How to design a Managed Futures Portfolio

There are thousands of Managed Futures program, how do you know which one is suitable for you? How do you design a balanced portfolio that can minimize your risk while still have reasonable expected turns? A lot of investors are puzzled when they are faced with such questions.

There are several principles which we believe will be useful to investors:

1.   Assets allocation. Even in the managed futures space, there are different asset classes, such as equity futures, energy, metal, currency, agriculture, options etc. While it is not necessary to have exposure in every asset class, you don’t put all your money in just one or two asset classes.

2.   Compare programs within an asset class. You want to find best 3-5 programs within that asset class as candidates for your portfolio. There are many parameters to rank programs, such as annual return, largest draw down, risk adjust return(Sharpe Ratio, Sortino Ratio), AUM etc. Different investors may have different risk appetites and return expectation. So this is a very personal selection. Moreover, most institutional investors will do much more than this. They will do their own Due Diligence on the portfolio managers regarding their academic & professional background, infrastructure, Accounting, Compliance etc. There is a very time consuming process. Most individual investors probably won’t have the time & energy to conduct such due diligence. They will most likely to rely on their financial advisor to make a recommendation. But it is best to prepare a list of questions (like those parameters we mentioned above) to ask your financial advisor regarding the programs, so you know what you will expect.

3.   Portfolio selection. Now you know asset allocation and best programs in every asset class, how do you make your final selections? Should you choose a big firm or an emerging manager? Should you choose a popular name or find a niche program? There are lots of studies and articles regarding portfolio selections. For institutional investors, they often have some mandates to their investors. For example, they may be required to invest in only invest graded bonds or they can only invest in programs with at least certain AUM. For individual investors, they are more flexible and their top priority usually will be the expected return or risk adjusted return. While popular names in the Managed Futures space such as Winton, AHL, Bluetrend, Transtrend have produced respected returns in the past, the correlations among them are very high. So it means that they tend to make money at the same time and also lose money at the same time. The largest 5 CTA programs have total of about $75B AUM, that is about 30% of total AUM in the managed futures space. They also tend to trade every product except options in the managed futures space. If you want something different and complimentary, you need choose some other programs as well. Since those largest 5 CTA programs are all trend following and usually don’t trade options, a mean reversion, option program could be a perfect diversification for this purpose. By choosing a mean reversion program, when those trend following programs lose money, the mean reversion program will most likely to make money. This negative correlation will help you reduce risk without sacrificing expected returns. Also an option program could be a nice asset diversification. So you want to select top mean reversion, option programs which are also negatively correlated to those trend following programs in order to truly diversify your portfolio. So next time when you talk to your financial advisor, make sure you raise such questions!

Manager Bio: Dr Rao started his professional financial career as a quantitative analyst at Ellington Management Group in early 2005. In June 2006, he joined SAC Capital as a global macor trader, where he managed more than $100M capital and traded all kinds of markets such as Currency, Rates, Commodity, Equity ETF/Index/Futures, CDS, Bond, High Yield, Credit etc and their options. His main focus is liquidity Equity & Commodity ETF/Index/Futures and their options. In January 2009, Dr.Rao moved to Millennium Partners as a statistical arbitrage trader before starting his own CTA fund in December 2009 to serve outside QEP clients. Dr. Rao received his PhD in 2005 and MS in 1998 both from Harvard University, his BE IN 1997 from Tsinghua University.

For more information on Dr.Rao and his managed fund/CTA, feel free to visit www.ibtrade.com

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