One of our regular reads is The Reformed Broker, a financial blog written by one the best in the field, Josh Brown. His insight is frequently valuable, and nearly always entertaining. And although he’s generally focused on the traditional stock/bond approach, that just means he’s often a great source of ideas for us to borrow and apply to managed futures.
And that’s exactly what crossed our minds when we saw his post yesterday entitled “Two Things That Are Never Discussed in the Financial Media.” He identifies time frames and position sizing as two important ideas that are too often neglected by mainstream financial journalists, as they instead focus on content that is more likely to grab viewers’ attention: investment ideas, directional calls, and breaking news.
Perhaps this is why you don’t see managed futures in the mainstream media that often. While decidedly directional, they aren’t making directional calls. You won’t see David Harding on TV calling for $120 Oil or 1,400 in the S&P, because managed futures strategy is to respond to trends that are in place, not predict where the market is going. And a multi-billion dollar manager looking in the camera and saying he really doesn’t care which way the markets go just doesn’t make for a great article or television.
But that doesn’t mean time frame and position sizing are any less important in the managed futures world.
If your investment time frame is a couple of months, managed futures is not for you. With managed futures looking, generally speaking, to catch multi-month trends (and those trends cycling in and out of phase over several years) managed futures is a long-term investment – at minimum you should be looking at a 2-year time frame, if not longer. Given that we should judge the success of a Commodity Trading Advisor over years, not months or weeks or days, it is the height of futility to get upset at any one trade or day of losses. If you are getting upset about a manager long Soybeans when they are down 1% today, you are missing the bigger picture.
Managed futures comes in many shapes, sizes, and return profiles, but generally the investment profile is one of decent annual returns when the rest of your portfolio is doing well, and outsized gains during extreme periods (like when the rest of your portfolio is tanking). Of course, past performance is not necessarily indicative of future results, and managed futures does not come without significant risk of loss. But if you’re getting into or out of managed futures based on a year or less of data, you’re not getting the long-term diversification value that the asset class can provide.
While position sizing to a stock investor means how many shares of a particular stock to buy or sell – that doesn’t really apply to a managed futures investment. There, the CTA is doing the position sizing for the investor (that’s what you hire them for), looking at your balance, the potential risk and reward of a certain market, and entering the appropriate number of futures contracts.
Where it does apply is at the portfolio level, where you are deciding not how many shares to purchase, but how much of the portfolio to allocate to managed futures. We’ve taken a look at the “efficient frontier” on several different occasions in an effort to determine what the “best” level of exposure to managed futures actually is.
Both our research and the work of others finds that the optimal allocation between stocks, bonds, managed futures, and other asset classes changes depending on what time frame you’re analyzing. But generally, we find the optimal exposure to managed futures is between 20%-40% of your portfolio. Managed futures is not suitable for all investors, and depending on your own risk tolerance and financial objectives this may be too high or too low.
Bottom line: the when and how much of investing can matter just as much as the what. If you get the what right, but not the when and how much – a great idea poorly executed won’t seem like such a great idea after all.