I mentioned last week that I might investigate some of the concerns raised in recent podcasts regarding the apparent increase in the dispersion of returns in the Trend Following space. So I played around with the concept of dispersion in relation to those Funds that are classified as Long Term Globally Diversified Systematic Trend Following funds that are the subject of this monthly performance report.
Now typically when discussing concepts such as dispersion as a ‘bad thing’ you need to be careful about what class of Fund Manager you are referring to. For example those passive managers that seek to hug an index inevitably achieve a lower dispersion of returns to those active managers seeking absolute returns. This is quite understandable as the passive manager seeks to map to an index whereas an active manager strives to deliver positive ‘absolute returns month after month. Lower dispersion should not necessarily be deemed a positive attribute. Furthermore it is widely recognised that performance dispersion can also be accounted for by important differences between Funds such as the style, fund size, manager skill etc. However when you look at the dispersion of returns between the funds discussed in this monthly report, the notion of the ‘why’ for the dispersion of returns is not that self-evident.
For example here is a scatter plot of the long term performance of the constituents of the TF Index comprising 36 long standing systematic globally diversified trend following programs for the period 1 Jan 2000 to 30 June 2020.
On a first glance it appears that while the group is widely dispersed in terms of CAGR. You might be therefore tempted to conclude that this disparity may relate to Manager skill. As a result you may therefore have a preference towards Funds offering the highest CAGR. However what you need to also keep in the back of your mind is that many of these firms use risk adjusted methods to smooth their equity curves. When you therefore turn to a different scatter plot which measures $ return against drawdown you can clearly see that clustering is very evident with far less dispersion of returns.
So simple CAGR dispersion does not tell the full performance story and if you used CAGR or monthly % return as a basis for your fund selection decision in this particular grouping you might find that in the long term that you are sorely disappointed.
What you should however note in the scatterplot above are the 4 outliers to the right of the scatter plot. Now this is where you should direct your attention. They clearly stand out as outliers from the overall cluster in terms of absolute $ returns Why?
We will get to that shortly….but it revolves around a concept referred to as the Geometric mean.
So let’s now look at the monthly dispersion about the TF Index and see what it says in terms of whether or not the dispersion of returns is increasing or decreasing for this long term TF grouping.
The graph above reflects the average absolute deviation of monthly returns between each fund and the TF Index index itself between 1 Jan 2000 to 30 June 2020. What appears evident is that, contrary to what we might think, the dispersion of monthly returns of this TF grouping is actually slightly decreasing over time. This suggests that if we are looking for clues for why it appears that return dispersions are increasing in the TF space over the long term time horizon….then the degree of monthly variation of returns plays a limited role in shedding light on this ‘actual long term return dispersion’. So traditional factors such as style, fund size, manager skill etc. may have a very limited role to play in any ‘actual return dispersion’ in this grouping.
So let’s see if we can find the culprits of this riddle to understand why there is a long term dispersion of returns in this grouping. I have highlighted the ‘clues to this riddle below.
Hopefully some of you may be now becoming enlightened to this riddle. It is not the regular monthly variation of returns that have a significant impact of long term return dispersion as we might think, but rather it is the impact of a handful of outliers that has a dominant role in this story of return dispersion. It is the outliers of dominant variation that are the main drivers of dispersion in compounded returns of the TF CTA’s.
We can see this with the chart below. The top left of the chart highlights in the Histogram a handful of outliers in red (about 3% of monthly returns). These are the major contributors to the overall $ return of the return stream on the top right. The top right equity curve increases to $7.5 in total equity from an initial $1.0 start.
Now if I stunt the small number of outliers (tail events) to eliminate their overall impact on the curve (refer to bottom left histogram) look at the impact on $ return expressed by the chart on the bottom right. The curve increases from a $1.0 start and ends with a very mild $2.4 in total equity. Simply by removing the outlier impact of a handful of months….we turn a spectacular wealth story into a very average story of mediocrity.
Now the moral of this tale (about tails) is that if you attempt to tamper with these outlier events through volatility adjusting methods you may be successful in delivering a smoother equity curve for your investors…..however the sting in this tale (when diluting tails) comes with a severe reduction in total returns over the long term horizon.
The reason for this significant disparity is due to influence of compounding over the entire period. The step ups in the equity curve achieved through positive outlier impacts (combined with adverse tail mitigation methods adopted by all TF firms) exert a non-linear impact on the nature of the overall equity curve and the raison d’etre to longer term dispersion in this grouping.
Those 4 outliers you can see in the scatterplot below arise from those Programs that managed to successfully capture the bounty of the major market outliers throughout the 20 year history. They were not scared away by the volatility and they embraced it. Furthermore these Programs were at the right place at the right time to catch these outliers. You may say that this is a story of ‘luck’….however we trend followers know how to turn luck into a skill.
