The Concept of Non-Correlation

How Will Your Portfolio Respond During Times of Market Stress?
Modern Portfolio Theory tells us that holding a well-diversified 'basket' of investments can be one of the best ways for individual investors to reduce risk to achieve a given level of performance. But a portfolio comprised of only stocks, bonds and real estate may not be enough to provide true diversification.

A Non-Correlated Portfolio: The Key to True Diversification
The key to Modern Portfolio Theory was the revelation that the risk of any investment can be reduced and/or performance increased by forming a portfolio of diverse and non-correlated assets. Simply put, a truly diversified portfolio contains not only a range of different asset types, but also assets that have low correlations to one another. Constructing your portfolio this way will reduce the likelihood that your assets will move in tandem, which can be especially important when the broader markets may be down and diversification may be most needed.

Diversity is a pretty general concept meaning simply a lack of similarity. When we want to speak technically with more precise language we use the statistical terms correlation and dependence, which describe and measure similarity. Correlation describes how pairs of securities act in relationship to each other over some period of time; if you can predict the change in one based on the change in the other, you have demonstrated inter-dependence. As investors, we know that owning a portfolio of highly correlated assets does little to cushion the impact of down markets, and we are told by our investment advisors that owning non-correlated or negatively correlated assets will protect us from market crashes and dampen our losses in bear markets. In short, you want something that will zig when the rest of the assets zag!

The Items in Your Basket
Think about non-correlation this way: You get up on a bright sunny day and decide to go to the farmer’s market quite a distance away. Once there you fill your basket with apples, oranges, bananas, lettuce, and on the way out you decide to add some eggs.




Market Volatility and Uncertainty
On your way home from the market your car overheats and breaks down. Let’s call this macro-economic stress, kinda like the near global meltdown in 2008! You’re quite a distance from home, with no cell signal, and the sun is blazing hot! (Market Stress!) You take your basket out of the car because of the furnace-like temperature inside. As you sit on the side of the road contemplating a resolution the temperature rises well above 100 degrees (Extreme Market Stress!), and you notice that it’s having quite an adverse effect on the items in your basket.

In the extreme heat your lettuce (Bonds) are the first to go. Your apples (Stocks) get brown and soft, and look totally unappetizing. Your bananas (Mutual Funds) begin to turn dark brown and mushy. Your oranges (ETF’s), because they are thick-skinned, go bad at a slower rate. But, go bad they do as well! And then you notice your eggs.

Because your produce items are all “of the earth” they are, in a manner, correlated. But, your eggs are of a slightly different ilk. Extreme heat actually cooks an egg. While in this scenario it might not make the tastiest, most appetizing morsel, it would certainly sustain. And more importantly, the extreme “market stress” not only didn’t render it useless, but rather, made it somewhat useful! The non-correlated nature of the eggs versus the produce proved beneficial in the event of the severe stress.

Commodity returns are expected to show small or even negative correlation with the returns of assets that belong to traditional asset classes like stocks, bonds and mutual funds. This is because the value of commodities is driven by factors such as weather and geopolitical conditions, supply constraints in the physical production, and event risk that are distinct from those that determine the value of stocks and bonds.

Commodities seem attractive because, after all, they are real assets, whose values are determined by immediate supply and demand factors. They are not financial assets, whose values depend on some contingent estimate of long-term earnings. With financial assets, market randomness is traditionally managed by mean-variance models (stemming from the work of Nobel Laureate Harry Markowitz) that result in an efficient frontier allocation of stocks and bonds to achieve the highest expected return per unit of risk (or standard deviation).

An Advantageous Twist
Another facet of commodity non-correlation that is often overlooked and/or misunderstood is the directionless trading/profit possibilities. Commodity futures and options trading allow for long or short positioning with a greater degree of ease than most other asset classes listed. The ability to profit in any market environment without regard to its direction is a priceless advantage over buying stocks, bonds or mutual funds. Commodities afford an investor the opportunity to trade without regard to a particular company's competitive position or future earnings prospects. That's, more often than not, a simpler forecasting proposition. Investors should be willing to sacrifice some of the upside potential of a pure equity/bond portfolio in order to preserve capital in times of a declining stock or bond market.

