The 20 Minute Guide To Managed Accounts

Transcription

1 The 20 Minute Guide To Managed Accounts E X P E R I E N C E I N V E S T M E N T I N N O V A T I O N Drashta Capital Pty Ltd - Australian Financial Services Licence no ABN

2 INTRODUCTION The popularity and use of managed accounts and managed investments have grown substantially in recent years, as investors look to have their funds managed by professional money managers. Having your account in the hands of some of the world s top performing traders can be incredibly rewarding. Just as it is important to mitigate risks in trading itself however, selecting the right money manager is of equal importance. Drashta Capital has spent years seeking the best performing money managers and traders globally to now offer our investors a managed portfolio of the leading managed account offerings available. Having had countless "learning experiences" with a range of managed account providers and traders, the purpose of this guide is to steer you through the world of managed accounts without having to experience the ups and downs, so as to minimise the risk in your investments. Trading and investing is a blend of art and science. From a managed account perspective, the science is in having a systematic process to select the right investment manager, while the art is taken care of by the investment manager themselves, which is their speciality. By following the steps and processes in this guide you will skew the odds in your favour substantially, allowing you to select robust managed accounts and investment managers more effectively while avoiding those who have a much lower probability of success. 1

3 Guide to Managed Accounts WHAT ARE MANAGED ACCOUNTS? It is a well-known fact that the large majority of financial traders lose money. Out of those who do make money, only a select few are profitable on a consistent basis while managing their risk diligently. The idea of a managed account is to have one or more of these elite traders or money managers using their profitable strategies to trade your account as you normally would. While many investors may hold a portfolio of stocks or own property, managed accounts are typically more actively traded to seek higher returns than the traditional buy-and-hold approach of investing. The most common markets traded in managed accounts include foreign exchange (forex), equities, futures and options. Advantages of managed accounts include: Higher potential returns The ability to achieve higher returns than those typically obtainable in other asset classes such as property or a stock portfolio. Furthermore, a professional, dedicated money manager has the ability to deliver higher returns than you generate through trading the same markets. Profitability potential in all market cycles The majority managed accounts are able to capitalise on both rising and falling markets. Time efficient Managed accounts outsource the full time commitments of trading to a professional money manager, creating more time for you. Diversification Whether you currently trade yourself or if you hold an existing investment portfolio, diversification can add substantial value to your investments. Safety of funds The funds are held in a broker account in your name and the money manager cannot withdraw or transfer the funds. Transparency You are able to monitor the performance of your investment in real time. Liquidity Managed accounts rarely have lock-in periods, meaning you can access your capital whenever you desire. Customisable investments Contrary to a fixed investment product, managed accounts can often be customised to meet your needs and investment objectives. 2 Drashta Capital 2015

4 At the same time, there are a number of risks involved, particularly for those without prior experience or who plan to invest directly in the managed accounts, without going through a professional, regulated investment management firm. These can include: Lack of qualifications or experience of the managed account provider These days, anyone can set up a website and claim to be a money manager without experience or regulation. Lack of integrity of the managed account provider Even if the managed account provider is experienced, they may be providing misleading information or promises of unrealistic returns. Downside risks if not monitored If risk management is not in place and the trading is not monitored, the downside risks can be substantial. Poor trading venue Many managed account providers select substandard brokers to trade through. This can have significant adverse effects on performance. With the right approach and ongoing management, these risks can be mitigated by following the principles outlined in this guide. 3

