A Higher Standard

We were really confused when we walked into the office this morning to a slew of emails asking us to refute the erroneous conclusions found in an article entitled “Debunking Myths About Managed Futures” by one Jason Whitby. The piece is, in our opinion, riddled with misinformation and inaccuracies. What confused us, though, was that we had already responded to this article.

The original article was published by Mr. Whitby in July on Morningstar.com. We addressed each inaccuracy explicitly, and then tried to comment on the article with a link to our analysis. The comment was not published (gee, we wonder why). Now, despite us making what we believed were valid and verifiable counterpoints, he has reposted the same piece on Seeking Alpha. We’ve left a comment there as well, but we won’t hold our breath on it being set public.

This is a Registered Investment Advisor- someone who is supposed to be guiding the public into sound investment decisions- making very broad and inaccurate assertions (like the assertion that most commodity trading is done by airlines and chemical companies, or that the CFTC provides inadequate investor protection, or that CTAs hide their poor performance by shuttering old programs) – making you wonder how well he knows his craft.

We posited in an old post on RIA’s and golf balls that most RIAs avoid talking about managed futures because they don’t understand them, and Mr. Whitby’s article both proves and disproves that theory at the same time. He doesn’t understand them, as we thought, but, contrary to our theory, he’s talking about them- despite the knowledge gap. And we wonder why people have a distrust of professionals in finance- it’s behavior like this, where anyone who has done even a cursory look into managed futures can clearly see the errors and omissions in his article.

We need to hold each other accountable if perception of the finance industry is ever going to change. As far as Attain is concerned, if someone disagrees with our conclusions, we are always open to dialogue, because that’s the only way people can learn and grow. If we’re making a mistake- we want to hear about it. We owe it to the public, industry, each other, and ourselves to hold one another to a higher standard when it comes to transparency and engagement on the issues.

Following the lead of Mr. Whitby, we’ll be republishing our rebuttal in its entirety below. Feel free to forward it to him and his company here if you feel distributing this type of misinformation is irresponsible.

CAN I GET A WARRANT WITH THAT ASSERTION? (Originally published here on 8/11/2011)

“The constant assertion of belief is an indication of fear.”
– Jiddu Krishnamurti, 20th Century Indian Philosopher

When traditional investments seem indefensible (like recently), traditional advisors lash out by the asset classes they feel threatened by. Unfortunately, sometimes that looks like a blind-folded child trying to crack open a metal pinata with a roll of wrapping paper. The latest attempt, much to our disappointment, was actually posted on Morningstar.

The article, ironically entitled, “Common Misconceptions about Managed Futures,” seemed to be a rambling list of the author’s own misconceptions about the investment. In some ways, the author, Jason Whitby, did us a favor, as we were thinking about putting together a piece on some of the worst arguments circulated against the asset class anyway. While we had intended to simply comment on the piece, we thought our readers might benefit from the succinct breakdown of just how misguided some of these criticisms are.

We’ve actually been meaning to to post a rebuttal to this for a week or so now, but current events have gotten in the way. But with stock market investors licking their wounds right now and likely looking around the internet for information on alternative investments, we figured it was better to address these points before some unsuspecting investor was led astray by Whitby’s own numerous misconceptions, so here they are:

Misconception #1

The core issue with this misconception is that Managed Futures is actually a motley mix of eclectic investment strategies, not an asset class, and that is a very important distinction. 

Managed futures IS an asset class based on current financial definitions of the term (see here: http://bit.ly/q6YxVL).

Misconception #2

If attractive returns are relative, I suppose Managed Futures (RYMFX) were very attractive in 2008 relative to the S&P500 (SPY) but no more attractive than the 1-3 year Treasury (SHY) and compared to the 20+ Treasury (TLT), Managed Futures were not so attractive.  Since 2008 the relative attraction amongst the group continues to change, but the point here is that in relative perspective to more traditional and much lower cost options, Managed Futures really haven’t been all that attractive.

