CTA's will talk about their ability to manage risk; however, there have not been any good tests or measures of what this means. There are different methods for conducting risk management, but a recent paper by Kathryn Kaminski of Campbell & Co has spelled out four well-defined key factors to measure risk management differences across firms:
All of these risk management factors or betas can be compared with an index or an individual manager. Liquidity measures the effect of allocating more risk to liquid markets, the correlation factor measures the excess returns from investing in markets that are better diversifiers, volatility measures the responsiveness to changes in volatility, and capacity measures the sensitivity of returns to a constrained portfolio given the size of a program.
The paper measures whether engaging in these activities have been helpful for the CTA. This testing was done against an equal weighted portfolio, the Newedge trend manager index, and individual managers. These measures can tell us whether one of these factors have been employed and whether there are excess returns versus that factor. The first test compares the risk constrained or adjusted portfolios against an equal weighted portfolio.
The author finds that there are positive risk factor returns for liquidity and correlation but negative risk factor returns for capacity and nothing significant for volatility against an equal weighted portfolio. When used against the Newedge trend index, the factors show positive signs with a strong value for correlation or diversification risk management. There is also a positive value for liquidity and capacity.
This provides some interesting and useful measure for risk management with CTA's. Obviously, understanding the risk management of an individual manager takes more detail, but these factors provide a good start for any discussion.