5 Guide to Managed Accounts GETTING STARTED Before investing in managed accounts, we would highly recommend having at least a basic understanding of trading and the markets. This will provide you with the knowledge needed to know what is reasonable and realistic in terms of returns and how to quantify the risk. If for instance someone offered you a property and told you that the returns on the rental income were 80 %, in most parts of the world you would soon realise that this was very unrealistic. In a similar way, managed account providers promising enormous returns need to be treated with caution. While strong returns are certainly achievable, you need to ascertain whether or not this is sustainable over the long term and what level of risk they are taking to achieve these returns. While there are countless investment strategies and approaches, when it comes to finding the right managed account for you, we suggest that you look more at the numbers and the overall investment management approach. If you are comfortable with the risk parameters on the account and the targeted returns are in line with your investment objectives, it is then a matter of considering whether you feel the investment offering itself is robust and can deliver returns across the range of market cycles. For instance, a long only equities investment strategy will typically do well in bull markets but experience losses in bear markets, whereas a forex strategy stands to deliver returns regardless of market direction. In order to evaluate the quality and robustness of an investment manager and their managed account offering, we recommend asking the following questions. 4 Drashta Capital 2015

6 10 QUESTIONS EVERY INVESTOR MUST ASK THEIR INVESTMENT MANAGER ARE YOU REGULATED? It is alarming how many people and groups offer money management services without being regulated. While an investment licence in a reputable jurisdiction (UK, US, Australia, Europe) is not a guarantee of performance, it certainly displays credibility and accountability. Anyone can set up a website in a few minutes or promote their services online, but be aware that these groups can disappear without a trace just as quickly. Going through the regulatory process shows that a firm is serious and has a long term business plan. WHAT ARE THE RISK PARAMETERS ON THE INVESTMENT? People invest to make good returns and grow their capital, not to risk it. There is however risk in any investment and as such, it is the first thing that we assess when considering an investment. Knowing and understanding what the downside is on any investment provides a foundation on which returns can be built. Knowing whether a -3 % loss in a single day for instance is within the risk parameters is critical to knowing whether the manager is sticking to their risk management or exceeding the limits, which is a strong warning sign of further potential risks. HOW DO YOU MANAGE RISK? Knowing the maximum drawdown or risk limit is a start but how is this enforced in practice? Getting an understanding of how the risk is minimised on your account is critical and provides you with the comfort of knowing how robust the overall approach is. WHERE ARE THE FUNDS TRADED? Many people underestimate the importance of trading through an optimal venue. We have witnessed profitable strategies become unprofitable strategies, simply by trading with a lower quality broker. Beyond the face value and the pricing shown, there are unfortunately a lot of dirty tricks that retail brokers can play, which can deteriorate investment performance significantly. In many such cases, the broker and money manager profit from the situation, but this is almost always at the expense of the investor. Only trade your funds with the most reputable brokers, as trading anywhere else puts you at a disadvantage before the trading even starts. If an investment manager insists upon trading with a low quality broker, we see this as a red flag and it begs the question of why they are choosing higher trading costs with lower quality service, at your expense. 5

7 Guide to Managed Accounts WHAT IS THE LIQUIDITY OF THE INVESTMENT? With most managed accounts the funds are fully controlled by the investors. We have heard of cases however where the money managers have had control of the funds and refused to return them. Always confirm that you have full control over the funds and that if there is a lock-in period or minimum investment period, ensure that you are comfortable with this. HOW TRANSPARENT IS THE INVESTMENT? How regularly will you receive updates of the performance of your managed account? While real-time tracking isn t imperative, daily updates are desirable so you can keep track of performance. If you are comfortable with your investment manager, you should not need to check the performance more often than once a month, though the fact that a manager will allow this level of transparency is a positive sign. WHAT IS THE FEE STRUCTURE? Ensure you are comfortable with the fees being charged and if there is anything unclear, ask the money manager to clarify. The ideal situation is if a third party (usually the broker) can oversee the fee transfer process or if it is automatic, as this simplifies the process substantially and prevents potential disputes. 6 Drashta Capital 2015

