Managed commodities can counter volatility…NOT
Posted July 9, 2012on:
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:
- 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.
- 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.
- 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.
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