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Commodity Trading Advisors: Risk, Performance Analysis, and Selection Chapter 19

CHAPTER 19 CTA Strategies for Returns Enhancing Diversification. In this chapter, we analyze the risk and performance characteristics of different strategies involving the trading of commodity futures, financial futures, and options on futures employed by CTAs. | 19 CTA Strategies for Returns-Enhancing Diversification David Kuo Chuen Lee Francis Koh and Kok Fai Phoon In this chapter we analyze the risk and performance characteristics of different strategies involving the trading of commodity futures financial futures and options on futures employed by CTAs. Differing from previous studies we employ full and split samples to examine the correlations and compute risk and performance measures for various CTA strategies. We rank the returns of the S P 500 and MSCI Global Indices from the worst to the best months and partition the sample into 10 deciles. For each decile we compute the relationship between the CTA indices and the equity indices and compare their risk and return characteristics. We find that CTA strategies have higher Sharpe and Sortino ratios compared to other asset classes for the entire sample period under study. Further unlike hedge funds the correlation coefficients between CTA and equity portfolios for the first decile worst performance of the equity indices are mostly negative. The volatility measured by downside deviation of CTA strategies is lower compared to equity indices. And for the up-market months CTA strategies are associated with high Sortino ratios. Our results are consistent with previous findings that returns from CTA strategies are less correlated with equity market indices during down markets than hedge fund strategies. One possible explanation is that CTAs unlike hedge funds are exposed to lower liquidity risk in down markets and therefore do not suffer any severe liquidity squeeze. Our findings suggest that the negative correlations of CTAs with equity indices during periods of equity downturns can provide an effective hedge against catastrophic event risks. Although hedge funds may provide diversification they have positive correlation with equity indices in down markets especially when extreme events occur. Hence our findings suggest that adding CTA investments to an equity portfolio can