Screening the DARWIN Providers

By | February 7, 2016

Following the discussion in the comments section of this blog post, I decided to put my investor cap on and write an article on screening DARWINs. For those who don’t know already, Darwinex is an FCA (UK) regulated broker and asset manager where traders can have their strategies packaged into an investable product called DARWIN ( Dynamic Asset and Risk Weighted Investment). Darwin takes care of all the regulatory and logistical issues; you’re left with doing the trading, and just like if you were running a CTA or hedge-fund, you’re compensated via a percentage (20%) of the quarterly profits you make for your investors.

At the time of this writing, there are already 521 DARWINs listed, that investors from all over the world (excluding US and Japan) can invest in, starting from $200.

There are three major red flags that I have identified when browsing through the DARWIN providers list and I think potential investors should be aware of them.

Firstly, the number of strategies a provider has: there is no limit here; it can be anywhere from one to a ridiculous 24 strategies. I’ve already mentioned how professional traders have built a career and are known for one style of trading or investing. The same thing is true for other fields such as law, medicine or sports. In order to excel at something, one has to specialize. How then can a person who most probably is trading part-time be on top of not 2 or 3 strategies, but 24? I’ve heard the following argument: they are run on EAs (robots) and therefore the requirement for human involvement is greatly reduced. My answer to this: someone must monitor and constantly reevaluate them. How can you keep an eye on 24 EAs when hedge-funds have one or more persons working full time on strategies executed pretty much automatically too? Furthermore, why don’t you select the very best 2-3 of those 10-20 or whatever and only list them? Or is it that you don’t really know/trust what you’re doing and just throw out there as many DARWINs as possible, hoping to get lucky on at least one of them?

Secondly, the amount of capital that the trader backs his strategies with. There is an important proviso though: low capital doesn’t necessarily mean bad and high capital doesn’t necessarily mean good.

If all I have is ten dollars and I risk it, I am much braver than when I risk a million, if I have another million salted away. – Jesse Livermore

Having said that, what rational person would invest any money in a provider that has, for instance, $50 a piece on 10 DARWINs? The minimum amount you can open an account with at Darwinex is $500. But there’s no threshold for opening a sub-account with a fraction of that amount and listing a DARWIN. Consequently, you can find many DARWINS that are backed with less than $100 of the provider’s capital (those cases where the ‘trader’s risk’ is <$100 and VaR is close to 100).

Thirdly, many strategies are run on absurdly high VaRs – 50%, 70% even 100%. In other words, those strategies can lose a significant percentage of capital or blow-up in any given month. This type of trading is more often than not a sign of an amateur.  Now because DARWINs are standardized for 20% VaR, investors are protected from a sudden blow-up. Some DARWINs will even be profitable, despite the fact that the underlying strategy is losing money. Notwithstanding these facts, why would an investor back with capital such reckless trading?

I believe that only after eliminating those DARWINs that display the above red flags (usually if a DARWIN has one red flag, it will have all three of them), can we continue the due diligence process by looking at the strategy, performance metrics and so on. All this in future articles.

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