year-to-year basis as well as the risk-adjusted returns over the longer term.
This is how we see the world: the risk-adjusted returns of CTA funds are not generated by the general and schematic investment, and trading processes pictured in the presentations or described in one-on-one meetings with investors. The risk- adjusted return of a specific fund is a direct function of the detailed specification of their alpha models. The model specifications are different between the different CTA funds and thus short-term and longer- term risk-adjusted returns will differ. However, since none of the largest CTA managers are willing to reveal their models in such detail to enable fund pickers to make a detailed comparison between funds, it is probably quite far-fetched to believe that you will find predictive power in the soft contents of presentations. You can quite easily tell, however, who is good at producing professional-looking hand- outs.
When it comes to the hard contents of presentations (the track record), let us come back to that a bit later. In spite of the mandatory consumer warnings, it may be the only relevant straw you can hold onto in the end.
2. The Slick Presenter Fallacy The impression you get from a meeting is not just based on the presentation material used in the meeting. It is probably fair to say that the presenter’s ability to connect with the client, to explain, to argue, to reason, to create a positive atmosphere, to establish a professional rapport and to convey energy is at least as important as the quality of the pitch book.
What a well versed presenter can do is to make you feel comfortable with the idea of handing over money to the asset manager. A good presenter is able to minimise any uncertainty that the investor may feel. Will the investment team be able to deliver good performance in the future? Will the asset management organisation be able to fulfil its risk control, compliance and other duties? Is the back and middle office staffed with competent people and equipped with good, efficient and safe systems? Is the fund valuation done by an independent and professional party? Are the assets of the fund held by a respectable custodian or not?
Of course, there are some hard facts (e.g., fund valuation being done by an independent and respected party or not, assets being held by a respected custodian or not) which the presenter cannot do too much about – i.e., typical yes-or-no questions. However, since most questions are of a more open nature, there is often enough flexibility for a good presenter to make a good impression.
Fig.1 The Big Team Fallacy
0.70 0.60 0.50 0.40 0.30 0.20 0.10 0.00 -0.10 -0.20 -0.30
Source: SEB Investment Management AB, Bloomberg
080 20 40 60
100
120
140
NUMBER OF RESEARCHERS AT THE CTA FIRM IN 2013
3. The Big Team Fallacy When it comes to the size of different investment teams, many fund pickers think that larger research teams should generate higher risk-adjusted returns than smaller teams. To most people, it seems like an obvious fact. The reasoning goes like this: “100 researchers must be able to beat a team of 10 researchers…” and the reasoning may continue like this: “of course, in a single year, randomness may disturb the picture, but over time, it must be true.”
Because it is such an obvious ‘truth’ and because it takes a bit of time to gather the relevant data to check the hypothesis, most people would not even bother to do the work. As opposed to the above- mentioned pitch book fallacy and slick presenter fallacy, it is substantially easier to test whether team-size has an effect on future returns or not.
In Fig.1 we have pictured the number of researchers per CTA manager in 2013 against the Sharpe ratio of each CTA fund over the period from October 2006 to August 2013. We have chosen to use risk-adjusted returns, but of course there are other performance measures that could be used as well.
For the full sample of 23 CTA managers, the correlation between the number of researchers and the risk-adjusted returns amounted to a mere 0.09. If you were to exclude the CTA funds with the highest and lowest Sharpe ratios, you get a negative correlation of -0.31, i.e., the more researchers you have, the lower your Sharpe ratio.
Irrespective of whether you choose to exclude some funds from the sample or not, the R-square (how well the values of the X-variable are able to explain the variation in the Y-variable) is very close to zero in both cases (only 1% if you include all observations and 10% if you eliminate the observations with the highest and lowest Sharpe ratios). From this analysis, it is not possible to conclude that larger research
teams are able to generate higher risk-adjusted returns than smaller research teams. Nor can you claim the opposite.
Thus, if you are looking for risk-adjusted returns, do not get fooled to believe that larger CTA teams will deliver better performance for you. In the CTA industry, team size seems totally uncorrelated to performance. This implies that larger teams (with the exception of one manager) seem to be unable to capitalise on their vast research resources.
At least two criticisms can be put forward to our analysis. First, the sample contains only 23 observations. The absolute minimum for statistical testing is generally thought to be 30 observations. We would like to encourage database companies who might have gathered this kind of data from a larger set of CTAs to publish their research on this topic.
Second, observing the number of researchers at the end of the period rather than at the beginning of the period basically implies a test with perfect hindsight. Over this seven-year period, there has been a tendency that the most successful managers have been recruiting more researchers and the least successful have been making people redundant. In other words, if the number of employees had been measured ex ante, the correlation between team size and Sharpe ratio is likely to have been even lower (or more negative). We leave that for an independent researcher to study.
4. The Title Fallacy Would it not be reasonable to assume that a person with a higher academic title has a better chance of delivering good performance than a person with a lower or no academic title? It seems like a reasonable hypothesis. Also, in the marketplace, a lot of investors seem to get impressed by academic titles, the PhD title in particular.
23
SHARPE RATIO (OCT 2006 - AUG 2013)
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