With a view to encouraging portfolio diversification, DARWIN investors are refunded part of the commissions they pay, the exact amount being determined as a function of their portfolio diversification.
What are they?
In the trading industry, the word rebate refers to the return of commissions previously paid.
Darwinex encourages investors to create diversified portfolios and incentives them to do so via the payment of diversification rebates. The more diversified your portfolio, the more diversification rebates you will receive, the lower the net % commission costs you pay:
We do this for two main reasons.
Reason 1: To compensate performance fees in diversified portfolios
DARWIN providers earn 20% performance fees on the profits they generate for investors, earning these fees quarterly. Investors pay these performance fees at the individual DARWIN level and not at the overall portfolio P+L level, a situation which can incentivise investors not to diversify their portfolios.
Let's illustrate this with an example and say an investor has a portfolio of 2 uncorrelated DARWINs and at quarter end one DARWIN has generated €2,000 in profits while the other has lost €2,000, for a net portfolio level P+L of zero. In spite of not making money overall, the investor must pay €400 in performance fees (20%*€2,000) to the DARWIN provider who made profits, meaning the investor himself actually has a net loss of €400. A not very satisfactory situation which may lead to the investor deciding to concentrate all his investment in just one DARWIN in the future.
Darwinex believes it is vital that investors build diversified DARWIN portfolios to protect against sudden market movement. A daily diversification rebate based on a correlation factor is the most appropriate compensation methodology that we have identified to incentivise this diversification.
Reason 2: A stable "profit potential / commissions" ratio
Imagine two investors with portfolios with similar trading volumes comprised of:
- Investor A has invested €1,000 in a single DARWIN.
- Investor B has invested €500 in two DARWINs that are completely uncorrelated.
With similar trading volumes, let's assume that each portfolio pays €2 commissions per day. Despite the fact that they are paying the same commission, Investor A has a portfolio with VaR of 10%, while Investor B has a portfolio with monthly VaR of about 7%.
Due to the symmetric nature of the VaR measurement, a 10% VaR portfolio has a greater profit potential than that of a 7% VaR portfolio (if you are willing to assume greater risk, you should be expecting greater return). But as both investors have been charged the same execution commissions, Investor B who has invested in 2 DARWINs to reduce his risk, would have a worse potential profit/commission ratio. Again this might lead to an unwanted outcome where investors maintain under-diversified portfolios.
This difference in VaR between a diversified and un-diversified portfolio is what we use to calculate the "diversification factor" which determines the rebate paid to an investor on a daily basis.
At Darwinex we encourage portfolio diversification as a way to protect against unexpected market risks.
How are diversification rebates calculated?
Let's continue with the example above, Investor A with a single DARWIN and Investor B with two DARWINs:
This investor has a portfolio VaR of 10% as he has decided to not diversify his portfolio. Consequently the diversification factor is 0 and so they will receive no diversification rebates.
This investor with two uncorrelated DARWINs has a monthly portfolio VaR of 7% meaning he has an expected profit or loss 30% lower than investor A with his 10% VaR.
Rebate calculation and payment for diversified portfolios
Darwinex' net margin on investor commissions is approximately 40%. As such any rebate should always be less than 40%. But how should they be split?
We've looked for a simple, transparent calculation that correlates with portfolio diversification. If we assume that correlation among DARWINs in the portfolio is 0, the diversification factor is
Diversification factor = √(∑invi)/∑invi
where invi is the amount invested in each DARWIN.
Assuming that all DARWINs generate the same commissions and that they are dependent on volume of investment, we can use the diversification factor above, along with our rebate cap of 40% to calculate the value of the rebate:
where ci is the daily commission generated by each DARWIN in the portfolio.
Continuing with our prior example Investor B's portfolio has a risk level 30% below that of Investor As. The diversification factor for his portfolio would thus be 30% of the maximum rebate of 40%, or 12%. It is this 12% of execution commissions that would be paid back to investor B by way of diversification rebate on a daily basis
Where can I see the information about diversification rebates?
Keeping track of your diversification rebates is easy. By simply opening your DARWIN Terminal and clicking on the Rebates tab, you have access to all the information.
1. Don't put all your eggs in one basket
As good as our Risk Manager is, it can't predict the future or protect you from sudden unexpected events. A well diversified DARWIN portfolio is the only way to protect against "Black Swans".
2. Optimal number of DARWINs to maximise diversification rebates
The greater the diversification factor the higher your diversification rebates will be. The diversification factor will increase as you add uncorrelated DARWINs to the portfolio but typically it will approach a cap when you have included 8-10 DARWINs. Beyond this number the diversification factor will barely increase.
3. Don't confuse execution commissions and performance fees
Execution commissions are what traders and investors pay Darwinex to access the market whereas performance fees are what investors pay (and traders earn) when traders generate profits for them.
Download this spreadsheet which will help you calculate diversification rebates as a function of the number of DARWINs in your portfolio.