Global Diversification: The Free Exotic Lunch

Read on for our test results – using our State of Trend Following systems – on how global diversification can boost trading performance, compared to a more standard diversification approach.

Is classic diversification enough?

The rise of correlation in developed markets has reduced the advantage offered from “classic diversification”. To regain the benefits of the proverbial “free lunch”, traders now have to seek exotic markets and access global diversification.

In this article, we explore the advantages of global diversification over a more standard approach consisting of a portfolio composed of mainstream markets from different sectors.

Intuitively, it makes sense that adding more exotic markets provides more opportunities to catch big trends, with less inter-market correlations. But we wanted to test and quantify the potential performance improvements of trading more exotic markets.

Global vs Classic Diversification: Exotic Markets Impact Test

Using the same systems as in the Wisdom State of Trend Following report, we compare the performance over two different diversified portfolios:

  • “Standard” portfolio – using “classic” diversification
  • Global diversified portfolio – including some exotic markets

For the purpose of this test, we defined an exotic market using three criteria:

  • Remote/“exotic” exchanges or products (South African exchange or Brazilian Real)
  • Alternative markets to the mainstream ones (Corn on the MATIF instead of the CME)
  • Niche markets (like Milk or Lumber)

In order to avoid any portfolio selection bias we did not limit the test to two portfolios only. Instead, we selected a list of “standard” and “exotic” markets and developed a tool allowing us to draw at random from these lists, and form multiple portfolios.

Standard portfolios can only draw from the list of standard markets, whereas exotic portfolios can draw from both lists. Each portfolio contains the same number of overall instruments with the same number of instruments per sector.

The details of markets and portfolio composition can be found further below, after the test results.

How Exotic Portfolios Out-Perform Standard Ones: The Test Results

We ran the Wisdom State of Trend Following systems over 500 different portfolios and collated the performance stats for each test run.

Below is a chart showing all of the 500 simulations based on their respective CAGR and Max Drawdown. Each dot represents a specific run. The green cluster shows portfolio including exotic markets, while the red one only includes “standard” markets.

 
Better runs are located on the top-left (and conversely worst ones in the bottom-right corner). Increased CAGR and reduced Max Drawdown make it quite apparent that exotic markets bring in a boost in performance.

Further below are summary stats for both groups of tests:

CAGR

AverageMinMax
Standard6.26%4.38%8.45%
Exotic13.8%9.15%17.67%

MAR

AverageMinMax
Standard0.210.150.29
Exotic0.610.340.99
 

Sharpe

AverageMinMax
Standard0.170.070.28
Exotic0.530.30.78

MaxDD

AverageMinMax
Standard29.90%23.80%36.50%
Exotic22.20%16.50%32.90%
 

 
Performance is increased by a significant margin across all 4 metrics.

Test Details

The systems (and system allocation) used in the test are identical to those used for the Wisdom State of Trend Following.

A large list of markets were then selected and classified as exotic or standard, as well as by sector. These markets were then fed to the random portfolio generator, constrained with specific numbers of instruments per sector – to make the portfolios relevant for comparison, in the context of diversification:

SectorStandardExotic?
Currencies42+2*
Energies21+1*
Equity Indices42+2*
Grains42+2*
Long Rates31+2*
Meats22+0*
Metals31+2*
Short Rates21+1*
Softs31+2*

The “starred” number is the number of exotic markets. For example, the metals sector always contains 3 different markets and in the case of exotic portfolios, 2 of these markets are exotic, with the remaining 1 being standard.

 

Below is the list of all markets selected for the test:

CurrenciesExchangeExotic?
Australian DollarCMEN
British PoundCMEN
Canadian DollarCMEN
EuroCMEN
Japanese YenCMEN
US Dollar IndexICEN
Brazilian RealCMEY
Euro / Japanese YenCMEY
Indian RupeeCMEY
Korean WonKRX (Kofex)Y
New Zealand DollarCMEY
EnergiesExchangeExotic?
Gasoline (RBOB)NYMEXN
Light Sweet Crude Oil (WTI) E-miniNYMEXN
Natural Gas (Henry Hub) E-miniNYMEXN
Brent Crude OilICE EUR (IPE)Y
Gas OilICE EUR (IPE)Y
Gas OilTOCOMY
GasolineTOCOMY
KeroseneTOCOMY
MetalsExchangeExotic?
CopperCME (NYMEX)N
GoldCME (COMEX)N
PalladiumCME (NYMEX)N
SilverCME (COMEX)N
GoldTOCOMY
PalladiumTOCOMY
SilverTOCOMY
MeatsExchangeExotic?
Cattle FeederCMEN
Live CattleCMEN
Short RatesExchangeExotic?
Euribor 3-monthEURONEXT (LIFFE)N
Fed FundsCME (CBOT)N
90-Day NZ Bank BillsASX (SFE-NZFE)Y
Australian Bank Bills (90 day)ASX (SFE)Y
Equity IndicesExchangeExotic?
Dax indexEUREXN
Dow JonesCMEN
Mini Russell 1000 indexICE US (NYFE)N
Nasdaq 100CMEN
S&P 500CMEN
FTSE Xinhua China A50 indexSGXY
Hang Seng index miniHKExY
MSCI Singapore Stock indexSGXY
TOPIX indexTSEY
GrainsExchangeExotic?
CornCME (CBOT)N
OatsCME (CBOT)N
Rice RoughCME (CBOT)N
SoybeansCME (CBOT)N
WheatKCBTN
WheatCME (CBOT)N
Azuki BeansTOCOMY
CornNYSE Liffe (MATIF)Y
Crude Palm OilBMD (MDEX)Y
Milling WheatEURONEXT (MATIF)Y
RapeseedNYSE Liffe (MATIF)Y
Yellow MaizeSAFEXY
Long RatesExchangeExotic?
Euro German BundEUREXN
Japanese 10-Year Govt BondSGXN
U.S. T-Bonds-30 Yr.CME (CBOT)N
US T-Notes 5-YearCME (CBOT)N
Australian Govt BondASX (SFE)Y
Canadian 10-Year Govt BondMXY
Swiss 10-Year Govt BondEUREXY
SoftsExchangeExotic?
CocoaICE US (NYBOT-CSCE)N
CoffeeICE US (NYBOT-CSCE)N
Cotton (#2)ICE US (NYBOT-NYCE)N
Robusta CoffeeNYSE Liffe (LIFFE)Y
Sugar (#11)ICE US (NYBOT-CSCE)N
CocoaNYSE Liffe (LIFFE)Y
LumberCMEY
Milk (Class III)CMEY
RubberTOCOMY
 

Boost your trading opportunities: Access more Exotic Markets

At Wisdom Trading, we strive to take your trading further. One way we do this is by expanding the frontiers of your trading universe. We offer one of the widest product offerings in the industry with access to over 300 markets on 30+ global exchanges.

Take your trading truly global: get in touch today to discuss how exotic diversification can boost your trading performance. We’ll be happy to discuss portfolio selection and recommended trading capital, specific markets coverage, or more specific system performance over different globally diversified portfolios.

 

Disclaimer

Hypothetical performance results have many inherent limitations, some of which are described below. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown. in fact, there are frequently sharp differences between hypothetical performance results and the actual results subsequently achieved by any particular trading program.

One of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight. In addition, hypothetical trading does not involve financial risk, and no hypothetical trading record can completely account for the impact of financial risk in actual trading. For example, the ability to withstand losses or to adhere to a particular trading program in spite of trading losses are material points which can also adversely affect actual trading results. There are numerous other factors related to the markets in general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical performance results and all of which can adversely affect actual trading results.