The Investment Scientist

Managed commodities can counter volatility…NOT

Posted on: July 9, 2012

While reading USA Today at Panera Bread, I came across an article with a headline that blared: “Managed commodities can counter volatility.” You should have seen the chagrin on my face; you would have thought I was a facial contortionist.

How could such an uninformed article ever get published by a major newspaper? Just imagine the large number of people who will be misled by this article to put money into a financial product they don’t understand.

The claim of this article is based on a comparison of a managed futures index and the S&P 500 index. The managed futures index was compiled by a private firm called Barclay Hedge, basically a marketing arm of the managed futures industry.

There are major problems with the index’s construction:

  1. Barclay Hedge does not have regulatory or oversight power over managed futures operators (aka, commodity trading advisors). In other words, those advisors who have a good year will no doubt report their returns, while those who don’t are free NOT to report their returns. This is called self-selection bias.
  2. Managed futures operators that went kaput would not be there to report their returns. So the worst performances are automatically eliminated from the index. This is called survivorship bias.
  3. Volatility can be manipulated downward and returns upward. Let me show you how.

Example: Managed future A had two-year returns of -50% and +70%; managed future B had two-year returns of +70% and -50%. Investors in both managed future A and B lost 15% in two years. (1-50%)*(1+70%)-1 = 85%-1 = -15%.

Now let me construct a managed futures index that is the average returns of managed future A and B. The two-year index returns would be (-50%+70%)/2=10% and 10%. The two-year cumulative return of the index would be 21%.

See, it’s like magic. Investors could lose 15% and the index could still show a 21% gain! And the volatility just magically disappears!

It’s sad that 99% of financial articles in mass circulated magazines and newspapers are at best junk, at worst hazardous to your wealth. I can’t blame it all on the reporters, though; most of the time they don’t understand what they are writing about. Counting on them for good advice is like a blind man riding a blind horse: you just hopes they are not near a cliff.

Get my white paper: The Informed Investor: 5 Key Concepts for Financial Success.

9 Responses to "Managed commodities can counter volatility…NOT"

Michael, while there are CTA indexes that are corrupted by survivorship bias, Barclay’s publishes the BTOP 50 index which is an investable index of the largest commodity trading advisors and those CTAs are included in the index for each entire year. Because of this there is no survivorship bias in the index. What you see is what you get.

Mike, thanks for the comment.

I have to look into their construction to determine whether it is indeed free of survivorship bias. Even with that, it’s hard to conclude it is free of self selection bias. I follow a local CTA that routinely offer tens of nicely named strategies to its clients. Some strategies did fabulously well, some did horrible, like losing 70% a year. If the strategy did badly, it is dropped from their offer menu and a newly named one is started. So all the strategies in their menu look very good. I am sure all these major CTAs have multiple strategies as well, how they report their performances is entirely their discretion.


I agree that there are many CTA that offer multiple programs and that ones that underperform simply disappear (kind of like mutual fund companies’ fund offerings!). BTOP 50 is different. Barclay Hedge selects the CTA programs it will follow, and then it follows them throughout the year. It is reconstructed at the end of the year to once again contain the largest CTA programs necessary to represent 50% of the assets in the industry. So a CTA or its program can’t drop out mid-year due to poor performance.

Mike, thanks for the explanation. How do they construct the index? Weighted average or simple average?

Michael, Here’s the link to the explanation for how the BTOP 50 is constructed:

It doesn’t mention equal or dollar-weighting, but I’m pretty sure it’s dollar-weighted.

Attain Capital Management wrote a really good piece on the different managed futures indices:

Michael (and Mike),
How is following a fund for only one year any indication of a fund being good or bad? Sounds like that is enough time to see if it is lucky, but not to show a good long term strategy. They’re selecting the top 50% by assets which are at least 3 years old, so these are the popular funds and short term survivors by definition.
If someone is interested in tracking good funds for long term capital gains, then doesn’t the ‘reconstruction’ of this index every year kill that ability? By the BTOP50’s own selection criteria, a marginal fund would drop out in bad years and reappear only in good years. A lucky then unlucky fund could appear for a few years, then drop out, and advertise only the years it appeared in the BTOP 50. In this way, wouldn’t a bad fund still look good, even if it lost more than it gained? This appears pretty much the definition of survivorship bias. How is this index useful to anyone who is a long term investor instead of a short term speculator?


Very good point you brought up. I don’t even think the index reveal much for short term speculator.

In my previous life as a hedge fund manager, I dealt with index companies, I know the tricks they pull to make their index look good because they told me as such.

Then you read Burton Malkiel’s dissection of hedge fund returns and Fama and French’s papers on commodity investments, natural you become skeptical about all claims that sounds too good to be true.

Fama and French basically say the commodity futures markets are zero sum game. Not counting transaction costs, the aggregate participant must break even. The aggregate participant is made up of speculators (CTAs,) and hedgers (commodity producers). Many years ago, Prof Robert Merton did a study that found that speculators lost money to hedgers. He even joked speculators are offering a free social service since they pay to take on risk.

How CTAs make money if the aggregate of them lost money? they make money from clients who gave them money to speculate. Their clients are the dumpest money of all, paying CTAs a hefty fee to lose money.

That’s why I am so agitated by the article on USA Today and on CMBC by the same Jack Waggoner.

Michael, when investors are new to the managed futures space, I often hear them bring up the point of staying away from managed futures simply because they believe there is survivorship bias in the indices.

However, they are more then happy to invest in equity indices even though those indices have survivorship bias. Time and time again stocks are added and dropped from stock indices, but no one complains about it.

Could you explain why you believe investors are dumb for investing in managed futures? What data do you have to show it should not be considered when an investor is seeking to reduce tail risk and correlation risk?

You may want to check out for some research on managed futures.

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Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.


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