Do You Know What You’re Investing In ?

By | February 28, 2016

But when you don’t know what you’re doing, it’s fatal, Mr. Moore. Not knowing what you’re doing – Bretton James, Wall Street: Money Never Sleeps

Precisely targeting and controlling the volatility level (20% monthly VaR) for DARWINs is one of the great strengths of Darwinex. To put this in perspective, compare it to the roller-coaster volatility of S&P 500 – from 10% to over 50% in the past 10 years. This makes DARWINs much more similar to systematic firms which offer funds and managed accounts with constant volatility than to stocks or equity indices.

But, volatility and risk (the prospect of permanent capital loss) are not the same things. The stock of a company with a business model that is opaque and overly complex is much riskier than the stock of a relatively simple, transparent company. Think for instance Bear Sterns or Lehman Brothers vs McDonald’s or Coca-Cola.

Coming back to Darwinex: there is a big difference between buying something you can assess and understand and buying a black box. Or worse yet, a black box within a black box. After going through the screening process mentioned in a previous article, there are two more things a prospective investor should check:

  1. Just like funds and CTAs offer a prospectus or a disclosure document, does the DARWIN provider have something similar? ie, Is there any description of the strategy used? Are you buying a short/medium/long term system? Discretionary or systematically traded? Does it use fundamental analysis, technical or a mix of both? What is the risk management process? Granted, some of this information can be gleaned from the statistics that Darwinex offer, but it would be good to know that the trader has an articulate plan put forward and which is adhered to.
  2. The DARWIN’s equity line should be similar to that of the strategy. Furthermore, you can check the month by month VaR variance of the strategy. If this month it trades with 5%, next with 30%, then 10% then 50% and so on, the performance of the DARWIN will be very different from that of the strategy. Why does it matter? Because only if they resemble one another are you actually investing in the strategy that convinced you at the previous point – scaled up or down to meet the 20% VaR target. Otherwise, you’re buying a black-box. Consider this DARWIN for instance: during 2015, all months were positive for the strategy, whereas the DARWIN had 6 negative months. Two totally different things.

Finally, remember that nobody has a crystal ball to predict the future with. But a good understanding of what you’re investing in and trust in the team behind it will go a long way in both increasing the probability of success and making it easier to withstand difficult periods.