One of our favorite bloggers, Barry Ritholtz over at The Big Picture, published a post today talking about five reasons to fire a mutual fund manager, but he may as well have titled it five reasons to fire your CTA. All but one of his reasons fit nearly as well for any type of manager, be it mutual funds, managed futures or hedge funds.
Ritholtz’s five reasons to fire your manager:
“When they suffer from style drift: This happens quite often; a manager developed an expertise in a given areas, but is looking beyond that. Maybe they got bored, maybe the new cow in the pasture caught the bull’s eye. Whatever it is, they are doing less and less of why you bought them in the first place. That’s a signal to move on.”
“When they become too big: Some managers find a niche that they can profitably exploit. But beyond a certain size — and that can range from $1 billion to $5 billion dollars — they no longer can create alpha with that strategy.”
“ When they fight the dominant market trend: Bill Miller’s streak came to an end amidst a value trap. He bought more and more of his favorite holdings — banks, GSEs and investment houses — right into the financial collapse. Doubling down again (and again) is not a valid investment strategy. Whatever advantages he had heading into 2008 disappeared.”
When they become a closet indexer: When a fund owns 100, 150, 200 names, they effectively become a high cost index. Even if they have the top performing stocks, it will be in such small quantities as to not move the needle. This is an easy fix — you replace them with a low cost, passive index.
“ When they seem to lose their edge: Whether its success or money or a loss of interest, managers sometimes lose the fire in the belly. Determining this is admittedly challenging in real time, and we often find out after the fact about some personal issues.”
However, the point at which Barry really hits the nail on the head (especially for managed futures) is when he talks about performance. As he puts it:
“Notice that Performance is not a factor in any of the 5 bullet points above. There are two reasons for that
1. Process, not outcome: I want to be focused on creating a reproducible methodology, regardless of luck or misfortune in any given quarter. Investing is a probabilistic process, and performance can slip for a quarter or two even when the manager is doing everything right.
2. Mean Reversion: The opposite of chasing performance (and buying high) is dumping a weak quarter (selling low) that then snaps back.”
These are great lessons to apply to your managed futures portfolio and CTA reviews, and the point we have long tried to make about not getting emotional during losing periods and dumping a manager just because they are losing money. Losses happen in all investments. You will have monthly, quarterly, and even annual losses. Knowing that a manager has not changed her stripes, become too big, become stubborn, or doesn’t care anymore really helps in sticking with a program during a drawdown.
To paraphrase Mr. Ritholtz – Invest in the process, not the immediate results
DISCLAIMER
Forex trading, commodity trading, managed futures, and other alternative investments are complex and carry a risk of substantial losses. As such, they are not suitable for all investors.
The entries on this blog are intended to further subscribers understanding, education, and – at times- enjoyment of the world of alternative investments through managed futures, trading systems, and managed forex.
The mention of asset class performance is based on the noted source index (i.e. Newedge CTA Index, S&P 500 Index, etc.) , and investors should take care to understand that any index performance is for the constituents of that index only, and does not represent the entire universe of possible investments within that asset class. And further, that there can be limitations and biases to indices such as survivorship and self reporting biases, and instant history.
Unless distinctly noted otherwise, the data and graphs included herein are intended to be mere examples and exhibits of the topic discussed, are for educational and illustrative purposes only, and do not represent trading in actual accounts.
Managed Futures:
Past Performance is Not Necessarily Indicative of Future Results. The regulations of the CFTC require that prospective clients of a managed futures program (CTA) receive a disclosure document when they are solicited to enter into an agreement whereby the CTA will direct or guide the client’s commodity interest trading and that certain risk factors be highlighted. The disclosure document contains a complete description of the principal risk factors and each fee to be charged to your account by the CTA.
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