The Great Volatility Adjustment in CTAs

Once again, it has been noticed that the volatility of CTA's as measured by the SG CTA index continues its decline from above 15% to the magic 10%. Call this the "Great Volatility Adjustment". Of course, with the volatility decline, there has been a decline in rolling returns; however, the overall impact on Sharpe is a slight increase. 

Some have argued that the lower volatility is a result of a strategic change by CTA managers to lower volatility to make funds more palatable to institutional investors that have a strong desire for low volatility products. While there has been a conscience effort by some managers to lower volatility, some of the decrease in risk has been associated with more diversification through trading more markets, better risk management, a decrease in market volatility, and in some cases lower correlation between markets. 

Is this lowering of volatility a benefit for investors? I don't think so. Managers should always try and increase the Sharpe ratio of their strategies. This is the holy grail of investing, yet volatility is a good thing when it comes to futures trading and portfolio allocation. First, using derivatives means that you don't have to borrow to gain leverage or volatility. The financing costs for a fully funded account do not come into account. Second, the investor gets more exposure for the same price if the manager increases risk. Third, for same dollar allocation, the investor will get more trend diversification benefit which is a great benefit for the overall portfolio.

Investors have to get over the issue of looking at line-item performance and think about overall portfolio risk. This broader view is never easy to digest, but all an investor should care about is how the CTA manager fits within the portfolio and if it is negatively or zero correlated with the rest of the portfolio, you want to bring on the exposure. 

So, what why do managers target the magic 10% volatility over 15% or 20%? As managers have matured and grown in AUM, they have become more risk averse to protect the management fees given their higher fixed costs. There is a desire to play it safe, and the investors are disadvantaged. Of course, do you want to be the manager that tries and move volatility to a higher level and see business at risk? Seems like it is better to follow the pack and hug other managers at the 10% target and hope to differentiate on alpha or marketing.