When analysis of a CTA begins, where is the appropriate place to start?
This article makes the point that beta performance drivers are the logical starting point. This is important from a number of perspectives, including correlation and determination of the proper considerations for CTA analysis going forward.
Performance Drivers Not Often Discussed
At its core, the CTA strategies have market environments in which they perform positively and negatively. This is considered a beta performance driver.
By first recognizing these macro performance factors, the asset manager can describe the investment in terms that sets performance expectations and fits within typical equity analysis protocols.
Obtaining this information can sometimes be a challenge, however, as some CTAs prefer to obfuscate their strategy or might not understand the beta performance concept. The key is to recognize the difference in performance drivers in various strategies and do so through a categorization system that is not uniform.
In the case of trend following, the beta performance driver is price persistence. When the price of a traded asset continues to move in one direction, either up or down, this price persistence is generally considered to be beneficial to the strategy; conversely. when the market environment changes towards a directionless trading environment one might expect CTA strategies to exhibit difficulty. Compare this to a relative value strategy, for instance, that operates under a macro performance driver of divergence and convergence back to a statistical mean.
Challenges Extracting Information
What can be a challenge is the categorization of different strategies. Some strategies are called breakout strategies, momentum algorithms or just plain trend following. In all these cases, the strategy is based on the beta performance driver of price persistence and is thus understood first from this perspective.
In any trend following strategy, when the market environment of price persistence is present the strategy has potential to perform positively; conversely, when the market environment of price persistence isn’t present the strategy can exhibit enhanced risk.
Each of the major CTA strategies is first considered from this beta performance driver standpoint. From this alpha factor analysis is undertaken, which uses different factors for analysis depending on the beta performance driver. For instance, a strategy influenced by the performance driver of price persistence had different analytic priorities than does a volatility CTA.
Next Educational Piece:
Second Educational Piece: First Understand Strategies From the Standpoint of Market Environments and Performance Drivers
Third Educational Piece: Examples of CTA Analysis based on performance driver factors.
DISCLOSURE: These are the opinions of the author and may not have considered all risk factors. Nothing on this web site should be construed as an individual recommendation, talk to your independent advisor. The author and Opalesque may have relationships with those people they cover in the publication. Mr. Melin provides a full disclosure of his business relationships to regulators and certain eligible participants who engage him in consulting projects. Managed futures investing involves risk and there are no guarantees of safety or future performance being implied. Managed futures can be a risky investment. This web site and its content is subject to the terms of the web site. Risk Disclosure and terms of web site are available here: http://www.uncorrelatedinvestments.com/templates/Disclaimer.html Performance information received on this site is provided by third parties and deemed reliable but there is no guarantee relative to same. Performance reporting sources and quality assurance techniques may include, but are not limited to: disclosure document, CTA self reporting, brokerage firm reporting, consultant reporting, spot checking other reporting databases; nonetheless no guarantee of accuracy or implication performance verification or auditing is being made by the publishers. The CTA Database is a project separately managed from www.uncorrelatedinvestments.com.