The book excerpts below are designed to highlight the important issues, with answers contained inside the book. To see the full table of contents, click here. For content extras and detailed research from the book, click on Chapter Research and Extras at the end of each chapter review below (registered book readers only).
Chapter 1: Understand It: The Truth about Risk and Misunderstood Investments
Key concept: Understand the real risk in overexposure to equity investing, risk not generally recognized in our stock-centric world. Introduction to perhaps the most misunderstood and ignored asset class that is ironically perhaps the most uncorrelated to the performance of the stock market, managed futures.
Key chapter excerpts:
From third paragraph of 1st chapter:
“In fact it could be argued that managed futures is the most uncorrelated major asset class in history, the most diversified from stocks. Here is why…”
From section titled “Wall Street’s Motivation for Keeping Managed Futures a Secret”
“Financial professionals have a duty to understand the latest products and methods of investing; at minimum, they have an obligation to understand an asset class that performed positively in nine of the last ten stock market declines and offers such uncorrelated diversification opportunities. So the question exists:
Why does traditional Wall Street thinking ignore managed futures?”
From the section titled: “In Managed Futures Diversification, not Cash, is King
“The next two points are not widely disclosed in the cloistered managed futures world, but they should be…”
“A deep industry insight, however, is to question the core validity of the diversification within the managed futures indexes, which can be understood in part by considering 2009 index performance.”
Author’s Comments on Chapter 1: This was probably my favorite chapter to write. I feel as though an injustice has been done to an asset class and an industry by an omni-powerful force centered on a small island of thought. Managed futures can no longer be ignored, particularly at this moment in our debt-ridden history. This outlines the mission, and I hope it is communicated it with a degree of passion but also accurate logic.
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Chapter 1 Research and Extras click here (requires membership, book readers only)
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Chapter 2: Define It: Establish Performance and Risk Targets
Key concept: Understand basic managed futures risk and performance benchmarks.
Key chapter excerpts:
From the section “Conservative is a Relative Term in Managed Futures”
“The risk and reward of conservative investment in managed futures compared with stocks is akin to skiing black diamond runs in Utah and then coming to the Midwest to ski black diamonds. Technically they are both black diamonds, but they are very different ski runs.”
From the section “Moderate Risk/Reward”
“Comparing targets to the actual performance is interesting, but comparing actual performance of different categories to each other provides additional insight into the personality of any asset class.”
From the section “Managed Futures Returns / Drawdown Insight”
“This is an interesting insight that points to what is a different investing animal where the unvarnished reality is that volatility is often the price one pays for returns. The challenge is to try to tame the animal: Understand and manage the risk behind powerful returns without dramatically reducing the reward. And this leads to the start of a formula…”
Author’s Comments on Chapter 2: This was a challenging chapter to write and may be a touch controversial. Without any real basis of comparison from other published opinions, categorizing performance can be subjective to hindsight bias and establishing performance benchmarks as was done in this chapter isn’t widely done in this industry. Having said that, what made it interesting was in using performance categorization to point out asset class insights.
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Chapter 2 Research and Extras click here (requires membership, book readers only)
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Chapter 3: Work With It: Build Basic Portfolios Using Targets
Key concept: This begins to provide insight into CTA selection and the power of diversification.
Key chapter excerpts:
From the section: “$200,000 Minimum: Multimanager Portfolio versus Top-Returning CTA”
“The benefit of a diversified CTA portfolio versus a single investment manager is obvious, considering risk factors such as volatility and drawdown and then comparing this to returns.”
From the section: Consider Win Percentage as it Relates to Strategy
“Analysis of this strategy can be tricky when only looking at headline performance numbers; it requires one understands what lies beneath the surface. (This managed futures) strategy can appear conservative during most times, with apparent lack of correlation to the stock market (but this can be deceiving to the untrained eye, particularly during periods of extreme stock market volatility).”
Author’s Comments on Chapter 3: Understanding the different strategies is what makes managed futures so interesting and unique. This chapter starts that process.
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Chapter 3 Research and Extras click here (requires membership, book readers only)
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Chapter 4: Realize It: The Old Way versus High Performance
Key concept: This chapter defines the managed futures asset class at a basic level.
Key chapter excerpts:
From the section: “The Fastest Growing Asset Class?”
“It is amazing that managed futures is one of the fastest-growing asset classes and yet it remains relatively unknown and misunderstood.”
From the Section: “If you Want Advice You Won’t Get It From a Commodity Trading Advisor”
“We have identified two parts of the term commodity trading advisor that are somewhat misleading, and more importantly, we have used this to put on display the nature of a managed futures investment. But it doesn’t end there. The third word in the term is perhaps most inaccurate, almost to the point of deception.”