The Bottom Line
Constructing a portfolio capable of weathering all types of macro economic and political conditions is the key to successful trading. Properly diversifying a portfolio will reduce the amount of risk an investor is exposed to and allow for less volatile returns. Due to the prospective ability to capitalize on both up and down price movements in the futures market, the trading arena seems like a likely vehicle to produce results that are not necessarily correlated to more traditional holdings such as stocks, bonds, mutual funds and real estate.


-- Jeff Anthony, Managed Futures Specialist, Park Avenue Asset Management

Futures investing can involve significant risk, and is therefore not suitable for every investor. Past performance is not necessarily indicative of future results. Only risk capital should be used.

Indentifying the Risks Involved in Managed Futures Investing

With all the furor lately regarding Managed Futures programs investors more and more are assessing risk to determine the real prospect for portfolio growth and asset protection. Paramount to this assessment is a real understanding of the factors that may not be immediately apparent but can be critically important.

The idea that futures investing, of any variety, can involve substantial risks should be ingrained in the minds of any investor considering the venture. If your prospective broker does not give you an unbiased explanation of the risk involved along with his profit potential presentation hang up the phone! Run, don’t walk! Avoid the guy. He’s probably not too honorable! While professionally managed futures money managers purport to approach commodity trading with an eye toward mitigating or minimizing the substantial risk involved, the risk is still very real and one should examine some very important factors to determine if the CTA has a proper approach both for the market(s) he intends to trade and for your own personal risk tolerance.

Just like trading in equities, futures investing is a speculative activity. Depending on the markets traded and some other inherent factors the level of volatility can he quite high. This can be one of those trick areas. Some money managers seek to take advantage of periods of increased volatility. Quite a few are quite good at it! Option sellers are principally volatility traders. However, even option sellers can be victimized when volatility whipsaws or spikes inordinately due to influences beyond their understanding or control. Among the factors that can greatly affect volatility are:

• Central bank policy decisions both foreign and domestic
• Political or civil unrest
• Geopolitically ignominious events (i.e. terrorist attacks, etc.)
• Large scale national and international economic events
• Major change in climate and weather dynamics
• Trade policy changes or disruptions
• Fiscal, monetary or currency exchange rate changes
• Changes in interest rates, or sentiment thereon
• Changes in interrelated markets philosophies, emotions and pricing

Government intervention can also greatly affect certain markets from time to time. Governments have the capacity, and in some instances, the sovereign obligation, to influence prices. Their action can be performed by direct action or investment or tacitly by regulation. Such intervention can cause rapid spikes in price with resultant changes in the dynamics of the markets.

Commodity markets can be, at times, illiquid. This illiquidity can prohibit entry or exit at desired prices, and can be attributable to a number of factors. Certain conditions on the exchanges can precipitate preemptive closure or “time out”. Also, almost every market has a daily price move limitations. In any given trading day if prices move either up or down to a certain set limit U.S. commodity exchanges will literally cease trading activity. Absolutely no trades will be executed and the market will take a breather. Certain markets have been known to lock limit for several consecutive days at a stretch.

Managed Futures money managers might not be able to favorable execute trades at desired prices if trading volume is small or non-existent. Remember, commodity trading is “zero-sum”. There is always someone (either individual or entity) on the other side of every trade. If there are no takers for what you’re offering you’re left with your offer. This is especially true for options on futures. For a CTA price execution is paramount. He as an absolute obligation to give fair and equitable pricing for each participant in a particular program at all times. In instances where the pricing can be the same for all he must make up the difference. Options can also be subject to restriction if the underlying futures contract has been in any manner suspended.

