Risk Measurement for Managed Futures Funds

There are five main types of risk management formulas that apply to managed futures funds.  Each has their limitations and caveats.  They also are separate measures.   They are:

• Margin-to-equity ratio:  This is the initial margin (in cash or Treasury bills) needed to establish the portfolio divided by the amount invested.  A low percentage means high leverage.  This may be misleading as the manager may have long and short positions or may be trading across different exchanges.
• Capital at risk:  When managers add a position, they attach a stop-loss rule to limit their losses.  This ratio calculates the total of the portfolio's losses if each position triggers the rules and divides it by the amount invested.  This is not an exact number because of the terms of the stop-loss rule.  The rule begins a transaction when the price is hit.  In a extremely volatile market, the actual trade price may be very different from the stop-loss price.  Capital at risk also does not account for offsetting long and short positions.
• Value at risk:  The potential loss for a given period and confidence level.  For example, a 95% one month figure of $10 implies that the portfolio has a 5% chance of losing more than $10 and 95% of losing less than $10.  Since the credit crisis of 2008, this has been the subject of some papers as measuring tail risk inadequately.  This is because the calculation is based on a normal distribution.
• Maximum drawdown:  This figure calculates the largest percentage loss for an investor for a specific period.
• Stress test:  This calculates a portfolio's losses by running different scenarios on the individual holdings to determine the effects on each scenario.