From the section: “The Important Differences Between a CTA, Commodity Broker, and Trading System”
“…Giving advice and the ability to display a valid past track record are two key points of differentiation. But perhaps the most important difference lies in the profit motivation.”
“…sometimes the performance can be audited, but that performance could be based on follow-the-leader methodology, where the trade system’s main account is audited but not the performance of all the individual accounts. Such performance is not as valid as that of a CTA in an NFA-audited environment.”
From the section: “Examples of How CTAs Invest Client Capital”
“An emerging subcategory is the diversified premium collector who executes the premium collection strategy in 15 to 20 different markets, from gold and oil to wheat and interest rate products…”
“…Thus, trend traders are not necessarily correlated to the upward price movement of any market in which they invest. There are also several counter trend traders that operate as a foil to the trend-trading strategy… Combining these complementary CTAs in a portfolio yields interesting results.”
Author’s Comments on Chapter 4: This chapter requires taking a step back… and realizing just how different this quirky yet powerful asset class was. Then I worked to define a complicated topic with a dash of humor, making the chapter easy to read and a complicated asset class understandable.
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Chapter 4 Research and Extras click here (requires membership, book readers only)
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Chapter 5: Don’t Be a Victim: Leverage Managed Futures Regulation and Account Structure to Avoid Hedge Fund Fraud
Key concept: Understand how unique industry regulatory structure can benefit investors in a way very different from hedge funds and other alternative investments.
Key chapter excerpts:
From the second paragraph of the chapter:
“This chapter dissects limited aspects of Madoff’s Ponzi scheme as it relates to managed futures, highlighting the account structure and regulation that provide a very different investor environment. It matters not who perpetrates the fraud, Madoff or future would-be scam artists; the principles of how to avoid fraud outlined in this chapter are timeless because of their focus on the core levels of transparency, control of client capital, having different eyes monitor investor capital, and intelligent yet firm industry regulation.”
From the section: ”The Limited Protection of a Segregated Account”
“In fact, much of what happens with hedge fund fraud regarding misappropriation and unseen manipulation of client assets would be difficult to duplicate in managed futures due to the account segregation requirements and managed futures regulation regarding the transparency of a direct segregated account.”
“In the author’s opinion, much of the secrecy and lack of transparency in fund investments is unnecessary to varying degrees and a major issue that investors should consider.”
From the section: “Auditing Performance and Money Flow”
“While the report says it is confidential, for the member’s eyes only, here is a little-known insight…”
From the Section: “Fees and Performance Reporting”
“…Performance reporting should be true to the concept of showing exactly the past returns less any fees and expenses. This is one reason why reporting performance after commissions, fees, and expenses, as is done in managed futures, is generally a more honest representation. This is not to say that managed futures performance reporting is without its own issues.”
From the Section: Does Regulation Work?
“While some inside the futures and options industry may consider regulation somewhat onerous, it is clear regulation has cleaned what was at one point considered a dirty industry and made the investment legitimate by protecting the investor.”
Author’s Comments on Chapter 5: I am frankly amazed that many of the structural components used in managed futures regulation are not used as a template with hedge fund investing. The core concepts of transparency, account segregation and regulation by a truly independent authority should run in the headlines of financial services reform, but they aren’t even being discussed.
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Chapter 5 Research and Extras click here (requires membership, book readers only)
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Chapter 6: Recognize It: Volatility + Volatility and Lintner’s Message
Key concept: Understand the difference in risk between drawdown and volatility. Then ask the question: should Lintner’s message be about managed futures or should we take it to the next level, making it a message about integrating uncorrelated volatility into a portfolio?
Key chapter excerpts:
From the third paragraph of the chapter:
“Societal norms to which investors have been indoctrinated teach that investing risk, as measured by volatility and standard deviation, should be avoided; you can avoid the pain, yet expect the gain. In the fall of 2008 stock investors learned the truth about risky investments: Stock market volatility is the price to play a game of high risk/high reward poker. It is traditional for financial professionals to measure investment risk based on volatility using an antiquated standard deviation formula, which leads to a question:
Is all volatility the same degree of bad?”
From the section: “All Volatility is Risky… To Different Degrees”
“Certain types of volatility can be better than other types of volatility in the author’s opinion. . While all volatility represents risk, it does so based on degrees. There are occasions when risk can be required to yield appropriate return: circumstances when a risky/volatile investment can generate positive overall results in a portfolio.”