8 8 WHAT ARE THE PROJECTED RETURNS? In the same way that you would buy shares or stock in a company based on its future prospects, you allocate capital to money managers based on the returns you believe they will generate in the future. Knowing what performance to expect relative to the risk you are taking provides you with a benchmark to assess the investment both initially and on an ongoing basis. While not being indicative of future performance, past performance can be informative, and with increasing track record length, it demonstrates how the manager performed and adapted to a range of market conditions and cycles. Beyond absolute returns, we look at the consistency of these returns which is a strong indication of solid risk management and a robust investment approach. 9 IN WHAT MARKETS DOES THE INVESTMENT PERFORM BEST/WORST? Understanding the strategy and how it generates returns is crucial for long term outperformance. If for instance the money manager has a single strategy that capitalises on calm, range bound markets, they are not someone you would look to allocate your investment capital to in times of increased market volatility. Knowing this also provides telling signs as to whether a strategy s recent strong returns were perhaps a result of specific market conditions which have now changed and, as such, similar returns are not to be expected unless things revert to those conditions. 10 HOW CAN YOU VERIFY YOUR PERFORMANCE HISTORY? Posting figures on a website or sending through a performance table can be informative but unless it can be substantiated, it does not carry much weight. Request additional documentation such as statements or other forms of verification that you can acquire to ensure that these figures accurately represent live performance. While a positive and informative response to these questions by no means ensures that you will achieve the projected investment returns, it certainly skews the probability of success in your favour. 7

9 Guide to Managed Accounts ACCOUNT OPENING PROCESS This process involves two main steps which can usually be undertaken simultaneously. You will need to complete the documentation and agreements with the investment manager. As a regulated firm, they will undertake some basic KYC (know your client) and identification checks as well as requiring you to read and understand the agreements outlining potential risks involved. Broker account opening forms are fairly similar in their requirements and should be commenced at the same time so as to avoid delays in the opening of the account. The process is typically straightforward and self-explanatory, but your investment manager will guide you through the process if you have any queries. 8 Drashta Capital 2015

10 MAXIMISE YOUR RETURNS Beyond the potential for superior returns, the main idea behind a managed investment account is that it is managed entirely for you. That being said, there are a number ways in which you as the investor can maximise these returns once the account is open and actively traded. 1 2 TAKE A LONG TERM INVESTMENT VIEW. While we all naturally seek the highest returns in the shortest period of time, the real money is made by sticking with profitable investments over an investment horizon of at least one year. In addition to getting a better feel for what the investment can deliver across different market conditions, sophisticated managed account providers will typically commence with more conservative parameters on new accounts before incrementally scaling things up as the account moves into profit. By taking a shortterm investment view, you are likely to miss out on the majority of the profits as a result of this. TAKE YOUR HANDS OFF THE WHEEL... So you have decided to take a long term view on your managed account. Don t jump in and out to try to outperform the strategies themselves. Any solid investment management firm will have finely tuned their offering for optimal performance through a deep understanding of the underlying strategies. Trying to interfere with this is the equivalent to reaching over and grabbing the wheel from a professional racing driver while speeding around the track. This also can include questioning the investment strategy or even specific investment decisions. If you are uncomfortable with the level of risk or the trading style itself, then that particular investment offering or service is most likely not for you BUT KEEP YOUR EYES ON THE DRIVER. Following the driving analogy, someone needs to be watching the driver. When everything is within the predefined parameters and the strategy is being adhered to, it is almost always counter-productive to interfere. But what do you do if the driver falls asleep at the wheel? If you have a risk limit at -10 %, for example, what do you do if the trader continues to trade through this limit? Some of the biggest losses we have heard about have involved traders ignoring risk limits. Any reputable investment manager will have solid risk management in place but without that additional layer of oversight, your account may be exposed to significant downside risk. This monitoring may be undertaken by you as the investor if you have the experience and time, or by an investment management firm that oversees the managed accounts. 9

11 Guide to Managed Accounts 4 COMPOUND YOUR RETURNS. The human mind typically finds it challenging to compute exponential growth, however compounding is one of your most powerful allies in investment achieving success. Many investors underestimate the profound effects and are enticed to withdraw their profits on a monthly basis. This may be required from time to time but keep in mind that the highest profitability can arise from reinvesting all net profits. The following chart demonstrates the comparison of a hypothetical investment returning 4 % per month compounded vs. non-compounded over a period of 5 years. $ $ $ $ $ $ $ Year By simply leaving the profits in the account over the investment period, the returns are almost four times greater. 10 Drashta Capital 2015

