As one of the world’s largest futures databases, we begin talking to traders often at the earliest stages of their evolution up to billions of dollars in assets. But not all beginnings are equal, as some achieve early success and others never find it. Our challenge is determining which ones provide our investors with the best opportunities.
One might think that this is a simple process. A few favorite search methodologies on our site include the Sharpe ratio, returns, or minimum investment amount. Each can be a good filter, but ultimately, each is limited in its efficacy. Most importantly, they ignore the “inside story” for many programs. Often managers are even better than they appear, but sometimes they look great but should be avoided at all costs.
Let’s review some of the pros and cons of typical investor searches.
Limitations of the Sharpe Ratio
The Sharpe ratio was invented to help identify the best risk-adjusted returns. The simple idea is that if two investments yield the same return, but one does it with less movement and more consistency, it is a better investment. There are a couple of limitations to this. One is that upside movement can also be punished. What if a program only made money (a lot of it) when the equity market was down but was otherwise choppy? It could find a place in a portfolio but exhibit a low Sharpe. The other failure is that some investment styles lend themselves to high Sharpe ratios but mask tail risk. Option writing is the primary example, as range-bound market conditions can persist for long periods, yielding a smooth and consistent return profile. When markets crash, these programs can lose substantially over a brief period.
Returns and Minimum Investment Amount
Returns and minimum investment amount are the simplest factors to consider when evaluating trading talent. After all, who doesn’t want high returns at a level you can afford to enter? Futures contracts have leverage built into them, so if two managers have the same return profile, but one achieves it using half the margin, they have done so much more efficiently.
Understanding Margin Usage and Risk
See the chart below that shows the same program with different leverage applied. An investor with $400k might skip over the “too conservative” profile even though they might like the $100k version. A manager with a 100% return might have taken reckless chances, gotten very lucky, or simply took advantage of unique market circumstances and managed the trade well. Understanding how managers use margin in conjunction with their risk-taking can open up many possibilities that a simple search will not uncover.
| Aggressive | Normal | Conservative | |
| Trade level | $100k | $200k | $400k |
| Average margin | 40% | 20% | 10% |
| Return | 60% | 30% | 15% |
| Drawdown | 20% | 10% | 5% |
| Leverage | 4x | 2x | 1x |
The Importance of Strategy Evolution
In my opinion, the last and most significant limitation of searches is a lack of understanding of the history and development of a strategy. Many beginning or experienced traders start their program with different goals that evolve. A proprietary trader might be trading money for himself and a couple of aggressive friends who tell him to “swing for the fences” as they allocate risk capital. This might result in concentrated bets with high-margin usage. If it succeeds, they could make a couple hundred percent with 30% up and down months. They may then decide to register with the NFA and adjust to a marketable product that targets 20% annualized returns and 5% down months. Others make significant changes to markets traded, systems, or risk overlays. Many of these track records get skipped in searches because they are disjointed or have “wild” months that might have more risk than a customer would like. But they aren’t the same programs anymore.
Overlooked Managers
Below is a brief list of managers often overlooked on our site for the reasons listed.
Adalpha Asset Management
A long track record that is steady year to year but displays a lower Sharpe than newer programs. New research and development added systems to improve performance and potentially reduce risk steadily from year to year. Averages 4% margin to equity which is very efficient usage.
Covenant Hedged Equity
Returns look overly aggressive based on specific market conditions that occurred in 2020. It is designed to be a more efficient equity replacement, running at 1.8X leverage, so $100k would replace $180k of equity exposure.
Quality Capital
Added a tactical overlay designed for shorter-term trading to smooth out returns. A popular program struggled with the asset allocation model after a long and successful run before this introduction.
Blue Bar Futures
Shifted his technical trading experience to livestock after beginning a track record focused on the S&P. The program adjusted significantly for outside customers at lower targeted risk levels.
Orgone
Proprietary traders managed money for a few family and friends before opening to a broader audience and reducing margin by 5x.
Four Seasons Hawkeye
Margin to equity averages below 3% or $25k on a $500k minimum, with a peak around 8%. Return on cash used to hold positions is among the highest across all programs.
Working with someone from our industry to understand these nuances is helpful to get the portfolio that fits your needs and perhaps gets you in the one you skipped over. Please contact me to learn more about how to get the most from our site or with questions about our managers.
PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. THE RISK OF LOSS IN TRADING COMMODITY INTERESTS CAN BE SUBSTANTIAL. YOU SHOULD THEREFORE CAREFULLY CONSIDER WHETHER SUCH TRADING IS SUITABLE FOR YOU IN LIGHT OF YOUR FINANCIAL CONDITION. THE HIGH DEGREE OF LEVERAGE THAT IS OFTEN OBTAINABLE IN COMMODITY INTEREST TRADING CAN WORK AGAINST YOU AS WELL AS FOR YOU. THE USE OF LEVERAGE CAN LEAD TO LARGE LOSSES AS WELL AS GAINS. IN SOME CASES, MANAGED COMMODITY ACCOUNTS ARE SUBJECT TO SUBSTANTIAL CHARGES FOR MANAGEMENT AND ADVISORY FEES. IT MAY BE NECESSARY FOR THOSE ACCOUNTS THAT ARE SUBJECT TO THESE CHARGES TO MAKE SUBSTANTIAL TRADING PROFITS TO AVOID DEPLETION OR EXHAUSTION OF THEIR ASSETS.
Photo by Adrien Bruneau on Unsplash