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Opalesque Futures Intelligence

Sweden's RPM: the largest managed futures manager few in the U.S. Know

Friday, December 02, 2011


Innovative Approach to Managed Futures Portfolio Allocation and Risk Management Found in Sweden


When it comes to managed futures, Sweden's RPM (Risk & Portfolio Management) is among the largest and more respected institutional managers, overseeing over $6 Billion of client assets mostly emanating from Japan and Europe.あ What makes the firm unique is not only the firm's longevity - with a performance track record dating back to 1993 - but the commodity pool's interesting commodity trading advisor (CTA) allocation and risk management system that considers market environment, market correlation and adjusts risk and leverage accordingly.

"We take a macro market environment outlook as it relates to managed futures risk management," said Mikael Stenbom, the CEO and founder of the firm, who sat down for a rare interview to discuss the firm's methods on managing a CTA investment by recognizing market environments.

The RPM managed futures portfolio system might be considered one of the more sophisticated approaches due to its use of these proprietary market environment risk management indicators.あ This isあ coupled with correlation analysis and worst case scenario planning, which is then communicated to clients on a daily basis.

According to Mr. Stenbom, RPM's primary indicators include the Coordinated Market Selloff Indicator, which considers the potential for markets in general to reverse course; the Market Friendliness Index, which determines the force of a market trend; the Economic Surprise Index, which measures the surprises in economic statistics and then relates this analysis to the strength of the trend following market environment.あ The firm also utilizes methods to analyze correlation of various CTAs to one another, utilizes a method to invest in various CTAs on a drawdown and considers market positioning on a daily basis, analyzing worst case scenarios relative to expected returns. These indicators do not predict the future with a crystal ball, but rather help RPM determine their opinion on mathematical probability.

"If we accept that markets are at times inefficient, we thought that we might find statistics or measures of market behavior give us a clue as to the probability of occurrence of such reversal events in the future," Mr. Stenbom said. "We cannot predict the behavior of any individual market.ああ What we can attempt to determine is the general behavior of the markets as an aggregate.あ The traders, the CTAs, are looking at individual markets, the sectors.あ As a portfolio manager we are taking more of a macro approach."

RPM's market environment indicators are generally not geared to a specific market or sector, but are rather general in nature.あ "We are looking at all financial and commodity markets as one.あ We look at correlation and volatility of all markets and make portfolio management decisions to re-allocate or reduce manager exposure accordingly," he said.
"The genesis of all the indicators spring from the same approach: market decisions are not always rational and markets are not always efficient."あ The Coordinated Market Selloff Indicator is one such example, attempting to determine when the market "crowd" is all moving in the same direction near a market top, for instance.

Coordinated Market Selloff Indicator:

Perhaps RPM's most significant indicator, according to Mr. Stenbom, is one that determines the potential for a trend reversal to enter markets.

"There has been an increase in the frequency in seemingly random market reversals," he noted.あ "Such reversals typically occur in environments where the speculative activity is high, at the peak of equity bull markets.あ We observed the frequency of reversals occurs at this point, impacting trend followers as well as long only investors."

The Coordinated Market Selloff Indicator is designed to address these issues because it is based on the degree of speculative positioning, namely the recent performance of risk seeking strategies and general consensus in positioning of market participants.あ "When this indicator reaches a high level, then RPM may reduce exposure to trend followers or those traders that are positioned the same way as the general consensus.あ We also may reduce positioning in traders who typically employ "sticky positions," that is a trade position slow to change.あ When the indicator reaches a high point, we might increase allocation towards traders that utilize a shorter term time horizon, are more nimble and may benefit from short term volatility."あ Different trend following programs can exit trades or reverse positions at different times, which is a component of the CTA's risk management plan.

Market Friendliness Index

While the Coordinated Market Selloff Indicator might determine when a market trend has potential to reverse, the Market Friendliness Index attempts to determine the strength of the trending market environment.

"We measure the absolute price move over corresponding volatilities over different time horizons," Mr Stenbom noted.あ "We correlate the time window based on the individual trader's trade execution strategy.あ For instance, a long term trend follower this measure could be calculated over a 90 day rolling period, a medium term trend follower might potentially have a 60 day rolling window while a shorter term trend follower might have a 30 day rolling window."

In 2008 the index indicated a very favorable environment for trend followers, while 2009 the trend index identified weak conditions for trend following, according to Stenbom.あ "In 2008 the stress in the markets were so intense, investors were scrambling to get out of the same door at the same time.あ They wanted to reduce their equity exposure, increase their fixed income positions, reduce their long only commodity positions, buy the U.S. dollar.あ Essentially risk assets were sold and safe haven assets were purchased.あ Trends in all other markets were really expressions of stress in the equity markets."