Counterparty risk, while relevant, is not as big a factor as it once was. This is truly a case where one must do in depth due diligence on the trader and the markets he intends to trade. Counterparty risk occurs when a managed futures manager trades in an over-the-counter instrument or contract with an individual counterparty as opposed to on an open outcry exchange. While it obviously can exist, in reality, most managers today, if for no other reason but increased liquidity, will limit their trading to the normal exchanges and vehicles therein. It would serve well to read the CTA’s federally required Disclosure Document carefully, paying special attention to any entries regarding “forward contracts”. In the past forward contract dealers have quoted especially wide spreads between bid and ask prices to limit movement or effect inordinately favorable conditions for themselves when few other options exists for unwitting traders. Dealers have also outright refused to make markets or quote prices for forward contracts leaving holders in extremely adverse situations requiring them to liquidate at severe losses if not done with due haste. It’s a jungle out there!

Leverage is the double-edged sword of commodity trading. Successful managers employ varying degrees of leverage in numerous forms almost consistently. But, leverage, improperly employed, could increase incurred losses by an order of magnitude. Many brokers presenting individual, broker-assisted trading will almost always give you the upside of the leverage story. The story can take on one of a few forms. For example: A contract of Sugar is 112,000 pounds. A one-cent move in your favor in the price of sugar can put $1120.00 in your pocket for each contract you control. (One cent (.01) X 112,000 = $1120.00)

What the broker may carefully leave out is that that same leverage can work against you to the same degree (amount) or more! Obviously, that occurs if the contract price moves opposite your desired direction and you don’t have exit order(s) or other protection mechanism in place. Because most trading is done on margin an extremely high degree of leverage can be permitted with small deposit amounts in play. Relatively small movements in price can amount to quite substantial gains or losses in the value of your investment.

Another mechanism of leverage that is occasionally employed but seldom fully understood is notional trading. Notional trading (or, notional funding) is, in a nutshell, utilizing a degree of leverage to increase the actual trading value of an account. Clear as mud, right? Well, in plain English notional funding is trading at a level that is over and above the amount of funding in your account. It could at a rate that is doubled, tripled, quadrupled or even quintupled! Conceivably you could deposit $50,000 in a notionally funded account and the money manager will trade it as though it were $150,000 in a 3-to-1 notional arrangement. The upside is that if the manager gets it right you’ll enjoy three times the profit. But, the other side is he can be three times as wrong with you account suffering three times the hit!

There is a presumption that Managed Futures Managers will maintain better controls with respect to leverage. Many tout eligibility to manage tax-qualified accounts (IRA’s, 401k’s, SEP’s, KEOUGHS). Part and parcel to this eligibility is proper risk controls with respect to margin and leverage. In most instances money managers will never over-leverage your account with respect to trading volume and/or number of contracts traded. As one of the most attractive features of Managed Futures investing is the absolute transparency, an account holder will be able to determine the level of leverage employed and the margin exposure at any given time. Most enjoy 100% liquidity with no lock-down or redemption periods to assessment and exit are always available options if the levels are outside the managers stated aims or your risk tolerance parameters.

Finally, Managed Futures CTA’s base their trading decisions on trends and/or technical analysis. As there are many different styles and approaches to trading the types of analysis can vary significantly, with none being absolute. To say that any one particular style or methodology is right or wrong would be egregious and irresponsible. However, it is incumbent on a potential investor to get a proper understanding of what the particular manager’s approach will be. Also, assess what his performance has been over a period of time, especially during and immediately after periods of extreme market stress. This can give you a better sense of the manager’s ability to react to adversity and recover from loss. My grandfather used to say, “It’s not how many times you get knocked down but how many times you get up that bespeaks your character.” And so it goes with Managed Futures CTA’s!

Investment in futures can involve substantial risk, and is not suitable for every investor. Only truly risk capital should be used for futures investing. Past performance is not necessarily indicative of future results.

Managed Futures Info: What Markets Can Be Traded in a Managed Futures Ac...

Managed Futures Info: What Markets Can Be Traded in a Managed Futures Ac...: "In the span of just over thirty years the Managed Futures asset class has gone from being a little known exotic niche of institutional inves..."

