SCOTT WELSH TRADING BLOG

Is Too Complex Too Much?

Is Too Complex Too Much?

June 17, 2020

What’s best for our trading?

Should we be more complex?

Should we be smarter?

I was listening to a podcast this weekend and the guest was an “allocator”. That means he looks at trading strategies from all over the world and decides what to pick to bring “alpha” (profits) to his clients.

He was very well spoken and used the amount of jargon that someone his level should use. He was a smart guy.

And he has to be. To be able to decipher the best strategies from the very good is hard. Determining how to fit a strategy in with other strategies is harder. And then determining at the allocation level of each strategy while managing the volatility targets of the clients? That’s complicated stuff.

Specifically, his fund’s goals are to pursue “capital efficient equity exposure while balancing risk and reward through a dynamic hedging strategy with a core laddered fixed-income portfolio with futures and equity hedges designed to provide uncorrelated sources of returns.”

No wonder Morningstar rates his funds as 4-Star (out of 4).

It’s easy to feel intimidated. And we probably should be. To do what this fund does takes a ton of brain-power.

Feeling inadequate, I glanced over to the “Annualized Rates of Return” section of the fund page. I was curious to see what kind of return high intellect produces.

What would you guess? 20% per year? 30%? More?

Since the inception of this fund, the annual return is 5.83%.

In same time period, the S&P 500 produced 9.25%.

All those complex configurations under-perform the market by a wide margin.

And that’s not all. In the past five years, the fund’s returns drop down to only 3.65%.

Yikes.

It begs the question: what is all that complexity for?

A monkey throwing darts could beat 3.65% per year.

But monkey trading is unconfirmed. Here’s what is confirmed.

Let’s take the ES Futures contract and put a childish breakout system on it. Here are the rules.

We will only go Long because we’re not smart enough to go Short. We enter Long when price breaks above the high of the past 40 bars. We exit only when price goes below the low of the past 20 bars.

No stoploss. No target. No volatility sizing. No non-correlated diversification. Just a breakout and a trailing stop.

We’d get laughed out of the room at an allocation presentation.

How did it do?

Here are some trades:

If we used typical drawdown numbers for the S&P 500 as a guide and traded this on a $25,000 account with no compounding and only 1 contract per trade, we’d make about 12% per year.

That’s more than double what the fund did overall and it would have blown it away over the past five years.

It’s not even close.

So why be complex at all?

Complicatedly-intelligent works very well on a podcast, and probably in investor meetings.

But, in the real world, simple eats complex’s lunch.

Talk to you soon.

 

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Disclaimer:
It should not be assumed that the methods, techniques, or indicators presented in these products will be profitable or that they will not result in losses. Past results are not necessarily indicative of future results. Examples presented on these sites are for educational purposes only. These set-ups are not solicitations of any order to buy or sell. The authors, the publisher, and all affiliates assume no responsibility for your trading results. There is a high degree of risk in trading.

HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE CERTAIN INHERENT LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, SINCE THE TRADES HAVE NOT ACTUALLY BEEN EXECUTED, THE RESULTS MAY HAVE UNDER- OR OVER-COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN.