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From Chidem Kurdas, Editor, Opalesque Futures:

A veteran investor I know used to talk about how he controlled the risk in the fund of hedge funds he managed. He invested in as many as 100 hedge funds at a time, across a wide range of strategies and styles. Managed futures was not among those. It was possibly the only hedge fund sector he avoided on principle.

We’re talking about a seasoned pro. After several decades of experience, he had developed his own diversification tactics and analytical devices. The latter gave advance warning of rising correlation among strategies so that the allocations could be changed to keep the portfolio diversified and losses at a minimum—or so his robust track record suggested.

The credit crisis was not kind to my friend. While fund of funds generally lost less than 20% in 2008, the loss in one of his pools was more than double that. Part of the reason was that the portfolio was levered, which magnified the losses made by the underlying funds. Another reason emerged last month. He had a long-standing allocation to Bernard Madoff. It was not a big part of his fund, but still large enough to add a significant amount of red ink.

Here’s a knowledgeable person who gave money to Madoff, about whom there were doubts for many years, but avoided managed futures as too risky. What is it about managed futures that turns off investors? Does it carry special risks not found in other strategies? How do longtime managers control the risks? T......................

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