The Hidden Max Drawdown

As you read this week’s newsletter, we may sound like a broken record, but when it comes to investing managed futures, understanding risk is the single most important component of success, in our opinion. The cornerstone of risk analysis, for many investors, is the dreaded drawdown. A drawdown is the “pain” experienced by an investor in a specific investment. As an example, an investor starting out with a $100,000 account who sees it fall down to $80,000 before it runs back up to $110,000 saw a $20,000 loss ($100K – $80K), which would equal a -20% ($20K/$100K) drawdown. The so called Maximum Drawdown (Max DD) is the worst such peak to valley down period for an investment.

The standard across the managed futures industry when talking about Max Drawdown is to show Max DD as the worst peak to valley loss on an END-of month-basis. This presentation of data is derived from the NFA rules on creation of disclosure documents which states all performance calculations must be done on a monthly basis.

But the story takes an unexpected turn if the max drawdown number is calculated using daily data instead of month end data. When considering the worst intra-month performance (using daily data) instead of the numbers CTAs put on the books at the end of the month, a very different picture can emerge.

Consider the example below of a fictitious investment which starts at $100,000 and meanders back and forth for a few months before settling out at around $130,000. Now, the whole point of looking at the drawdown in the first place is to know that the investment didn’t just go from $100k to $130k in a straight shot upwards. There were many bends and turns lower in the process.

But when using the standard end of month drawdown measure, the green line, we end up ignoring many of those same bends and turns we were intent on seeing with the max drawdown number.  Consider that in the standard end of month drawdown measure (in green in the graph below), the fictitious investment had an end of month Max DD of around $45,000 (from $225,000 down to around $180,000), or -20%. Now,  it is plain that there were higher highs and lower lows on the blue line (the daily ups and downs), and when running the numbers on this we can tell you that the fictitious investment went from around $245,000 down to $150,000 for a max Drawdown on a daily basis of -$75,000 or -30%.

The following is a mere example and not representative of trading in actual accounts:

Now,  it’s easy to say that “all’s well that ends well,” but is that really the case? This is just a fictitious example, but the intramonth DD here was 1.5 times what you would see on the end of month basis. That’s a pretty big difference, especially when considering many investors use 1.5 times the past max DD level as a rule of thumb for assessing when a CTA has become riskier than the investor signed up for.

With all this in mind, to what extent should intra-month drawdowns guide investor portfolio decisions? In our high-speed, hyper-connect world, where clients can see their balances in real time during the day and review statements sent to them every night, these intra-month drawdowns are just as visible, and, especially as we repeatedly drill into their heads that past performance is not necessarily indicative of future results, can be even more unnerving.

Our research provides some interesting insight for investors and managers at alike. Click here to see the full piece: http://bit.ly/nsxKxx

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Disclaimer
The performance data displayed herein is compiled from various sources, including BarclayHedge, and reports directly from the advisors. These performance figures should not be relied on independent of the individual advisor's disclosure document, which has important information regarding the method of calculation used, whether or not the performance includes proprietary results, and other important footnotes on the advisor's track record.

Benchmark index performance is for the constituents of that index only, and does not represent the entire universe of possible investments within that asset class. And further, that there can be limitations and biases to indices such as survivorship, self reporting, and instant history.

Managed futures accounts can subject to substantial charges for management and advisory fees. The numbers within this website include all such fees, but it may be necessary for those accounts that are subject to these charges to make substantial trading profits in the future to avoid depletion or exhaustion of their assets.

Investors interested in investing with a managed futures program (excepting those programs which are offered exclusively to qualified eligible persons as that term is defined by CFTC regulation 4.7) will be required to receive and sign off on a disclosure document in compliance with certain CFT rules The disclosure documents contains a complete description of the principal risk factors and each fee to be charged to your account by the CTA, as well as the composite performance of accounts under the CTA's management over at least the most recent five years. Investor interested in investing in any of the programs on this website are urged to carefully read these disclosure documents, including, but not limited to the performance information, before investing in any such programs.

Those investors who are qualified eligible persons as that term is defined by CFTC regulation 4.7 and interested in investing in a program exempt from having to provide a disclosure document and considered by the regulations to be sophisticated enough to understand the risks and be able to interpret the accuracy and completeness of any performance information on their own.

RCM receives a portion of the commodity brokerage commissions you pay in connection with your futures trading and/or a portion of the interest income (if any) earned on an account's assets. The listed manager may also pay RCM a portion of the fees they receive from accounts introduced to them by RCM.

See the full terms of use and risk disclaimer here.

Disclaimer
The performance data displayed herein is compiled from various sources, including BarclayHedge, and reports directly from the advisors. These performance figures should not be relied on independent of the individual advisor's disclosure document, which has important information regarding the method of calculation used, whether or not the performance includes proprietary results, and other important footnotes on the advisor's track record.

Benchmark index performance is for the constituents of that index only, and does not represent the entire universe of possible investments within that asset class. And further, that there can be limitations and biases to indices such as survivorship, self reporting, and instant history.

Managed futures accounts can subject to substantial charges for management and advisory fees. The numbers within this website include all such fees, but it may be necessary for those accounts that are subject to these charges to make substantial trading profits in the future to avoid depletion or exhaustion of their assets.

Investors interested in investing with a managed futures program (excepting those programs which are offered exclusively to qualified eligible persons as that term is defined by CFTC regulation 4.7) will be required to receive and sign off on a disclosure document in compliance with certain CFT rules The disclosure documents contains a complete description of the principal risk factors and each fee to be charged to your account by the CTA, as well as the composite performance of accounts under the CTA's management over at least the most recent five years. Investor interested in investing in any of the programs on this website are urged to carefully read these disclosure documents, including, but not limited to the performance information, before investing in any such programs.

Those investors who are qualified eligible persons as that term is defined by CFTC regulation 4.7 and interested in investing in a program exempt from having to provide a disclosure document and considered by the regulations to be sophisticated enough to understand the risks and be able to interpret the accuracy and completeness of any performance information on their own.

RCM receives a portion of the commodity brokerage commissions you pay in connection with your futures trading and/or a portion of the interest income (if any) earned on an account's assets. The listed manager may also pay RCM a portion of the fees they receive from accounts introduced to them by RCM.

See the full terms of use and risk disclaimer here.

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