Know Your Skew- by Quest Partners

Our newsletter is up for this week, and this time around, we’re taking a look at some fascinating research coming from other corners of the industry. A recent research piece by Quest Partners, a systematic multi market CTA out of New York, was forwarded to us by a client (thanks Mr. S) last week, and their findings resonated so well with us that we asked permission to share their work in our newsletter.

Their research essentially showed that relying on volatility as a predictor of future drawdowns is an exercise fraught with risk, as in tests of past performance – low skew strategies saw wide variances between the expected and realized drawdowns, while high skew strategies saw less variance.

.. This is ironic as investors commonly invest in low skew strategies due to their low volatility and avoid high skew strategies due to their higher volatility. For investors, this often results in large negative surprises due to the mistaken confidence in low risk that is implied by the low volatility strategies.

 

Now, this isn’t groundbreaking necessarily, and one of the reasons programs have a low skew rating is because there have been negative outliers in their performance, which we would assume cause larger drawdowns. But the link with volatility is somewhat new. We usually don’t equate skew with volatility, but they do a good job of it in their piece, showing that low skew strategies (negative skews) are usually those which have low volatility of returns.

Basically, volatility indicates the degree to which a program’s performance has deviated from the average, while skew indicates the direction the bulk of that volatility has been in. Positive meaning outliers to the upside, negative meaning outliers to the downside.

The goal of Quest’s piece is, “to assist hedge fund investors evaluate the risk of disproportionate losses relative to volatility.” You can view the full piece in PDF format here.

 

The arguments being made are solid, so we wanted to take a moment to go through the points made. To read the full scope of our comments, click here: http://bit.ly/lPtMhj

One comment

  1. Excellent article. I look forward to reading the Quest paper. It would be interesting to see the conventional angle of predicting drawdowns similarly done with the Sortino ration rather than the Sharpe ratio.

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Disclaimer
The performance data displayed herein is compiled from various sources, including BarclayHedge, RCM's own estimates of performance based on account managed by advisors on its books, and reports directly from the advisors. These performance figures should not be relied on independent of the individual advisor's disclosure document, which has important information regarding the method of calculation used, whether or not the performance includes proprietary results, and other important footnotes on the advisor's track record.

Benchmark index performance is for the constituents of that index only, and does not represent the entire universe of possible investments within that asset class. And further, that there can be limitations and biases to indices such as survivorship, self reporting, and instant history.

Managed futures accounts can subject to substantial charges for management and advisory fees. The numbers within this website include all such fees, but it may be necessary for those accounts that are subject to these charges to make substantial trading profits in the future to avoid depletion or exhaustion of their assets.

Investors interested in investing with a managed futures program (excepting those programs which are offered exclusively to qualified eligible persons as that term is defined by CFTC regulation 4.7) will be required to receive and sign off on a disclosure document in compliance with certain CFT rules The disclosure documents contains a complete description of the principal risk factors and each fee to be charged to your account by the CTA, as well as the composite performance of accounts under the CTA's management over at least the most recent five years. Investor interested in investing in any of the programs on this website are urged to carefully read these disclosure documents, including, but not limited to the performance information, before investing in any such programs.

Those investors who are qualified eligible persons as that term is defined by CFTC regulation 4.7 and interested in investing in a program exempt from having to provide a disclosure document and considered by the regulations to be sophisticated enough to understand the risks and be able to interpret the accuracy and completeness of any performance information on their own.

RCM receives a portion of the commodity brokerage commissions you pay in connection with your futures trading and/or a portion of the interest income (if any) earned on an account's assets. The listed manager may also pay RCM a portion of the fees they receive from accounts introduced to them by RCM.

See the full terms of use and risk disclaimer here.