Our weekly newsletter is out, and this time we’re taking a look at the long-term risks and benefits of diversification. Unfortunately, it’s not always fun to do the responsible thing. People who pay their insurance premiums year after year may get a little envious when their neighbors spend that money on a new boat. Students who diligently crack open their textbooks on the weekends may pine for the kind of adventures that their less studious classmates are enjoying. And investors who have done the responsible thing and diversified may find themselves gazing longingly at the returns they could be getting if they had only stayed in stocks.

In the long run, the responsible choice is most likely to provide the best outcome and protect you from potentially catastrophic losses – a storm that sweeps away your home, failing your classes and being expelled, or watching a market collapse wipe away your nest egg. But that expectation of future benefits doesn’t make it any easier to ignore the feeling that you’re missing out. And unfortunately for those who have diversified their investments away from a traditional portfolio, the last few years have been tough to watch.

60/40 Portfolio = 60% Stocks (S&P 500) + 40% Bonds (Barclays Capital Long-Term Treasury Index). 42/28/30 Portfolio = 42% Stocks (S&P 500) + 28% Bonds (Barclays Capital Long-Term Treasury Index + 30% Managed Futures (Dow Jones Credit Suisse Managed Futures Index). Disclaimer: past performance is not necessarily indicative of future results. The above index results are for illustrative purposes only and do not reflect actual investment gains or losses.

Naturally, this got us to thinking – how long would the current rally need to last before the investor without any managed futures exposure would make enough money to overcome the additional losses he/she would incur in the next selloff by not being diversified? Click through to see what we found.

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To read more Managed Futures research pieces, visit Attain’s Managed Futures Newsletter archive and our Managed Futures Blog.

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. 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.

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.

Managed Futures Disclaimer:

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.

Copyright © 2013 Attain Capital Management, licensed Managed Futures, Trading System & Commodity Brokers. All Rights Reserved. Reprinted with permission.

The fastest growing segment of the financial services industry was the one hardest hit by MF Global’s suspicious demise and overt fraud at Peregrine Financial Group (PFG).

The managed futures industry, which had grown from $14 billion under management in 1991 to over $329 billion to end 2012, was a shining star of the new economy. Offering the unique ability to zig when other investments zagged, the lack of correlation and performance during crisis were key points of attraction. This attraction came to a screeching halt with the MF Global and PFG criminal incidents. Not only were investors getting acquainted with the asset class shocked to learn their accounts were looted of assets, but more troubling criminal behavior appeared the cause - casting a shadow over all participants.

“There is a severe loss of trust, a loss of confidence. There is incredible anger and frustration. Things need to change,” said Diane Mix Birnberg, president of Horizon Cash Management. Her firm just released a study, The Aftermath of MF Global and Peregrine Financial Group Meltdowns: A Crisis of Trust, showing that a whopping 91% of respondents believed there was a breakdown in audit procedures.

The study themes that emerged included:

• The laws and rules that govern the industry need to have ‘teeth’ – and those involved in fraud and theft need to be punished.
• Customer segregated funds must either be kept completely out of the FCM and/or be verified in real-time by regulators.

A strong and rare female voice inside a Type A male dominated industry, Ms Birnberg’s firm, Horizon Cash Management, has become the top cash management firm for participants in the managed futures industry. Starting in the 1970s as a secretary in a stock brokerage firm in Atlanta, where “women generally didn’t think about career aspirations,” she later joined Lehman Brothers in the bond business. After moving to New York City to work on Wall Street, she was recruited in 1980 by investors to operate a cash management firm in the futures industry and in 1991 founded Horizon Cash Management, which currently has $2 billion under management.

In MF Global “there was very little institutional leadership (from exchanges, regulators and major firms),” she said. “This resulted in rumor, innuendo and ultimately a lack of trust. The void in leadership is terrifying.”

Looking back on the MF Global and PFG disasters, Ms. Birnberg has the experience of witnessing 10 FCM implosions. “In every FCM implosion it has negatively touched the CTA / CPO segment of the industry.”

“Think about a plane crash,” she said. “When it happens? Key issues and facts are addressed by the airline, the FAA and even the US president. Information is available regarding what happened, why it happened and steps being taken to address the problem.”

With MF Global a plane crashed and there was silence.

This is the first part of a two part article.

