD MAY BE DISTORTED BECAUSE THE ALLOCATION OF ASSETS CHANGES FROM TIME TO TIME AND THESE ADJUSTMENTS ARE NOT REFLECTED IN THE COMPOSITE.