Thread by @mikeharrisNY

Thread about trading strategy and fund performance analysis. #tradingstrategy #funds

Advanced performance analysis is fine but nothing beats common sense. Below are some common sense ways of analyzing strategy and fund performance.

1. Annualized return

The strategy must offer an acceptable annualized return subject to constraints. Very low annualized return is undesirable but also high annualized return that comes at high risk is also undesirable and even more so.

Note that even if annualized return is low, the strategy may be acceptable due to the leveragability it offers. Often is better to leverage 2X a strategy with a smooth equity than use one w/o leverage but with volatile equity.

2. Drawdown profile

Many funds and strategy developers state the maximum drawdown but that offers a measure of historical max drop from ATH. The historical drawdown profile is more important b/c it offers an extended view of performance rather than just a snapshot.

3. Recovery time

Recovery time from drawdown is an important metric and feature. If it takes a few years to recover from 20% drawdown, then the strategy or fund may cause uncle point to traders and investors.

For example, $ARKK has been in a drawdown for about a year since the all-time highs.

Note that $ARKK compound annual return peaked at 40.5% but maximum drawdown is currently at 54%. Some make the naïve claim that despite the high drawdown the annualized return of the ETF since inception is still 20.5%. See #6 below for the reasons this is a naïve claim.

The drawdown profile of $ARKK shows that about 10% of the time the drawdown has been larger than 33%; this is a high risk drawdown profile that can cause uncle point depending on risk aversion profile.

4. Leveragability

Why is leveragability important? It is because if the drawdown profile remains acceptable under leverage, then the probability of a large loss in the future is lower.

Leveragability does not mean that necessarily the strategy or fund performance will be leveraged but that it can accommodate a larger-than-expected drawdown without causing uncle point or even ruin.

5. Performance ratios

Some performance ratios used for strategy and fund performance evaluation can be misleading. One of them is the Sharpe ratio. For example, Sharpe of 1 can mean 10% excess return divided by 10% volatility or even 30% excess return divided by 30% volatility.

MAR (annualized return divided by maximum drawdown) of 1 can mean 10% annualized return divided by 10% max DD or 30% annualized return divided by 30% max DD. It is always important to evaluate the significance of dimensionless ratios in the context of actual performance.

6. Time irreversibility

Some strategy developers and fund managers point to past performance in an effort to justify current underperformance. This is of no consolation to those who started using a strategy or invested in a fund just before the drawdown.

No one can travel back in time to realize the benefits of past performance. This is why #2, drawdown profile, is important.

“We are down 25% year-to-date but last year we made 60%.”

The above is a frightening statement and those who make it forget to account for the investors or traders who invested in a fund or traded a strategy just before the drawdown.

“But CTAs made in excess of 20% in the 90s!” Someone once told me.

Sorry, this is 2022. Investing is not about history, is about the future.

To summarize, advanced statistical analysis of performance and fancy ratios are nice for filling marketing brochures and blog pages but common sense evaluation is probably the most robust way practitioners have used all along and will continue to use.

This thread is also available in article form here: priceactionlab.com/Blog/2022/01/s…