Mark Melin is author of three books and taught a managed futures course for Northwestern University’s Executive Education program. To read additional blog posts visit www.UncorrelatedInvestments.com (requires free registration).

As the introductory Commodity Corner column of the magazine I found this to be a good opportunity to introduce commodities and futures.

One could argue commodities have been around since the beginning of civilization. People have produced, paid or bartered for commodities to use for either production or to consume. Some of the uses of commodities include food, energy, construction, manufacturing, and clothing.

According to the Merriam-Webster dictionary, commodities are defined as: 1) an economic good. 2) A product of mining or agriculture. 3) An article of commerce especially when delivered for shipment. 4) A mass produced un-specialized product. [i]

In today’s global markets both large and small firms will trade and hedge commodities as part of their daily business as either a producer or end-user of the commodity. For example a chocolate candy producing firm will need to purchase cocoa, sugar and of course energy to fuel their factories. If they do business in foreign countries they may need to buy and sell foreign currencies for hedging or delivery purposes. (See “Currencies in Your Future Portfolio?” of the Spring/Summer 2012 issue).

To manage their price risk, a commodity producer, such as a farmer may sell a futures contract to lock-in their selling price. An end-user, such as a coffee chain may buy a futures contract to lock-in their purchasing price. Keep in mind commodity markets tend to be mean-reverting markets as they spike or decline from an average price and then revert back towards that average price overtime. This is often due to shocks in the system such as increased demand, reduction of supply, weather concerns, disruption of distribution channels or possibly political or regional events. If a commodity becomes too expensive, the market participants’ behavioral mechanism will appear as they seek less expensive substitutes. This is known in economics as the substitution effect and one of the differences to note between commodity and equity trading.

Commodities are traded in two common locations: either the spot/cash market usually reserved for industry or sometimes known as “commercials” such as producers, distributors and end-users as the actual physical commodity is traded. Or the products trade on an exchange such as one of the futures exchanges found around the world.  The futures exchanges are often utilized by both commercials and speculators. An exchange offers commercials the opportunity for immediate offset of their commodity risk by speculators offering liquidity to take on the risk. If a commercial has a loss from hedging, it often means they profited in the underlying cash market, because they are holding the opposite direction in the cash market. One can think of the loss on the hedge as a premium on an insurance policy.

Read more
[i] Shore, M. (2011) DePaul University 798 Managed Futures Lecture notes

Copyright ©2013 Mark Shore. Contact the author for permission for republication at info@shorecapmgmt.com Mark Shore has more than 20 years of experience in the futures markets and managed futures, publishes research, consults on alternative investments and conducts educational workshops. www.shorecapmgmt.com

Mark Shore is also an Adjunct Professor at DePaul University’s Kellstadt Graduate School of Business in Chicago where he teaches a managed futures / global macro course and an Adjunct at the New York Institute of Finance. Mark is a contributing writer to Reuters HedgeWorld.

Past performance is not necessarily indicative of future results.  There is risk of loss when investing in futures and options.  Always review a complete CTA disclosure document before investing in any Managed Futures program.  Managed futures can be a volatile and risky investment; only use appropriate risk capital; this investment is not for everyone.  The opinions expressed are solely those of the author and are only for educational purposes. Please talk to your financial advisor before making any investment decisions.

The voluntary return of $546 million in MF Global customer assets, the subject of hard fought 2 ½ year battle, was not motivated solely by the kindness of JP Morgan.  Rather, it could be considered fruit from a likely hard investigation now gearing up if not already under way.  This investigation, declared “dead” many times over in leaks to the press from official sources, has heated up, as first discussed here.

The return of illegally transferred MF Global customer assets was always a key bone of contention.  JP Morgan had summarily dismissed regulatory and public pressure to return customer assets, so the question is: why submit to authority now?

In 2012 the National Futures Association (NFA) went so far as to send the bank a public letter, which was generally brushed aside as were numerous verbal requests and mounting public pressure from groups such as the Commodity Customer Collation and its leaders James Koutoulas and John Roe.  This significant pressure was dismissed, yet an attempt by bankruptcy trustee James Giddens was successful.  The fact this occurred at this moment in time is not a coincidence.

Speculation is JP Morgan’s normally dismissive attitude towards government regulators might have changed in the face of what is expected to be a no holds bar CFTC / DoJ criminal investigation.  In other words, the specter of government actually asserting itself and allowing career investigators to do their jobs unimpeded is enough motivation for JP Morgan to return what are documented to be illegally transferred customer assets.

