The Sharpe penalizes volatility, i.e. wide swings in the value of the account. From a risk perspective according to Sharpe, the perfect trading method would be one that increases in a straight line with no spikes either way. This approach makes sense because downside swings become more dangerous the larger they become. Think about it- to overcome a 20% drawdown, you will have to make 25%. To overcome a 50% drawdown, you will have to make 100%. To make back a 100% drawdown, well- go wash dishes and get another stake. So it is logical for the sharpe ratio to be harsh on swings. However, the ratio short changes dynamic traders who adjust their exposure accordingly. It doesn't differentiate from a big upswing and a big downswing. It just divides everything by the standard deviation of your monthly returns. Thus Sharpe doesn't care if your big swings are all on the upside and it doesn't care if you slam on the brakes and dial down when necessary, it will still penalize you because all it sees is deviation from the average, and thus it doesn't really tell the whole story. If a trader is only aggressive when he is ahead of the game, and correspondingly conservative when he is not, thus preserving his initial capital at all times, then sharpe doesn't capture the true beauty of his style.
A CTA trades futures and futures options for others. A CPO oversees a commodity pool (also called a managed futures fund). Sometimes the CPO and CTA are the same company. Sometimes the CPO does no trading itself and selects an independent CTA or CTAs. Some CTAs only trade individual accounts. Some CTAs only trade for pools. Some do both. "Hedge Fund" doesn't have a strict definition. The prototypical hedge fund is a macro fund like the Quantum Fund that takes big bets on the securities and currencies of various countries. Long-short equity funds are also a typical hedge fund strategy. Some people consider managed futures funds to be hedge funds; Some consider them to be a separate category.
Good post, Darkhorse. Some people calculate the standard deviation of only the down months (the "semi-deviation") and use it in the Sharpe ratio and call it the semi-Sharpe.
In the end it sounds like they belong to the same category. However I like to view a CTA as a newsletter writer as opposed to a CPO who does the hard work himself. Thanks for the explanation.
Ah, yes, thank you. That's a category I forgot... Some CTA's print newsletters or have websites with futures trading recommendations and don't do any actual trading for clients.
darkhorse, Thank you for the explanation. Admittedly I am pretty ignorant when it comes to 'sharpe ratios' and other performance measurement formulas. I use my own simple, yet effective measurements... Again thankyou for your time...
I looked at that list of funds from that link back a page or so. Why come only one fund is up on an annualized basis more than 60%. Why come only 3 are up over 40% on an annualized basis. Just a standard bell curve should give at least a few more who are up 40%. BTW: why advertise if you're up like 20% or so.
as a general rule of thumb, wealthy investors are more interested in capital preservation than capital appreciation. the more you have, the more you want to keep it. if fund A is up 50% and fund B is up 25%, that doesn't tell you a whole lot. it may be that A simply takes on more leverage (and thus more risk). i know someone at a $900 million outfit with an annual performance target of 15%. the flipside of this, of course, is that their drawdowns are practically nonexistent.