Systematic Vs. Discretionary CTA’s: Understanding each Investment

When an investor enters the Managed Futures space, two of the first terms that he/she hears is “systematic” and “discretionary.”  Those are the two most frequently used expressions when it comes to describing a Commodity Trading Advisor’s (CTA) investment strategy.  As a new Managed Futures investor, it’s important to understand the differences between the two to fully comprehend the potential benefits and pit-falls of each.

A systematic trader or CTA is one that relies solely on signals produced by a computer program or model.  Many times, these signals can consist of technical analysis (recognizing patterns or trends in historical charts) of market data, or fundamental analysis of economic data, to identify and make trades, with limited or no human intervention.  Since all trades are being provided be a “computer,” all human emotions are removed from the trading process allowing for the most unbiased form of investing.  The downside to systematic strategies is that because they are so carefully designed and programmed, it can take a long period of time to make changes to them.  Therefore, if certain market or economic conditions change over time, a system may not be able to adapt to the new conditions and require some “tweaks” and changes.

On the other end of the spectrum from Systematic trading, is discretionary trading.  As the name suggests, discretionary trading advisors’ investment decisions are all made by a human-being.  All trading decisions are made based on real-time market data, and it is ultimately the trader’s discretion to decide which market to trade, when to trade, and how much to risk. While discretionary CTAs have the ability to immediately react to changing market conditions, they also have to battle their own emotions when picking a trade to enter.  While this may be good in certain instances, in other instances it may lead to a bad trade being selected or a good trade being missed.

As you can see, both types of investment strategies have their pros and cons – the ultimate question you might be asking is “which one is better?” The answer is not as clear-cut as one might think, but based on the data available on our database,  it seems that discretionary CTAs have been slightly outperforming systematic CTAs over last three to four years.

 Systematic Vs Discretionary CTAs


 * Data and results are independently reported by each Commodity Trading Advisor. aiSource has not verified the returns for accuracy. Past performance is not indicative of future results and there is substantial risk of loss.

The above results point in favor of discretionary strategies when looking at rate of return and drawdowns.  However, there is one caveat to consider: there are many more systematic strategies than discretionary strategies (more than double in our database).  Does this mean that the results displayed for discretionary strategies are not statistically significant? No, but if there were an equal number of programs to consider in both strategies, it would make us feel just a little more confident.  Nonetheless, based on our experience, we believe the data correctly depicts the truth.  Systematic strategies that were around pre-Lehman (prior to the Lehman Brothers collapse, and eventual economic collapse of 2008) have struggled to perform well since 2008.  The reason for the struggle is simple – the global economic environment has changed after 2008, and the conditions/rules around which these systems were designed, no longer exist. If a system is designed to perform under a specific set of conditions, rules, and criteria, then that system ceases to do well if the conditions start to change.  This is what we believe to be the root cause for the recent underperformance of systematic CTAs and strategies.

One last thing to remember is that we are not saying that ALL systematic strategies are doing poorly – you can clearly see that the average rate of return across all of them is +10.40%.  There are systematic CTAs out there that did well prior to 2008, and have continued to perform well since then.  There have also been new systematic strategies developed after 2008, which presumably are designed for our current market/economic conditions.

Finally, it is important to know that an investment strategy cannot always be classified as either only systematic or only discretionary.  In many cases, you’ll hear CTAs say that they are a hybrid of the two.  This could mean a few things:

  • Systematic with discretionary overlay – all trade signals are produced by a black-box system, but the trader (human-being) has ultimate discretion on which trades to place and which ones to ignore.
  • Discretionary, technical traders – all trades are entered at the discretion of the head trader (human being), but he/she makes all trading decisions based on technical analysis of charts and automated signals.

While most investors are not too concerned with the type of strategy that they’re investing in, and concentrate only on the risk to reward, it is important to know what type of investment you are getting yourself into.  Understanding the pros and cons of each keeps you prepared for the future.

-Rishab Sharma

Managing Partner, aiSource

Disclaimer: Past performance is not indicative of future results. Futures trading involves substantial risk of loss.  By no means is this newsletter offering any investment advice or suggesting to make any trade recommendations. Please consult an aiSource advisor prior to opening any managed futures accounts.