What Markets Can Be Traded in a Managed Futures Account

In the span of just over thirty years the Managed Futures asset class has gone from being a little known exotic niche of institutional investors to one of the largest, most consistent investments on the planet. As investors have seen the light on “buy-and-hold” in the equities markets, and with the meteoric rise in commodity prices smart money has begun to leave the traditional investment vehicles in droves and head straight toward the managed futures industry.

Now you may be thinking, that all sounds okay but what markets are actually traded in a managed futures account? It is my hope that this article will answer that question and maybe encourage you to seek out the real opportunities that exists for diversification and solid non-correlated portfolio growth with a managed futures account. The futures markets are broken down into sectors with each having its own inherent characteristics. The respective sectors, and the individual markets therein provide immense opportunity for a tremendous diversity of trading philosophies, approaches and strategies. This alone should have most every investor, at least, functionally aware of the asset class and it’s inherent capabilities and risks.

The aim of this list is to give you a fundamental understanding of the available markets, as well as an idea of the range and popularity of the many different sectors available in a managed futures trading account. For simplicity’s sake I’ve categorized each as “futures”. However, almost all include options on futures contracts, and are actually traded as such.

CTA’s (Managed Futures Money Managers) can trade:

Stock Index Futures: With the advent of stock index trading the futures markets witnessed explosive growth in a relatively short period of time. The most popular segment of managed futures trading has been the stock index sector for a number of years. Examples of tradable stock index futures are: the S& P 500, the Nasdaq, the Dow Jones Industrial Average, the Nikkei and the Russell.

Interest Rate Products: Gaining in popularity of late are the interest rate trading sector options available to managed futures money managers. Among the choices are: Eurodollar futures, Treasury Bonds and Notes, Fed Funds and Interest Rate Swaps. Traders can trade the yield curve, The Fed, and even the U.S. Dollar as a function of change in interest rate.

Currency Futures: Currencies are very popular due to the truly global scope and large number of available markets to choose from. Among the currency futures markets available are: the U.S. Dollar Index, the Australian Dollar, the British Pound, Canadian Dollar, Swiss Franc, Japanese Yen and Euro FX. Currency markets allow for true global hedging and risk arbitrage.

Metals Futures: One of the more popular segments over the last five years has been the Metals sector. With the advent of a pretty serious global financial crises, and a ten-year bull market run in the Gold market, Managed Futures Money Managers, especially those that are trend traders have found the metals markets to be a vital source of absolute return as the investing public has flocked to metals as a safe haven for turbulent financial times. The metals markets include: Gold, Silver, Platinum, Palladium and Copper.

Energy Futures: Arguably the most actively traded, and among the most volatile sectors, the Energies sector includes Crude Oil, Unleaded Gasoline, Natural Gas, Home Heating Oil, and Ethanol. With global demand for energies unwaning for the foreseeable future, the energies futures markets promise to provide unlimited profit and growth opportunities for money managers and investors for years to come.

Grains Futures: With global hunger for grains increasing, the grains markets are currently witnessing a surge in growth and popularity among Commodity Trading Advisors. Once of little relative volume and lesser consequence, the grains markets were far less popular and less glamorous. Today however, due to client demand and a stark growth in trading/profit opportunities, grains are quickly becoming a market of choice for emerging Managed Futures Money Managers. The grains markets include: Corn, Wheat, the Soy Complex (Beans, Meal, Oil), Oats, and Rice

Soft Commodity Futures: Just as with the Grains sector the Soft Commodities sector is currently in the middle of a demand and profit driven growth spurt. With markets like Sugar and Cotton experiencing record highs of late, the very high volatility can be effectively harnessed and managed for tremendous profit. Additionally, soft commodities (as well as Grains) provide opportunities that are not immediately apparent as some are used for alternative fuel production. Other examples of Soft Commodity markets include: Coffee, Cocoa, Orange Juice, and Lumber

Meat Futures: The Meat sector is little used and often overlooked. Primarily prone to low volume and strict seasonal tendencies, meats suffer a bit of an identity crises. Traders in the know are well aware that these markets can be quite volatile and present quite a marketable opportunity for option sellers and premium collection strategies.