While dismissing managed futures as an eclectic mix of strategies in point #1, Whitby then selects just a single strategy (RYMFX) to prove managed futures as a whole has not performed. Dig a little deeper into RYMFX and you’ll find it does a very poor job of tracking managed futures. (see here: http://bit.ly/iDCfiR).

Misconception #3

If the temperature variations in Lake Michigan are negatively correlated to stocks, would you be interested in buying a “Lake Michigan Temperature Volatility Fund?”  Besides, an investment should provide a positive expected return, not just reduce risk.  Yet Managed Futures is a “zero-sum game” which means there will be an equal number of winners as loser, i.e. there is no expected positive return in Managed Futures.

Whitby has the classic misunderstanding between non correlation and negative correlation here- not uncommon. Managed futures is NON-correlated to stocks, not negatively correlated (see here: http://bit.ly/mTSpzO). More importantly, managed futures has a long history of positive returns, so we were a little confused by this blanket dismissal of its value (here for starters). (Disclaimer: Past performance is not necessarily indicative of future results.) Finally, his understanding of managed futures in the context of the zero sum game is incomplete (see here: http://bit.ly/r9ad7c).

Misconception #4

There isn’t enough verifiable data to support the claim that an investment in Managed Futures helps hedge against inflation.

The reasoning behind the claim that managed futures can provide a hedge to inflation is that they can ride price trends higher in commodities. The lack of data supporting this neither proves or disproves it.

Misconception #5

[In response to crisis performance benefits] Maybe, maybe not.  Perhaps if the exact same things all happen again as they happened in 2008, exactly the same way, in the same sequence and the same severity, then maybe.  But history doesn’t repeat itself exactly nor will investors behave exactly the same way.  The truth is managed futures, including RYMFX, have very little verifiable performance data, so no one really know how they will perform for investors.

Managed futures didn’t just perform well during the 2008 crisis, they have posted gains in each of the recent major financial crises, such as the Internet Bubble, 9/11, LTCM blowup, Asian crisis, and surprise rate hike  (see here:http://bit.ly/p4zTRG).  (Disclaimer: Past performance is not necessarily indicative of future results. Futures trading is complex and carries a risk of losses, meaning it may not be suitable for all investors.) As for there being little verifiable performance data, we’re happy to showcase 20+years of data on a wide range of managed futures investments to clear up that misconception.

Misconception #6

CTA’s do provide disclosures, no argument.  Yet remember, CTAs are allowed to assess incentive fees only on “net profits” and 20% is pretty compelling.  So if a CTA has a bad year, they must recoup that loss for those clients and get up over the “high watermark” before they can take incentive fees.  Which is good for investors, right?  After all, if the CTA lost 20% in year 1, then they shouldn’t get any bonus until they break even, right?  So what do you expect CTAs do if they are under the water mark?  They close shop, start a new shop and get a new disclosure.  After all, the CTA has a really strong incentive to start over.  If the CTA makes 20% the next year trying to get an old client back to even: no bonus.  However, if they make a new client 20%: big bonus.  This is why many managed futures firms have multiple CTAs under their umbrella which gives the picture of history yet allows them to disclose the attractive CTAs and to close CTAs that are too far underwater.

This is a nice scare tactic, and it is true that CTAs can stop programs and start new ones. There’s just one integral component missing in this conspiracy theory, though – which is the fact that registered CTAs are not just required to list the performance of the program you’re investing in, but of any other programs they have been involved in at any time during the past 5 years. This regulation is in place to thwart exactly the type of behavior cited here.  As an aside, do you really think the near $300 Billion invested in managed futures has been duped by this simple parlor trick? We were left wondering if the author had ever done due diligence on an investment, interviewed managers, searched old databases… anything…

Misconception #7

CTAs do register with the Commodity Futures Trading Commission, so what?  CTAs are required to get an FBI background check, so what?  CTAs are required to provide disclosures, so what?  CTAs have independent audits of financial statements every year, so what?  So what to all of this?  None of it provides any investor protection, reduces conflict of interests or increases transparency.

