One of the most common bits of advice we dole out is to invest in quality managers when they experience a drawdown. It’s not a hard and fast rule, but there’s a tendency for managed futures performance to follow a cyclical pattern. It’s why performance chasing often leads to disappointment, and why we prefer allocations during rough patches.
But timing can be about more than cycles – it can also make a difference where in that program’s life you allocate. We’ve noticed a common pattern of programs offering diminished risk/return profiles as they age, meaning it was better to be an early investor than a late one. But in practice, this can be difficult to visualize, as the compound rates of return and other metrics are calculated on the whole track record (including those usually higher returns).
Consider the following pair of VAMI (Value-Added Monthly Index) calculations:
Disclaimer: past performance is not necessarily indicative of future results. This comparison is hypothetical in nature and is only for educational purposes.
The first program appears to post consistent returns throughout its lifetime, while the second program offers a whole lot of nothing for the two-thirds of its existence, before rocketing up in the last third of its record. But both of them end up in the exact same place. So, which of these programs would you rather have invested in? Which do you believe has the higher volatility? The higher max drawdown?
Perhaps a look at their stats would help you decide?
|
CTA 1 |
CTA 2 |
|
|
Compound ROR |
40.4% |
40.4% |
|
Annualized Volatility |
46.5% |
46.5% |
|
Maximum Drawdown |
-37.7% |
-37.7% |
What? They have the exact same Compound ROR, Volatility, and Maximum Drawdown? Why yes, they do. That’s because these two “programs” are actually the exact same program with one minor change – we’ve put the second (red) set of returns in reverse chronological order. A sort of mirror image. No, we’re not getting bored and finding random things for interns to do. We just like to look at things from a different angle every now and then (180 degrees different in this case). And here, the reverse view puts the difference between the early years and the recent returns into sharp relief, and shows how a program can turn into something very different as it ages. The fact that these two curves are so different – and yet the stats are exactly the same – also shows how you need to do more than just look at the basic stats of a program to get a feel for how it has traded.
So put your impressive CTA equity curve in front of the mirror, and see what its reverse cousin looks like. A rather flat line to start out, and you’re likely invested in yesterday’s success. Two closely aligned curves, and you’re likely seeing more consistent performance over time.
April 26, 2013
Interesting, but a log-scaled chart would have told you the same story!
Lex
April 26, 2013
If you try reinvestment the story changes and you cannot invert.