The Small Managed Futures Account Conundrum

I recently scanned a Commodity Trading Advisor Data base to look at minimum account sizes for managed futures accounts

. I found minimum account sizes ranging from $25,000 to $5,000,000. I also found the typical CTA trading a small minimum account size has concentrated portfolios, high-margin requirements, little money under management, a short track record, high volatility, just traded options or was offering a pooled investment. Diversified trend followers offering individually managed accounts seemed to have minimums that were usually at least $1 Million.

Small managed futures accounts in the futures markets (less than $250,000) face significant challenges not experienced by large accounts. Considering that most commodity futures contracts have face values in the tens or hundreds of thousands of dollars, it is easy to surmise that these contracts are for large accounts. But, low-margin requirements have long enticed smaller speculators and are the proverbial "rope to hang oneself with".

Let's evaluate why large managed futures accounts may have it easier than small accounts. First, large managed futures accounts can afford to trade nearly any opportunity at any time. There are over 100 tradable futures markets globally, and should buy or sell prospects simultaneously exist in any or all of them, a large managed futures account can easily afford the margin and exposure. It is stated that when it comes to investing that "diversification is the only free lunch" and large managed futures accounts can afford to diversify with impunity. This is in marked contrast to the small managed futures account where prudence dictates only having risk and exposure in a few markets at the same time.

A large managed futures account is not restricted from trading contracts whose volatility is fairly high. For example, a London copper trade with a stop loss $14,000 away represents a risk of 1.4% in a million dollar managed account, but in a $100,000 managed account, this same trade would represent a risk of a whopping 14%! Any sensible trader would avoid that trade in such a small account; however, having to skip these opportunities is yet another penalty paid by the small managed futures account.

What's more, the large managed futures account can use one of the easiest forms of risk control available, contract scaling. For example, let's assume a large account is long 50 gold contracts during a large bull market run and wishes to cut his open trade profit exposure. He can simply scale off as many contracts as he needs to lock in profit, while maintaining his profitable position, but what can the small managed futures account do for scaling out if he only has on one contract in the first place!? Once again, the small managed futures account does not enjoy the flexibility to control risk in the same fashion as the large managed futures account.

Now, for all the negativity I've just discussed above I believe the smaller account has advantages over large ones. Small accounts are able to trade markets that would be far too illiquid for large accounts. Most institutional size funds are practically confined to the trading of financial and energy instruments. They end up missing out on trading opportunities in the traditional physical commodity markets. Specifically commodities like Grains, Foods, and Fibers and the like. This results in a lack of diversification and an over dependence on those few sectors. The ironic thing is that many small accounts end up with the same problem because they have decided to deal with their small account dilemma by only trading a few (or one) market! They end up missing out on the sharpest advantage they have on the "big boys".

It is for those smaller traders who want the benefits of true global diversification, with an individually managed (not pooled) account, that we formed Hoffman Asset Management. HAMI is chiselling out a unique market by featuring a managed account program that screens and trades over 70 diversified commodity markets, while trading accounts as small as $30,000. The program's design tries keeping draw downs and volatility in line with what might be obtainable in a large widely diversified account. This combination of trading many markets inside of a small account while keeping volatility in line is truly unique. It fills what we feel is a tremendous void in traditional managed account offerings.

What we do is proprietary; however, the fundamental philosophy uses a form of relativity. HAMI screens a large universe of tradable commodities for possibilities, yet, is extremely selective in those trades that it will take. For roughly every 10 trading opportunities identified by HAMI's combination of trading systems, it takes only 1. HAMI's formulas are not only taking into account the market's direction and movement potential, but also how that potential ranks on a risk-adjusted basis. The idea is that an opportunity can only be assessed relative to what else is obtainable. For example, how do traders know if a 5% return is satisfactory or not? The answer should be "it depends on what else is obtainable". In other words, the 5% return is only acceptable or not relative to different options. Only a small percentage of all the markets tracked by HAMI's strategy get identified as the best, and then it looks at only those markets should one of its numerous trading systems produce a signal.

The portfolio selection process is dynamic and rebalanced every day. From day to day the basket of markets that we will look at trading changes. We feel this keeps HAMI's trades limited to only those markets with the best risk adjusted potential. This permits us to consider a large portfolio while nevertheless keeping trades and margin requirements low.

Monitoring a large portfolio is essential because if investors limit themselves to a fixed small portfolio, how do they know that those markets will be the best markets? (Hindsight bias portfolio selection is a form of curve fitting and is a primary downfall of many traders). If an excellent opportunity evolves in a market outside a predetermined portfolio, a investor should want to take advantage of it. By trading with Hoffman Asset Management's trading systems, traders do not randomly rule out any market that may perform well, and they have lessened the probability that a portfolio is just the product of past performance (curve fit) considerations. The key is tested logic that can do this automatically, and that is what Hoffman Asset Management's trading strategy uses.

by: Dean Hoffman

The Small Managed Futures Account Conundrum

I recently scanned a Commodity Trading Advisor Data base to look at minimum account sizes for managed futures accounts

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