RCG Managed Futures has compiled this glossary to supplement their growing list of investor resources. Through understanding these common terms, investors can more readily navigate the world of managed futures and alternative investing.
* Denotes terms defined by Barclay Hedge regarding the statistics and reports used on the CTA profiles available on the RCG Managed Futures website.
Alternative Investments – An investment category that is not based on holding traditional assets, such as stock, bonds or real estate. Alternative investments can include futures and options.
*Average Recovery Time (ART) – This is the average time in a recovery from a drawdown measured from the low point of the drawdown to a new peak. If a trading program is in an on-going drawdown, for purposes of calculating the ART we assume that the current drawdown is over.
*Barclay Index – The Barclay CTA Index measures the composite performance of established programs. For purposes of this index, an established trading program is a trading program that has four years or more documented performance history. Once a trading program passes this four-year hurdle, its subsequent performance is included in this unweighted index. The CTAs that comprise this index change over time. This index is not necessarily an indication of how the CTA(s) you select will perform. The Barclay Index does not represent an actual portfolio, which could be invested in, and therefore the index performance results should be deemed to be hypothetical in nature and of comparative value only.
*Barclay Ratio – This ratio was developed by Barclay Hedge. In simplest terms, the Barclay Ratio is equal to the trend of the VAMI divided by the standard deviation of the monthly returns. Although similar in certain respects to the Sharpe Ratio, it has a much higher correlation with percentage of profitable 12-month time windows than any other reward/risk ratio.
CFTC (Commodity Futures Trading Commission) – A federal regulatory agency established under the Commodity Exchange Act that oversees futures trading in the United States. The CFTC monitors the futures markets, and options on futures markets, in the United States.
Commodity Trading Advisor (CTA) – A Commodity Trading Advisor is a person or entity, who for compensation or profit, provides advice regarding the buying and selling of futures and options. A CTA will exercise trading authority over a customer’s account through a limited power of attorney. A CTA is registered with the CFTC, and generally is a member of the NFA.
*Compound Annual Return – This is the rate of return which, if compounded over the years covered by the performance history, would yield the cumulative gain or loss actually achieved by the trading program during that period.
Correlation – Correlation is a statistical measure of how much the movement of two asset classes or two CTAs are related. The range of possible correlations is between -1 and +1. A result of -1 means a perfect negative correlation, +1 means a perfect positive correlation, and 0 means no correlation at all. A positive correlation between two CTAs, or a CTA and an asset class, means that they tend to move up and down together. A zero correlation means that the change in value of one CTA or one asset class, has no impact or bearing on the change in value of the other CTA or asset class. A negative correlation between two CTAs or between a CTA and an asset class, means that they tend to move in opposite directions.
Modern portfolio theory uses correlation analysis to assist with the asset mix decision for an investment portfolio. *Distribution of Monthly Returns – This report displays the number of months in which a trading program’s monthly performance historically has fallen within varying performance increments.
*Drawdown Report – A drawdown is defined as a loss of equity from a peak to valley in a single month or period of consecutive months. The Drawdown Report presents data on the percentage drawdowns during the trading program’s performance history ranked in order of magnitude of loss.
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
Start Date: Month in which peak occurs.
End Date: Month in which valley occurs.
*Efficiency Index – This is a ratio calculated by dividing the annual return by the annualized monthly standard deviation.
Fundamental Analysis – A method of anticipating future price movement, using supply and demand information.
Futures Commission Merchant (FCM) – An FCM is a brokerage firm that solicits or accepts orders to buy or sell futures contracts, or options on futures, and accepts money or other assets from customers to support such orders. The FCM executes, clears, and holds positions for customers. FCMs are licensed by the CFTC.
*Hurdle Rate – The appreciation in a fund, or CTA performance that must be achieved before the investment manager may take a performance (incentive) fee.
*High Watermark – A requirement that the fund, or CTA, must recoup any prior losses before the investment manager may take a performance (incentive) fee. In addition to performance losses, prior losses may include any combination of fees that the investment manager charges, such as management and administrative fees.
Incentive Fees – Most CTAs charge an incentive fee on net new profits. Fees typically range from 10% – 30% and are paid either monthly or quarterly. If there are no net new profits, there are no incentive fees.
Leverage – The ability to control large dollar amounts of a commodity with a comparatively small amount of capital.
Managed Futures – Represents an asset class traded by professional money managers known as Commodity Trading Advisors (CTAs). CTAs manage client assets on a discretionary basis, using the futures and options on futures markets, as an investment medium.
Management Fee – Most CTAs charge a management fee for their services. Fees are typically charged on a monthly or quarterly basis and are determined as a percentage of assets. Although management fees are typically charged monthly or quarterly, management fees are normally quoted as a yearly rate and typically range from 0%-3%.
Margin (Performance Bond) – Funds that must be deposited by a customer with an FCM to initiate or maintain a market position. Margin funds are required of both buyers and sellers of futures contracts, and sellers of options contracts to ensure fulfillment of contract obligations. Also referred to as a performance bond.
Margin Call (Performance bond call) – A call from a clearinghouse to a clearing member, or from a brokerage firm to a customer, to bring margin deposits up to a required minimum level.
National Futures Association (NFA) – The NFA was authorized by Congress in 1974, and designated by the CFTC in 1982 as a registered futures association; the NFA is an industry wide self regulatory organization for the futures and options on futures markets.
Options – A contract that gives the buyer the right, but not the obligation, to buy or sell a specified quantity of a futures contract at a set price within a set period of time, regardless of the market price of the futures contract. The price paid for the option is called the premium.
Sharpe Ratio – The Sharpe Ratio is equal to compound annual rate of return minus rate of return on a risk free investment divided by the annualized monthly standard deviation. A ratio greater than, or equal to one indicates that the return is greater than or proportional to the risk the investor incurred to earn that return.
Standard Deviation – Standard deviation measures the degree by which the monthly returns vary from the average (mean) return. A higher standard deviation indicates higher volatility.
*Sterling Ratio – This ratio is a comparison of historical reward and risk and was developed by Deane Sterling Jones. The Sterling Ratio is equal to the average annual rate of return for the past three calendar years divided by the average of the maximum annual drawdown in each of those three years plus 10%.
Technical Analysis – A method used to anticipate future price movements, by using historical prices, trading volume, open interest, and other trading data.
*Time Windows – This tabular analysis summarizes the best, worst and average performance for the trading program during time windows of varying lengths. For example, three-month time windows measure performance in all rolling three-month time periods (e.g., months one through three, two through four, etc.).
*Value-Added Monthly Index (VAMI) – VAMI is defined as the growth in value of an average $1000 investment. VAMI is calculated by multiplying (1 + current monthly ROR) X (previous monthly VAMI). VAMI assumes the reinvestment of all profits and interest income. Incentive and Management Fees have been deducted.