Managed Futures Glossary

Beta
Beta is the slope of the regression line. Beta measures the risk of a particular investment relative to the market as a whole (the “market” can be any index or investment you specify). It describes the sensitivity of the investment to broad market movements. For example, in equities, the stock market (the independent variable) is assigned a beta of 1.0. An investment which has a beta of 0.5 will tend to participate in broad market moves, but only half as much as the market as a whole.

Correlation and correlation coefficient
The correlation coefficient is a statistical measure of the degree of linear relationship between two variables. The correlation coefficient may take on any value between plus and minus one. The sign of the correlation coefficient (+ , -) defines the direction of the relationship, either positive or negative. A positive correlation coefficient means that as the value of one variable increases, the value of the other variable increases as well; as one decreases the other decreases too. Taking the absolute value of the correlation coefficient measures the strength of the relationship. Thus a correlation coefficient of zero indicates the absence of a linear relationship and correlation coefficients of one and minus one indicate a perfect linear relationship.

Drawdown
A drawdown is any losing period during an investment. It is defined as the percent retrenchment from an equity peak to an equity valley. A drawdown starts with the beginning of an equity retrenchment and continuous until a new equity high is reached. (a drawdown encompasses both the period from the equity peak to the equity valley (length) and the time from the equity valley to the new equity high (recovery).

Maximum Drawdown is the largest percentage drawdown that has occurred in any investment data record.

Kurtosis
Kurtosis characterizes the relative peakedness or flatness of a distribution compared with the normal distribution. Positive kurtosis indicates relatively peaked distribution. Negative kurtosis indicates relatively flat distribution.

Multifactor analysis
This technique is trying to determine the link that may exist between the program return and chosen factors.

Omega
These are total probability weighted gains / losses. The steeper the curve is, the less the possibility of extreme returns (risky distribution is flatter). The function is equivalent to the return distribution itself, as it combines effect of all of its moments. Returns are distributed into loss and gain above and below a return threshold and then the probability weighted ratio of returns above and below a threshold is considered.

Sharpe ratio
The Sharpe Ratio is a measure of the risk-adjusted return of an investment. We calculate the average monthly return and then calculate the standard deviation of the monthly returns over the same period. The next step is to calculate the "excess return", which is the average return in excess of the risk-free rate of return (average monthly return – risk-free return). This is the extra return you receive by taking certain level of risk (risk is measured by the standard deviation of the returns, which is actually the "variability" of the returns).

Then you calculate the Sharpe Ratio as follows:

Sharpe = (average monthly return – risk-free return) / annualized standard deviation

This gives you the monthly Sharpe you can annualize by multiplying it by the square root of 12.

Skewness
Skewness characterizes the degree of asymmetry of a distribution of returns around its mean. Positive skewness indicates a distribution with an asymmetric tail extending toward more positive values. Negative skewness indicates a distribution with an asymmetric tail extending toward more negative values.

Sortino Ratio
This is also a return/risk ratio. The concept is the same as in the Sharpe Ratio. The only difference is that it is calculated using standard deviation of negative returns only (returns below a minimum acceptable threshold). In this case, excess positive returns don’t have a negative impact on the ratio.

Sterling Ratio
This is another type of return/risk ratio. Return is defined as the Compound Annualized Rate of Return over the last 3 years. Risk is defined as the Average Yearly Maximum Drawdown over the last 3 years less an arbitrary 10%. To calculate this average yearly drawdown, the last 3 years (36 months) are divided into 3 separate 12-month periods and the maximum drawdown is calculated for each of them. Then these 3 drawdowns are averaged to produce the Average Yearly Maximum Drawdown for the 3 year period. If data for the last 3 years are not available, the available data are used.

Style Analysis
This is a part of the multifactor analysis. An interesting method has been developed by F.S.Lhabitant in 2001 which is an adjusted application of the analysis initially suggested by Sharpe in 1998. CS/Tremont hedge fund indices are used as factors and Beta coefficients are used as exposure to these style indices.