This market stress that occurred during the 2008 time period culminated with one of the best environments for trend following programs, which generally ended higher on the year, with the Barclay Systematic (Trend Following) Index up 18.16%.あ Contrast this with 2009, where a generally trendless market environment produced the third worst yearly performance in the history of managed futures indexes.

Economic Surprise Index

Another innovation is the use ofあ Economic Surprise indices.あ Another counter-intuitive model, these indicesあ attempt to determine the level to which economic numbers are surprising markets.あ Environments where surprises are generally occurring imply a correlation to trend following, in Mr. Stenbom's opinion.

"An Economic Surprise index is a mean reverting time seriesあ where realized economic statistics such as jobless claims, housing starts, etc., are correlated with expected statistics .あ When that index is in negative territory, meaning the investing world is negatively surprised by economic numbers, that tends to correlates highly with trend following performance," Mr. Stenbom said, providing interesting insight.

Investing on a Drawdown:

Interestingly, RPM uses many of its indicators as a counter-intuitive measure, investing in various strategies after they have experienced a sustained period of negative performance.あ "Typically we increase allocations to various strategies after that strategy has experienced a sustained period of negative returns," Mr. Stenbom said.あ The strategy is to accumulate a stable of what it considers strong CTAs and then invest in these CTAs when they reach their average drawdown point.あ "This significantly increases the expected rate of return over the first year."

While investing in a drawdown of the wrong CTA can lead to enhanced risk, the RPM approach of recognizing when to allocate to appropriate managers has been utilized as a key component of the firm's portfolio management regiment.あ "Investing in drawdowns is one key to success in managed futures," Mr. Stenbom said.あ "This is counter -intuitive for investors.あ Investors have great difficulty with this concept, and typically invest exactly when they should not invest, at the point of an equity peak."

The RPM approach is to invest around one standard deviation below the mean and reduce exposure when, say, 1 た standard deviations above the mean.あ "Time series has a memory in it and cyclicality to it.あ It is not easy to exploit but it is exploitable," he said.あ "Ideally we may have a low reading on the Market Friendliness Index, a low reading on the Coordinated Market Selloff Indicator, if we have a seasonality situation, if the Economic Surprise Index is below zero.あ This is an ideal allocation point."

Risk management and Diversification

"Occasionally we have situations where a majority of different strategies in the world are essentially in the same position," noted Mr. Stenbom, highlighting a truth of computer-based trend following algorithms and how they may react, particularly during times of crisis when markets may be strongly trending in one direction.あ This type of high correlation of position concentration is considered a risk factor.

Risk management through diversification is an important component of the RPM portfolio management process.あ On a daily basis, RPM calculates various worst case scenarios. "We ask the what if all positions in CTA accounts move against us by two standard deviations? What would be the expected negative rate of return on a daily basis." Such worst case risk management projections are communicated to clients on a daily basis.

A key component of RPM's portfolio risk management occurs through diversification, where they are considering the impact of a breakdown in correlation structure of various CTAs and then considering the economic impact, looking at the relationship between inherent risk and observed risk.あ In this case, RPM considers the expected returns and the worst case scenario returns, and this points to the effectiveness of diversification, he said.あ "A high degree of diversification in a CTA portfolio is generally considered as good. But the flip side to diversification is that it implies a high dependence on correlation stability. When standard risk measures like VaR is significantly lower than our stress measures, then proper portfolio adjustments are considered."

Risk Disclosure:

MANAGED FUTURES IS NOT APPROPRIATE FOR ALL INVESTORS.あ IT CAN INVOLVE VOLATILITY AND RISK OF LOSS.

While this article is written with balance and accuracy in mind, the content is designed for sophisticated qualified eligible persons.あ It is not appropriate for all individuals.あ
Qualified Eligible Person as defined under the (CFTC) Regulation 4.7., because they are: Registered investment company; Bank; Insurance company; Employee benefit plan with >$5,000,000; Private business development company Organization described in Sec. 501(c)(3) of the Internal Revenue Code with >$5,000,000 in assets; Corporation, trust, partnership with >$5,000,000 not formed to invest in exempt pool; Person with net worth >$1,000,000; Person with net income >$200,000 each of last 2 yrs. or >$300,000 when combined with spouse; Pool, trust separate account, collective trust with >$5,000,000 in assets; あUserあalso confirms they meet the following Portfolio Requirement: Own securities with a market value >$2,000,000; Have had on deposit at FCM, in last 6 months, >$200,000 in margin and option premiums; Have combination of securities and FCM deposits. The percentages of required amounts must = 100%.

