Investment Research: The Importance of the Secret Sauce

When we conduct regular due diligence on managers, and especially when we’re getting to know a manager for the first time, we like to get a sense of how their system operates. Depending on the manager, we might get a litany of details, or a terse summary from a manager who prefers to keep the details private.

We sometimes refer to this as the “secret sauce,” the part of the manager’s method that remains an in-house secret. Like chef carefully guarding their recipe (or a space-bound billionaire hiding the technology behind the ascent), it’s not hard to imagine why some managers adopt such a secretive posture.

As it turns out, recent academic research has come out to reinforce this idea. Past performance is not necessarily indicative of future results, but if that past performance is published in an academic journal, it just might be responsible for diminishing future results. Via CNN Money:

Professors David McLean (MIT) and Jeffrey Pontiff (Boston College) set out to learn what happens after academic papers on new trading strategies are published, and found that the strategies quickly lose efficacy.

“Our results suggest that when academics publish a paper about a new strategy, investors learn from the paper and begin to trade on that strategy,” McLean explains. “This trading impacts prices, bringing them more in line with fundamental values. This in turn makes the strategy less profitable, so it appears that academic research destroys stock return predictability.”

This research focused on stock-picking strategies, but this is exactly the fear that drives managers to keep secrets. Imagine a scenario in which other manager out there knew that your CTA was going to initiate a long position in crude oil if the 50-day moving average crossed above the 200-day moving average. Other traders could take this into account, bidding the price up to get your system to initiate a position, then selling on the bump that your allocation caused.

For the biggest traders, this can be a serious risk, and it’s part of why JP Morgan’s “London Whale” suffered losses as deep as he did – other traders found out about the position and made unloading the portfolio much more expensive for JP Morgan. (Incidentally, high-frequency traders are often accused of similar practices, except they “sniff out” standing orders through trial-and-error rather than foreknowledge).

It may be frustrating from time to time to encounter a tight-lipped manager, but in a world where one traders’ losses are another traders’ gains, the “secret sauce” can be the difference between a winning strategy and a played-out theory.

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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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