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As a writer, it’s frustrating when you come across a piece of work that expresses your own views more eloquently and more convincingly than you ever could. That’s pretty much how I feel about today’s guest post from Attain Capital Management.
For the record, I could not agree more with what they have to say — everything from the way they set the stage with Europe as the key macro backdrop to how using managed futures can help investors navigate a messy environment like that. The guys over at Attain always seem to have something interesting to say in their startlingly intelligent blog. You can also follow them @AttainCapital.
I seldom feature guest posts because I enjoy writing this newsletter so darn much and it’s such an important part of my weekly routine. So in the meantime, if you’re hungry for additional content, check out an article I wrote over the weekend for Seeking Alpha. It turned out rather well and was even featured on their front page! It’s about why the market could be set up for a meaningful medium-term bounce.
Attain occupies an interesting niche as a commodities futures broker. But they, their commentary, and even their industry as a whole are all under-appreciated by mainstream finance and under-utilized by investors. Investments in managed futures products can be powerful tools to help diversify your portfolio, and it’s why our firm has managed products like this for almost 30 years.
So that’s why I’m featuring this guest post. Consider it an introduction to the world of managed futures and how awesome it can be. If you want to learn more about that sort of thing, check out Attain’s site or send us an email (note: these products are not for everybody).
Batter Up: Managed Futures and the Coming Crisis
by Attain Capital Management – 5/16/12
Last week, we dedicated everything we had to attending multiple conferences and absorbing as much as we could about alternative investing trends in the industry. If you’re interested in what we found out, it’s all up on the blog for your perusal. But as we said throughout the week and for hours back at the office, Europe is flat out dominating the conversation among investing professionals. Whether or not they’ll admit it out loud, people are nervous. There’s marketing spin everywhere you look, but one scratch below the surface tells us that there is a real fear that we could be witnessing the unraveling of the European Union in slow motion… and the global financial system is biting their nails over the fallout, from bank exposure to investor confidence to overall liquidity.
While these are interesting times, I guess you could say we aren’t quite at the Mayan’s level on what the end of the year will bring. Make no mistake- there is volatility on the horizon, and it may end up being a bitter pill to swallow for most of the investing population, as their attempts at diversification fall victim to the rising correlation of asset classes. However, in the managed futures world, there’s a sense of “been there, done that” that gives us a slightly different perspective. Banter in our office has been less focused on Greece and more focused on some of the managers that have either already been tearing it up in this climate, or positioning their portfolios to capitalize should things worsen from here. To be fair, there are other managers who are struggling, and past performance is not necessarily indicative of future results, but the tides seem to be shifting in a way that we can’t help but get excited about.
See, while we’re always trumpeting the benefits of managed futures for a portfolio, we feel like the current environment is getting set up for moves that could benefit managed futures in a big way. To understand why that’s the case, we have to understand how the buzz words of the day- “liquidity,” “debt,” “volatility,” and “risk”- play into the market movements we’re witnessing right now, and could impact the markets tomorrow. At that point, we can take a look at how managed futures has performed during those periods in the past, and then you might understand why we’re a lot less “somber” than the rest of the investing world right now.
The Wind Up
In some ways, evaluating market climates can be described as similar to reading a baseball pitcher. You reflect on what the game situation is (does he need to throw a strike), you consider their posture, their wind up, and try can get a glimpse of the ball coming out of their hand as quickly as you can. That wind up, what takes a few seconds in a baseball game, is the current phase of matters. Right now, we’re looking back and watching that wind up, and we like what we’re seeing. How do we mean?
Let’s start out with the general sociopolitical environment. Over the past year and a half, we’ve seen a lot of choppy, sideways actions in the movements, or short-lived trends that reversed in a moment’s notice, leaving most traders (including those in managed futures) floundering for solid ground. Much of this has had to do with the unfolding global drama that seemed, for a very long time, to be without resolution. This is particularly true in Europe, where Greece’s unsteady ground has been the never-ending source of financial dramatists in journalism for months on end (they’re doomed, they’re saved, they’re doomed again… ).
The basic summary: Greece (like the rest of the world) was spending more than they were bringing in, and with no options for realistically turning it around, were facing a very ugly default that would have impacted the entirety of the Eurozone had it been allowed to play out unassisted. The ECB and Euro powers did step up to the plate, though, in exchange for the promise of strict austerity measures. While, in theory, that might have been a solution that would avoid a complete meltdown, the people of Greece have continued to refuse the bitter pill. It’s getting to a make or break point, where we’re running out of solutions for Greece. What was once a far-fetched, Zerohedge-esque conspiracy theory has become what more and more people are referring to as a reality- the eventual departure of Greece from the Euro Zone.
