Since I have been trading for quite a few years, been
through a few hard economic cycles, "retired" (sort of), moved to a
foreign country (ok it's only FL but you know what I mean), watched a family
split in half, ran an albatross angel-investing-consulting strategy, helped boot-strap and close a hedge fund start-up,
etc. etc I thought I'd take a moment to look at some good stuff,
performance-wise, while I'm at a relative high point…and while I still
can.
But before we get to the numbers, let's first look at why I went down this path in the fist
place so I can connect results to the original reasons for seeking them. Let's also ignore the underlying
purpose of why I do what I do (covered here already) and focus more on the
technical reasons why I rolled my own systematic alt risk rather than either
"do nothing" or outsource to something like a hedge fund. My rationale looked like this:
- I figured that going forward into the return expectations one could reasonably have for the next 10 years that adding risk premia other than equity and credit risk would be an appropriate thing to do: it enhances real diversification (real risk premia sources vs. traditional asset classes or hedge funds that might have fake alpha that look a lot like beta) and it holds the potential for real improvements in portfolio efficiency (especially if one were to view risk as merely variance…which it isn't) during what might be some hard times to come.
- Hedge funds and related options where alt risk premia can usually be found are expensive. I detest the 2 and 20 model (this world is finally changing a bit). That’s a lot to pay especially given the next point.
- Whether expensive or not, the guys you want to manage your money -- the top tier where there are maybe only 5 or 10 or 20 real and consistent performers in the world (maybe that's overstating it but I don't think so) that have a sustainable edge and long term credibility -- have more often than not closed their funds. That means you are left with the others and why, really would you want a second or third or fourth rate manager.
- Even if you could get into the top two or three tiers you probably can't afford the minimums. For the upper class managers it can be 10 million or more, sometimes a lot more. That clearly is not my path.
- Even if you could afford the minimums there are all sorts of other characteristics that I find unpleasant like lockups, gates, agency and counter-party risk, strategy shift risk, fraud risk, opacity and poor communications, etc.
Well, I thought, I can do this myself instead! Except that here
we have to provide even more context. That's because the conventional wisdom about independent retail-level self-managed traders trading
as a sideline or as a second career is that:
1. Their profile (ignoring ex-institutional castaways) is typically that of a middle aged male age
45-60 (me) with a current or prior career in a long-process education-heavy discipline like law
or medicine or engineering or software-consulting or accounting. (me again). The idea that forms in these heads (which
might look like mine) is that all that work and intelligence and success will
just have to naturally translate to huge success in trading because,
well, because they just worked so hard and were so smart and successful. But this is kind of like an attorney --
because he went to a swank college and a decent law school, won some tort
cases, and is sitting on decent pile of $ -- thinking he is perfectly capable
of performing heart surgery or building enterprise software which, without even needing to say it, he is not. And,
2. The conventional wisdom is also that these types of
traders fail not only at a rate of about 95% but often they fail three times:
1) first with their own money, 2) then with money from their family and
friends, and then 3) with anything else they can cajole out of anyone else.
And,
3. For the ones that pass through this crucible it has been said
that it takes two years to lose money, two years to break even, and 2 years or
more to limp along making pathetic but possibly rising profits. After that, it
all depends…
So, technically speaking, I happened to choose a path
("purpose" notwithstanding though in the end I think that purpose is what
saved me) where my cognitive and behavioral biases blinded me and the
deck was more or less stacked against me.
Now, with all that behind us, let's look at the last three years. I pick three years here, even though my strategy is
older, because 2014 is when I hit the seven year mark in trading (see point 3 above) and
started to feel like I was finally getting some traction. Braggy as it is, here below is what it looks
like. I used some imperfect reference data/index sources
because, well because I can get them for free.
I also used composite indexes because my strategy is hard to pin down
and crosses several of the categories.
Relative Performance 2014 - 2016:
In mean-variance map form it might look like this (the link is for 2016 only but includes Barclay Hedge data...though the EF map only had Barclay data as of Nov at that point). At some point I'll go back and true-up the start dates for the CAGR but it is a little bit indicative as it is.
Any Conclusions From All of This Given My Reasons For Going Down This Path?
While I have not made the instant lottery-like fortune that
some seem to think trading will offer, let's recap what I now know looking
back over at least three years if not ten:
1. Did I lose all my money three times and then lose the money of
others?
No, I never lost vast sums. I mostly broke even (through
intense study and discipline in risk management and an arduous effort at
collecting and cycling back data from the process) for 5-7 years and obtained very modest
returns thereafter.
2. How long did it take?
Evidently about what the conventional wisdom says.
3. Did I make huge, infinite, money-tree-like sums?
Nope, but I think I did ok on a risk adjusted basis. As a capital allocation choice it has been accretive.
4. Have I added constructive forms of diverse risk
premia to my meta portfolio (at least viewed ex-post)?
Yes, though limited.
The best I can say is that I am gaining some advantage from the momentum
anomaly and the volatility risk premium and there is probably some indirect
advantage from the value anomaly and a tiny bit of illiquidity premium in there
too. There is some commodity exposure
too but I already had some of that on my passive side. There are some asset
class enhancements like international debt and currency but the underlying risk
premia can be sometimes hard to characterize. There may be others. On a net basis I am over-exposed to interest
rate risk (that is being taken care of) but I feel like my incremental "real
risk premia" exposure does not look anything like my passive portfolio which is good, I think. I have not measured correlations lately but plan to.
5. Did I have to pay 2 and 20?
5. Did I have to pay 2 and 20?
No way. It costs me maybe anywhere from 20-50 bps depending on how
it's measured and what kind of overhead is included.
6. Did I have to consign myself to a fourth-rate hedge fund
manager or CTA?
No, not unless I am considered a fourth- or fifth-rate manager. The performance numbers above tell me
that I am likely in at least the 2nd quartile for at least the last three years. Not too shabby, all things considered. Importantly, note also that I did not get myself locked into some other guy's fund where the promise of "alt" or "hedge" or even "return" was big but the delivery was all market/equity risk, all beta, all "closet indexing." (see # 4 above).
7. Did I have to pay a minimum?
No, and now I can scale up or down more or less as needed. There are probably some practical limits on how small I could do this. I am also finding a few scaling difficulties going up, even in my scale range. I know with great certainty that I could not scale this at institutional levels but that, for what it's worth, is one of the advantages of working on micro-scaled strategies. Big guys can't touch this stuff.
8. Are there any
lockups or gates, etc?
No, I have near instantaneous liquidity and no lockups or
gates. Counter-party risk? Ha, that's funny. Strategy-shift risk? Of course but sometimes that
can be called adaptation (at least when it works). Opacity? Only if I am not thinking clearly or
keeping the data. Communications? Moot, or only
when I talk to myself which I have been known to do.
9. Did I, in the end, and only looking at last 3 years, need to either "do nothing" or outsource?
No, I think three years in a row of besting no small number
of professional and very highly paid managers (the analysis is very imperfect
but when boasting one has to do what one has to do), most of whom look like
they have been pretty disappointing in retrospect, is enough to convince me I
did the right thing. It's too bad my
results are not really auditable, maybe I could raise a little money…
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