But perhaps more important to the future, a real investigation could also be motivation for JP Morgan to provide critical testimony regarding the criminal activity of MF Global executives, including that of Jon Corzine.

The need for deterrence that derives from a Jon Corzine conviction is more important because the future that matters most.  Since 2008, when financial crimes that damaged the US financial system were was documented not to be investigated by DoJ’s former assistant attorney general in charge of criminal investigations Lanny Breuer, Wall Street crime has imploded in its brazen disregard.  MF Global is one example, but the case of HSBC laundering money for terrorist organizations and drug cartels – after being warned on several occasions not to do so – is a sign of complete disrespect and a breakdown of law and order on Wall Street.   When the full story is known, Mr. Corzine’s disrespect for the US financial system and its cogs of justice will likely stand as the turning point in a long battle.

Is this real?  Is the investigation a serious point where the rule of law might actually apply to once exempt Wall Street players?  We don’t know for certain at this point, but one key tell is going to be the type of charges filed against MF Global executives.  If RICO charges are used, this will send the powerful message that a cop is in fact back on the beat.

Mark Melin is author of three books and taught a course on managed futures for Northwestern University’s Executive Education program.  To read more of his blog posts, click here (requires free registration).  Contents Copyright (C) 2013 Mark Melin.

Unfamiliar to even many sophisticated asset managers, volatility investing provides unique opportunities for risk management and market understanding.

Volatility investing involves trading programs based on market price volatility.  The primary volatility market is based on the stock market, but variations of volatility investing methods are used in commodity markets as well.  In light of an approaching debt crisis and always unpredictable world events, volatility-based investment techniques, both long and short, are worthy of detailed investigation.

A recent educational opportunity sponsored by AlphaMetrix and the CBOE Futures Exchange revealed interesting issues as it relates to the debt crisis and volatility investment techniques.  In addition to stock and commodity option contracts, one of the primary methods of volatility trading occurs with the VIX, the CBOE’s popular measure of implied volatility in the equity market.

Did Volatility Skews on December 21, 2012 Reveal a Market Imbalance?

“Just before the conclusion of the fiscal cliff debate, the time horizon spread in the VIX options exhibited unusual expectations,” noted Christopher Cole, managing partner at Artemis Capital Management and one of the panelists.  “We could buy the front month VIX options and sell the back month with a positive carry.”  This is unusual because such a long volatility position typically involves the purchase of premium, but in this unusual relative value situation the trading manager collected premium and had long volatility exposure.

“What was the shoe that was expected to drop?” questioned Bruce Rogoff who, as managing partner of option market making firm Gargoyle Group, noted highly unusual professional action leading up to the fiscal cliff negotiations.  “And when is that shoe expected to drop.”

Behind the scenes, derivatives professionals have been observing the mathematical properties of the US debt crisis for several years.  While predicting the exact date of a potential volatility implosion is speculative, what is known is there is a certain point at which compounding on the debt and a continued path of deficit becomes unsustainable, potentially leading to a transformational market crash.  While the date cannot be predicted, the mathematical underpinnings of the problem are generally understood along with the practical knowledge of the likely political battles that could arise out of the problem.  If the US debt crisis is left unaddressed, speculation is a transformational debt crisis crash could occur within three to five years, while more conservative estimates indicate a 10 year time horizon.  Just like former CFTC Chairperson Brooksley Born predicting the OTC derivatives would eventually cause a market crash, she didn’t know the date would be 2008 but a logical understanding of derivatives structure and mathematical probability also indicates that at some point a debt crisis crash should be considered.

Can Market Volatility Be Predicted?

Perhaps one of the more interesting discussions to take place occurred regarding the predictability of market volatility.

“Volatility can be predicted,” said Scott Reamer, CIO at volatility trading program Rotella Chora.  In subsequent conversations Mr. Reamer, who operates a short-term time horizon volatility strategy, observed that even longer term volatility events can be predicted to a degree based on structural instability leading up to the event.

To read the full article, register (free) on the web site

http://www.uncorrelatedinvestments.com/blog/?p=64

Mark Melin is author of three books including High Performance Managed Futures and taught a course on the topic for Northwestern University’s Executive Education Program.

While it sounds mundane, the “Residual Interest Income” issue has the potential to literally change the face of the regulated derivatives industry.

