Investment Strategy: Risk Parity

Some say that the benefits of diversification are enhanced by "risk parity" strategies.  The Financial Times had a good article on this increasingly-popular investment approach.

... (The) formula for diversifying is not to spread money equally between asset classes, but to spread risk, in a concept known as risk parity.

This approach allows investors to specify the risk they can accept, measured by volatility, then maximise the return they can get for that risk.

Please read more here:
http://www.ft.com/cms/s/0/10cd4030-af0b-11e1-a8a7-00144feabdc0.html#ixzz1xU1ox0JG

Risk Parity approaches have been growing in popularity.  However, the use of leverage for some of the lower risk approaches means that this strategy is not for everyone.  Some investors -- and especially institutional investors -- prefer to avoid leverage.  Indeed, the investment policies of some large institutions prohibit the use of leverage.

Our work and investment approaches are similar to risk parity methods.  In addition, our strategies adjust portfolio allocations / mixes based on technical and fundamental indicators and market action.

Alternatives in the News

How Managed Futures Fit into Your Portfolio

In a nutshell, what managed futures provide is an important non-correlated asset that any serious investor should have in their portfolio. Statistical studies—academic studies—suggest that that should be anywhere from 5% to 15% of a portfolio.

Some people say, “Well, it should be held for three to five years.” I would posit that it should be held as long as you own equities and/or fixed income in a portfolio, because of the diversification effects.

What we’re trying to do is to provide some stability. One of my colleagues likes to suggest that it’s the seatbelt in the portfolio. You get into a car, you’re in a high-performance car, you still want to put a seatbelt on in case there’s an accident.

Read more here:

http://www.forbes.com/sites/katestalter/2012/01/17/how-managed-futures-fit-into-your-portfolio/3/

Bruising Year for Commodities Hedge Funds

The drop came as multibillion-dollar commodities hedge funds such as Blenheim, Clive Capital, BlueGold and Merchant posted double-digit losses for the year.

Some of the industry’s best-known managers were hardest hit. Blenheim, which has $5bn in assets, posted a loss of about 17 per cent, according to three investors. The fund, founded in 1988 by trader Willem Kooyker, suffered its worst month since inception in September, weighed down by bets on corn and aluminium, an investor said.

(May need free registration at FT.com)

http://www.ft.com/cms/s/0/9179ec9a-4c2f-11e1-bd09-00144feabdc0.html#ixzz1lLDjfXjv

Interview with Carlton Chin of CARAT / Adamah Capital

I truly believe that the best way to enhance diversification is through managed futures. A lot of hedge funds will use the same basic building blocks - using stocks and bonds - while managed futures uses everything from currencies to commodities. That really adds diversity to a portfolio.

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I love to look, especially for hedge funds and managed futures, at downside volatility. We can look at the standard deviation of the S&P 500, which over the past 30-plus years is 15.6 percent. Interestingly, if you look at the downside volatility, that is 11.7 percent. So the scary, or downside volatility, represents 75 percent of the overall volatility. This is one place where managed futures shines because based on a series of returns, mostly the BarclayHedge CTA Index but also my performance, the volatility has been 17 percent in total. The standard deviation is about 17 percent which is a little higher than the S&P 500 but if you look at just the downside volatility, when the performance for managed futures was negative, that number is just 10.1 percent.

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I’ve been lucky to work with some folks at the University of Chicago -- and Frank Vannerson was from Princeton. These academic studies can add credibility as well, and show that managed futures/alternative investments have benefits.

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Carlton Chin is chief investment officer and head of research at CARAT/Adamah Capital LLC, a fund manager and CTA focused on systematic managed futures strategies. An investment professional since 1990, he spoke with Managed Futures Newsletter editor Jim Kharouf about his start in the business, whether markets change and how he looks at volatility.

Read more here:

http://www.jlnmanagedfutures.com/2012/02/five-minutes-with-carlton-chin.html

On Diversification & Active vs. Passive Management

In our work and research related to portfolio optimization, asset allocation and quantitative investment strategies, we use historical data and seek to maximize “forward information.” Our goal is to improve risk-adjusted returns and achieve prudent diversification.

In a recent article on Managed Futures and Commodities, we reviewed the performance of several asset classes during 2011 (through the end of November). Some investors noticed that the actual performance of some key asset classes outperformed professionally-managed funds. For instance, the S&P 500 is actually positive (+1%) as of the end of November, beating many actively-managed funds. In addition, because the S&P 500 was positive – along with government bonds (intermediate-term government bonds are +8% through November) – some investors are surprised to see Global Macro approaches down for the year.

Active versus Passive Management

Based on the performance of the S&P 500 and government bonds so far in 2011, we can see that a simple 60% stock / 40% bond mix would have eked out a small, but positive return, through the end of November. Why, then, are Global Macro, as well as many stock funds – and so many hedge fund categories, down for the year?