Our secret sauce lies in diversification and capital preservation.
To be in the ‘right place at the right time’ requires that you have your systems turned on 24/7, deploy capital preservation at all times …and that you are widely diversified across ‘every place’ and ‘every time’. By achieving this you turn ‘luck’ into a ‘skill’….but for goodness sake, do not compromise more volatile long term returns for short term less volatile smoothness. Provided our adverse volatility is mitigated through system design, then we want to allow for unlimited upside potential. Sharpe won’t tell you this but MAR will.
Now back to the monthly CTA Fund Performance Report for June 2020.
We use NilssonHedge for reporting purposes which allows us to expand our performance coverage to include a broader array of long term established FM’s who occupy the CTA space and have been in operation since 1 January 2000 to the current day. This performance report focuses only on those funds with a long term track record (approx 20 years). The reason we adopt this long term horizon for reporting purposes is that to survive in these financial markets over such a long timeframe and still be alive today offering absolute returns to the client takes a special breed of Fund Manager who has expertise in surviving the turmoil of a variety of different market regimes. We like these guys and that is why we focus on them. As the years roll on we will progressively expand our coverage to include those FM’s who narrowly miss out in their inclusion when they reach the 20 year performance track record horizon.
So far for the month of June 2020 we have 54 CTA’s reporting and within that grand total we have 36 Systematic Global Trend Following funds. We have to draw the line somewhere and the slow coaches unfortunately miss out.
For those that like the detail, below are the index constituent performance results for the CTA Composite Index (59) and the TF Global Index (37).
- CTA Composite Index (Program Composition)
- CTA Systematic Trend Following Global Index (Program Composition)
The CTA Composite Index 54 was down -0.26% for the month with the calendar year offering modest growth of 2.03%….and the TF Global Index 36 was down -1.20% with an almost breakeven YTD contribution of 0.80%.
Systematic Trend Following Global Index Overview
Now as ardent trend followers ourselves, we like to narrow our focus to the Systematic Diversified Global Trend Following community of CTA’s.
For an overview of what moved and what didn’t for the month in this investment space then you should go straight to the source and listen to the Fund Managers themselves. In this regard, there is no better resource than that provided by Niels Kaastrup-Larsen of ‘Top Traders Unplugged’ and (Dunn Capital Management) in his Systematic Investor Series with Moritz Seibert, Rob Carver and guests. Great to have Jerry back this month.
- The Systematic Investor Series (Featuring Jerry Parker) – June 1st, 2020;
- The Systematic Investor Series – June 8th, 2020;
- The Systematic Investor Series (Featuring Robert Carver) – June 15th, 2020;
- The Systematic Investor Series – June 22nd, 2020;
- The Systematic Investor Series – June 29th, 2020;
Top 10 by CAGR since 1 January 2000
Below is a performance table and an equal weighted performance chart of the top 10 performers of the Long Term Trend Following Index Composite in terms of annualised returns to investors (net of all fees and expenses) since 1st January 2000.
Here is a scatter plot that highlights where the top 10 sit in terms of their Compound Annual Growth rate (CAGR) and Maximum Drawdown over the performance monitoring period.
Below are the performance metrics of the Top 3 from this Top 10 list by CAGR. Just look at those returns. It might be a bumpy journey along the way….but when these guys nail it…they hit it out of the ball-park.
Top 10 by Risk Adjusted Return (using the MAR ratio) since 1 January 2000
Now onto the risk adjusted return category. This category is for those that get ulcers when riding the drawdowns of leveraged volatile equity curves. Here are the results of the Top 10 in this category.
….and the top 3 from this Top 10 category.
Top 3 Equal Weighted Combination Portfolio – The Blend of Blends
Now as great as the individual risk adjusted returns of the Top 10 in the prior category are….we can do better when we look at the performance of possible combinations from the TF list. We iterate across the TF Index to find the Top 3 in terms of Risk Adjusted returns as a combination portfolio each month. So for those avid readers looking for the best risk-adjusted result of a possible equal weighted threesome….here is the result for the month.
Just look at those risk adjusted metrics. With a bit of leverage we can reach for the stars with this combination.
The 3 contributing funds for this month based on an equal weighted blend are as follows:
Top 10 for the last 12 months
So how are the guys going in the short term? There is enough style drift in this camp to observe significant variation in performance returns over the short term. Some of the mob have performed strongly over the last 12 months.
….and the top 3 from this Top 10 category.
Well that’s a wrap for the month…
July 2020 has seen a bit of movement in the precious metals so hopefully that translates to some great returns coming up for the mob with the ‘midas touch’. Even better if some of those moves turn into major outliers.
Dream the ‘Fat Tail’.
Looking forward to next months report.
Trade well and prosper
The ATS mob