Why would anyone invest in these funds?

[srinir]

From the blog post you linked to:

"The strategy behind COINX is simple: at the end of each month, a coin is flipped by the portfolio team. If the coin lands on heads, the investors earn a 3% return for the day. If it lands on tails, the investors receive a -3% return"

and

"Rather, we decompose it into a portfolio that is 60% stock return, 40% bond return, and then some added idiosyncratic risk. We’ll assume this idiosyncratic risk is normally distributed with a volatility of 3%"

See economist joke above... (post #31)

Here, I'll one-up you: there are plenty of CTAs and hedge funds in the real world with persistent negative returns, albeit uncorrelated to equities or whatever. Why then aren't they raising more and more money, or more humbly, simply continuing on with business as usual? Why was 2016 the worst year for hedge funds? Why did quant firm Cantab with billions under management sell itself to another firm? Could it be because in the real world from an investor's perspective, risks are more nuanced and real than naive CAPM/finance 101 type models present them to be?

https://www.bloomberg.com/news/arti...t-chase-trends-are-this-year-s-biggest-losers

3% return per day must be a typo, because strategy states that coin is flipped at the end of the month.
For stock and bonds that model is using JPM assumptions.
"We use a simulation-based approach and employ J.P. Morgan’s 2017 capital market assumptions for U.S. Large-Cap and U.S. Aggregate Bond returns, volatility, and correlation". In my opinion, you can change the model to some fat tailed distribution results will still be the same. That is the power of diversification.

I understand you quoted buffet's "diworsification", But his action speaks louder. " My advice to the trustee couldn't be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard's.) I believe the trust's long-term results from this policy will be superior to those attained by most investors — whether pension funds, institutions or individuals — who employ high-fee managers."
https://www.marketwatch.com/story/warren-buffett-to-heirs-put-my-estate-in-index-funds-2014-03-13
He is not investing few stocks, but well diversified SPY and bonds.

Regarding your second part of your post, why Cantab sell themselves? I have no idea. I am an index investor, who believe in diversification. So i added managed future and short vol strategies at the margin.

 

[Maverick1]

I'm done here, thanks for the thoughts. Do carry on without me if you'd like

 

[sss12]

That isn't a recent assertion of the managed futures industry, as I've already said it's basic portfolio maths that has been around since the early 1950's. However as this theory has obviously passed you by let me show you an example.

Suppose you have a classic 60:40 equity / bond portfolio. Realistic forward looking numbers for performance would be mean of around 4% and vol of around 12%. Already note that the Sharpe Ratio is a mere 0.33, so adding even a 'rubbish' SR of 0.5 would improve this. The geometric mean is 3.3% (for people who only care about return not risk).

We have a choice of two assets we can add, a CTA with a SR of 0.5 (with equity like vol of 15% and a mean of 7.5%) or a fantastically good equity trader with a SR of 1.0 (also with equity like vol of 15%). The correlation of the CTA with the starting portfolio and the equity trader is -0.1. The correlation of the equity trader and stocks is 0.5.

The optimal weight to the equity trader is around 65%. This improves the SR to around 0.51 and the geometric mean return to 5.5%.

You might think there is no point adding the CTA to this portfolio. But in fact changing the portfolio so it is 30% CTA, 30% traditional, 40% equity trader improves the SR to 0.94 and the geometric mean to 8.9%.

This analysis actually understates the benefit of CTAs since correlation is a linear measure and SR is an symmetric measure.

GAT

This is a very good and concise explanation.

But coming from the Private Wealth side (glorified retail) it is unbelievably hard to keep even the more sophisticated clients engaged with alternatives with the horrible nominal returns.

I realize the environment has not been favoritable towards the CTA's but there have been some trends in USD, gold, etc. but very few have caught any part of them. I mean the T in CTA is for trading isn't it ?

 

[Alexpung]

I understand you quoted buffet's "diworsification", But his action speaks louder. " My advice to the trustee couldn't be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard's.) I believe the trust's long-term results from this policy will be superior to those attained by most investors — whether pension funds, institutions or individuals — who employ high-fee managers."
https://www.marketwatch.com/story/warren-buffett-to-heirs-put-my-estate-in-index-funds-2014-03-13
He is not investing few stocks, but well diversified SPY and bonds.

S&P 500 is ok as diversification because it's performance does not suck.
It is totally different from "diworsification" in which you add uncorrelated investments with dubious returns. I mean, you can't even be sure the fund is +ev, if they earn 0 after fee over 4 years then actually you lose quite a lot due to inflation already.

 

[Martinghoul]

Question: are there any low return, low sharpe (say, less than 0.4 or even 0.5) but uncorrelated CTA funds that have been raising money in the past 3-4 years or more recently? Can anyone provide any examples?

Bluetrend, when it spun out into Systematica, was a pretty big one. I think they raised new money then, but I am not 100% certain.

 

[globalarbtrader]

Reminds me of that physicist, chemist and economist (quant) horse race predicting joke, "First, let's assume the horse is a sphere"...

Ever heard of a logical fallacy called begging the question?

I'll deal with this in two parts.