In just one line of a massive Dodd Frank bill with unnecessary complexity and obfuscation, large bank interests may complete monopolistic control over the derivatives industry.

This is the point that has been absent from many of the industry comment letters and should be on the radar of government regulators.

To understand, keep the topic simple.

With one line amongst millions of legislative words, government regulators will effectively dis-advantage mid-sized Futures Commission Merchants (FCMs), likely forcing many out of business, which has been widely discussed and commented on. The point missing in discussions is the implications, the “unintended” consequences of how this provides literal control of the futures brokerage industry by a small cartel of banking interests with a Too Big to Fail guarantee.

Monopolistic control over the futures industry is not a new topic. The discussion has always taken shape on the exchange side of the business. Brokerage has not been actively considered in the public discussion, but the impact could be the same.

Consequences for farmers and hedgers could be dramatic, as most of these independent business executives work with mid-sized brokerage firms. In effect, this could impact the stability of the market, which is why certain large bank executives might have taken the side of independent FCMs.

In particular Mike Dawley of Goldman Sachs has been a vocal voice in the logical questioning of the impact on market ecosystem, as have many industry participants including The Commodity Customer Coalition and The National Introducing Brokers Association, who stands to be decimated if the “residual interest” issue is allowed to create a large bank monopoly in the commodity markets.

At a minimum the long term impact of this issue should be studied by the CFTC and openly discussed relative to the impact it might have on hedgers and creating a monopoly in a key sector of the US financial services industry.

To read this an other recent blog posts follow this link to my managed futures blog (requires free registration): http://www.uncorrelatedinvestments.com/blog/?p=45

Mark Melin is author of High Performance Managed Futures (Wiley 2010), Co-Editor of The CBOT’s Guide to Futures and Options and taught a managed futures course for Northwestern University’s Executive Education Program.

Dear HedgeWorld readers.

You may have noticed the HedgeWorld site is acting up today - no new stories in the HedgeWorld News portion of the site, no search functionality and no Lipper performance data access or charts. The same server issues we experienced last week are messing with us again. And just like last week, the tech guys are on it (no, really this time) and we hope to have things back to normal soon. In the meantime, read HedgeWorld news stories on the Alternative Reality blog today.

Thank you for your patience,
Chris Clair
Managing Editor, Reuters HedgeWorld

Creative inspiration is derived in many ways. The recent fiscal cliff debate in Washington D.C. may impact the economy at both the local and national level. I was inspired to write the following fun piece below:

Was the Night Before Fiscal Cliffness

By Mark Shore 12/28/2012

Inspired by “Twas the Night Before Christmas” and the craziness of D.C.

Everyone lets gather around the fireplace,

I have a story to tell you of a distant place,

Where everyone kicks a can without any disgrace:

Was the night before Fiscal Cliffness and all thro’ the house,

Not a congressional member was stirring, not even the speaker of the house,

The line was drawn in DC with care,

In hopes each would get what they wanted, but would not share,

Read More

Copyright ©2012 Mark Shore. Contact the author for permission for republication at info@shorecapmgmt.com

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Continuing the series of discussing various methods of trading the CBOE Volatility Index® (VIX®) futures contract at CBOE Futures Exchange, LLC (CFE), we will discuss the utility of the True Range indicator and the Average True Range indicator. In previous articles we discussed the use of spreading, correlations, moving averages and the Aroon indicator as methods of trading VIX futures.

Liquidity is an important factor of risk management. CFE announced on November 1, 2012, record volume in October 2012 for both the VIX futures contract and total volume of the Exchange. VIX futures reached a record 2,443,878 contracts traded in October 2012, a 172% increase from October 2011 and a 2% increase from September 2012. The October 2012 Average Daily Volume was 116,375 contracts, a 172% increase from October 2011 and a decrease of 8% from September 2012. However, the markets were closed for two days in October due to hurricane Sandy.i

In previous articles we discussed VIX futures as a mean-reverting market tending to find major price support between 10 and 15 and major price resistance around 40. However, within this range, market turning points do develop from time to time. The True Range indicator is a method of seeking changes in market momentum.

