When investing in any particular program, two critical things come to mind: risk and return. Does the investment provide a sufficient return given its risk characteristics? We believe that our Polaris Program (Polaris) offers attractive returns and superior risk characteristics to traditional investments.
Compare the cumulative return of Polaris and a common CTA benchmark, the SG CTA Index, versus the S&P 500:
The total return since 2000 for each of these investments may be attractive. However, the equity markets have experienced painful drawdowns during this period, each exceeding several years in length. Both CTA series tend to have superior drawdown characteristics, but Polaris even beats its benchmark in this respect, since its drawdown-to-volatility ratio never exceeds 2, unlike the SG CTA Index:
It is important to examine how a program, or any potential asset, performs in conjunction with an investor’s existing portfolio. That is, does adding the investment improve or detract from the returns of the portfolio, and does risk reduction occur?
Polaris has a weak negative correlation with the S&P 500 at -8%, and a positive but weak correlation to the Barclay Capital Bond Index at 17%. This stylized fact implies that drawdowns are less likely to occur in Polaris simultaneously with the equity and bond markets. Additionally, the impact of adding Polaris to an equity portfolio’s volatility is less than adding another positively correlated equity product.
While low correlation by itself is an appealing characteristic, the return of an investment must be sufficient to justify its addition to a portfolio as well. We can measure portfolio performance in many ways, but the de facto standard has become the Sharpe ratio, which offers a means of calculating risk-adjusted returns: the average return (from historical data) relative to historical volatility. If we compare an equal allocation scheme, 50% stocks and bonds (using S&P and Barclay Capital Bond indices respectively) to an equal allocation with 1/3 stocks, bonds, and Polaris, the risk-adjusted performance measured by Sharpe improves from 0.62 to 0.84. This occurs due to an increase in the mean return from 5.9% to 6.3%, and a reduction in volatility from 9.6% to 7.7%. The diversification benefit is clearly evident, and there is no accompanying drop in performance.
An equal allocation scheme is intuitive, but if we allocate capital in a manner that optimizes the in-sample Sharpe ratio, even more desirable outcomes may be obtained.
The mean return is unchanged, but volatility drops from 8.38% to 7.40%. This is due to the diversifying effect of managed futures, and the low correlations we observed. This benefit in risk does not result in a decrease in the historical mean return.
This effect can also be visualized through the efficient frontier. The efficient frontier depicts the set of attainable historical annual returns and their respective minimal risks. Shifting the frontier to the left is desirable because it means that the same historical returns are attainable at lower risk.
Below is a chart of the frontier, before (dashed red line) and after adding Polaris (solid red line). Points are plotted for the individual asset classes. Notice that equities are the least efficient asset class, having simultaneously the highest risk and lowest expected return over the study period (2000 through January 2016).
The frontier shifts to the left when Polaris is added to the stock and bond portfolio.
Past performance is based on actual performance but is not a complete track record. The above discussion is for example only. No representation is being made that any single account will or is likely to achieve a record similar to that shown; individual investor experience may vary due to timing of investment, fees and expenses, and other factors. The investment program involves risk of loss and is speculative, and may not be available in all jurisdictions. PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.