12 5 DON T BE EXCESSIVELY CONSERVATIVE. Any reputable managed account provider will put risk management at the forefront of their operations and investment methodology we would not consider investing in if they didn t. Once the risk management approach is robust and clear, the investor should then be able to assess what investment size and risk they are willing to take based on their investment objectives. We still receive enquiries regarding "risk-free" investments and whether we are able to cover potential losses on the account. If you are not comfortable or in a position to put any capital at risk, once again managed accounts are not for you. The first step is to determine the amount of capital you are comfortable putting at risk based on your own investment plan and objectives. Keep in mind that the idea of losing money isn t necessarily something that we can always feel 100 % comfortable about mentally or emotionally, but the question to ask yourself is whether you will be comfortable with the situation and where you are at in your investment journey if the risk capital were to be lost. It is then a matter of determining the probability of a loss on the account compared to the potential gains. If there is say a 10 % probability of an overall loss on the account and for every 1 % of the investment you put at risk you stand to gain 4 %, for instance, then only risking 1 % will generate minimal returns. If 10 % of the investment is at risk, then the targeted return will be 40 % which, given the probability of success and favourable reward-to-risk ratio in this example, one can justify the increased potential risk. While we always recommend exercising caution while investing, excessive conservatism can constrain returns well beyond what is necessary for prudent risk management. 11

13 Guide to Managed Accounts THE POWER OF DIVERSIFICATION Strategy 1 Performance Similar to the effects of compounding returns, investors typically underestimate the power of diversification. We have all heard not to put all our eggs in one basket and intellectually this makes sense from a risk perspective. If we are fully allocated to a particular investment which experiences a loss, then our overall investment performance is negative. By diversifying across a number of investments, the probability of positive overall returns increases substantially, even if some individual investments experience losses. The key is to ensure that the investments are non-correlated. If they all move in unison then the benefits of diversification are negated. If for instance an investor attempts to diversify their portfolio by investing in a number of oil stocks, they will lose value simultaneously if oil prices drop sharply. For investors holding an equity and/or property portfolio, a managed account that can capitalise on a market downturn can provide a fantastic hedge and potentially even outweigh losses in the other investments to yield positive overall returns. To demonstrate this effect, consider the following hypothetical returns. Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Total 2% 5% -5% 6% -6% 8% 2% 3% 5% -3% 5% -2% 20% Strategy 2 Performance Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Total 1% -6% 4% 3% 4% -2% -1% 3% -1% 4% 1% 2% 12% The first strategy has a superior risk adjusted return: a 20 % return with a maximum drawdown of 6 %, while the second strategy delivered a return of only 12 % with the same maximum drawdown of 6 %. If you have fully invested in the first strategy, would you consider allocating some of your investment capital to the second strategy? To answer this, let us examine the effect of combining the strategies together with an equal portfolio weighting. 12 Drashta Capital 2015

14 Portfolio Performance Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Total 1.5% -0.5% -0.5% 4.5% -1.0% 3.0% 0.5% 3.0% 2.0% 0.5% 3.0% 0.0% 16.0% 25 % 20 % 15 % 10 % 5 % 0 % -5 % Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec -10 % Strategy 1 Strategy 2 Portfolio While the second strategy has inferior risk adjusted returns relative to the first strategy, since they are non-correlated, combining them together into a portfolio produces a better risk adjusted return of 16 % with a 1 % maximum drawdown. While 16 % is lower than 20 %, the returns are far smoother and if leverage is available, these returns can be increased above that of the first strategy while still maintaining a lower drawdown. Diversifying a portion of your investment portfolio into managed accounts can provide good diversification by increasing performance and smoothing the overall returns. We would in fact go one step further and recommend managed accounts that comprise a number of non-correlated investment strategies, as this single product will then have diversification built into the investment itself. Even if you are currently trading successfully, diversifying across a number of successful strategies can increase the consistency of your returns substantially. 13

