What are you going to do to differentiate yourself from everyone else in the industry?
That’s the question Marty Bergin would ask the next guest on Top Traders Unplugged.
Welcome back for the second part of our interview with, Marty Bergin.
In This Episode, You’ll Learn:
- How trade decisions are generated and executed at Dunn Capital Management
- The way Marty and Dunn manage the emotional challenges of trend following
- Why many CTA firms are giving allocations to long equities and the results of that decision
“Portfolio development is a huge thing in our industry. I don’t think it’s appreciated as much as it should be.”
- How significant drawdowns help to make firms stronger
- Dunn Capital Management’s approach to research
- How Dunn Capital identifies and reacts to issues with external/strategic alliance situations
- Portfolio development and decision-making at Dunn Capital
“Dunn is a democracy, but only one vote counts”
- On the importance for personal ownership in a CTA firm
- Learn about Michael Covel’s interview with Harry Markowitz
- The importance (or lack of) of being located in a large financial hub
- Dunn Capital’s investor focused fee structure
- Why European CTA’s seem to be out growing the American firms
- What does it take to become a great CTA in today’s environment
Resources & Links Mentioned in this Episode:
Sponsored by Swiss Financial Services and Saxo Bank:
Connect with Dunn Capital Management:
Visit the Website: www.dunncapital.com
Phone: +1 772 286 4777
“There is a place for CTAs, even in today’s environment where we are not making a lot of money. We’re comfortable because we’re still making money in this environment. Even if the CTA’s aren’t making money as a whole, that risk protection or insurance that can be bought by an allocation to a CTA is significant. People with large portfolios need to understand that.”
Niels: You are listening to Top Traders Unplugged, Episode number 010, where we continue our conversation with Marty Bergin, President of DUNN Capital Management. This episode is sponsored by Swiss Financial Services.
Introduction: Welcome back to Top Traders Unplugged. Where the best traders in the world come to share their experiences, their successes and their failures. Let's rejoin the conversation with your host, veteran hedge fund manager, Niels Kaastrup-Larsen.
Niels: I think there are certainly a lot of things to be said about if you can identify the markets that are trending, and getting a full position, so to speak, in those markets, at the same time not having a full position in the market and stock and ranges, I do think that that has a significant impact on performance. And that, in a sense, is very much the holy grail of what we are all trying to do.
Marty: Yeah, the only thing is you have to be careful. So, I agree with you and I think the key there is being able to reduce your positions in the non-trending, or your allocation of risk to the non-trending environment. What we do not do, we do not borrow risk from some markets and give it to other markets. So each market is treated with an equal allocation of the risk pie. Now, there'll be a lot of markets where we aren't using up the allocation, but when we're not using it up we are giving it to another market to allow it to take on a whole lot more risk. I think that's why we have survived for 40 years. You know, everybody looks at us and says, "my gosh, you all trade at such a high volatility, I don't know if I can handle that." But we've been doing it for 40 years and yeah, we've had our drawdowns in our history, but we've never...we're still here, we're still here, and still making new highs.
Niels: Absolutely. I think this is the other key thing that, often I believe investors confuse volatility with risk, and in my mind there's a clear distinction between the two, and you've clearly proven that. I also think that's an important point to take away. Does the program simply just run itself. There are no other influences on the program in terms of overrides or other inputs?
Marty: No, no other inputs what-so-ever. If a trader was to not execute on one of the trades that the system generated that would be their quickest way out the door...done. We have very, very low turnover. It's just understood here. We would never think that we're smarter than the system.
Niels: How long a time does it actually take to run the system like yours?
Marty: Well, it's all predicated on how good the coding is. We can run our system today in a number of seconds. There have been times in the past where it took minutes or a 1/2 an hour to run, but it really just comes down to how much computing power and how well things are coded. You have this ability to do multi-dimensional calculations in MatLab and other software programs that allow you to take calculations that would take several minutes and do them in one second. So it's utilizing the resources that have been provided.