The True Range indicator and the Average True Range were developed by Welles Wilder, also known for developing the Relative Strength index, Directional Movement and the Parabolic Stop and Reverse. True Range is considered a metric of a market’s activity or volatility. Wilder first published the True Range indicator in his 1978 book “New Concepts in Technical Trading Systems”. The True Range indicator posits that the higher the number, the more likely the market will change direction. A lower number would indicate a weaker trend or indication of a sideways market. The True Range is defined as the maximum value of the following: 1) today’s high to today’s low; 2) yesterday’s close to today’s high; and 3) yesterday’s close to today’s low. The Average True Range is a moving average of the True Range.

VIX futures are an indicator of S&P 500 Index volatility and True Range is a volatility of the volatility or a second derivative of the READ MORE

Copyright ©2012 Mark Shore. Contact the author for permission for republication at info@shorecapmgmt.com Mark Shore has more than 20 years of experience in the futures markets and managed futures, publishes research, consults on alternative investments and conducts educational workshops. www.shorecapmgmt.com

Mark Shore is also an Adjunct Professor at DePaul University’s Kellstadt Graduate School of Business in Chicago where he teaches a managed futures / global macro course and an Adjunct at the New York Institute of Finance. Mark is a contributing writer to Reuters HedgeWorld.

Past performance is not necessarily indicative of future results. There is risk of loss when investing in futures and options. Always review a complete CTA disclosure document before investing in any Managed Futures program. Managed futures can be a volatile and risky investment; only use appropriate risk capital; this investment is not for everyone. The opinions expressed are solely those of the author and are only for educational purposes. Please talk to your financial advisor before making any investment decisions.

Many Wall Street experts think that the JOBS Act will change the hedge fund industry. According to Daniel Strachman, a financial expert who serves as the Director of Research and Strategy for the GAIM Conference Series, it could also lead to the consolidation of existing funds—and the creation of others.

“It would not surprise me if you saw consolidation in the industry, meaning large mutual fund or asset management companies acquiring independent firms,” Strachman told StreetID. “It wouldn’t surprise me to see mergers of independent firms together. I expect that you’ll see a number of funds growing, both independent funds — guys who come out of big houses, whether it’s Goldman Sachs (GS), Morgan Stanley (MS), Merrill Lynch (BAC), wherever—they’re gonna launch funds.”

Strachman believes that the industry is “poised for another growth spurt.”

“We saw a big growth spurt in the late ’80s,” he said. “We saw another in the ’90s, and then another in the post-crash bubble of 2000. I think you’re gonna see that also going forward. Our research here is showing that all signs are pointing to new fund launches in 2013, new asset flows in 2013.”

Overall, Strachman thinks that the JOBS Act could be “something along the lines of the great equalizer into the hedge fund industry and the asset management industry.”

“It could really blur the lines between what are investment vehicles for the masses,” he said. “There’s a potential that the SEC comes out and says that hedge funds can advertise openly on billboards, in Times Square, or put an ad in the Super Bowl, or buy a full-page ad in The Wall Street Journal.”

Still, Strachman said that with the way the hedge fund industry is today, it is already open. “If you look at what’s going on within the major news networks, if you look at the major financial newspapers, as well as the major financial publications, the hedge fund industry is covered with some regularity,” Strachman explained. “I’m not sure that [the JOBS Act] affects it as much as people think it does and what people are talking about.”

That won’t stop the JOBS Act from serving a greater purpose, however. “When the rules do finally come out about what is and what is not allowed, I think what this will do is really open up an opportunity for the hedge fund industry to experience massive growth,” said Strachman.

“I think that you’ve seen over the last few years, in the wake of the credit crisis, in the wake of the poor economy, in the wake of the economic uncertainty and volatility in the markets, hedge funds have sort of been all to themselves in terms of asset flows. I think once the JOBS Act [and] the rules are put into place, and people understand how the game needs to be played, then you will see growth in the industry.”

Further, Strachman said that there are two things that everyone knows: that markets don’t always rise and that investors must protect themselves to continue making money when the markets go south.

“The only vehicles that allow you to do that are funds that are operating on both sides of the market,” said Strachman. “That’s why we’ll see what I think will happen, which is more fund launches in 2013, more asset flows from investors — not only just the pension plans and endowments and family offices — but high net worth investors and others will be driving to these products because now there will be a better understanding of how these products work, and there will be a better understanding of how they can affect your portfolio. I think that’s significant.”

This content originally appeared on StreetID, a financial career networking, matchmaking and news site. To learn more about StreetID, visit StreetID.com. StreetID’s financial career news can be found on its blog, streetid.com/newsblog/.