15 Guide to Managed Accounts FREQUENTLY ASKED QUESTIONS 1 HOW MUCH CAPITAL DO I REQUIRE TO INVEST IN A MANAGED ACCOUNT? This will vary depending on the investment firm and some groups do not have a minimum. What we have found however is that the most reputable and best performing managed accounts require a minimum of $ 50,000 but can start from as high as $ 500, HOW MUCH DO I NEED TO KNOW ABOUT TRADING AND INVESTMENTS TO BE ABLE TO INVEST IN A MANAGED ACCOUNT? While the investment manager will undertake and oversee all of the trading and investments on your account, we recommend that you have at least a general understanding of the markets that are being traded. More importantly, it is critical to understand the risks involved in the investment. 3 WHAT IS THE DIFFERENCE BETWEEN A MANAGED ACCOUNT AND A FUND STRUCTURE? The main difference between a managed account structure is that the capital remains in the name of the client, whereas a fund structure pools all of the clients funds together. The managed account structure provides more transparency and higher safety of funds, as well as better access to the capital, should it be required. 4 WHAT ARE THE TYPICAL FEES CHARGED? This again can vary substantially, with performance fees typically ranging from % of profits. Management fees are more common in fund structures but are sometimes used in managed accounts. While the fees of a particular investment management firm may be higher, don t take these at face value. A managed account with a 40 % performance fee may be favourable to one with a 20 % fee if the net returns after the fees are higher. 14 Drashta Capital 2015

16 5 HOW MUCH CONTROL DO I HAVE OVER THE INVESTMENT STRATEGIES? The idea of a managed account is that the money manager invests on your behalf and as such, they have full control over the trading on the account. You can of course close your account at any time if you are dissatisfied with the performance HOW QUICKLY CAN I ACCESS MY FUNDS IF REQUIRED? As the funds are held in your name, they can typically be withdrawn quite quickly if there isn t a lock-in period on the account. Assuming the strategy is trading in liquid markets, the funds should typically be available to be withdrawn within 24 hours of the request, providing the investment manager with sufficient time to close any open positions. HOW SAFE ARE MY FUNDS? If the funds are being traded at a reputable, regulated broker, then the safety of the funds is quite high in that they are held at top tier banks and the investment manager cannot withdraw the funds to their account. Keep in mind that losses can still arise on the account as a result of trading activities and the investment manager s risk parameters should be made clear to you. HOW CAN I MONITOR THE PERFORMANCE OF MY INVESTMENT? As the funds are traded in your account, you should have good access to the investment performance. This may either be in the form of daily performance statements or through an interface. 15

17 Guide to Managed Accounts THE NEXT STEPS Managed accounts are versatile investments with significant potential. With the right approach and ongoing management, they can be the driving force of an investment portfolio when it comes to achieving consistent outperformance. While this guide may appear to just touch the surface of managed accounts or only provide simplistic insights, the reality is that almost every "learning experience" we have had ourselves and negative experiences we have heard about could have been avoided by following the principles in this guide. Knowing now with clarity what to look for in an investment manager as well as what to avoid, you will be drawn to those who fit your criteria and can provide a robust managed account offering to meet and exceed your investment objectives. To learn more about the managed account services in which Drashta Capital currently invests for our clients, please visit our website: 16 Drashta Capital 2015

18 E X P E R I E N C E I N V E S T M E N T I N N O V A T I O N Drashta Capital Level 13, Citigroup Centre 2 Park Street, Sydney 2000 NSW Australia Managed accounts involve risk of loss and may not be suitable for all investors. Any advice provided is general advice only and is based solely on consideration of the investment or trading merits of the financial products alone, without taking into account the investment objectives, financial situation and particular needs (i.e. financial circumstances) of any particular person or entity. You must undertake your own investigations and obtain your own advice regarding the suitability of managed accounts for your circumstances. Drashta Capital All rights reserved.