The fear that has been harped on, again and again, is that such a departure, or even a hastily considered organized departure, would create a contagion effect, essentially demolishing investor confidence in the Euro currency and all participating economies. The argument is often directly discussed in relation to Spain and Italy (and more recently, France), where rising interest rates (those countries are having to pay more and more to get people to lend them money) have the world getting ready for panic mode. And, in some ways, maybe they have good reason to be afraid. Most people are looking at the interest rate markets for a reflection of investor confidence in the health of an economy, but while many would view spiking rates in Italy and Spain to be a death sentence for those economies and the Euro overall – in the new normal world we now live in, the markets aren’t always rational, with investors believing the increasing interest rates will lead to more bailouts/cheap money, leading to a stronger economy (just like in the US, when the jobs numbers are worse, but the market goes up because they want the Fed to intervene in the markets… chew on that one for a minute). This backwards thinking has caused some analysts to dismiss the rising rates in Italy, Spain, and Portugal (and previously Greece) as nothing more than a required ante in order to get to the prize at the end of the day (more free money).
The problem comes when you pair those interest rate moves higher with what’s happening in the consumer space in Europe. In Spain, you have 24% unemployment. Think about the unrest in the U.S. over 8% unemployment, and imagine how things are going over there. And in Greece, according to their president, over $700mm has been withdrawn from consumer savings accounts in Greece since the May 6th election, with others in finance have rumored that the number is closer to $2 billion. That isn’t exactly chump change.
As some have begun asking, isn’t this what a run on the banks looks like? Oh, and if Greece can’t get their act together (which looks like a probable outcome at this point), and investor fear spreads in a more meaningful manner to other Euro nations to the point that we’re seeing similar consumer behaviors, aren’t we setting ourselves up for one hell of a liquidity crunch with the banks?
And what about those banks? Can’t forget them in all of this. From a rogue trader at UBS last September, to VAR calculation missteps at JPM in the past week, to Corzine’s risky bets on European debt, the prominent school of thought would indicate that the banks are in no way, shape, or form prepared for another liquidity crisis. Frankly, the recent issues with the larger banks call into question their claims to have limited exposure overseas. After all, if JPM, arguably one of the more stable U.S. banks, can so grossly “miss” so many red flags, it’s not that much of a stretch to wonder whether or not they have any strong grasp of what that exposure is… and it also wouldn’t be the first time that a bank had misled the public on what kind of risk they’re taking on.
To be fair, we do live in an era of Central Bank intervention (and “Helicopter Ben” could start dropping money from the sky any day now, making this all a moot point….until he lands the helicopter), but it’s getting to a point where investors are raising an eyebrow at the veracity of those actions, and with good reason. The poster child for poor government intervention in markets is Japan, who is quite possibly the worst forex investor in the history of the world. And Quantitative Easing has lifted risk on markets for periods of time, only to fall again at the first sight of the easing ending (with markets asking – when’s our next fix coming?). Really, the quantitative easing and 0% rates haven’t exactly been a panacea stateside in terms of employment, the housing market, and so on. And whether or not the ECB has the ability- or political willpower, more realistically- to step into the mix and save the world is definitely in doubt at this point.
The great unknown in all of this is China. Over and over again, we’ve seen the data they provide (however much that might be) called into question, and their opaque moves in commodity markets have had analysts preparing for some sort of downward movement for a couple of years now. This manifestation has yet to take hold, but the impact of the rest of this fiasco on China should not be glossed over. China is a production-fueled superpower, and in a world where the largest consumption economies in the world falter, it doesn’t matter how soft of a landing they have their eyes on right now- they’re in trouble.
To say things have become chaotic might be quite an understatement.
Keep Your Eye on the Ball
So we know what the scene looks like. We’ve watched that wind up. Now is the time to make sure you’ve got your eye on the ball, because the next six or seven months (or split second if you’re sticking with the baseball analogy) are critical. Let’s talk timeline.