Niels: Sure, sure. I want to jump to another point that I think is really important and I know you're experience will be really valuable for many people, and that's the topic of drawdowns. A big part of what a CTA strategy does is kind of being in a drawdown most of the time. What I'd love to know is a little bit about what you've learned because I have a feeling that some of the thing, some of the improvements that you've done over time probably is from the learning experience from being in drawdowns, so I'd love to know what you've taken away from that and also in the sense, from a completely different angle, the emotional side of being in a drawdown, how do you go about balancing that, which is very difficult for many investors?
Marty: Yeah, well, I'll hit the last part first. That was pretty easy, all you had to do is watch Bill Dunn. Every day is the same, you wouldn't know if we were up 100% or down 30%, there's no change at all. The way we view it here, and I think this is true in any kind of systematic trading, every day is a new day. This whole adage of you've made 40%, it's got to revert to the mean - no it doesn't; and if you've lost 30% it doesn't have to revert to the mean. Each day a new calculation is made, new positions are taken, and you start at zero.
I think from an emotional standpoint you just have to believe in the program you're using, in trend following you have to understand that drawdowns are a part of the process. If there weren't drawdowns, then you are not doing trend following. It's just by definition, it's part of the process. Now, does that mean that you have to go through a period like we did in 2002 through 2007 where we lost 60% and had a 50 plus month drawdown - that's severe and that's significant. I think the only thing that gave us comfort during that phase was that there were a lot of people in our industry that were going through the same problem, and if you remember right, in 2007 and early 2007 late 2006 everybody talked about trend following being dead, and then you had 2008, the credit crisis came along.
What I think is really significant about our industry during that time frame is that every alternative investment class, prior to 2008, was viewed as being uncorrelated to the S&P, and they weren't highly correlated, but they were correlated. Every asset class was more correlated to the S&P than managed futures, but when the crisis hit they all became very correlated. Except for the S&P and Global Macro, probably, which became negatively correlated. I think the interesting thing that's happened since the crisis for the 5 years after the crisis, every one of those alternative investment classes has become more correlated to the S&P than they ever have been in the past and most people don't realize that. Now, we're basically zero correlated. I think the CTA space, in general is actually increased its correlation, but it's only up to 18%, 20%, and I think that's because there's a number of CTAs that have given allocation to long equities, and that is built into the returns, and because of their size, that number is picked up in the data.
People have to understand there's a place for CTAs even in today's environment where we're not making a lot of money. We're comfortable because we're still making money in this environment. But even if the CTAs aren't making money as a whole, that risk protection, that insurance that can be bought by an allocation to a CTA is significant, and people with large portfolios need to understand that, because if something else comes down the pike, similar to 2008, that's going to be your only safe harbor. The CTAs weren't putting up blocks to get any money out. The CTAs were liquid and the CTAs were continuing to make money. That's an important thing to remember.
Niels: Would you say that the drawdowns that you have been through have made you a stronger firm? Not many people would emotionally survive being in a drawdown like you described?
Marty: Well I think we're better, we're definitely better because we've learned from it. I think that's something. I am not one of these people that think just because you have a long history that that makes you better than somebody else. One thing that you have to remember is, when you're looking at data, it's easy to have a good sharp ratio if you don't have a long history and you came out at the right time, or your system was in a good market environment for that type of system, so that's number one. Number two is you want a CTA that has gone through the drawdown, especially if you are looking at systematic trend following because the drawdown will occur. If it hasn't happened yet, then you don't really know how that CTAs going to react. You probably want to look for somebody who's been through it.
Niels: I guess it's also been very interesting to note, in fact, if I look at DUNN compared to other CTAs is in fact that whereas your drawdown through the difficult time we've been through has actually gone down, and it goes to your point, most of the managers who have also been around for at least a couple of decades, they saw their drawdowns significantly expand in the last 12, 18 months, so I think you are absolutely right about that that longevity doesn't mean you're necessarily better unless you've learned and you've made changes.
