For many years, investors have maintained a rather simplistic, almost dogmatic, approach to investing.  This strategy entailed purchasing an asset that you believed would head higher- and holding it until it became profitable. Generally speaking, this approach was most applied to the equities markets and was further reinforced by Wall Street. If an investment would go against you, your broker might advise you to “cost average” your investment.  If you wanted to “take your profits” or “cut your losses” they might quickly remind you that “market-timing” has historically underperformed a typical buy and hold strategy.

More recently, this “buy and hold” strategy has grown to apply to all types of investments, including real-estate, private equity and commodities.  The idea that prices could come down -or that markets conditions are not always predictable- was somehow forgotten by investors.  Indeed, while this buy and hold strategy worked well during the bull market reign, it quickly failed as the recession and credit crunch forced virtually all markets to head  substantially lower.

The Rise and Fall of College Endowments

A poignant example of this over exposure can be seen by the recent performance of college endowment funds. A couple of weeks ago, Barron’s Magazine ran an article in which they looked at the “Rise and Fall” of the investment genius that was- college endowments.  The article started off with the following summary:

FOR YEARS, TOP UNIVERSITY ENDOWMENTS at Harvard, Yale and Princeton were the envy of the investment world, thanks to the outsized returns they generated from significant investments in nontraditional assets such as private equity, real estate, hedge funds and commodities, and low exposure to U.S. stocks and bonds.

Now that widely imitated asset- allocation strategy, dubbed the Yale model because of the enormous success of the Yale endowment under the 24-year leadership of David Swensen, is facing its sternest test amid the bear market of the past 12 months. Harvard and Princeton are assuming their endowments fell about 30% for the fiscal year ending June 30, while Yale is projecting a decline of 25%.

At one point, the endowments’ trail blazing approach was lauded by many investors as pure genius.  However, it is quite clear that their approach was much more similar to an average Joe investor who religiously purchased company stock in his 401k than to a market guru who could adeptly navigate through a changing investment landscape. It is true that they ventured into “alternative investments” and diversified away from traditional investments. However, bear markets – and liquidity crunches-wreak havoc on all types of assets. Ultimately, their “buy and hold” strategy that worked so wonderfully well during the bull market reign, failed miserably during the new market conditions.

Where Do We Go From Here?

Harvard, Yale and Princeton’s investment woes are emblematic of the struggles that most all investors have had deal with in the past year. Not only do they have to deal with the decline of their investment portfolios (in the case of the college endowments, it means cutting back jobs, etc), but they have to re-evaluate their investment strategy all together.  Should they revert back to their asset allocation models that employ one single trading strategy- buy and hold? Or should they consider a more strategy-focused model.

Strategy diversification is an investment portfolio tactic that focuses more on diversifying your funds across a variety of non-correlated investment strategies, than on diversifying it across different asset classes.  With asset allocation, the underlying assets are what determine whether or not your portfolio will make money.  For instance, if you happened to purchase gold at $300/ounce…and gold headed higher, it was the actual gold investment that contributed to your returns. With strategy diversification, however, investing in the actual trading strategies of the advisors will ultimately dictate your portfolio returns. (You can find out more about the different types of strategies by reading an article I wrote a year ago: Managing Wealth In A Bear Market)

From Asset Allocation to Strategy Diversification

Indeed, it can be argued that the asset allocation model that was developed by Wall Street has extreme limitations. While much of the focus on that model is based on diversifying among different asset classes and finding investments that are non-correlated to each other, the model failed to provide investors with the benefits that it has espoused over the past few decades.  Why? Well simply put, investors quickly found out that there investments were more highly correlated then they initially thought.

Had investors invested in other strategies that were not buy and hold, they might have had an opportunity to profit from the markets. Or, at the very least, soften the decline of their investment portfolios.

To be fair, the ferocity of what transpired in 2008 took many people by surprise. And it is also fair to say that there are legitimate benefits to implementing a buy and hold strategy. However, investors should learn from this recent decline and understand that “buy and hold” is one of many different strategies.  If portfolio diversification is ones true objective, strategy diversification is just as important- if not more so- than the underlying investments.