First up is Europe. We’ve got maybe another month of Greek dramedy to witness before the tide definitively turns across the pond, based on the information we’ve got right now, but even then, the initial movements will likely be painfully slow, with no one- least of all Germany- wanting to admit defeat on the Euro. That, friends, will be four months of bureaucratic nonsense. But the real danger comes in the form of that dreaded fiscal cliff story that people have more frequently begun to circulate. Essentially, at the end of December and beginning of January, without action, we will face the expiration of the Bush Tax cuts, the faltering of the payroll tax deduction, the kick-in of $1.2 trillion in spending cuts as a result of last year’s Supercommittee failure, and the debt ceiling being breached.
That’s a lot of fiscal shenanigans for the course of year, but realistically, it will likely play out over the course of two months, barring some kind of miracle. For those unfamiliar with American politics, there is essentially one thing you can count on as true throughout every political climate- no one risks anything this close to an election, particularly a Presidential one. That means that these pressing fiscal issues in the U.S. won’t be touched with a ten foot pole in any meaningful manner until the elections are over in November, and then we’ll be looking at a lame duck session charged with accomplishing more in 6 weeks than they have over the past two years.
How optimistic are you feeling so far?
The big concern is the juxtaposition of American political grandstanding with a caving Euro and a sputtering China. It was borderline amusing to hear panel moderators at the conferences we attended ask what the biggest threat on the horizon is. Bottom line? The horizon is the threat, and the cacophony that we hear in the aftermath could, theoretically, rival what we saw in 2008 in terms of people pulling out of stocks, mutual funds, and other asset classes which need a strong economy. It could leave 2008 in the dust in terms of liquidity and available credit. It could make banks long for the days of 2008 in terms of regulation.
It could change the game.
Ball? Meet Bat.
Don’t get us wrong, we’re not about to become a Nouriel Roubini (as much as we may respect his work). This is definitely a worst case scenario, and we’re fully aware of that. However, at this point, the conversation about how the worst case scenario might play out has been so muddled by financial analysts and commentators that we felt it important to explain how it all looks when you take the conversations out of a regional vacuum and stack them up side by side. It’s not pretty. Probability is definitely an unknown at this point, and anyone who tells you otherwise is lying through their teeth, but we’re risk people- we want to know what could happen next.
Whenever the conversation gets to this point, we find investors ask the same question, “So what am I supposed to do now?”
The answer depends on you as an investor- what’s your risk tolerance? What kind of risk capital do you have available? What are your goals? Depending on your answers, we know ours.
You didn’t see that coming, did you? [heavy sarcasm] Look, we get it, we’re managed futures people – we weren’t about to talk about a wine collection or rare coins as the answer to a 2008-like sell off across asset classes. But just because we’re neck deep in this stuff day in and day out doesn’t mean our arguments and conclusions are unfounded. Let us explain why we are more optimistic about the asset class today than we have been for quite some time.
1) Credit Crunch Immune
Managed futures is a uniquely beneficial addition to an investment portfolio during times of constrained liquidity and credit, if only because of how it derives its returns. Unlike hedge funds, which may use investor funds to take out loans to finance their market bets, or trade over the counter instruments like credit default swaps or mortgage backed securities which require counter-party agreements, the bulk of managed futures managers do not need credit extended to them in order to do their trading. So if credit tightens and hedge funds see their access to capital get cut off, it’s of little consequence to managed futures programs – they just keep on doing their trading. In a traditional hedge fund, the inability to finance their strategy may result in poor performance as they are unable to put on (or get out of) trades, leading to less flexibility to reverse positions and ultimately higher correlation to traditional assets, like U.S. stocks.
2008 was the perfect example of this. Managed futures, while struggling in the sideways action of 2009 and 2011, was able to capitalize in 2008. The BarclayHedge CTA Index reports 2008 performance of managed futures at 14%, while the BarclayHedge Hedge Fund Index came in at -21.63% (Disclaimer: past performance is not necessarily indicative of future results). In our minds, the numbers say it all. If you want alternatives AND want to remove the risk of a credit crunch, managed futures, in our opinion, is your best bet.