Professional portfolio managers are paid to manage risk. In the case of the stock market, we have seen very large swings – and money managers need to protect their clients and portfolios from large declines. In 2011 alone, the S&P 500 had at least five declines of 100 S&P points, or relatively large declines of about -7.5%. These declines took place in March, May, August, October and November. The August decline totaled about 200 S&P points, or about a -15% decline.

Read more here:
http://seekingalpha.com/article/314209-diversification-active-vs-passive-management

Carlton Chin, CFA, is the portfolio manager for ADAMAH Capital, which specializes in Computer Aided Research & Advanced Technology (CARAT). He is a specialist in quantitative investment strategies, managed futures, alternative assets, global macro & strategic asset allocation. Carlton combines a CTA hedge fund background with portfolio optimization work for institutional investors. 

Managed Futures: Performance & Diversification

Some of our readers know that our specialty is "alternative investments." We believe that alternative investments such as commodities, managed futures, and other diversifying strategies offer good diversification benefits to a traditional portfolio of stocks and bonds.

CARAT Capital was originally started to combine concepts of Modern Portfolio Theory, downside measures of risk, and robust trading systems. CARAT is an acronym for Computer Aided Research & Advanced Technology. Today, all money management activities are handled byAdamah Capital, a firm founded by Carlton Chin, CFA and his long-time friend and associate, George Parr.

Managed Futures have had a nice run over the past several months. Please check out the performance of our Diversified Program, tracked by a third-party firm. Carlton Chin, has a solid longer-term track record. Over time, managed futures have proven to earn returns from opportunities in the futures markets -- that are non-correlated to traditional assets such as stocks and bonds.

Please visit our websites and contact us for more information.

Article on Commodities Indices, Managed Futures & Diversification

As gold has continued to rally to all-time highs, there has been increased interest in gold, commodities, and managed futures as “diversification plays.” Indeed, these “assets” have been receiving increasing attention as true “asset classes” that offer good risk/returns and diversification benefits – for a traditional portfolio of stocks and bonds.

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A “buy and hold” commodities approach has proven to be a solid diversifier over the years. However, just like “buy and hold” stock strategies have come under fire, the 2008 decline in commodities has led some investors towards actively “managed futures” as a good alternative investment.

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During the 2008 financial crisis, many managed futures programs were able to profit from the extreme moves, with the Barclays CTA Index posting a +14.1% return.

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For the complete article, please visit:

http://seekingalpha.com/article/226247-commodities-managed-futures-and-diversification

Risk Management, Kurtosis, Skewness & Extreme Value Theory

My article at SeekingAlpha.com was published as a full-fledged article - and I am now an official "Contributor" at their website. Someone asked a few good questions that I answered on the website. I also copied it below, since I thought it was good information.

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More realistic estimate of probabilities: I like semi-deviation as an easy-to-explain measure (volatility and risk to the downside). Additional measures that help describe return distributions -- would involve calculating additional "moments" such as skewness and kurtosis (the fat-tailed distributions that many investment strategists strive for = minimize losses, fattening profits).

More on Semi-Correlation: Semi-correlation is somewhat similar to correlation, except it studies periods where certain assets decline. This can give a "true" measure of diversification during financial crises.

There is also a branch of statistics that studies the probability of big dislocations such as crashes in markets (Extreme Value Theory) - which is very interesting...

My Article at SeekingAlpha - Portfolio Optimization and Rising Correlations

Here's a link to my article at SeekingAlpha.com.

In particular, it talks about "true" diversification amidst rising correlations and the evolving world -- and some implications for portfolio optimization. I show a tool I developed that I call semi-correlation. This statistic can show which asset classes offer more "true diversification" when many assets start moving together in a financial crisis.

http://seekingalpha.com/article/215457-portfolio-optimization-with-rising-correlations-and-an-evolving-world

Sports Investing Book # 1

I was asked to help edit a book on "Sports Investing" -- which applies concepts of contrarian investing to the sports marketplace. The book has been holding the # 1 spot in Amazon's "Sports>Gambling" category.

The academic viewpoint will interest everyone from the casual sports bettor trying to improve results - to the professional sports gambler looking for additional angles - to the Wall Street trader researching additional markets to trade.

Public sentiment and betting activity cause the sports marketplace to act irrationally, in a way which can be measured and exploited. The massive flow of public wagers force betting lines to fluctuate like an inefficient market. Point spreads, betting line movement, public betting percentages, money management, statistical analysis, and other important topics are studied. The implementation of contrarian investing – and theories such as "Betting against the Public" and "Smart Money" are developed.

Collecting Volatility

We had a huge snapback rally in April following the sharp decline into March. Since that time, stocks have been generally calm with a slight upward trend. This "calm" market action has released some of the "fear" in the marketplace. May was up around +8%; while June is currently down -2.5%. This has allowed us to collect volatility in the marketplace over each of the last two months.

Premium Members who used our approach of "collecting volatility" had some good diversification for their stock portfolios these past few months. This system collected near the expected maximum of around 4% in both May and June.