Sleeping Well at Night…

When most investors hear the term “Managed Futures,” they immediately assume that managed futures are “risky” or “volatile,” and are not safe investments.  While it’s true that managed futures are not for everyone, structuring them to match your risk tolerance is possible.  Obviously, past performance is never an indication of future results, but, if you take the right steps in the beginning, structuring a Managed Futures portfolio that meets your volatility appetite is possible.


When most investors analyze a CTA, they look at the monthly returns to make an investment decision.  Many times, these investors may overlook daily numbers, and after investing with a CTA, they realize that the daily swings are a bit “too much” for them.  For example, let’s say a CTA has the following returns for the year 2011:



Just based on the above returns, we’d classify this CTA as “conservative” – based on the fact their monthly returns are in the 1% to 3% range (either negative or positive), and that based on this range, they’ll most likely end up with a single digit return for the year.  While this CTA may look “conservative” on the surface, their daily returns might tell a different story.  Let’s say their daily returns are also in the 1% to 3% range – do you as an investor want to see your account make or lose 1% on a daily basis, to only potentially make +9% for the year? Our guess would be “no.” No one wants to be on a roller coaster ride when it comes to their investment, unless it offers the potential for an aggressive return.


So…how do you structure your Managed Futures portfolio, so that it’s not a roller coaster ride for you? That’s a question that each investor has to figure out for themselves, but one that we’re here to help you with.  Sticking with the “roller coaster” example, when you go to a theme park, an individual may find a certain roller coaster to be “scary” or “dangerous.” That same roller coaster might be “fun” and “exciting” to someone else.  There may be other individuals that don’t go on roller coasters, and are happy simply going on the Ferris Wheel.  Deciding how much volatility you’d like with your investments is very similar  to deciding which roller coaster to go on, or rather which one to avoid. If you’re conservative by nature, then it’s highly likely that you want “conservative” investments that have limited drawdown potentials. If you’re more aggressive, and have more aggressive goals for your investments, then it’s likely that you’re willing to invest in volatile investments if they have the potential to produce high returns. While this example may not categorize everyone (someone might be a conservative investor, but a thrill seeker at the theme park), it’s a good way to visualize what you’d like to do with your Managed Futures portfolio.


The first question to ask yourself when deciding how much volatility you can tolerate is “how much of a drawdown can I tolerate before I start losing sleep at night?” (Just as a reminder drawdown is a consecutive losing period during an investment).  For some people the drawdown tolerance might be -5%, for others, it could be as high as -20%.  The reason determining your drawdown tolerance is important, is because your investment decision should be based on your ability to tolerate drawdowns.  Once you’ve made this decision, it is then important to go back and analyze the daily returns of the CTAs that you are considering.  Daily returns will give you a better idea of their volatility, which can provide an indication of what type of drawdown to expect in the future.


The reason it’s important to determine your tolerance for volatility and drawdowns is because, we here at aiSource believe that your Managed Futures investments should NOT determine your sleeping behavior.  Therefore, it’s important to invest with only those CTAs that are in line with your risk/reward appetite, because the last thing you want is to be up at night thinking about the losses you’re taking in your managed futures investments.  It’s important to work together with your aiSource advisor to determine what your thresholds are, and have the advisor show you CTAs that have shown in the past to behave similar to your future expectations.  One important thing to remember is that just because a CTA hasn’t had a large drawdown in the past DOES NOT mean they cannot have one in the future – this is where getting an expert’s opinion comes in handy, because he/she will tell you the probability of that happening in the future.


-Rishab Sharma



Disclaimer: Past performance is not indicative of future results. Futures trading involves substantial risk of loss.  By no means is this newsletter offering any investment advice or suggesting to make any trade recommendations. Please consult an aiSource advisor prior to opening any managed futures accounts.