2) Daily Liquidity and Transparency
Before we go here, we will say this: the optimal period for investing in managed futures is going to be around 3-5 years, so daily liquidity can be more of a danger than a blessing as it leads to the ability of investors to stop trading before they see the good times. That being said, we understand that investors feel most comfortable in liquid investments in times of a crisis – just in case. That is where managed futures via managed accounts makes so much more sense than other high level alternative investments. You have daily liquidity and daily transparency, and no lock-ups or waiting periods or withdrawal fees- it is what it is. The one problem with this benefit (as far as the managed futures industry is concerned) is that investors treat their managed futures portfolio as a bit of a piggy bank in times of trouble – using that liquidity to draw down their managed futures investment to cover losses elsewhere. Oh well…
3) New Trends in the Aftermath
Part of the reason managed futures was able to benefit in 2008 is because the way it works allows investors to derive benefit (or losses) from up AND down movements, a topic we cover quite frequently. In a credit/liquidity crisis, specifically, losses in asset classes such as stocks, foreign currencies, and energies can beget more losses, as forced selling due to margin calls and in ability to fund more trades puts unique pressure on markets - as was seen in 2008. What’s more – the flight to safety bid in bond markets resulting from all the liquidated cash needing to go somewhere, can create nice uptrends in bond markets and has traditionally been one of managed futures best trades.
Finally, depending on how this epic of a geopolitical drama plays out, there may be new trending opportunities hitting the markets. Should the Euro disappear, we’ll be looking at a slew of new currencies and interest rate relationships for managed futures to partake in – a climate that many a trend follower today recalls with fond memories. Although we won’t hold our breath for any tradable volume and liquidity in Greek Drachma futures…..
4) Cycle Performance Opportunity
Managed futures came into the month of May down -.59% for the year, which if persisted through the end of the year would represent two losing years in a row for BarclayHedge CTA Index and three out of the past four (all of which would be unprecedented losing streaks never before seen in managed futures as an asset class).
Why are such streaks so rare? Because markets cycle – up and down, in and out of trends, volatility expansion and contraction, etc. – making it difficult for a poor market environment (be it managed futures, stocks, real estate, or bonds for that matter) to persist year after year after year. Eventually conditions cycle back the other way.
Having said that – the three facts below stand out to us quite starkly, in sort of a “if you liked it at 20, you’ll love it at 15” sort of way.
- The BarclayHedge CTA index has never had back to back losing years.
- Managed futures, historically, has outperformed in 2nd half of year.
- Managed futures was down YTD as of the end of April.
We’re going to repeat ourselves here- past performance is not necessarily indicative of future results. It’s why we tell investors getting into a managed futures program, chasing high performance, that they should be anticipating a drawdown around the corner. But that disclaimer cuts both ways – and for us, that means the timing couldn’t be more perfect for people looking to get into the asset class. We’re big believers in buying into the drawdown, and if 2012 shapes up the way we think it might…. well, this is the stock equivalent of buying low, in our opinion.
Going, going, gone?
This is all speculative. We know that. You know that. We don’t have a crystal ball. But the probability of this getting much worse before it gets better is still greater than zero, and in that case, if managed futures is appropriate for you, we believe now is the time to get in. We might be wrong, and in that case, if managed futures is appropriate for you, now is still probably the right time to get in, if only because we’re in good cycle positioning right now. In all fairness, some programs have already initiated short positions, and investors may have already missed out on some of the crisis performance managed futures is known for, but there may still be time. As we frequently discuss on our blog, the time to diversify is before- not after- a crisis, and it will never be a matter of if the next crisis hits, but when. So even if this is nothing but an intellectual exercise, diversification should still be at the top of your investing to do list- today and always.
Cognitive Concord Special Disclosure: our firm has investments in products that utilize Attain’s brokerage services. I mention this because the regulators require me to, but also to let you know how I was introduced to Jeff Eizenberg and the guys over there in the first place.
Forex trading, commodity trading, managed futures, and other alternative investments are complex and carry a risk of substantial losses. As such, they are not suitable for all investors.
The entries on this blog are intended to further subscribers understanding, education, and – at times- enjoyment of the world of alternative investments through managed futures, trading systems, and managed forex. Unless distinctly noted otherwise, the data and graphs included herein are intended to be mere examples and exhibits of the topic discussed, are for educational and illustrative purposes only, and do not represent trading in actual accounts.
The mention of asset class performance is based on the noted source index (i.e. Newedge CTA Index, S&P 500 Index, etc.) , and investors should take care to understand that any index performance is for the constituents of that index only, and does not represent the entire universe of possible investments within that asset class. And further, that there can be limitations and biases to indices: such as survivorship and self reporting biases, and instant history.
Managed Futures Disclaimer:
Past Performance is Not Necessarily Indicative of Future Results. The regulations of the CFTC require that prospective clients of a managed futures program (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. The disclosure document contains a complete description of the principal risk factors and each fee to be charged to your account by the CTA.