The Answer to your Dreams?

Abstract

For many years, investors have faced a dilemma in making asset allocations to commodity trading advisers (CTAs). On one hand, numerous studies indicate that investing in CTAs makes sense due to their relatively high risk-adjusted returns and low correlation with traditional assets such as stocks and bonds. At the same time, it is widely acknowledged that reported CTA returns are overstated due to survivor bias. As a result of this uncertainty, assets invested in CTAs remain relatively small when compared to hedge funds in general. In this article it is argued that CTAs possess overlooked performance characteristics-positive skew and excess kurtosis-which are of significant value to investors. Specifically, positive asymmetry in CTA returns serves as an offset to the negative asymmetry of other assets in portfolio construction. Indeed, when portfolio optimization techniques that consider higher-order moments are employed instead of simple mean-variance analysis, the resulting allocations to CTAs are significantly higher. For this reason, instead of focusing only on lower moments, investors are well advised to take into account CTA return skew and kurtosis. Ignoring skew and kurtosis can lead investors to the impression that CTAs are more risky than they really are, thereby increasing the likelihood of diminished investment returns in the process.