DC Spotlight: Why Daily Numbers are Key to the CTA Challenge
Why Daily Numbers are Key to the CTA Challenge
In our last few articles, we discussed the advantages of managed futures and how Coquest Advisors has created its CTA Challenge competition to present the best-of-breed commodity trading advisors (CTAs) and rank them based on their risk-adjusted returns.
In past articles, Coquest Advisors Managing Director Max Eagye and Director of Brokerage Trade Services Group Mike Lock have pointed out the difficulty of relying simply on the raw monthly performance number and metrics provided in manager tear sheets and CTA databases. Those numbers provide a one-dimensional picture of a CTA’s performance and do not measure the risk taken to achieve those returns.
As an alternative, Coquest developed seven return- and position-based criteria to measure a manager’s risk-adjusted return and incorporated them into the CTA Challenge annual competition.
“We want to know what the CTA did — their absolute performance — but we also want to know what they did to achieve that performance,” Lock says, adding, “The second level to that is that we don’t want to use monthly numbers; we want to use daily numbers.”
While the use of various risk metrics like the Sharpe ratio, Sortino ratio, and Sterling ratio — all part of Coquest’s CTA Challenge due diligence process — go a long way in providing a more holistic picture of the risk taken to achieve returns, the key, according to Lock, is applying those risk metrics to daily data instead of the monthly data provided by most databases.
“The majority of CTA managed futures accounts are not a fund, they are managed accounts with daily activity,” Lock says. “The customers have daily experience with the p/l of their account. If you look at a monthly statement it could say the CTA is up 1%, or down 1%; you don’t know what happened every day or every week, just the monthly result.”
That daily data Lock refers to provides much more detail and can uncover risk that will not show up in the monthly results.
“When you get the daily data, you could see that a CTA was up 7% in a day, down 6% on another day, and net 1% for the month. There was actually a bit of volatility during the month,” Lock says. “You can see what happens when there is geopolitical news — higher volatility in real-time.”
The latter point is key to finding risk obscured by monthly data. Any time there is a major geopolitical event — an important economic indicator released that defies market expectations or a central bank intervention — it can create market volatility. Since actual leverage employed through either the CTA or the manner an investor funds their account is greater than a manager’s official risk metrics, it is important to know how a strategy performs during these intraday volatility spikes.
Managed Accounts
To properly gauge the risk of a trading strategy you have to think about how most managed accounts are funded. With managed accounts, customers fund their margin accounts based on the margin requirements of their brokers — they can notionally fund their account so they may face more risk than if they fully funded their accounts based on the CTAs stated minimum investment level.
“Investor sentiment changes [with] a managed account vs. a fund that has monthly liquidity,” Lock says. “With that, it was hard to justify why we were still looking at monthly data when a majority of investors all had daily transparency. They had a different investment experience than what was reported in the databases. We wanted to change that to have a ranking program for CTA products that reported daily.”
Given the way many accounts are funded, what appears to be a relatively minor volatility event in a small drawdown with monthly data, can actually create too big of a hit for an investor to maintain their account.
“The monthly tear sheets are averages, when we look at daily data we see what the maximum risk is, we see where the spikes are,” Lock says. “The amount of clarity we get in each underlying CTA program is phenomenal. We have no interest in reverse engineering any of the CTA programs, we are not getting timestamps on every trade intraday, but we are getting enough data from end-of-day reports to give us a huge amount of information that is extremely beneficial for our research and due diligence in evaluating the quality of a CTA program.”
A strategy that involves more risk than an actual investor can handle may not be as strong as its monthly returns show. The only way to know for sure is to see the daily returns. While all trading involves risk and volatility is not inherently bad, investors need to know precisely how much risk they are taking on to make an appropriate decision when investing.
When measuring CTA performance, daily data reveals key information necessary for an investor to commit money to it.
“The daily data is the most important thing that we glean from the process, especially when we talk to our institutional client base,” Eagye says. “We are not giving investors the daily data, but we are able to validate what we see.”
Eagye explains that the daily data can reveal things like style drift and whether the CTA held true to its stated risk parameters, all while protecting the manager’s proprietary methods. He adds, “We report what we see and confirm.”
That confirmation can be the difference between a strong investment, or one likely to end with losses and a closed account.
Next time: A look at how the CTA Challenge can help investors select the right strategy for their investment goals.
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Disclosure: The risk of loss in trading futures and/or options is substantial. Past performance is not indicative of future results. The information in this message derived from third-party sources is believed to be accurate and reliable; Coquest does not guarantee the accuracy or completeness of the information. Opinions expressed in this material are subject to change without notice. This report should not be interpreted as a request to engage in any transaction of futures, options, and/or OTC derivatives. The information contained in this material is not to be relied upon in substitution for the exercise of your independent judgment. Seek independent financial, tax, legal, and accounting advice from your own professional advisers, based upon your particular circumstances.
