April 24, 2014

Global Diversification: The Free Exotic Lunch

At Wisdom Trading we strongly believe in the power of global diversification. This is why we offer our traders and clients access to over 300 markets on 30+ global exchanges, one of the widest product offerings in the industry.

In the following article, we make the case for adding exotic markets to your portfolio. The resulting global diversification can boost trading performance, compared to a more standard approach.

Check the test results below, showing a strong increase in average return (over 100% improvement) and substantial drawdown reduction.

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 the standard approach (consisting of a portfolio composed of mainstream markets from different sectors).

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

     vs.

  • 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)

To avoid portfolio selection bias we did not limit the test to two portfolios only. Instead, we picked multiple random portfolios for each category (standard/classic vs. global/exotic.

We divided the product universe in two categories (standard vs. exotic). Standard portfolios only contain standard markets, whereas exotic portfolios contain products from both categories. To keep a balance, each portfolio contains the same number of overall instruments with the same number of instruments per sector.

Markets and portfolio details 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.

scatter plot chart-2

 
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.

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%
 

Chart quadrant

 
The chart above displays Average and Min/Max values for the four stats across the whole testing results. 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 EXOTIC
Euro / Japanese Yen CME EXOTIC
Indian Rupee CME EXOTIC
Korean Won KRX (Kofex) EXOTIC
New Zealand Dollar CME EXOTIC
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) EXOTIC
Gas Oil ICE EUR (IPE) EXOTIC
Gas Oil TOCOM EXOTIC
Gasoline TOCOM EXOTIC
Kerosene TOCOM EXOTIC
Metals Exchange Exotic?
Copper CME (NYMEX) N
Gold CME (COMEX) N
Palladium CME (NYMEX) N
Silver CME (COMEX) N
Gold TOCOM EXOTIC
Palladium TOCOM EXOTIC
Silver TOCOM EXOTIC
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) EXOTIC
Australian Bank Bills (90 day) ASX (SFE) EXOTIC
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 EXOTIC
Hang Seng index mini HKEx EXOTIC
MSCI Singapore Stock index SGX EXOTIC
TOPIX index TSE EXOTIC
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 EXOTIC
Corn NYSE Liffe (MATIF) EXOTIC
Crude Palm Oil BMD (MDEX) EXOTIC
Milling Wheat EURONEXT (MATIF) EXOTIC
Rapeseed NYSE Liffe (MATIF) EXOTIC
Yellow Maize SAFEX EXOTIC
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) EXOTIC
Canadian 10-Year Govt Bond MX EXOTIC
Swiss 10-Year Govt Bond EUREX EXOTIC
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) EXOTIC
Sugar (#11) ICE US (NYBOT-CSCE) N
Cocoa NYSE Liffe (LIFFE) EXOTIC
Lumber CME EXOTIC
Milk (Class III) CME EXOTIC
Rubber TOCOM EXOTIC
 

Wisdom Trading: A Truly Global Futures Broker

Boost your trading opportunities: Access more Exotic Markets

At Wisdom Trading, we strive to take your trading further. 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.

 

Credits

This post and underlying research work was partially inspired from the Trading Blox forum post by user sluggo comparing US-centric vs. international portfolio performance.

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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