Exotic Post

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.

Portfolios can be customized to various account sizes, risk, and markets traded.

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

 Average Min Max
Standard 6.26% 4.38% 8.45%
Exotic 13.8% 9.15% 17.67%

MAR

 Average Min Max
Standard 0.21 0.15 0.29
Exotic 0.61 0.34 0.99

Sharpe

 Average Min Max
Standard 0.17 0.07 0.28
Exotic 0.53 0.3 0.78

MaxDD

 Average Min Max
Standard 29.90% 23.80% 36.50%
Exotic 22.20% 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:

Sector Standard Exotic?
Currencies 4 2+2*
Energies 2 1+1*
Equity Indices 4 2+2*
Grains 4 2+2*
Long Rates 3 1+2*
Meats 2 2+0*
Metals 3 1+2*
Short Rates 2 1+1*
Softs 3 1+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:
Currencies Exchange Exotic?
Australian Dollar CME N
British Pound CME N
Canadian Dollar CME N
Euro CME N
Japanese Yen CME N
US Dollar Index ICE N
Brazilian Real CME Y
Euro / Japanese Yen CME Y
Indian Rupee CME Y
Korean Won KRX (Kofex) Y
New Zealand Dollar CME Y
Energies Exchange Exotic?
Gasoline (RBOB) NYMEX N
Light Sweet Crude Oil (WTI) E-mini NYMEX N
Natural Gas (Henry Hub) E-mini NYMEX N
Brent Crude Oil ICE EUR (IPE) Y
Gas Oil ICE EUR (IPE) Y
Gas Oil TOCOM Y
Gasoline TOCOM Y
Kerosene TOCOM Y
Metals Exchange Exotic?
Copper CME (NYMEX) N
Gold CME (COMEX) N
Palladium CME (NYMEX) N
Silver CME (COMEX) N
Gold TOCOM Y
Palladium TOCOM Y
Silver TOCOM Y
Meats Exchange Exotic?
Cattle Feeder CME N
Live Cattle CME N
Short Rates Exchange Exotic?
Euribor 3-month EURONEXT (LIFFE) N
Fed Funds CME (CBOT) N
90-Day NZ Bank Bills ASX (SFE-NZFE) Y
Australian Bank Bills (90 day) ASX (SFE) Y
Equity Indices Exchange Exotic?
Dax index EUREX N
Dow Jones CME N
Mini Russell 1000 index ICE US (NYFE) N
Nasdaq 100 CME N
S&P 500 CME N
FTSE Xinhua China A50 index SGX Y
Hang Seng index mini HKEx Y
MSCI Singapore Stock index SGX Y
TOPIX index TSE Y
Grains Exchange Exotic?
Corn CME (CBOT) N
Oats CME (CBOT) N
Rice Rough CME (CBOT) N
Soybeans CME (CBOT) N
Wheat KCBT N
Wheat CME (CBOT) N
Azuki Beans TOCOM Y
Corn NYSE Liffe (MATIF) Y
Crude Palm Oil BMD (MDEX) Y
Milling Wheat EURONEXT (MATIF) Y
Rapeseed NYSE Liffe (MATIF) Y
Yellow Maize SAFEX Y
Long Rates Exchange Exotic?
Euro German Bund EUREX N
Japanese 10-Year Govt Bond SGX N
U.S. T-Bonds-30 Yr. CME (CBOT) N
US T-Notes 5-Year CME (CBOT) N
Australian Govt Bond ASX (SFE) Y
Canadian 10-Year Govt Bond MX Y
Swiss 10-Year Govt Bond EUREX Y
Softs Exchange Exotic?
Cocoa ICE US (NYBOT-CSCE) N
Coffee ICE US (NYBOT-CSCE) N
Cotton (#2) ICE US (NYBOT-NYCE) N
Robusta Coffee NYSE Liffe (LIFFE) Y
Sugar (#11) ICE US (NYBOT-CSCE) N
Cocoa NYSE Liffe (LIFFE) Y
Lumber CME Y
Milk (Class III) CME Y
Rubber TOCOM Y

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.

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