Whitby is merely stating that annual audits, FBI background checks, and registration with the CFTC does not provide any investor protection without any evidence to back him- and we’re not sure such an assertion, without warrant, even qualifies as an argument. Still, we’re pretty sure the CFTC and NFA would disagree with you, after all – the CFTC mission statement on their website reads: The mission of the CFTC is to protect investors and the public from fraud in the commodity futures and options markets.

Misconception #8

The SEC requires most mutual funds that invest in other managers to disclose those fees.  Yet the managed futures mutual funds have an exemption because they can invest through off-shore subsidiaries.  Even our granddaddy, RYMFX may invest up to 25% of total assets in a wholly-owned and controlled Cayman Islands subsidiary.

We’ll agree with on this point. Managed futures mutual funds are, for the most part, overpriced, poorly disclosed in terms of fees and risks, and do a poor job of tracking managed futures as a whole. But the problems of managed futures mutual funds do not carry over to managed futures managed accounts. Quite the contrary- managed accounts alleviate these problems by making everything more transparent.

Misconception #9

There is a lot of money in managed futures.  But how much is for “business applications” versus investments?  The futures market was created for business risk reduction, not investing.  Aluminum producers, airlines, chemical companies, farmers and so on are why the futures industry evolved and why there are CTAs and futures in the first place.

Looks like Whitby was running out of steam by the time he got to this item, as this is completely out of left field. To answer the question of how much of the money in managed futures is for investing, the answer is all of it.  The end users mentioned – Aluminum producers, airlines, chemical companies, etc., are not investing in managed futures- they’re purchasing and selling futures directly on the exchange themselves.  You can see a breakdown of how many contracts are traded by commercial entities such as those you mention and speculators (investments) on the CFTC website.

We’re not necessarily trying to pick on Whitby here, as some of the mistakes he makes in the article are common ones. However, it’s incredibly important, especially in this volatile investing climate, that people understand the mechanics, risks and benefits associated with any opportunity they consider.

David Hume once said, “A wise man proportions his belief to the evidence.”

If it boils down to evidence on the viability of managed futures for investors seeking a non-correlated addition to their portfolio- case closed.

12 comments

  1. Dear Attain Capital,

    In your January 9, 2012 “ATTAIN CAPITAL’S SEMI-ANNUAL TOP 15 BLOG POSTS”, you awarded #8 to “A Higher Standard” which was your second rebuttal to an article which I had written.

    Your introduction for the #8 post states; “We tend to pick a good amount of fights on the blog, particularly with unscrupulous journalists, genuine and not. In this post, we found ourselves not just responding to false statements made in an article, but to an author who was knowingly disseminating false information to the public.”

    To be fair and completely accurate, your statement should have stated’ “an author who was knowingly disseminating information to the public which Attain Capital believes to be false.” After all, I still believe that all 9 points which I laid out in my article are still valid.

    It would be proper of you to restate your accusation.

    Thank you very much,
    Jason Whitby

  2. Jason, we will amend our statements if you can refute them. Believing your points are valid doesn’t make them factually accurate, unfortunately.

  3. You statement “an author who was knowingly disseminating false information to the public” is absolutely inaccurate. The author is, and continues to disseminate information which the author believes to be correct to the public. The fact that Attain Capital believes the information to be incorrect does not change the author’s belief of said facts.

    The fact that you have a different opinion and counter points isn’t my concern and the topic of refuting them in an attempt to change your opinion is a completely separate item.

    Thanks
    Jason

  4. Our statement is based off the fact that we pointed out the inaccuracies in your arguments, supporting our comments with research where applicable, and you continued to disseminate them without edit. While some of your arguments could at least be given a moment of consideration, some of them (such as the business application angle, or the fact that there is no long-term verifiable performance data for the asset class) are so patently false that they are indefensible. So yes- until there is refutation, our statement will stand.