Author’s Comments on Chapter 6: The concept of volatility and risk are fascinating. I really made an effort to get inside volatility and show the value of different risk types, which is particularly appropriate in managed futures.
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Chapter 6 Research and Extras click here (requires membership, book readers only)
CONTENT DISCLOSURE
This web site and related communication substantially represent the opinions of the author and are not reflective of the opinions of any exchange, regulatory body, trading firm or brokerage firm, including Peregrine Financial Group. The opinions of the author may not be appropriate for all investors and there is no warrantee relative to the accuracy or completeness of same.
RISK DISCLOSURE
PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS.
THE RISK OF LOSS IN TRADING COMMODITIES CAN BE SUBSTANTIAL. YOU SHOULD THEREFORE CAREFULLY CONSIDER WHETHER SUCH TRADING IS SUITABLE FOR YOU IN LIGHT OF YOUR FINANCIAL CONDITION. THE HIGH DEGREE OF LEVERAGE THAT IS OFTEN OBTAINABLE IN COMMODITY TRADING CAN WORK AGAINST YOU AS WELL AS FOR YOU. THE USE OF LEVERAGE CAN LEAD TO LARGE LOSSES AS WELL AS GAINS. YOU COULD LOOSE ALL OF YOUR INVESTMENT OR MORE THAN YOU INITIALLY INVEST. IN SOME CASES, MANAGED COMMODITY ACCOUNTS ARE SUBJECT TO SUBSTANTIAL CHARGES FOR MANAGEMENT AND ADVISORY FEES. IT MAY BE NECESSARY FOR THOSE ACCOUNTS THAT ARE SUBJECT TO THESE CHARGES TO MAKE SUBSTANTIAL TRADING PROFITS TO AVOID DEPLETION OR EXHAUSTION OF THEIR ASSETS.
THE DISCLOSURE DOCUMENT CONTAINS A COMPLETE DESCRIPTION OF THE PRINCIPAL RISK FACTORS AND EACH FEE TO BE CHARGED TO YOUR ACCOUNT BY THE COMMODITY TRADING ADVISOR (“CTA”). THE REGULATIONS OF THE COMMODITY FUTURES TRADING COMMISSION (“CFTC”) REQUIRE THAT PROSPECTIVE CUSTOMERS OF A CTA RECEIVE A DISCLOSURE DOCUMENT WHEN THEY ARE SOLICITED TO ENTER INTO AN AGREEMENT WHEREBY THE CTA WILL DIRECT OR GUIDE THE CLIENT’S COMMODITY INTEREST TRADING AND THAT CERTAIN RISK FACTORS BE HIGHLIGHTED. THIS DOCUMENT IS READILY ACCESSIBLE AT THIS SITE. THIS BRIEF STATEMENT CANNOT DISCLOSE ALL OF THE RISKS AND OTHER SIGNIFICANT ASPECTS OF THE COMMODITY MARKETS. THEREFORE, YOU SHOULD PROCEED DIRECTLY TO THE DISCLOSURE DOCUMENT AND STUDY IT CAREFULLY TO DETERMINE WHETHER SUCH TRADING IS APPROPRIATE FOR YOU IN LIGHT OF YOUR FINANCIAL CONDITION.
YOU ARE ENCOURAGED TO ACCESS THE DISCLOSURE DOCUMENT. YOU WILL NOT INCUR ANY ADDITIONAL CHARGES BY ACCESSING THE DISCLOSURE DOCUMENT. YOU MAY ALSO REQUEST DELIVERY OF A HARD COPY OF THE DISCLOSURE DOCUMENT, WHICH WILL ALSO BE PROVIDED TO YOU AT NO ADDITIONAL COST.
PFG BEST DOES NOT HAVE AN OWNERSHIP STAKE IN ANY OF THE CTAS WE RECOMMEND OR UPON WHICH WE PROVIDE RESEARCH. MUCH OF THE DATA CONTAINED IN THIS REPORT IS TAKEN FROM SOURCES WHICH COULD DEPEND ON THE CTA TO SELF REPORT THEIR INFORMATION AND OR PERFORMANCE. AS SUCH, WHILE THE INFORMATION IN THIS REPORT AND REGARDING ALL CTA COMMUNICATION IS BELIEVED TO BE RELIABLE AND ACCURATE, PFG BEST CAN MAKE NO GUARANTEE RELATIVE TO SAME. THE AUTHOR IS A REGISTERED ASSOCIATED PERSON AT PFG BEST.
Entire website Copyright © 2010 by Mark H. Melin. All rights reserved. Book published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada.
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