An Interview with Author and Consultant Arthur Bavelas
Mark Melin (MM): Arthur, your family office consulting practice helps mitigate risk for clients. Some in the regulated derivatives industry have been watching what appears like a glide path to a debt crisis. It is mathematical. What are your thoughts?
Arthur Bavelas (AB): We are concerned as well with fundamental problems, the ones that are being talked about in the media: debt crisis, the fiscal cliff, the promises of politicians that can never be kept. We are very concerned about how quickly things could go bad. Even more sophisticated clients are preparing for potential forthcoming volatility. We cannot get everybody frightened because it will become problematic. It will create self-fulfilling prophecy. Because everything is done out of emotion no matter what the numbers have to add up to.There is not a family that I know of that does not react to things by emotions. So, emotions are involved I think in every thing and we need to cause legitimate good sentiment.
MM: What trends do you see in family offices? How are they looking at investments and the world?
"(Family offices) are driven by fact patterns and each family has unique agendas and motives at any given moment."
AB: There is a variety of things that I can put my finger on that are similar among wealthy and among the family offices trends. First, everything is driven by fact patterns and each family has unique agendas and motives at any given moment.
However, we are always interested in keeping legacy money or stay rich money and how to accomplish that. Events of recent past with US being downgraded with their credit worthiness and that safe places to put cash are not as safe as they once were, is a challenge. Investments we formerly considered risk assets are now being re-evaluated, on a liquidity curve. One of these investments is managed futures.
MM: Moving into the managed futures space can be complicated without the proper guidance. Tell me about some of the challenges you faced?
"We can't look at everything the in the same way. We develop a number of scenarios (scenario planning), how the investments will potentially operate in different market environments."
AB: It is a challenge recognizing how to risk allocate the asset class. We can't look at everything the in the same way. We develop a number of scenarios (scenario planning), how the investments will potentially operate in different market environments.
MM: Understanding market environment relative to risk is best understood by first recognizing the impact of beta / strategy on risk exposure. Look at managed futures education from the perspective of a pyramid. My personal model is to start at the top by recognizing the macro strategy and how it operates. Once you have this foundation, then begin to recognize the alpha risk factors in each strategy. To provide an example, trend following is a strategy based on the market environment of price persistence. When markets exhibit price persistence, this environment is generally considered beneficial to beta strategy return. This helps identify the market environment risk modeling.
AB: We have similar approaches with equities and other strategies. Input into risk models involves many features, including both beta and alpha considerations. Another of our considerations are the different account types in managed futures.
MM: This is a big topic. There are different account structures with different features. There are traditional limited partnerships, typically limited to qualified investors. For an investor, these LPs can require a degree of paperwork and often K1 tax forms that investors (and their accountants) don't prefer. LPs are a limited liability structure and are not subject to undefined loss, which is a feature of a derivative contract. The direct managed futures account might be the most transparent with the best ability to monitor the investment on a daily basis, but investors much understand the theoretical risk potential relative to a limited liability structure. The managed futures mutual fund is growing in popularity, but the CFC corporation structure that makes up the foundation of the mutual fund can be the cause of performance drag, depending on structure. Fund of funds structures receive different treatment than do certain direct trading strategies. Another consideration is liquidity, which raises a host of issues. At the end of the day appropriate account choice might just boil down to investor sophistication.
AB: When you are working with leverage it is important to recognize counterparty risk, which is often unclear. So under what circumstance is that counter party -- are we subject to that counter-party risk and what does it mean and how do we assign a value to that risk?
MM: Well that is a good question. MF Global and its related issues aside, counterparty risk in managed futures is similar to counterparty risk in a trade on the New York Stock Exchange. The NYSE is the intermediary, and the counterparty risk is with the clearing mechanism. This stands in contrast to an OTC trade, where the counterparty risk might be centered on a trade counterparty.
AB: There are not systemic problems to the extent the financial markets and the mechanism to support those financial markets are sturdy. But this is a big part of the question now. It dovetails into exactly what this conversation is all about is, where things are at this moment in time. What we could at one point count on, we can't count on them any longer.
MM: It is a sad commentary.
AB: We do live in a great country and I wake up every morning being grateful that I am here; there is no question about it. Unfortunately some things that are happening right now need to change. It just appears as though much of what is happening the founding fathers did not have in mind. We have to do a serious of adjustments inch by inch, brick by brick, the old crawl walk run thing. Everybody needs to experience things on their own and you just take responsibility for when you veer off the path and try to get back into alignment that is your true alignment. We have to do recognize things for what they are without putting shock waves, any more shock waves in the system. And control things to the extent that there are things that we can manage. Some things that we cannot like an anomalistic event, the whole black swan thing. We need to prosper as best we can. We need to focus on the small brick by brick things that we can do every day to cause positive sentiment and to create an environment where people can work and be employed and start businesses and come up with great ideas and execute on them as we have in the past which is what built this country.
As we approach the mounting concerns regarding the fiscal cliff and taxes, recognize the interest of politicians is often driven by how they view hazards in being re-elected. They are creatures of public opinion. Often what they do is not what they actually intend to do. And so their intentions need to be more like our founding fathers that wanted to build a strong foundation and actually execute on it.
About Arthur A. Bavelas
Arthur has written numerous articles, white papers and books focused on wealth preservation and asset protection. A published author, he has been quoted in the several publications, including the Wall Street Journal, Elite Traveler, Wealth Management, Investment Advisor. He most recently co-authored: Fortune's Fortress: A Primer on Wealth Preservation for Hedge Fund Professionals