  5. “They (managed futures) are not really an asset class; they’re a collection of strategies.”
    – Brian Cunningham, President and Chief Investment Officer, 361 Managed Futures Strategy Fund (as seen in August 2013 Financial Advisor Magazine)

  6. Fooling Some of the People All of the Time: The Inefficient Performance and Persistence of Commodity Trading Advisors
    Geetesh Bhardwaj SummerHaven Investment Management
    Gary B. Gorton Yale School of Management; National Bureau of Economic Research (NBER)
    K. Geert Rouwenhorst Yale School of Management – International Center for Finance
    August 13, 2013

    Investors face significant barriers in evaluating the performance of hedge funds and commodity trading advisors (CTAs). The only available performance data comes from voluntary reporting to private companies. Funds have incentives to strategically report to these companies, causing these data sets to be severely biased. And, because hedge funds use nonlinear, state-dependent, leveraged strategies, it has proven difficult to determine whether they add value relative to benchmarks. We focus on commodity trading advisors, a subset of hedge funds, and show that during the period 1994-2012 CTA excess returns to investors (i.e., net of fees) averaged 1.8 per cent per annum over US T-bills, which is insignificantly different from zero. We estimate that CTAs on average earned gross excess returns (i.e., before fees) of 6.1%, which implies that funds captured most of their performance through charging fees. Yet, even before fees we find that CTAs display no alpha relative to simple futures strategies that are in the public domain. We argue that CTAs appear to persist as an asset class despite their poor performance, because they face no market discipline based on credible information. Our evidence suggests that investors’ experience of poor performance is not common knowledge

  7. This is an old paper which hasn’t been given much thought or attention because of the methodology used. It is hard to take their conclusion that (all) CTAs display no alpha relative to simple strategies, when they knock 75% of the observations out of their analysis and in doing so reduce the average CTA return by 8% a year. We could easily do the same thing with the stock indices (AIG went down 98% and was removed, for example), and show that they do very poorly when you come up with a way to reduce their annual return by 8% per year. We also have a nice real world experiment of such a simple strategy versus CTAs now, with the Guggenheim (formerly Rydex) and Wisdom Tree managed futures products – which have significantly underperformed the CTA indices, and actual managers we know and track. We’ll put a more complete paper detailing (debunking) survivorship bias on our research list for 2014.

  8. CFTC Opens Probe Into Fees Charged by Managed Futures Funds
    Dec 19, 2013

    “The index of 582 commodity trading advisers is compiled by a small company in Fairfield, Iowa, with no connection to London-based Barclays Plc.
    The index isn’t investable; it’s actually just a chart. It relies on voluntary reports from fund managers, who can provide whatever data they choose, and can stop reporting at any time. The BarclayHedge index fell 2.5 percent over the first ten months of 2013 — and that investor loss doesn’t reflect hundreds of millions of dollars in fund fees.”

  9. Dec 19, 2013
    http://www.bloomberg.com/news/2013-12-19/cftc-opens-probe-into-fees-charged-by-managed-futures-funds.html

    “The index of 582 commodity trading advisers is compiled by a small company in Fairfield, Iowa, with no connection to London-based Barclays Plc. The index isn’t investable; it’s actually just a chart. It relies on voluntary reports from fund managers, who can provide whatever data they choose, and can stop reporting at any time. The BarclayHedge index fell 2.5 percent over the first ten months of 2013 — and that investor loss doesn’t reflect hundreds of millions of dollars in fund fees.”

  10. “The index of 582 commodity trading advisers is compiled by a small company in Fairfield, Iowa, with no connection to London-based Barclays Plc. The index isn’t investable; it’s actually just a chart. It relies on voluntary reports from fund managers, who can provide whatever data they choose, and can stop reporting at any time. The BarclayHedge index fell 2.5 percent over the first ten months of 2013 — and that investor loss doesn’t reflect hundreds of millions of dollars in fund fees.”

