We did a blog post a couple years back regarding common mistakes new managed futures investors make and thought it would be good to follow-up with more missteps we have seen over the years. Managed Futures investments provide many benefits to investors: diversification, non-correlation to traditional investments, and alpha generation. While the benefits are immense, just like any other investment, managed futures are not “fool proof.” The CTA due diligence process and portfolio construction must be carefully implemented, and investment goals must be precisely matched with the CTA portfolio that you will be investing with. By helping investors navigate this process, aiSource has firsthand knowledge of these mistakes:
- Overleveraging your portfolio: investor’s portfolios use too much notional funding or tie up a lot of their cash investment as margin (resulting in a high M/E ratio). While notional funding is an arbitrary number, our advice is to instead focus on the portfolio’s margin usage. Most of our client portfolios have average daily margin usage of under 30% of the cash investment; this leaves ample room for potential drawdowns and future adjustments.
- (Over)allocating to option strategies: option strategy track records are hard not to fall in love with. Investors, however, allocate to option strategies without understanding the embedded risks. aiSource recommends that option strategies should only be allocated to in $1M+ portfolios. Even so, the option strategy allocation should be 10% or less.
- Misjudging your risk-appetite: many times, an investor may think they can “handle” risk or “tolerate” large drawdowns. The fact is that most investors do not understand their own threshold for risk. When their portfolio starts to experience a drawdown, they may panic and prematurely exit a strategy. Our advice is to always start your managed futures journey more conservatively, learn the nuances of investing in CTAs, and once comfortable, you can take on more risk.
The best way to learn anything is by making mistakes. But, when it comes to investing, you want to make the least number of blunders possible. The above items coupled with our previous blog post, should give most investors a leg-up when starting their managed futures allocation.