Hedge Funds

Not too long ago, a trader asked me to review his track record, but I only had 5-minutes to do the review.  Is it possible to examine a track record in five minutes?   The answer is: yes. It should just take a few minutes to analyze a well-documented Forex track record*.

Unfortunately, most track records are poorly organized and difficult to glean any information from regardless of how long the reviewer has to peruse the trade statistics.  Well-organized track records will tell the reviewer the following (not listed in the order of importance):

1. The Forex trader’s name,  location and the name of the program.
2. Regulatory jurisdiction.
3. Brokers name and location.
4. Amount of assets that are under management.
5. Peak to trough draw-down.
6. Length of the trading program.
7. Month by month returns and  AUM.

Investing in emerging Forex traders (these traders are sometimes called managers) can be extremely rewarding, or it can be extremely disappointing.  Similar to athletics, catching a rising star before anybody else notices a person’s talents can be financially rewarding for both the discoverer and the discovered.  Generally, as assets under management grow, returns shrink. And here’s the paradox: the longer you wait for a emerging Forex trader’s track record to become statistically significant, the more likely it is that that manager is going to acquire more assets under management and the managers track record will suffer due to the law of diminishing returns. Forex fund investors know it is easier to manage a $100 thousand than  $50 million.

An investment is said to be in a drawdown when the account equity falls below the accounts last equity high. The drawdown percentage drop in the price of an investment from its last peak price. The period between the peak level and the trough is called the length of the drawdown period between the trough, and the recapturing of the peak is called the recovery. The worst or maximum drawdown represents the highest peak to trough decline over the life of an investment. The drawdown report presents data on the percentage drawdowns during the trading program’s performance history ranked in order of magnitude of loss.

• Start Date: Month in which peak occurs.
• Depth: Percentage loss from peak to valley
• Length: Duration of drawdown in months from peak to valley
• Recovery: Number of months from valley to new high

One of the most common measurements used by professional investors when they are comparing Forex funds track records is the standard deviation.  Standard deviation, in this case, is the level of volatility of returns measured in percentage terms over a period of many months or even years. The standard deviation of returns is a measurement that compares the variability of returns between funds when combined with data from annual returns.  Everything else being equal, an investor will deploy his capital in the investment with the lowest volatility.

A Forex trading advisor, sometimes called a trading manager, is a person or firm that, for compensation, advises others about trading currencies or trades currency accounts on their behalf. The role can be filled by an individual or by a company. This article is educational only; it is not investment advice or legal advice, and nothing here is a recommendation of any advisor, manager, or program.

The labels deserve care. In everyday conversation, manager, trader, and advisor are used loosely and often overlap, but they are not universally interchangeable, and none of them is, by itself, a legal status. Regulatory systems define their own categories, with their own tests, for people who advise on or manage trading in particular instruments, and whether a given person falls into such a category depends on what they actually do, where, for whom, and under which regulator’s rules. A term used on a website or business card settles none of that.

Registration is the same kind of question. In some jurisdictions and circumstances, a person who advises on or manages trading must register with a regulator or qualify for an exemption; in others, or for other activities, different rules apply. Whether any particular advisor is required to register, is registered, or relies on an exemption is a factual question about that advisor. A prospective investor can ask directly, ask for the basis of any exemption claimed, and verify registration status with the relevant regulator rather than relying on the label alone.

What an advisor actually does is defined by agreements, not titles. The scope of trading authority, the markets and instruments covered, how the advisor is compensated, and how the arrangement ends are all set out in the account, management, and disclosure documents. Compensation arrangements vary and are a matter of the specific contract; what any advisor charges, and how it is structured, should be read from those documents rather than assumed from industry shorthand.

If the advisor also acts as an introducing broker, examine the conflicts created by transaction-based compensation.

Evaluating an advisor is due-diligence work of the ordinary kind discussed elsewhere on this site: the advisor’s background and disclosures, the strategy and its risks, the costs, and a track record read as history rather than prophecy, since past performance is not indicative of future results.

Whether working with any advisor fits a particular portfolio is a judgment each investor must make independently, ideally with a qualified professional. Trading foreign exchange involves substantial risk of loss and is not suitable for every investor.

Related articles on this site cover the Forex market, managed accounts and hedge funds, disclosure documents, notional funding, and how to evaluate a manager’s track record.

Correlation describes how two investments’ returns have moved in relation to each other. It is one of the concepts investors weigh when thinking about how the pieces of a portfolio fit together, and it is worth understanding before reading any claim about diversification. This article is educational only; it is not investment advice, and nothing here is a recommendation of any investment or portfolio.

Correlation is summarized by the correlation coefficient, a number that always falls between -1.0 and +1.0, calculated from the returns of two investments over a chosen period. A positive coefficient means the two tended to move in the same direction over that period; a negative coefficient means they tended to move in opposite directions; a coefficient near zero means the measurements show little consistent relationship in either direction.

The word tended is doing important work in each of those readings. A correlation is a summary of tendency across many observations, not a rule about individual moves. A negative coefficient does not mean that every time one investment rises the other falls, and a positive one does not mean the two always rise together. Strength matters too: values near the extremes describe a strong tendency, while values near zero describe a weak one.

Three cautions keep the number honest. First, correlation is historical and period-specific: it is computed from returns over one particular window, at one particular frequency, and a different window or frequency can produce a different figure. Second, a measured correlation of zero is not a promise of independence; it means no consistent linear relationship appeared in that sample, which does not assure the two investments will behave independently in the future. Third, relationships between markets can change, and correlations measured in calm periods may not hold in stressed ones.

For those reasons, there is no universally ideal correlation target for a portfolio, and no category of investment can be assumed to carry a particular correlation. Whether any Forex fund or account is weakly or strongly correlated with anything else is a question about its actual measured returns over a stated period, not about its label. How correlation figures into diversification depends on the portfolio’s actual positions, their concentrations, and the strategy pursued, and diversification itself does not assure a profit or protect against loss.

Whether any of this matters for a particular portfolio is a judgment each investor must make independently, ideally with a qualified professional. Trading foreign exchange involves substantial risk of loss and is not suitable for every investor.

Related articles on this site cover the Forex market, alternative investments, the Sharpe ratio, managed accounts and hedge funds, and how to evaluate a manager’s track record.