The stock market just hit an all time high and real estate values continue rising rapidly. Investors could not be happier. The day I refer to, of course, is October 9, 2007 when the S&P closed at its new record of 1565.15. What followed was a bull run in commodities culminating on July 11, 2008 when oil hit its high of $147.27 on dollar weakness and insatiable raw material demand from China. By January of 2009, oil dropped to almost $30 a barrel, the dollar was much stronger as seemingly everyone flocked to its perceived safety, and the worldwide economy would begin digging out slowly from the depths of the credit crisis. The S&P would drop below 700 points.

Currently, we are still digging out of that hole in a number of areas but hitting all time highs yet again in equities. Real estate values seem to be stabilizing. Unlike the credit crisis where retail investors and banks leveraged themselves it seems the Fed balance sheet is providing the fuel for the rally now. The lesson history tells us from even this recent period is that different asset classes perform well at different times and things can change VERY quickly. This is especially true with the rate at which information travels now through the internet on most every phone, high speed trading platforms, and Twitter.

It is helpful to remember this as we choose our investment managers and get caught up in short term performance or lack thereof. A few questions that I think deserve particular focus when selecting investments at times like this are the following:

  1. Does a manager match up well with their peers in good times for their methodology?
  2. How does the manager perform in the worst environment for their strategy?
  3. How would a new allocation complement my other investments?
  4. Is the trade selection process repeatable and sustainable?
  5. Is there a method for managing risk?
  6. What is my tolerance for losses?

Using a hypothetical systematic trend follower as an example we can answer the questions above. The credit crisis was a good year for most of these managers as strong commodity trends up through the first part of the year led to even stronger trends down through the crisis. Equity futures declined throughout the year accelerating into September and October. I expect that any trend managers would do well in this environment.

The year following the credit crisis was one of the worst years for trend followers as big reversals of successful 2008 trades occurred, choppy markets persisted, and a lot of additional capital flowed into these firms which had to be deployed. The best trend followers were down a bit and a few made small gains. If you had equities in your portfolio in 2008 this would have been an excellent complement to your overall strategy and great diversification. The rebound of the stock market when the manager achieved lower (negative?) returns in 2009 still would leave you better off than had you not diversified. Trend followers are most often systematic with stop losses on every trade. This means, in theory that their returns can be repeatable and they have a plan in place if things go against them. All that being said, trend following can be a volatile asset class that is not a fit for many people.

This year has been a tough year for many managed futures managers. Many of the best have limited losses, dialed back their risk, and taken gains when they can get them. A few have not been able to adjust to a bad environment. A few have been able to continue their record of consistent positive gains. This can be frustrating when the stock market is doing well and the inclination would be to put money where it is working. Change will come again though as it always does. When that occurs the ones who do well on the questions above oftentimes will be the ones to do well again. The best we can do as investors is to be prepared for anything and choose our investments wisely.

If you would like to discuss investment choices that have held their own through tough periods, excelled in good times (past performance not indicative of future performance), and might complement your existing portfolio please feel free to connect with me at 312-561-3147 or gtaunt@iasg.com.