While some might argue that this analysis is backward looking, I made a similar point about the limitations of “buy and hold” strategies in July of 2005:

 ”Sometimes being fundamentally correct can be monetarily wrong. Too many advisors today espouse their economic views, while disregarding the idea that trends often ignore fundamentals and can last far longer than fundamentals may dictate. By stubbornly holding on to a certain view on the market, investors and/or advisors can either miss out on potential gains or may even give back some of their accumulated profits. ”

This is exactly what happened in 2008. The managers that stubbornly held onto their “buy and hold” strategies experienced losses in their client’s portfolios. Conversely, advisors that happened to participate in non-buy and hold strategies were able to have some profitable investments. Perhaps the most talked example is that of the systematic trend following strategy that some Commodity Trading Advisors employ. The trend following strategy was successful because the CTAs were able to trade both sides of the trend. Most trend followers made money as commodity prices were heading to record highs in the first part of the year, and they were also made money as they drastically retreated in the second part of the year.  

Even though trend followers are the most recognized of CTA strategies, it is important to point out that on a standalone basis, their strategy is no more diversified than that of “buy and hold.” In the same manner that there are market conditions that are not ideal for implementing a buy and hold strategy, there are also market conditions that are not ideal for trend-following strategies. As such, it is important to invest in a variety of trading strategies if one is to achieve a greater level of portfolio diversification.

Going forward, I believe that there will be a greater focus on strategy diversification. Investors will not put up with only having a “buy and hold” strategy in their portfolio. Rather, they will want to have portions of their portfolios that have the ability to profit from a diverse array of market conditions. Does this mean that all of these “non -buy and hold” strategies will make money all the time? No. It also doesn’t mean that “buy and hold” no longer has a place in an investor’s portfolio. However, it does mean that there will be a greater focus on investment strategies that are unique and can generate returns in a variety of market conditions. In short, investors will demand returns regardless of the dismal news, benchmark performance or market conditions.

Investing In Strategies

So where do you start? And how do you adequately put together an investment portfolio that invests in strategies?  Which strategies do you include? And how to you select the managers that trade those strategies?  For those of you who have an interest in this…

Balarie Capital Management will be holding a webinar titled, “Strategy Diversification: How To Build An Optimal Investment Portfolio”, which focuses on this subject matter. Please send an email to mfq@admis.com for further information and to sign up. Alternately, if you are interested in investing and would like to have a conversation over the phone, please request a free consultation here.

PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS.  THERE IS SIGNIFICANT RISK OF LOSS WHEN TRADING FUTURES AND OPTIONS. ALWAYS REVIEW A DISCLOSURE DOCUMENT BEFORE INVESTING IN ANY MANAGED FUTURES PROGRAM

Emanuel is Managing Director of Balarie Capital Management, the managed futures division of Archer Financial Services, Inc. Emanuel works with institutional and high net worth investors regarding their managed futures investments. After graduating from the U.C. Berkeley, Emanuel started his career working for the San Francisco branch office of Merrill Lynch.  After working for several other firms, ranging from dealing with commodities, stocks, futures, and alternative investments, Emanuel decided to combine his expertise and industry experience with the financial integrity and resources of Archer Financial Services, Inc.

Throughout his career, Emanuel has been an advisor to clients and institutions on the commodity markets and managed futures. His research has been published in many parts of the world, and he often speaks at national and international investment conferences. Balarie has appeared numerous times on CNBC, and is frequently quoted in dozens of financial publications such as, The Wall Street Journal, Reuters, Marketwatch from Dow Jones, Barron’s, MSN Money, and Bloomberg.

Mr. Balarie is also the author of the book, Commodities for Every Portfolio: How You Can Profit From the Long-Term Commodity Boom (Wiley 2007).

This edition focuses on risk and some of the trends that we expect to see in this sector.  Aleksey Matiychenko of Risk-AI, LLC writes about the importance of effective risk management and Emanuel Balarie discusses some of the trends that are likely to occur as a result of the current market environment. We also have an interview with Nicholas Pantazis of Dynahedge Capital Investments, who is featured in our Emerging Manager Spotlight. If you are an emerging manager and would like to be considered for this column, please email us at info@balariecapital.com.

Click here to view this quarter’s managed futures newsletter.

MFQ will be a free quarterly publication for investors in managed futures featuring a broad scope of information including interviews with industry leaders, profiles of emerging money managers, editorials and trading advice by specialists in the field.

BCM works with high-net worth investors, family offices, pensions, and endowment funds who are interested in adding managed futures to their investment portfolios. In addition, Balarie, through its affiliation with ADMIS, offers clearing and execution services for Commodity Trading Advisors, Fund of Funds, and professional traders. To find out more about all the products and services that BCM offers please visit: www.balariecapital.com

You can read more about this here.

Balarie Capital Management works with Pensions, Endowments, and Institutional Investors regarding their commodities and managed futures investments. Please contact us or access our managed futures database for more information.