  11. The comment “that investor loss doesn’t reflect hundreds of millions of dollars in fund fees” is false, managers report to BarclayHedge net of fees. Start contacting the 528 managers who report their performance there, as we have, to confirm this. For more on the inaccuracies in the Bloomberg article, and subsequent class action lawsuit, CFTC inquiry, and US Senate committee letter – please see our full rebuttal here.

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Disclaimer
The performance data displayed herein is compiled from various sources, including BarclayHedge, RCM's own estimates of performance based on account managed by advisors on its books, and reports directly from the advisors. These performance figures should not be relied on independent of the individual advisor's disclosure document, which has important information regarding the method of calculation used, whether or not the performance includes proprietary results, and other important footnotes on the advisor's track record.

Benchmark 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, self reporting, and instant history.

Managed futures accounts can subject to substantial charges for management and advisory fees. The numbers within this website include all such fees, but it may be necessary for those accounts that are subject to these charges to make substantial trading profits in the future to avoid depletion or exhaustion of their assets.

Investors interested in investing with a managed futures program (excepting those programs which are offered exclusively to qualified eligible persons as that term is defined by CFTC regulation 4.7) will be required to receive and sign off on a disclosure document in compliance with certain CFT rules The disclosure documents contains a complete description of the principal risk factors and each fee to be charged to your account by the CTA, as well as the composite performance of accounts under the CTA's management over at least the most recent five years. Investor interested in investing in any of the programs on this website are urged to carefully read these disclosure documents, including, but not limited to the performance information, before investing in any such programs.

Those investors who are qualified eligible persons as that term is defined by CFTC regulation 4.7 and interested in investing in a program exempt from having to provide a disclosure document and considered by the regulations to be sophisticated enough to understand the risks and be able to interpret the accuracy and completeness of any performance information on their own.

RCM receives a portion of the commodity brokerage commissions you pay in connection with your futures trading and/or a portion of the interest income (if any) earned on an account's assets. The listed manager may also pay RCM a portion of the fees they receive from accounts introduced to them by RCM.

See the full terms of use and risk disclaimer here.

Disclaimer
The performance data displayed herein is compiled from various sources, including BarclayHedge, RCM's own estimates of performance based on account managed by advisors on its books, and reports directly from the advisors. These performance figures should not be relied on independent of the individual advisor's disclosure document, which has important information regarding the method of calculation used, whether or not the performance includes proprietary results, and other important footnotes on the advisor's track record.

Benchmark 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, self reporting, and instant history.

Managed futures accounts can subject to substantial charges for management and advisory fees. The numbers within this website include all such fees, but it may be necessary for those accounts that are subject to these charges to make substantial trading profits in the future to avoid depletion or exhaustion of their assets.

Investors interested in investing with a managed futures program (excepting those programs which are offered exclusively to qualified eligible persons as that term is defined by CFTC regulation 4.7) will be required to receive and sign off on a disclosure document in compliance with certain CFT rules The disclosure documents contains a complete description of the principal risk factors and each fee to be charged to your account by the CTA, as well as the composite performance of accounts under the CTA's management over at least the most recent five years. Investor interested in investing in any of the programs on this website are urged to carefully read these disclosure documents, including, but not limited to the performance information, before investing in any such programs.

Those investors who are qualified eligible persons as that term is defined by CFTC regulation 4.7 and interested in investing in a program exempt from having to provide a disclosure document and considered by the regulations to be sophisticated enough to understand the risks and be able to interpret the accuracy and completeness of any performance information on their own.

RCM receives a portion of the commodity brokerage commissions you pay in connection with your futures trading and/or a portion of the interest income (if any) earned on an account's assets. The listed manager may also pay RCM a portion of the fees they receive from accounts introduced to them by RCM.

See the full terms of use and risk disclaimer here.