Managed Futures Today Magazine

John Hummel is president and CIO of AIS Group (www.aisgroup.com), a Wilton, Conn.-based investment firm that has been operating both futures- and equity-based funds since 1992.

Controlling risk in a managed futures program takes many forms — everything from properly selecting markets to allocating capital and sizing positions. But limiting losses is also accomplished through the same tool frequently used by individual investors — the stop order.

QFS Asset Management takes a unique view of managing money and profiting from the markets. It focuses on risk first and foremost, and then it builds an expected return model from within the risk model. But that “upside-down” process comes naturally to chairman Sanford Grossman, Ph.D.,  and CEO Karlheinz Muhr.  They both built investment firms based on risk management. Sanford Grossman founded QFS in 1988 and Muhr co-founded Volaris in 1999 (later sold to Credit-Suisse) and Cenario Capital Management in 2009.

Investors are routinely advised to diversify as a means of risk reduction. At its core, diversifica­tion is simply a way to mitigate the risk of having all your eggs in a single basket: Any single stock, futures market, currency, or option can suffer a unique shock that could devastate returns. By holding multiple uncorrelated assets — i.e., those that are unlikely to move similarly most of the time — you gain protection against single-asset shocks.

Published each week by the Commodity Futures Trading Commission (CFTC), the Commitments of Traders (COT) report details the positions (“open interest”) of different types of traders in the U.S. futures (and options on futures) markets. The release reflects 70 to 90 percent of all positions in each market; the CFTC only includes positions that meet or exceed specific thresholds for each market (e.g., 400 or more Japanese yen futures contracts).

While many newer investors often treat different assets identically — buying the same number of shares of different stocks, for example — one of the distinguishing characteristics of professional portfolio managers is knowing that varying position size is an integral aspect of their business. If a managed futures program is designed to diversify across all liquid U.S. futures, for example, it cannot simply buy or sell the same number of contracts in all markets. Trading one T-bond contract is not the same as trading one natural gas contract.

Although the majority of professional futures fund managers trade systematically — at least to a significant degree — there is still a great deal of confusion about what systematic trading really is. Often associated with complex computerized trading approaches, systematic trading is just a way of methodically defining trade goals and risk controls, from the portfolio level to the individual trade level.

If you asked most investors whether they wanted a 10-percent return or an 8-percent return, in addition to a puzzled expression you might also receive a hand on your forehead in an attempt to determine if you were running a fever. Two percent extra is two percent extra.

In casual conversation, any investor would naturally assume “All else being equal” is implied in the question. But little is ever equal with different investment opportunities, and the primary inequality comes in the amount of risk or uncertainty you have to accept to achieve your investment goal.

Trend-following trading systems have long been a favorite of futures traders, and the approach is probably used by more professional futures fund managers (“commodity trading advisors,” or CTAs) than any other method. Although the details of how professionals execute trend-following trading approaches can become quite complex, the underlying principles and tools of this school of trading are consistent across time frames, markets, and traders.