You can download the report for free here: http://www.aima.org/en/knowledge_centre/education/aimas-roadmap-to-hedge-funds.cfm

Balarie Capital Management works with Pensions, Endowments, and Insitiutional Investors regarding their commodities and managed futures investments. Please contact us or access our managed futures database for more information.

“The Rydex Managed Futures Fund is a rules-based product that goes long or short physical commodities such as energy (long or flat oil, never short), metals and agricultural commodities and also long or short financial futures like currencies and Treasuries. Long or short depends on the relative strength of each underlying commodity or financial product.” (Read Full Article)

While the Rydex Managed Futures fund is the first managed futures mutual fund available for investors, it only represents the systematic trend following strategy of the managed futures universe. While the argument for systematic trendfollowers is often that they can profit both in up and down markets, it is important to point out that trendfollowing managers will offer incur declines in choppy or sideways market conditions.

Thus, while the markets have had major( up and down) trends during the past year, it should be noted that many trendfollowers have suffered major drawdowns during sideways or choppy markets.

So the question becomes…Will Rydex( or other mutual fund companies) come out with a suite of managed futures mutual funds that will encompass a wider array of strategies and markets?  Only time will tell. But I would imagine the success of this current fund will spur on additional mutual funds that will focus on the managed futures industry.

In the meanwhile, Balarie Capital Management continues to offer investors access to a wide variety of Commodity Trading Advisors who implement a wide variety of trading strategies and who trade different markets.  Please contact us or access our managed futures database for more information. Also, if you are interested in learning more about managed futures, please request our free managed futures brochure.

PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS.  THERE IS SIGNIFICANT RISK OF LOSS WHEN TRADING FUTURES AND OPTIONS. ALWAYS REVIEW A DISCLOSURE DOCUMENT BEFORE INVESTING IN ANY MANAGED FUTURES PROGRAM.

Does this mean that investing in hedge funds was simply a fad? I don’t think so. What this means is that investors will now focus even more on multi-manager portfolios than single manager allocations. 

However, not all multi-manager portfolios are alike.  The manager selection should go beyond correlation and other statistical measures. While these quantitative measures are valid, it is clear that they become skewed during uncommon market conditions.

There will most likely be a greater focus on diversifying among managers that differ on trading strategies, trading time frames, markets traded, whether they are systematic or discretionary traders, risk taken per trade, and more.  You will also continue to see a greater focus on transparency and more frequent liquidity.

Balarie Capital Management realizes that institutions and individuals have different investment profiles, risk requirements, and investment policy mandates. As a result, we shy away from cookie-cutter investment recommendations and implement a more consultative approach. Our financial and operational integrity, combined with access to over 400 Commodity Trading Advisors, allow us to create and monitor custom portfolios that meet your investment needs.

Balarie Capital Management works with Pensions, Endowments, and Insitiutional Investors regarding their commodities and managed futures investments. Please contact us or access our managed futures database for more information.

PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS.  THERE IS SIGNIFICANT RISK OF LOSS WHEN TRADING FUTURES AND OPTIONS. ALWAYS REVIEW A DISCLOSURE DOCUMENT BEFORE INVESTING IN ANY MANAGED FUTURES PROGRAM.

If you are a CTA that is looking at diversying your FCM exposure, we encourage you to contact Balarie Capital Management for for a custom proposal. Balarie Capital Management is a division of Archer Financial Services (AFS), a wholly owned subsidiary of ADM Investor Services, Inc. (ADMIS).

Consider, for instance, some of the biggest companies we have today. Microsoft was started during the recession of 1975, Hewlett-Packard was born during the Great Depression, Disney was founded during 1923, and GE started during the panic of 1873. The founders of these companies were all able to thrive during times of economic turmoil.

Not an entrepreneur?  No Problem. Recessionary environments also provide investors with investment opportunities. There will be opportunities to buy real-estate at undervalued prices, shares in companies at historically low P/E ratios, and perhaps even invest in start-up or emerging companies that might become the next Microsoft or GE.

But, before you start counting the wealth that you can possibly make during this recession, it is best to first start thinking about how you are going to protect it. Indeed, while a recession provides opportunities, it also creates an environment where many investors are often afraid to invest in value opportunities, or simply do not have the cash to participate.  This, of course, makes perfect sense. After losing money in the stock market, real-estate or other investments, not many people will have the “contrarian” courage to purchase value investments.  Additionally, many investors that have stubbornly held on to their present portfolio will simply not have the means to re-allocate their wealth.

