On Size, Luck, and CTA Returns

There’s been plenty of press around Nassim Taleb’s new short paper arguing that those who are doing well in the investment business are just benefitting from luck (or more technically – spurious returns), plus the compounding effect of “winners win.” That latter part is the idea that success begets more success (in terms of raising assets), via the advantage of a larger pool of money in terms of being able to hire top talent, get beneficial terms (see Buffet’s 10% paying preferred shares in Goldman), and so on – making it that much more difficult for smaller managers to compete.

Business Insider has already summarized the main points pretty well, and the Wall St. Journal has even gone so far as to link it to Bill Gross’ recent comments about the death of the cult of equities. The line that’s getting the most reaction is the one Taleb ends with:

To conclude, if you are starting a career, move away from investment management and performance related lotteries as you will be competing with a swelling future spurious tail.

In English – the lucky few have  amassed huge asset bases, which will make it that much harder to knock them from their perch, and that much harder for the small guy to make a dent. That’s quite a claim – stay away from investment management entirely? You know we’re big Taleb fans, and there’s certainly something to be said for his argument, but we’re not so sure Taleb’s argument applies to managed futures.

You see, we’ve pointed out a few times that the really big CTAs tend to have lower volatilities, and lower average rates of returns than managers with smaller AUM. In our experience, as managers get bigger, their returns tend to turn over and flatten out. Case in point – the following graphic.

Disclaimer: past performance is not necessarily indicative of future results.

Whether this is intentional or a result of their being unable to access markets like the recently rallied grain markets is up for debate. But there is no doubting the statistics above showing the reduction of returns on both the up side and down side (they likely sell the fact that they are reducing the downside…but it’s hard to do one without the other).

So, while we agree with Taleb that a hedge fund manager may get more ‘lucky’ the bigger he gets and continue to see outsized returns, the argument for the same happening in the futures space may not match up, with limited ability to add ever increasing positions in exchange traded futures markets (see Bacon’s recent return of investor money). In fact, there is likely some upper bound for hedge fund managers as well – when their size stops begetting more size and starts to become an impediment (see the London Whale).

As for spurious returns in managed futures… We ran Taleb’s simple luck experiment on the BarclayHedge managed futures database. He posits that by simple luck, half of all managers can make money in a year, and the year after that half of those winners again winning, and so on until after 10 years you can end up with someone who has never had a losing year just because of dumb luck. Well, with 326 managers in the BarclayHedge database in 2002 – the number of managers currently who should have had no losing years over the past 10 should be 326/2=163/2=81/2=40/2=20/2=10/2=5/2=2/2=1/2 = 0.5/2 = 0.  Given only 300 managers, only a fraction should be at perfect track records after 10 years – and that is exactly where we are, with no managers we know of having that perfect track record.

All in all, we love seeing Taleb approach such topics, and only wish he maintained a blog or newsletter where we would get such insight on a more regular basis.

One comment

  1. I have some serious issues with Taleb’s argument. First of all, there is no reason why by pure luck 50% of managers should be up in any given year. In the equity mutual fund space that would depend in whether we are in a bull or bear market. In the CTA space that would depend on the strategy and the nature of the market.

    Taleb’s logic is very bad and the article’s too, it doesn’t prove anything. There is no reason why a CTA should or should not have a losing year in a 10 year span, either way it doesn’t mean anything. Calendar years are just an artificial construct anyway. You are the ones who always mention that the the turkey has 360 days of “positive days” before losing his life in Thanksgiving.

    I also want to mention that Taleb had the balls to say after 2008 that his fund was the one with the best performance in the industry in the last decade!! After that year there were like 40 different Trend Followers that had a much better track record. He is a very smart guy but he is also way too arrogant.

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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.

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.