Let’s face it; managed futures have not been a productive investment over the past three years. Many managers and multi-manager funds have been posting disappointing returns. Within multi-manager funds, diversification has helped reduce drawdowns, but each month the gains of some managers have been offset by uncharacteristic losses by others.
Recent poor performance of managed futures, meanwhile, has challenged the management methodology of multi-manager funds.
The good news is that, historically, managed futures have come out of negative periods and returned to impressive profitability. Success lies in surviving the bad times and preparing for the good times. has prevailed with principles drawn from our experience as commodity and financial futures traders, futures options market makers and trading firm owners. Through all kinds of market conditions, we have learned what it takes to survive and thrive.
Protect capital from drawdowns
Our experience has taught us that, in managed futures, losses are more detrimental than gains are beneficial. Large drawdowns make fewer assets deployable when markets improve. Better days will come, and when they do, a fund needs its capital base whole and ready to perform. Often not considered, but of equal importance, large drawdowns inflict trauma. Managers lose confidence, which can lead to under-allocated assets, impaired judgement, dissatisfaction, departures of good traders and degraded performance. By limiting drawdowns, managers recover more quickly and allocations retain their return capacity.
A multi-manager fund manager must evaluate trades and trading strategies throughout the trading day and after the markets close
At Genesis Multi Manager Futures Fund, we employ four principles when managing traders in difficult markets. First, difficult markets increase complexity and require the fund manager to work harder. Second, the market morass identifies truly great traders and provides a stress test for weaker traders. Third, strategies that do not mimic the crowd represent opportunities. Fourth, the right perspective on loss can limit drawdowns.
During unproductive periods, fund managers cannot lessen their efforts. Instead, they must work harder. Difficult environments increase the need for trade and manager scrutiny. Trading in complex futures markets requires active monitoring. A multi-manager fund manager must evaluate trades and trading strategies throughout the trading day and after the markets close. When traders are struggling, analysis becomes very particular – even down to individual trades and the trade execution. The fund manager must not only watch manager performance, but also analyse the elements of that performance.
The transparency of futures markets, along with our extensive trading background, enables us to monitor and interpret trading decisions and market conditions. It could be argued that such a micro managed approach is not needed. However, if loss reduction and asset protection are the manager’s first priority, then it is important to have the knowledge and awareness required to react rapidly and effectively. During difficult markets, traders and their strategies experience stress. If a fund manager detects stress, the next steps are to assess whether the trader is responding appropriately and whether the strategy can withstand the stress. The fund manager may decide to contact the trader to offer expertise or provide them with information on current market conditions.
The fund manager must gauge expectations of a trader and understand the limitations and strengths of a strategy
In addition to active monitoring, we use mathematical monitoring of our managers and overall portfolio. Our dual approach is more rigorous than active or mathematical monitoring alone. Mathematics can confirm what the fund manager observes, but active monitoring can detect problems before mathematics. Mathematics tends to be slower as the models need to accumulate data points before flagging up problems. In struggling markets, mathematical monitoring often fails because the issues are outside of historical, empirical observations. Mathematics can run in the background, but the time and attention of active monitoring is required. In periods of poor performance, the fund manager needs market experience, trading knowhow and strategy clarity to control loss.
Stress testing talent
During difficult markets, traders experience the trauma of drawdowns, especially if a loss is large. Traders who can manage and capitalise on adversity are hard to find. Yet adversity has a way of highlighting the exceptional. In good markets, marginal traders profit. In difficult markets, even good traders struggle. Often, the poor performers appear great on paper but fail without the support structure of trading desks. The best traders have had ultimate responsibility for trading decisions and the ability to function autonomously. In our experience, traders who recover from loss and even profit possess sheer talent and self-reliance.
To resource rare talent and address trader attrition, the fund manager must increase trader evaluations. Difficult markets add a stress test dimension to the due diligence process. The fund manager must gauge expectations of a trader and understand the limitations and strengths of a strategy. Beyond that, market stress can reveal trading talent. The art of discovering talent during bad times prepares the fund for better times.
Don’t mimic the crowd
Currently, the crowd consists of systematic strategies – primarily trend followers. Over 80 percent of assets under management in managed futures are in systematic strategies. In addition, most of the money has been placed with large managers. As former traders, we know that a concentration of assets with managers utilising similar strategies creates exploitable opportunities for professional traders. Market makers and traders take advantage of crowd conformity, which increases price slippage for the crowd. Strategy and asset concentration also increases execution costs. To offset these costs, long-term trends must materialise.
For a multi-manager fund, opportunities exist with managers who trade in smaller markets, such as agricultural products. They utilise experience and discretion and focus on trading implementation. They generally receive little attention from institutions. Yet these managers provide market-specific expertise and offer novel approaches.
Smaller, experienced traders utilise relative value or relationship-driven strategies. For example, common relationship trades are the soybean crush, inter-commodity spreads, and calendar spreads in the energy quadrant. We believe hiring these managers creates a lower risk portfolio while providing a more consistent return profile. Mathematical systems are valuable, but the complexity of commodity futures and options markets, and the traders who understand them, offer numerous ways to make money.
Perspective on loss
All managers attempt to limit drawdowns, but not all managers have the right perspective on loss. The perspective of a professional trader or options market maker is fundamentally different than that of systematic strategies. A professional futures options market maker’s margin to equity ratio is often at 100 percent. Losses and risk are treated with great urgency. Losses tend to impact a trading firm more profoundly than profits.
In the perspective of a systematic strategy, losses and gains are considered symmetrical. A systematic trader will accept a larger drawdown if the system forecasts higher average gains. But in the dynamic futures markets, theoretical future gains are not always realised. We treat loss as professional market makers and will sacrifice theoretical statistical gains in an effort to limit large drawdowns.
Managed futures returns come in short time periods and are unpredictable. Even astute, mathematically savvy managers have not been able to model their equity curve
Furthermore, traders are not machines; they are people whose emotions are negatively impacted by losses. Drawdowns portend loss of performance, mental clarity and discipline. Even mathematicians experience the trauma of losses, but many systems do not take traumatic effects into account.
Drawdowns are part of the business, but we take many measures to limit the depth of drawdowns. We place tight acceptable loss maximums on our managers. We construct a team-based portfolio in which each manager functions to lessen volatility and control risk. We contract with market experts that have a history of low drawdowns. We pay attention to the daily activity of our managers and address potential issues quickly. Protecting assets is our first responsibility.
Genesis Multi Manager Futures Fund is a managed futures fund that ‘treads water’ well: one that preserves capital during unproductive periods and stands ready for full functioning when markets are good. By protecting assets, we enable investing in managed futures without regard to timing. Managed futures returns come in short time periods and are unpredictable. Even astute, mathematically savvy managers have not been able to model their equity curve. Therefore, to profit from managed futures, an investor needs to be invested before market opportunities arise. Our ‘win by not losing’ mentality helps investors to invest with confidence.
For more information: Tel: +1 312-339-6042; email: [email protected]