As such, it is important to re-evaluate your financial situation and focus on protecting your wealth. While many pundits might still advocate buying into this market, I firmly believe that we are still in the early stages of a deep and long recession.  The first step is to focus on protecting your wealth. Once you protect your wealth, you allow yourself to invest in potential value opportunities that will inevitably arise.

Is Cash King?

So how exactly do you protect your wealth? Well, for many investors, the answer is simply to liquidate their positions and move everything into cash, money markets, or treasury bills.

The basic logic behind this move is simply that “cash is king”. In other words, while the stock market and real estate markets are declining substantially, keeping one’s money in cash will at least preserve what they currently have. It will also allow them to have money to invest in opportunities down the line.

While this logic makes sense in a non-inflationary environment, it fails to address the de-valuation of purchasing power that occurs during rising inflation. Simply put, rising inflation erodes at the purchasing power of cash or cash equivalent investments. In other words, while you might think you are preserving your wealth…you actually are not.

Not convinced? All you have to do is take a look at your current costs and compare them to your costs from 5 or 10 years ago.  You will quickly realize that you dollar does not buy what it used to buy. Consider, for instance, this hypothetical scenario.

Let’s assume that 10 years ago you retired from your job. For the previous 40 years, you worked hard to put enough money away so that you would enjoy a comfortable and relaxing retirement.  In preparation for your golden years, you put together a financial plan, calculated the potential costs of goods and services (using core CPI numbers), and decided that you had enough money to simply keep your wealth in a money market equivalent investment.

If you fast forward to today, you will quickly notice that the costs of goods and services are substantially higher that what you or your advisor had initially calculated. While you received some interest on your money, it by no means made up for the rising costs that have occurred around you.  In addition to record food and energy prices, you are now paying for your prescription medication, your cable bill, recreational activities, and travel costs.  You had even planned to help pay for your grandkid’s education, but are now noticing that tuition costs are also rising at quick pace.

If are your living this above scenario, you are quickly understanding that cash- or any type of fiat money- does not preserve your wealth.  Your wealth has eroded at a faster pace than you initially projected, and your purchasing power of your money has declined substantially over the past decade. Why is this? Well, a big reason has to do with the exponential growth rate of our money supply. While the Fed no longer reports the growth of the M3, the following chart can still give you an idea of the exponential increase of money that the fed has injected into our economy.

What is the result of an increase in the money supply? More money floating around. What is the impact of more dollars bills floating around?  It dilutes the purchasing power of the dollar that you have in your pocket. There is now too much money chasing too few goods.

The Fed has cranked up the printing press since the mid 90’s and the recent turmoil in the markets is forcing them to crank it up a notch higher. In fact, this is why I believe that the government’s current bailout package misses the point. Flooding the market with liquidity is simply robbing Peter and paying Paul. Investors who did not participate in the speculative investments of the last several years are now forced to pay for them, whilst inflation will continue to erode the purchasing power of their savings. You can read my comments here:

So how exactly do you preserve wealth? And how do you keep your wealth so that you can participate from these potential value investments? Here are some ideas:

•1)      Short- Term Treasury Bills

Even though I have cautioned against holding all of your wealth in cash- especially for the long-term- I still believe that it makes sense to hold some of your wealth in cash during these volatile markets.  In my opinion, you should not hold cash deposits that are higher than the FDIC insured levels. If you have additional money that you want to hold in cash, you should consider purchasing short-term treasury bills.

•2)      Gold

The price of gold has increased substantially over the past 7 years, but today might be one of the better times to allocate a portion of your portfolio towards gold.  In the first stage of this gold bull market, many investors were too focused on their profitable stock and real-estate investments to allocate towards this sector.  Today, it is becoming increasingly clear that gold’s tangible qualities go beyond capital appreciation.

Historically, Gold has served as a hedge against inflation, a hedge against a declining US dollar, and a hedge against times of economic and political crisis.  While many naysayers argue that gold is no longer money, but simply an archaic relic, gold’s actions over that past several years clearly prove otherwise.  Indeed, gold is the only currency in the world that has successfully preserved wealth for generations.

Consider allocating to gold bullion, gold coins, or gold futures.  If you are interested more about gold bullion or gold futures please info@balariecapital.com

•3)      Look For Trading Opportunities

I have long argued that buy and hold only makes sense if you buy when you are young and sell when you are old. First, many investors that subscribe to “buy and hold” will often not be able to stomach long periods of declines. In many cases, these investors will often exit their holdings right near the bottom. And even if investors were able to withstand the substantial decline, they will often miss out on better opportunities.  Don’t be afraid to sell your losing positions if you feel that there are better investments to make.  Also, consider trading for the short-term.   While the markets are volatile, they are also providing investors with trading opportunities.

