Before participating in a managed futures investment, an investor should determine his financial situation, which may include available risk capital, risk tolerance and investment time horizons as well as how this investment fits into his overall investment portfolio. Once an investor has determined his personal situation and needs, an investor needs to evaluate this investment space and make some important considerations, and much of this information can be found in the CTA's disclosure document as well as from independent performance measurement tracking services. Disclosure documents must be provided to an investor upon request. The disclosure documents contain important information about the CTA's trading program or style, strategy and fees, as well as any material facts that should be disclosed. Before investing in any managed program, an investor is required to read and confirm receipt of the CTAs Disclosure Document.

The Trading Program
It is important to know the type of trading program operated by the CTA you are researching. There are largely two types of trading programs among the CTA community, systematic and discretionary. Within these two groups CTAs can be further categorized between trend-followers or market-neutral strategies.

Trend-followers use proprietary technical or fundamental trading systems, which provide signals of when to go long or short in certain futures markets. The goal of most trend-followers is to profit from extended price movement in either direction, though some CTAs may only capture very small trends or short-term moves in the market. Market-neutral traders tend to look to profit from either arbitrage or spreading different commodity markets. Included in market-neutral strategies are the options-premium sellers who may use delta-neutral programs. The arbitragers, spreaders and premium sellers aim to profit from sideways or non-directional trading markets. In addition to styles and strategies, CTAs may trade diversified portfolios of as many as 100 world-wide commodity markets or they may be market specific and specialize in only one market like the S&P 500.

Drawdowns
Although most investors tend to look at the returns a particular trading program has generated over time, a drawdown spectrum (a list of cumulative declines in equity) may provide an investor insight into the type of risk he may have to absorb in order to realize those returns. A list of historical losses, however, does not mean drawdowns will remain the same in the future (drawdowns can get larger or smaller in the future), but can provide historical information on the depth, length and time of recovery of each of the drawdowns. Obviously, the shorter the time required to recover from a drawdown the better the performance profile. Regardless of how long a drawdown lasts, CTAs are only allowed to assess incentive fees on new net profits (that is, they must clear what is known as the "previous equity high watermark" before charging additional incentive fees).

Annualized Rate of Return
The annualized rate of return, which is required to be presented always as net of fees and trading costs by the CTA, is the returns an investment program has generated in the past. These performance numbers must be provided in the disclosure document, however they may not be the most recent month performance. CTAs must update their disclosure document no later than every nine months, when performance is not up to date in the disclosure document, you can request information on the most recent performance, which the CTA should make available. Additionally you would also want to know if there have been any drawdowns that are not showing in the most recent version of the disclosure document.

Risk-Adjusted Return
After determining the type of trading program you are interested in, which would include type of strategy, markets traded, and the potential reward given past performance (by means of annualized return and maximum peak-to-valley drawdown in equity), an investor should expand his evaluation using various Risk-Adjusted methods to get more a complete picture of the program. The NFA (National futures Association) requires CTAs to use standardized performance capsules in their disclosure documents, which is the data used by most of the tracking services, like CTA-Info.com

.The most important measure you should use to compare different trading programs, is return on a risk-adjusted basis. For example, a CTA with an annualized rate of return of 35% might look better than one with 10% at first glance, however, simple comparisons of return may be quite deceiving. The CTA with 35% returns may have had numerous drawdowns in excess of 50% of equity to generate his returns, while the CTA with 10% returns may have had only minor drawdowns of less than 2%. In order to evaluate and determine the trading program that is right for you, several statistical measures have been developed to help investors compare trading programs on a risk-adjusted basis.

• Sharpe Ratio
  A ratio developed by Nobel Laureate Bill Sharpe to measure risk-adjusted performance. It is calculated by subtracting the risk-free rate from the rate of return for a portfolio and dividing the result by the standard deviation of the portfolio returns.
  
  The Sharpe ratio tells us whether the returns of a portfolio are because of smart investment decisions or a result of excess risk. This measurement is very useful because although one portfolio or fund can reap higher returns than its peers, it is only a good investment if those higher returns do not come with too much additional risk. The greater a portfolio's Sharpe ratio, the better its risk-adjusted performance has been.
  
• Sterling Ratio

A ratio used mainly in the context of hedge funds and managed accounts. This risk-reward measure determines which investments have the highest returns while enduring the least amount of volatility. The formula is as follows:

                              Compounded Annual Return
              =     -------------------------------------------------
                       Average Maximum Drawdown – 10%

This formula uses the average for risk (drawdown) and return over the past three years. Drawdown is calculated at the maximum potential loss in the given year. Just like the Sharpe ratio, a higher Sterling ratio is generally better because it means that the investment is receiving a higher return relative to risk.


Calmar Ratio A ratio used to determine return relative to drawdown (downside) risk in a hedge fund or managed account. Calculated as:
 
                      Compounded Annual Return (past 3 years)
               =    -------------------------------------------------
                                    Maximum Drawdown

A higher the Calmar ratio is generally better. Some programs have high annual returns, but they also have extremely high drawdown risk. This ratio helps determine return on a downside risk adjusted basis. Most people use data from the past 3 years.

Volatility
Volatility is a statistical measure of the tendency of an investment to rise or fall sharply within a period of time. Standard Deviation is one of the most commonly used statistics in determining the volatility of a trading program. A trading program that is volatile is also considered higher risk because its performance may change quickly in either direction at any moment. The standard deviation of a program measures this risk by measuring the degree to which the program fluctuates in relation to its mean return (the average return of a trading program over a period of time). Many CTA tracking-data services provide these numbers for easy comparison.

Distribution of Returns
How a trading programs returns are distributed over time can be very valuable in evaluating a trading program. If the majority of monthly returns are between -5% and +5%, then ups and downs of a trading program may be more palatable, than a program where returns fluctuate between -25% and +25%. Many performance measurement reporting services provide charts that graphically represent these dispersions. Bear in mind, while past performance results are not indicative of future returns.

Correlation
The correlation of a trading program to other investments is an integral part of building a successful investment portfolio. Not only is it important to not be correlated to other CTAs in the portfolio, it also very important that the CTA you are considering fits in your traditional stock and bond portfolio. The goal of a well-balanced investment portfolio is that when some assets are losing value, the other assets are gaining value.

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