Over the last seven years the money professionally managed in the commodity futures markets has more than quintupled! According to hedge fund tracking firm Barclays, assets under management rose from about 41 billion dollars in 2001 to more than 219 billion dollars today!
As worldwide demand for commodities continues to heat up and more investors (institutional and individual) start seeing commodities as a sensible investment vehicle, this trend is expected to continue. This growth has also raised the need for ways to select a commodity trading advisor. In this article, we will outline what we believe are some of the best tools, and methods available to the individual investor when choosing a managed futures product.
Let’s first define what managed futures are and what they are not. Managed futures are not stocks or ETF’s that just invest in commodities. Managed futures accounts are investments in which funds invest in mainly leveraged sgx nifty, future dated contracts for commodities or financial instruments. Commodities can include sectors such as food, energy, raw materials and financial instruments like interest rates and stock indices.
The leverage, risks and rewards can be (but are not always) substantially higher when investing in the futures markets vs. the stock market. The National Futures Association and the Commodity Futures Trading Commission regulate managed futures investments in the United States (unless the firm / fund have “exempt” status). Regulated firms hold a Commodity Trading Advisors (CTA’s) or Commodity Pool Operators (CPO’s) license, but keep in mind, just because a firm carries a license is in no way an endorsement of future performance. Futures trading can carry large potential risks and is not for everybody. Investors should be familiar with all the risks before investing.
Finding lists of potential managers to sort through is fairly easy if you know where to look. Firms such as Barclays Trading Group, Stark Research, Autumn Gold and Altegris Investments have databases of manager information available. AutumnGold summarizes a free (with registration) online database of over 450 programs. Also, the programs can be sorted by a wide range of parameters such as minimum account size, funds under management, and various performance measurements.
The only problem we see with the online databases is that it can become somewhat overwhelming to try and narrow down your choices to just a handful of managers. To help simplify the process, we would like to share what we think are some of best performance metrics.
Our first recommendation is to forget return! The least significant statistic often is a manager’s return. How can that be you ask? What matters is RISK ADJUSTED RETURN. Just because somebody bet the farm and got lucky does not mean it was a nifty idea. Sooner or later (most often sooner) the inevitable wipe out will occur with a manager betting too aggressively.
There are many traditional risk adjusted return measurements, the most popular of which being the Sharpe ratio. The Sharpe Ratio compares the return relative to the underlying volatility in the investment. Although we are in agreement with the Sharpe Ratio’s logic, we feel it has one serious flaw. The flaw is that the Sharpe Ratio only views past volatility and does not try and predict future volatility. As a result, we feel the Sharpe ratio does not give an adequate view of the potential risks involved in a program.