•4)      Commodity Trading Advisors/ Managed Futures

If you are not a trader or familiar with commodities, consider allocating money with Commodity Trading Advisors. The term “Managed Futures” defines an industry that is made up of professional money managers- known as Commodity Trading Advisors- that trade client funds on a discretionary basis using a variety of alternative investment strategies. This is somewhat similar to investing with a mutual fund manager that ultimately decides what type of stocks to buy and when to buy or sell the stocks.

There are, however, a couple major differences. The first has to do with the fact that Commodity Trading Advisors strictly trade in the futures and foreign exchange markets. Hence, the term- managed futures. The other difference is that the manager can use a wide range of trading strategies that are not available to traditional managers.

Learn more about Managed Futures or request access our free CTA database where you can get performance reports on several hundred Commodity Trading Advisors.

If you would like to learn more about the above strategies, please do not hesitate to contact me.  This is not a time to be glued to the television- it’s a time to act.

Light At The End Of The Tunnel

While our economy first has to pay for the irresponsible lending practices, real-estate speculation, and wall-street greed that brought us into this situation, I fully believe that there is a light at the end of the tunnel. Unfortunately, this tunnel is much longer than most people will anticipate. Instead of focusing on what the government might or might not do, investors should focus on what they can do to protect themselves from this prolonged recession and rising inflation.  And perhaps, you might even be one of those investors who can profit from this tumultuous market environment.

Best,
Emanuel Balarie

Emanuel is Managing Director of Balarie Capital Management, the managed futures division of Archer Financial Services, Inc.  Emanuel works with institutional and high net worth investors regarding their managed futures investments. After graduating from the U.C. Berkeley, Emanuel started his career working for the San Francisco branch office of Merrill Lynch.  After working for several other firms, ranging from dealing with commodities, stocks, futures, and alternative investments, Emanuel decided to combine his expertise and industry experience with the financial integrity and resources of Archer Financial Services, Inc.

Throughout his career, Emanuel has been an advisor to clients and institutions on the commodity markets and managed futures. His research has been published in many parts of the world, and he often speaks at national and international investment conferences. Balarie has appeared numerous times on CNBC, and is frequently quoted in dozens of financial publications such as, The Wall Street Journal, Reuters, Marketwatch from Dow Jones, Barron’s, MSN Money, and Bloomberg.

Mr. Balarie is also the author of the book, Commodities for Every Portfolio and Editor of CommodityNewsCenter.Com

The risk of loss in trading futures and options contracts can be substantial. You should therefore, carefully consider whether such trading is suitable for you. Past performance is not necessarily indicative of future results.

One reason for why Harvard Endowment has been able to post positive gains in the midst of a declining stock market has to due with their steady decrease in allocation towards the equities sector and their increase in allocation towards the real assets, commodities, and absolute return sectors. (View the endowment’s investment policy)

From The New York Times:

“Harvard said that its domestic equity holdings, which account for 12 percent of the portfolio, lost money but outperformed its benchmark, while its foreign equity holdings also fell, declining 12.1 percent, a percentage point more than the benchmark.

Its emerging market holdings and private equities holdings exceeded their benchmarks by about 3 percent. Harvard also beat its benchmarks for domestic, foreign and inflation-indexed bonds. That sector accounted for 15 percent of the portfolio and in each case outperformed the indexes from 2.8 percent to 4 percent.

Its real assets – liquid commodities, timber and land and real estate – beat the benchmarks by nearly 3 percent.

The disappointments were absolute return funds, or hedge funds, which rose 0.1 percent (the benchmark was a 1.8 percent increase) and the high-yield sector, where Harvard’s holdings fell 8.3 percent while the index rose 0.7 percent. About 1 percent of Harvard’s total portfolio is allocated to high yield. ” Read Full Article

Balarie Capital Management works with Pensions, Endowments, and Insitiutional Investors regarding their commodities and managed futures investments. Please contact us or access our managed futures database for more information.

PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS.  THERE IS SIGNIFICANT RISK OF LOSS WHEN TRADING FUTURES AND OPTIONS. ALWAYS REVIEW A DISCLOSURE DOCUMENT BEFORE INVESTING IN ANY MANAGED FUTURES PROGRAM.