CTA Selection: Apply Statistical Analysis

The Calmar Ratio determines the dollars returned for each dollar risked over a given period of time and is usually calculated for the more recent 36-month period. It is the calculated annual return divided by maximum drawdown.

When employing the Calmar Ratio to evaluate CTAs, investors should not overlook the actual annual return and maximum drawdown figures. Despite a positive Calmar Ratio, the CTA′s annual return and maximum drawdown must be in line with the investor′s goals and risk tolerance levels. At least 24 months′ worth of data is recommended when applying the Calmar Ratio. With less than 24 months′ of data points the data is often upwardly skewed. As the number of data points increases, the Calmar Ratio often decreases.

Downside Deviation is a measure of downside volatility. It only considers those monthly performance results that are less than the monthly MAR (minimum acceptable rate of return) rather than the arithmetic mean. For example, if the MAR is assumed to be 10%, the downside deviation would measure the variation of each period that falls below 10%.

Downside deviation is inversely related to the Calmar, Sharpe, Sortino and Sterling Ratios. A lower downside deviation is preferred because it indicates less monthly underperformance of the MAR.

The Efficiency Index is a risk/reward measure calculated by dividing the compound annual return by the annualized standard deviation of the monthly rate of return.

A ratio developed by Nobel Laureate William F. Sharpe to measure risk-adjusted performance. It is calculated by subtracting the risk-free rate from the rate of return for a portfolio and dividing the result by the standard deviation of the portfolio returns.

The Sharpe Ratio tells us whether the returns of a portfolio are due to smart investment decisions or a result of excess risk. This measurement is very useful because although one portfolio or fund can reap higher returns than its peers, it is only a good investment if those higher returns do not come with too much additional risk. The greater a portfolio′s Sharpe Ratio, the better its risk-adjusted performance has been.

A variation of the Sharpe Ratio is the Sortino Ratio developed by Frank A. Sortino, which removes the effects of upward price movements on standard deviation to instead measure only return against downward price volatility. This differentiation of upwards and downwards volatility allows the calculation to provide a risk-adjusted measure of a security or fund′s performance without penalizing it for upward price changes. The Sortino Ratios for comparative CTAs are ranked from highest to lowest.

Standard Deviation is a method to look at consistency of returns and is a statistical measure of the dispersion of a set of data from its mean. It is applied to the annual rate of return of an investment to measure the investment′s volatility (risk). The more spread apart the data is, the higher the deviation and the higher the implied risk. Although standard deviation shows variance from the mean return, it says nothing about the overall profitability of an investment. Given a choice between two investments that have a similar annual return, we would want to choose the investment with the highest return and the lowest volatility. This would be the investment with the lowest standard deviation.

The Sterling Ratio is a return/risk ratio where return (numerator) is defined as the Compound Annualized Rate of Return over the last 3 years. Risk (denominator) is defined as the Average Yearly Maximum Drawdown over the last 3 years less an arbitrary 10%. To calculate this average yearly drawdown, the latest 3 years (36 months) is divided into 3 separate 12-month periods and the maximum drawdown is calculated for each. Then these 3 drawdowns are averaged to produce the Average Yearly Maximum Drawdown for the 3-year period. If three years of data are not available, the available data is used.

The Sterling Ratios for comparative CTAs are ranked from highest to lowest.