Firstly even if we assume the Sharpe Ratio is zero it's still worth making an allocation to a negatively correlated asset.

Let's switch from CTA's to tail protect strategies. These probably do have SR of zero, but they have stronger negative correlation. Measures like SR and correlation are even less useful here, but let's be conservative.

Classic 60:40 equity / bond portfolio. Mean of around 4% and vol of around 12%. Geometric mean is 3.3%

Tail protect with a SR of 0.0 (with equity like vol of 15%) or a fantastically good equity trader with a SR of 0.5 (and vol of 15%). The correlation of the tail protect with the starting portfolio and the equity trader is -0.5. The correlation of the equity trader and stocks is 0.5.

The optimal weight to the equity trader is around 75%. This improves the SR to around 0.51 and the geometric mean return to 5.5%.

Again you might think there is no point adding the tail protect to this portfolio: after all it has zero excess return (zero SR).

But in fact a 15% allocation to tail protect increases the SR to 0.56.

Don't believe in Sharpe Ratios (perhaps you are an investor with a high tolerance for risk who doesn't use leverage)? A 5% allocation to tail protect increases the geometric mean to 5.6%. A modest increase but to reiterate the vol is significantly lower, and these 'naive CAPM type models' that you hate so much massively understate the benefits of 'insurance' type strategies.

Sophisticated investors won't be putting their entire portfolio into CTA's or tail protect - that would drag down their returns too much. But they know that putting perhaps 5% into tail protect and 10% into CTAs will give them some protection with no effect on their performance (and also a source of liquidity in the event of a repeat of a 2008 type event).

In simple terms, cutting through the maths, it's worth insuring against your house burning down even if you expect the net cost of the insurance to be negative (insurance companies tend to be profitable so premium buyers must be losing out).

This makes sense if you understand Kelly betting. A tiny chance of a huge downturn is worth insuring against as it improves the geometric mean, even if it reduces the arithmetic mean (insurance costs money).

Secondly I don't think that 0.5 is an unreasonable number to assume for CTA Sharpe ratio.

The Sharpe Ratio for Cantab is roughly 0.5 over the funds entire 10 year trading history. Of course your rebuttal is based on the fact that they've been flat for the last few years. But it's daft to evaluate performance on such relatively short periods of time. Unless the true SR is very high you need many many years to be reasonably confident about what the performance was in the past (of course we're not talking about trying to predict the future here which is even more difficult). I won't go through the maths since I suspect you won't read it or care about it, and there has been more than enough maths in this thread already.

Now Winton is something else, they have a sharpe of almost 0.6 and very few down years. Makes a lot more sense to diversify with a manager like this. But I suspect they are the exception and not the rule.

Question: are there any low return, low sharpe (say, less than 0.4 or even 0.5) but uncorrelated CTA funds that have been raising money in the past 3-4 years or more recently? Can anyone provide any examples?

It depends over what period you define "low Sharpe". So if we take Winton for example who continue to be a formidable asset raising machine, if we use your favourite evaluation period of 3 years they made basically nothing in 2015 (+1.7%),2016 (+0.6%) and they're down 0.6% this year. But over the last 20 years they've made a SR of 0.6; very similar to Cantab. Clearly most investors prefer to use much longer periods when evaluating investments than you do.

Bluetrend, when it spun out into Systematica, was a pretty big one. I think they raised new money then, but I am not 100% certain.

Yes they did (private company so I can't prove this with a link, but it's public knowledge that they've launched a couple of decent sized funds ).

I'm done here, thanks for the thoughts. Do carry on without me if you'd like

Quite. Ultimately the title of this thread is "Why would anyone invest in these funds?" not "Why would @Maverick1 invest in these funds?". I think I've explained why plenty of people will continue to invest in this type of strategy - which I thought was the question you wanted answered.

GAT

 

[Martinghoul]

Yes they did (private company so I can't prove this with a link, but it's public knowledge that they've launched a couple of decent sized funds ).

Quite. Ultimately the title of this thread is "Why would anyone invest in these funds?" not "Why would @Maverick1 invest in these funds?". I think I've explained why plenty of people will continue to invest in this type of strategy - which I thought was the question you wanted answered.

GAT

One of the big doubts I have about the perceived attractiveness of strategies like CTA (and some others) has to do with the promise of liquidity. Surely, liquidity which is assumed to be readily available to a CTA mkt participant depends not just on the choice of instruments, but also on how big, crowded and correlated the community is at the moment of liquidation. Given that the AUM of the segment has grown a LOT since the crisis, I am just not that convinced.

This, clearly, is not that big of an issue for the tail risk funds.

 

[globalarbtrader]

One of the big doubts I have about the perceived attractiveness of strategies like CTA (and some others) has to do with the promise of liquidity. Surely, liquidity which is assumed to be readily available to a CTA mkt participant depends not just on the choice of instruments, but also on how big, crowded and correlated the community is at the moment of liquidation. Given that the AUM of the segment has grown a LOT since the crisis, I am just not that convinced.

This, clearly, is not that big of an issue for the tail risk funds.