From the list above it should be quite apparent that there are a wide range of markets and opportunities for Managed Futures Money Managers to choose from. This variety allows for a vast degree of non-correlated diversification from traditional investment vehicles, as well as timely, real diversification within this asset class. For those investors seeking commodity investment Managed Futures offers a far more professional approach typically with very precise, clearly stated risk controls and prudent market timing and endeavor.

While this may appeal an investor should always do their homework. This advice extends to the Money Manager, the program, the firm and the intended market(s). Futures investing, even more professionally managed futures investing, is not suitable for every investor. As always, past performance is not necessarily indicative of future results, and only truly risk capital should be used for futures and options on futures investing.

Managed Futures Info: Managed Futures Info: Why a Managed Futures Invest...

Managed Futures Info: Managed Futures Info: Why a Managed Futures Invest...: "Managed Futures Info: Why a Managed Futures Investment Matters to You!: 'For a great many investors today the idea of investment in commodit..."

Managed Futures Info: Why a Managed Futures Investment Matters to You!

Managed Futures Info: Why a Managed Futures Investment Matters to You!: "For a great many investors today the idea of investment in commodities is as about appealing as root canal surgery. And, that more than any..."

Why a Managed Futures Investment Matters to You!

For a great many investors today the idea of investment in commodities is as about appealing as root canal surgery. And, that more than anything else, is tragic and grossly misinformed.

Part of the problem stems from a serious lack of understanding of the differences that exist with respect to garden variety commodity trading/investing versus Professionally Managed Futures Investing. In some respects the differences can be stark. For some there is little or no distinction. But for those in the know the distinctions are precisely the reason to invest in managed futures.

The biggest difference is professional management. The sad truth is that most people that have horror stories about commodity trading weren't handled absolutely professionally. The presumption is that the person on the other end of the phone line, whose title is "Commodity Broker" is a knowledgeable, qualified professional. I hate to be the one to tell you: nothing could be further from the truth! Most brokers have a basic understanding of the markets and the terminology but lack any real in-depth knowledge or expertise. Simply put: they are salesmen, not traders! They are also account managers, customer service reps and cold-callers.

You do not need a professional money manager to invest in futures. However, the futures markets are so vast that it is difficult, if not impossible, for an individual to master more than a small segment of trading. The term "managed futures" describes a managed approach to futures market participation whereby professional money managers called commodity trading advisors ("CTAs"), trade futures and forward contracts pursuant to a limited power-of-attorney or limited trading authorization. CTAs are professional money managers specializing in trading futures and forward contracts. The term "CTA", however, is a misnomer-while futures and forward contracts may represent agricultural products, energies, cattle, hogs, metals, and other commodities, many CTAs also focus on trading currencies, financial instruments, stock indexes and single stock futures. CTAs work full time to trade and manage investments and are registered with the National Futures Association.

When investing in managed futures, the goal is to profit from moves in the contract prices of commodities, stocks, bonds and currencies, not an appreciation in value of the underlying asset. Each CTA employs his or her own strategy for profit maximization. Among the biggest benefits in managed futures investing in this financial environment is the idea that it can be done without consideration of economic circumstance or condition. It can be employed successfully in inflationary or deflationary environments. It can be beneficial in rising, falling or flat markets. It's generally transparent and liquid, so you're typically more aware and quite nimble. The benefits that professional management offers with managed futures are similar to those experienced with mutual funds and investment advisors. These include:

• Full-time dedication to the markets
• A disciplined trading approach
• Money management techniques that seek to control losses and protect profits
• Strategies that attempt to balance risk and reward

With the current uncertainty in the stock market as well as most traditional investments, managed futures as an asset class provides sound diversification that makes sound business sense. For a well-balanced portfolio investment in managed futures can represent, not only an efficient downside risk hedge, but also a very timely and opportunistic upside opportunity.

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