Usually the phrase “defense wins championships” is one commonly used in sports, but it can be used in many different aspects of life. Living “defensively” or “conservatively” can be applied to many things we do in life, and while it may not result in any type of “championship,” it can often lead to the best long-term results. Similarly, having a defensive strategy for your managed futures portfolio can be effective when employed during a rough cycle – like the one being experienced in 2013.
Most investors that track the major indices may have noticed that the major managed futures indices (New Edge, BTOP 50) are negative YTD for 2013. While the performance of an index is never an exact representation of a investor’s managed futures portfolio, it does provide a general insight into the overall direction of the asset class. While it is likely that managed futures investors are more than making up their losses through the bullish performance of their equity portfolios, it still disappoints us that their managed futures portfolios are underperforming. As managed futures advisors, we know that all asset classes have cycles and like any other investment, the performance of managed futures and CTAs will eventually turn around. However, as we wait for the turn around, we still have to make necessary adjustments in order to mitigate losses during this industry wide drawdown.
Reduce volatility
Since many CTAs are performing poorly this year, it’s frustrating monitoring your portfolio, and seeing losses day-after-day and month-after-month. Unfortunately, the best way to “battle” this losing period is sticking with a core group of CTAs who, for the lack of a better phrase, “lose less than the others.” Staying with CTAs with low-downside risk may be the best way to minimize the size of a drawdown. While the overall portfolio may still be negative on the year, it is highly likely that is performing far better than a portfolio that includes more volatile CTAs.
De-lever
Another solution – one less preferred – is to de-lever the portfolio, by decreasing the overall notional allocation. By decreasing your overall allocation, you are essentially decreasing your investment size and reducing your exposure to risk. The reason this method is “less preferred,” is because when managed futures turn-around, and have their first good month in their “coming back party,” you will miss the full exposure to the up-side. Unfortunately, it’s impossible to predict when this turn-around will happen, and whether it happens gradually over the course of many months, or if it starts off with one stellar month; thus why it may not be the best defensive strategy to de-lever all the CTAs in your portfolio.
In addition to the two strategies mentioned above, it’s also important to be very selective [during a rough year] when it comes to making new CTA allocations. We are being very cautious about which CTAs we recommend to clients this year, because we believe we rather miss out on a great CTA instead of investing with another poor performer. Once managed futures return to positivity, it may be time to discuss how “offense wins championships.” Until then, let’s play defense.