Opinions:

User represents themself to be a sophisticated investor who understands volatility, risk and reward potential.あ User recognizes information presented is not a recommendation to invest, but rather a generic opinion, which may not have considered all risk factors.

User recognizes this web site and related communication substantially represent the opinions of the author and are not reflective of the opinions of any exchange, regulatory body, trading firm or brokerage firm. The opinions of the author may not be appropriate for all investors and there is no warrantee relative to the accuracy or completeness of same.あ The author may have conflicts of interest, a disclosure of which is available upon request.あ

RISK DISCLOSURE

PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS.

THE RISK OF LOSS IN TRADING COMMODITIES CAN BE SUBSTANTIAL. YOU SHOULD THEREFORE CAREFULLY CONSIDER WHETHER SUCH TRADING IS SUITABLE FOR YOU IN LIGHT OF YOUR FINANCIAL CONDITION. THE HIGH DEGREE OF LEVERAGE THAT IS OFTEN OBTAINABLE IN COMMODITY TRADING CAN WORK AGAINST YOU AS WELL AS FOR YOU. THE USE OF LEVERAGE CAN LEAD TO LARGE LOSSES AS WELL AS GAINS. YOU COULD LOOSE ALL OF YOUR INVESTMENT OR MORE THAN YOU INITIALLY INVEST. IN SOME CASES, MANAGED COMMODITY ACCOUNTS ARE SUBJECT TO SUBSTANTIAL CHARGES FOR MANAGEMENT AND ADVISORY FEES. IT MAY BE NECESSARY FOR THOSE ACCOUNTS THAT ARE SUBJECT TO THESE CHARGES TO MAKE SUBSTANTIAL TRADING PROFITS TO AVOID DEPLETION OR EXHAUSTION OF THEIR ASSETS.

THE DISCLOSURE DOCUMENT CONTAINS A COMPLETE DESCRIPTION OF THE PRINCIPAL RISK FACTORS AND EACH FEE TO BE CHARGED TO YOUR ACCOUNT BY THE COMMODITY TRADING ADVISOR ("CTA"). THE REGULATIONS OF THE COMMODITY FUTURES TRADING COMMISSION ("CFTC") REQUIRE THAT PROSPECTIVE CUSTOMERS OF A CTA RECEIVE A DISCLOSURE DOCUMENT WHEN THEY ARE SOLICITED TO ENTER INTO AN AGREEMENT WHEREBY THE CTA WILL DIRECT OR GUIDE THE CLIENT'S COMMODITY INTEREST TRADING AND THAT CERTAIN RISK FACTORS BE HIGHLIGHTED. THIS DOCUMENT IS READILY ACCESSIBLE AT THIS SITE. THIS BRIEF STATEMENT CANNOT DISCLOSE ALL OF THE RISKS AND OTHER SIGNIFICANT ASPECTS OF THE COMMODITY MARKETS. THEREFORE, YOU SHOULD PROCEED DIRECTLY TO THE DISCLOSURE DOCUMENT AND STUDY IT CAREFULLY TO DETERMINE WHETHER SUCH TRADING IS APPROPRIATE FOR YOU IN LIGHT OF YOUR FINANCIAL CONDITION.

YOU ARE ENCOURAGED TO ACCESS THE DISCLOSURE DOCUMENT. YOU WILL NOT INCUR ANY ADDITIONAL CHARGES BY ACCESSING THE DISCLOSURE DOCUMENT. YOU MAY ALSO REQUEST DELIVERY OF A HARD COPY OF THE DISCLOSURE DOCUMENT, WHICH WILL ALSO BE PROVIDED TO YOU AT NO ADDITIONAL COST.

MUCH OF THE DATA CONTAINED IN THIS REPORT IS TAKEN FROM SOURCES WHICH COULD DEPEND ON THE CTA TO SELF REPORT THEIR INFORMATION AND OR PERFORMANCE. AS SUCH, WHILE THE INFORMATION IN THIS REPORT AND REGARDING ALL CTA COMMUNICATION IS BELIEVED TO BE RELIABLE AND ACCURATE, PFG BEST CAN MAKE NO GUARANTEE RELATIVE TO SAME. THE AUTHOR IS A REGISTERED ASSOCIATED PERSON WITH THE NATIONAL FUTURES ASSOCIATION.

No part of this publication or website may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher.



 
This article was published in Opalesque Futures Intelligence.
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