At a potential client meeting, I faced a very interesting question, "Why has managed futures not sold as well in the US versus Europe to many hedge fund investors?" It was the best performing hedge fund sector in 2008, yet there still seems to be many pension and endowments who will not touch this diversifier.
There is no easy answer to the question but there are reasons for failure by both the managers and the institutional investors. I don't want to advocate one position or another but it is clear that there are roadblocks that have to be addressed before managed futures is embraced by institutional managers.
Institutional managers and the aversion to momentum systems is a significant problem. Anyone trained at a business school or with an MBA has learned that markets are weak form efficient. This is a foundation of the rational expectations-efficient market paradigm. Hence, trading systems using price will not be able to generate excess profits. The argument is that sure they may be able to make profits during some extreme periods but these systems cannot do it consistently. This leads to large drawdowns and low information ratios. Take away the leverage and the occasional large trend moves and there is no basis for consistent profits. (Of course, if you rake away the profitable period for any manager they will not make money.)
It seems that the those investors who do not have the same exposure or belief in the efficient markets paradigm are more willing to accept that trading systems may work. Unfortunately, the behavioral school of finance has not fully addressed why some systems may work other than to embrace the idea that there is market irrationality and that systems may capture this behavior. While the eduction of investors is a problems more of the burden has to be on the managers and their ability to see the process.
Why cannot managers get the business? Money managers who have developed trading systems have a problem because their audience does not like the premise of what they do. There are two ways to handle this problem. One, you can avoid the investors who do not believe in your premise. Of course, this means a whole portion of the institutional market. is eliminated from consideration, or the manager can address the issue head on. This is often not done because the arguments for weak form efficient are strong and the alternative requires some thoughtful analysis. Additionally, the level of transparency to many models is limited which creates more uncertainty with investors.
Nevertheless, there are some themes that can be used to help. One risk management is a value enhancing mechanism. Risk management is not just for stopping loses but choosing opportunities. The environment matters. Some markets are more likely to be driven by price behavior versus others. For example, those markets that have limited fundamental information will more likely have price behavior that can be exploited through systems. Finally, systems are adaptable not like statistical tests. An evolutionary view is helpful when developing systems. This is part of the view of Andy Lo who has developed an adaptive efficient markets hypothesis.
There is no easy answer to the question but there are reasons for failure by both the managers and the institutional investors. I don't want to advocate one position or another but it is clear that there are roadblocks that have to be addressed before managed futures is embraced by institutional managers.
Institutional managers and the aversion to momentum systems is a significant problem. Anyone trained at a business school or with an MBA has learned that markets are weak form efficient. This is a foundation of the rational expectations-efficient market paradigm. Hence, trading systems using price will not be able to generate excess profits. The argument is that sure they may be able to make profits during some extreme periods but these systems cannot do it consistently. This leads to large drawdowns and low information ratios. Take away the leverage and the occasional large trend moves and there is no basis for consistent profits. (Of course, if you rake away the profitable period for any manager they will not make money.)
It seems that the those investors who do not have the same exposure or belief in the efficient markets paradigm are more willing to accept that trading systems may work. Unfortunately, the behavioral school of finance has not fully addressed why some systems may work other than to embrace the idea that there is market irrationality and that systems may capture this behavior. While the eduction of investors is a problems more of the burden has to be on the managers and their ability to see the process.
Why cannot managers get the business? Money managers who have developed trading systems have a problem because their audience does not like the premise of what they do. There are two ways to handle this problem. One, you can avoid the investors who do not believe in your premise. Of course, this means a whole portion of the institutional market. is eliminated from consideration, or the manager can address the issue head on. This is often not done because the arguments for weak form efficient are strong and the alternative requires some thoughtful analysis. Additionally, the level of transparency to many models is limited which creates more uncertainty with investors.
Nevertheless, there are some themes that can be used to help. One risk management is a value enhancing mechanism. Risk management is not just for stopping loses but choosing opportunities. The environment matters. Some markets are more likely to be driven by price behavior versus others. For example, those markets that have limited fundamental information will more likely have price behavior that can be exploited through systems. Finally, systems are adaptable not like statistical tests. An evolutionary view is helpful when developing systems. This is part of the view of Andy Lo who has developed an adaptive efficient markets hypothesis.
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