In my last article, Four Key Items for an Emerging Manager to Grow Their Business, was a discussion about track records. This article discusses it in more detail. Investors often ask for at least a three to five-year track record. Emerging managers may ask why do I need to have that long of a track record? There are a few reasons for the length.
- It shows if there is any consistency to the manager’s trading and environments where they profited and lost.
- More importantly it gives an investor enough monthly data to calculate various metrics on the trading system to begin a profile of the investment.
- From an organizational perspective, the longer track record implies the manager has been in business longer and if they are effective at running a business.
A fundamental metric that is sometimes forgotten or less emphasized is the drawdown profile. When the manager is in a drawdown mode, what is the investor’s expectation during the drawdowns? When drawdowns are viewed, it is often the maximum drawdown that is considered. But the average drawdown and recovery periods are helpful in creating a profile of the manager/ strategy. However, I always tell my students in the managed futures course I teach at DePaul University that a manager’s largest drawdown may be ahead of them.
What attributed to those moments of drawdowns and profits? Is it due to movements of specific markets in the portfolio, something universal across the portfolio, risk management of the portfolio, or the manager’s actions? These questions lead to a better understanding of the manager and their track record.
Does a Sharpe Ratio Matter?
I sometimes hear new managers talk very proudly about their Sharpe ratio. I also hear investors seeking high Sharpe ratios. Unless their return distribution is a normal distribution, the Sharpe ratio doesn’t mean much as it assumes a normal distribution of returns. CTAs may have a low Sharpe ratio because they may have a high standard deviation, but the volatility may be due to a positive skewness of their return distribution. This is often missed in the analysis of the track record. Ironically, it is the higher positive volatility that may reduce the investor’s portfolio volatility. I wrote about this topic in my paper Skewing Your Diversification, and I teach in my course and workshops, and I’ll discuss it in more depth in future articles.
What about a previous track record?
If it is a track record from a previous firm or fund, is the manager legally allowed to share it? Does it represent how the manager is currently trading? Sometimes a previous track record is best to mention as part of a manager’s career. It can build a profile of their experiences and appreciation for trading and the markets but not confuse it with their current track record.
In summary, understanding a manager’s track record is a combination of quantitative and qualitative aspects. Crunch the numbers as much as possible and ask questions that cannot be determined from the metrics. The shorter the track record, the more critical the qualitative methods become.
Mark Shore is an Adjunct Professor at DePaul University’s Kellstadt Graduate School of Business, where he teaches the only known accredited managed futures course in the country. He is also a Board Member of the Arditti Center for Risk Management at DePaul University.