All anyone can talk about today is the record low interest rates we’re seeing in the US and Germany (10-year US Treasury Bond hit a record low 1.53%, German 10-year Bund hit a record low 1.2%, and the German 30-year fell below the Japanese 30-year – has anyone ever gotten below Japan’s rates?)
But those low rates don’t represent the opportunity to refinance or some other economic event for those Attain clients invested in Clarke Capital. For them – the run up in bonds instead means the outlier gains managed futures (and Clarke Capital in particular) can see over short periods of time. Remember, managed futures in general, and trend following programs like Clarke Capital in particular – are long volatility programs which look to trade in small but frequent losses for large but infrequent gains (so called because that is the opposite of short volatility programs which trade small but frequent gains for large but infrequent losses).
Coming into today Clarke was long nearly every US and European interest rate maturity (multiple positions in each) and short several foreign currency markets – with gross gains in their various programs for May (yes, for just this month) estimated to be in the range of +35% for Worldwide and as much as +55% in Millennium. Wow! Outliers indeed considering their average winning month sits at just over 5% for the Worldwide program.
Now of course, past performance is not necessarily indicative of future results, and Clarke has been down to flat over much of the past 3 years in all of their programs after big run-ups in 2008, proving that point in spades. And one month surely doesn’t make a track record. But it’s not that often we get to talk about these types of outlier returns (in this case having to wait three and a half years). And what’s more, we actually did recommend to clients to get involved with Clarke during their 26% drawdown last May (here and here), so we’ll ask you to please excuse us for tooting Clarke’s (and our own) horn a bit after May’s impressive run.
Now, Clarke isn’t for everyone. Its 3-flag ranking on our website for all but the Global Basic program (2 flags) is a representation of this – essentially saying 40% of the universe of CTAs we rank are better risk adjusted return programs (most definitely due in this case to the roughly 3 times as high volatility of Clarke’s programs over its peers). But there are many clients who like Clarke’s programs given their long (if volatile) track record and lower than normal minimum balances.
It is those clients we were reaching out to today discussing just what they would like to do in regards to these outlier moves. The gist of it is – profits like these aren’t normal. Trees don’t grow to the sky, as we’re fond of saying. And, Clarke is one of the few managers we work with that is open to the idea of an “equity restart” (their terminology). Clients are given the chance to take open trade profits off the table and reinitiate trading at the original investment level on new signals only. In essence, Clarke allows its customers to ‘book the profits’ from time to time and essentially start over from that point.
But is this a good idea?
Now, before everyone jumps down our throat saying that the whole point of such an investment is to capture these outlier moves in exchange for the lean periods (and down periods), let us explain the idea. We talked at length with Clarke today, asking where the exit points are for many of these trades. The answer (and more coming on this in Monday’s newsletter) was: not much different than the entry risk levels. This means a sharp rally up in risk on assets, resulting in a sharp down move in bonds would likely mean Clarke’s +50% month would be followed by a loss of -25% or more.
Yes, that is partly the risk of such an investment – and trying to cheat the investment gods by booking profits can just as easily result in missed upside as it does in saving the downside. But while $20,000 in missed profits may be equal to $20,000 in saved losses in a textbook somewhere, most clients we talk to think $20K in profits lost is a whole lot different than $20K in profits missed (there’s a famous study on how loss aversion skews our ability to correctly weigh outcomes). We can also see in Clarke’s track record that some of its largest drawdown periods (and indeed this holds true across many programs) follow large run ups like these.
Given the above, most clients we talk to are thinking an equity restart is a no-brainer. But in the famous words of Lee Corso, “not so fast my friend.” You see, the downside of an equity restart is not just the aforementioned opportunity cost of exiting a profitable trade in trending market, but the unknown size of that opportunity cost. Trades such as this crash up in bonds are exactly why we hire trend followers in the first place, to identify a trend and ride it as long as possible. Thing is, it is impossible to say how much further a trend will go. Bonds could continue to run up (even with the zero bound – see Japan as exhibit A) or go into freefall – and therein lies the rub. By doing an equity restart – you’ll remove a fixed amount of potential loss for an unknown amount of potential gain. While it is perhaps easy to look at an option seller, for example, and realize that receiving a fixed amount of income (say $500) with the risk of an unlimited loss (say -$50,000) is probably not the best investment method – it is a little more difficult to see that avoiding a fixed amount of loss (say -$65,000) with the risk of missing out on an unlimited gain (say +$190,000) is essentially the same thing, albeit inverted.
So, is an equity restart right for you? It all comes down to the investor. We don’t usually recommend it, knowing that these are long term investments which shouldn’t really be micro-managed on a monthly basis. But… we also know that people have real money tied up in these investments, and that a gain of 50% in a month is A LOT. If you see other managers you have money with in similar positions, are fearful of a European resolution or bailout hitting the news any day now, or just like the sound of booking profits – it could make sense for you. If you think this move is just the beginning of another 2008-like run lower, or want to let the manager’s models determine the exit, not your emotions (just what we’ve written countless times to clients), then an equity restart likely isn’t right for you.
Sorry to do this… but it’s up to you.