Was Managed Futures Tackled by Turbulence? When is Volatility a Friend or Foe?
| May 3rd, 2012 | Filed under: Alpha Strategies, Commodities, Today's Post | By: Guest |
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By Kathryn M. Kaminski, Ph.D, CIO and Founder of Alpha K Capital.
Lackluster performance in the Managed Futures sector in 2011 has certain investors asking tough questions. The most common of these is related to volatility and the fact that during last year’s times of market turbulence CTAs seemed to struggle despite the fact that they are often sold under the tantalizing “long volatility” moniker. In a recent paper educational/thought piece for the CME Education Group, this complex or “convex” relationship is decomposed by volatility cycles to help clarify these issues.
Despite Managed Futures “long volatility” classification, volatility is truly of beast of its own, it is cyclical in nature similar to the booms and busts of equity markets, and it represents the markets perception of future uncertainty. Aggregating insights in behavioral and neurofinance, the cyclical nature of volatility may be driven by different cycles of human behavior initiated by either positive or negative stimuli. The core idea is that when we, as market participants, perceive success we become more certain (aka less volatility) and when we perceive threats we become more uncertain (aka more volatility). This means that risk taking is truly conditional on past experience consistent with what we, as practitioners, like to call “risk on – risk off”. Positive volatility cycles are driven by overconfidence, greed, and exuberance similar to a lucky gambler in a casino. Negative volatility cycles are driven by fear, anxiety, and distress. A schematic of volatility cycles and their connections is presented below.
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The majority of the money being managed by CTAs is in trend following strategies, and many of those CTAs track the same time frames. In recent years the markets tended to reverse direction just as many CTAs were fully entered in their positions, causing losses. That said, there are dozens of other trading strategies employed by CTAs, and many of those did quite well over the past few years. I discuss both trend following and commodities and futures trading in my best-seller, and am happy to provide complimentary links to the relevant chapters here:
http://bit.ly/wX2ONc
http://bit.ly/zvQwl4
http://bit.ly/w70k8w