Fair point - AUM is about 65% higher, although most other asset classes have grown in similar proportions. I guess the key figure would be something like AUM / average futures volume. Someone has probably worked that out, but I would imagine that hasn't change that much.

GAT

 

[srinir]

S&P 500 is ok as diversification because it's performance does not suck.
It is totally different from "diworsification" in which you add uncorrelated investments with dubious returns. I mean, you can't even be sure the fund is +ev, if they earn 0 after fee over 4 years then actually you lose quite a lot due to inflation already.

That was terrible advice from Buffet. Buffet trust lives forever, so it is good allocation for that trust (may be). But for mom and pop investor who retires on based certain pie, it is terrible allocation.

Imagine Japanese mom and pop investor retired in 1989 with that 90:10 allocation, because Japanese market did not suck till 1989 (as you said), they would have died eating cat food.

Buffet has done disservice to individual investors dissing diversification and advocating high stock allocation with out regarding to risk tolerance. Not only returns matters but sequence of returns matters.

No one predict the future. Japanese market had highest market cap just 30 years back, before that UK had highest market cap. Only free lunch left in the market is diversification.

It is totally different from "diworsification" in which you add uncorrelated investments with dubious returns. I mean, you can't even be sure the fund is +ev, if they earn 0 after fee over 4 years then actually you lose quite a lot due to inflation already.

Dubious return in which asset class? Ironic we are discussing in the forum where short term chart pattern trading is considered as investment.

Gold has zero or -ve real return over several stretches, but small dash of that asset has reduced volatility and produced some returns during time of stress and inflation.

This is chart of real return of gold. It has less return than even T-bills. (Source Dimson, marsh and strautton). Goal is to have market portfolio (based on their risk) with lowest possible standard deviation. They can always lever up that portfolio, if they need higher returns.

 

[Sig]

I'll deal with this in two parts.

Firstly even if we assume the Sharpe Ratio is zero it's still worth making an allocation to a negatively correlated asset.

Let's switch from CTA's to tail protect strategies. These probably do have SR of zero, but they have stronger negative correlation. Measures like SR and correlation are even less useful here, but let's be conservative.

Classic 60:40 equity / bond portfolio. Mean of around 4% and vol of around 12%. Geometric mean is 3.3%

Tail protect with a SR of 0.0 (with equity like vol of 15%) or a fantastically good equity trader with a SR of 0.5 (and vol of 15%). The correlation of the tail protect with the starting portfolio and the equity trader is -0.5. The correlation of the equity trader and stocks is 0.5.

The optimal weight to the equity trader is around 75%. This improves the SR to around 0.51 and the geometric mean return to 5.5%.

Again you might think there is no point adding the tail protect to this portfolio: after all it has zero excess return (zero SR).

But in fact a 15% allocation to tail protect increases the SR to 0.56.

Don't believe in Sharpe Ratios (perhaps you are an investor with a high tolerance for risk who doesn't use leverage)? A 5% allocation to tail protect increases the geometric mean to 5.6%. A modest increase but to reiterate the vol is significantly lower, and these 'naive CAPM type models' that you hate so much massively understate the benefits of 'insurance' type strategies.

Sophisticated investors won't be putting their entire portfolio into CTA's or tail protect - that would drag down their returns too much. But they know that putting perhaps 5% into tail protect and 10% into CTAs will give them some protection with no effect on their performance (and also a source of liquidity in the event of a repeat of a 2008 type event).

In simple terms, cutting through the maths, it's worth insuring against your house burning down even if you expect the net cost of the insurance to be negative (insurance companies tend to be profitable so premium buyers must be losing out).

This makes sense if you understand Kelly betting. A tiny chance of a huge downturn is worth insuring against as it improves the geometric mean, even if it reduces the arithmetic mean (insurance costs money).

Secondly I don't think that 0.5 is an unreasonable number to assume for CTA Sharpe ratio.

The Sharpe Ratio for Cantab is roughly 0.5 over the funds entire 10 year trading history. Of course your rebuttal is based on the fact that they've been flat for the last few years. But it's daft to evaluate performance on such relatively short periods of time. Unless the true SR is very high you need many many years to be reasonably confident about what the performance was in the past (of course we're not talking about trying to predict the future here which is even more difficult). I won't go through the maths since I suspect you won't read it or care about it, and there has been more than enough maths in this thread already.





It depends over what period you define "low Sharpe". So if we take Winton for example who continue to be a formidable asset raising machine, if we use your favourite evaluation period of 3 years they made basically nothing in 2015 (+1.7%),2016 (+0.6%) and they're down 0.6% this year. But over the last 20 years they've made a SR of 0.6; very similar to Cantab. Clearly most investors prefer to use much longer periods when evaluating investments than you do.



Yes they did (private company so I can't prove this with a link, but it's public knowledge that they've launched a couple of decent sized funds ).



Quite. Ultimately the title of this thread is "Why would anyone invest in these funds?" not "Why would @Maverick1 invest in these funds?". I think I've explained why plenty of people will continue to invest in this type of strategy - which I thought was the question you wanted answered.

GAT

It's a hard thing to explain something that requires understanding of statistics to people who don't understand statistics, but you did a good job here.