The independent risk manager has been carried out up until now based on a fixed target risk. This has two main aims.
- Protect the investor against excessive risk which might be taken on by the trader.
- Make it easy to compare the DARWINs’ returns as they all trade at the same risk.
The most solid criticism of the risk manager came from a user through a simile of a road.
I believe that the main complaints are down to the excessive leverage sometimes added by the risk manager. Imagine that we have a route on a stretch of road where there are many accidents, and many people travel along it. It is decided to start a risk manager which limits the speed to 120 km/h, which is based on the quality of the road in average traffic. The system takes into account all vehicles and acts when the limit is surpassed. Those who complete the route in less time win more, and it is estimated they can do x journeys in n time. The problem is that the road conditions change a lot and there are days when it rains. Therefore the more experienced drivers prefer to adapt to these temporary conditions and reduce their speed. They are penalised financially in exchange for safety. What would we think if the system didn’t allow them to reduce their speed because it is considered that an appropriate speed is 120 and not 90 at any given time. And when they complain they were told that as good drivers they ought to know how to drive at 120 in adverse conditions because statistically speaking the accidents on that road have only killed two people, with a probability of at least 2%.
At that time Darwinex responded:
The risk manager is necessary to ‘‘limit’’ the maximum speed. The investors can NEVER go more than 120. The current risk manager sometimes goes beyond its function and acts as a ‘‘cruise control’’, forcing you to go at 120, when it is raining and there are roadworks as well. If this is the case we agree, and we are working on improving this aspect.
We now announce that in the near future, the DARWINs will stop having a fixed target risk, and will start to have a target risk within a range. The maximum value of the range will be 10% (over a VaR of 95%), and the minimum value will be situated between 3-5%. Those DARWINs which stand out will have a greater flexibility after an individual evaluation.
The result of the change will be a greater proportionality between the strategy’s return and the DARWIN’s return. The DARWINs will earn less but the investors will also suffer less.
The fixed target risk tends to affect experienced traders more and benefit beginners. This can be observed for example by LVS. This DARWIN came out of a recent drawdown of more than 20% reaching a new maximum but also losing a lot of investment along the way. The underlying strategy, trading at a risk less than that of the DARWIN, had a much smoother drawdown and, although it has still not recovered, shows a curve which the investors would have hung in for which they did not with LVS’s curve.
We await your feedback in comments.