Marty: For instance, look at the long term capital. They hadn't gone through a drawdown and they had the best pedigree there was in the world, but they've done it twice now. (laugh)
Niels: (laugh) Sure. I want to jump to the area of research. Now, investors tend to always want people to innovate and do research, but they don't like necessarily change. So how do you balance that, and how do you approach research in general?
Marty: Well, first off we have a very dedicated team of guys that are doing research, and it's not a large group. We have four guys who focus on nothing but research, and then a number of other guys that wear multiple hats. They basically provide assistance with research. The way we approach it is, if you find something better why wouldn't you implement it. It just doesn't make sense not to. With that said, you can't fool yourself into thinking you found something better and you really haven't, and I think that happens a lot in this industry. We make a real effort to make sure that all of our research and our development is done in an out of sample type environment. So, in other words, we only release a certain amount of data for anybody to work on, and once they come up with something that they think is viable, then we will release more data.
Then the other thing that we do is we only use data up until the time frame that we're running it through. We never allow for the future data to come in and then we run it forward. So we never give it the data for the given day that it's running to, it's always historical data, and we let it run forward. The other thing that we do is we have an internal due diligence process where we have Daniel Dunn, which is Bill's son, who was in the medical field and was doing research at NIH, but he's a PHD and an MD, basically very intelligent guy. He's our last line of defense, so when they have something that they believe is ready to go, then it goes to Daniel and he will tear it apart and determine whether it's real or not.
At that point in time we paper trade it. Of course that's being done just to make sure that all the operational systems and everything are working. And then once we determine everything is a go, we'll put our own personal money in it first under the umbrella of DUNN Capital Management. It may be there for several years before we actually introduce it into anything where outside investors would be exposed to it. I guess from an outside investor standpoint you can look at it from one of two ways, if it's successful, we're reaping the benefits in the early stage, but if it's not successful, they're darn glad we were the ones that were doing it. If it's our money we're highly unlikely to implement anything that isn't going to be successful
Niels: That's true. That's looking for new things, but if we look at it the other way around, what might prompt a yellow or red flag, if I can call it that, that might indicate that one of the things already inside the system may not be working as you expected?
Marty: Well, we've never had that issue with any of our internal developed stuff. But what we look for, and we have had this happen in some of our external or strategic alliances situations where we start looking at when we update the program, as to whether parameters selection has anything to do with actual performance. Is there any correlation between the parameter update versus the actual performance of the system. Or is there a big divergence between performances, based on parameter selection? Some of those types of things would give you the idea that there's something wrong and that it really isn't as good as you thought it was.
Niels: So the risk of optimization, I guess?
Marty: Yeah, you know if you picked one point and then you picked a point right next to it, and in one case you make 100% and the other case you lose 50%, that's a big concern. If it's that subjective to the actual selection process. And then we've had programs that we stuck with that have lost money over a period of time, and we've had programs that have made money over a series of time, where we just realized that something happened to it and it doesn't function any more. Internally, but I think because we focus so hard on our systems to make sure that they are robust, and they all work. Our goal is to design systems that are going to work for high capacity over long historical periods of time.
Niels: I know diversification is very, very important and sometimes you have markets in your portfolio that are there for specific reasons, in a sense, are there some markets or sectors that your system struggle with more than others, or over time profits seems to be pretty evenly spread across sectors over the long run?
Marty: No, we don't even view it that way because as long as there are price movements it just doesn't really matter. Yeah, there are periods in history where there aren't a lot of trending environments in the price movement of a particular market, and you're not going to make money. But that doesn't say that the next 3 years aren't going to be a great move and you're going to make a ton of money. If we had a market that had consistently lost large sums of money, we would probably exclude it. But think about it this way, if it is losing money on a consistent basis, it probably is very uncorrelated to the other markets so it actually might enhance the portfolio.
Niels: Absolutely. That was the point I was trying to make that you sometimes have markets in the portfolio for specific reasons, and that is they tend to make money when everything else doesn't.
Marty: Exactly, portfolio development is a huge thing in our industry. I don't think it's appreciated as much as it should be.
Niels: No, no, I agree. I want to shift gears on you again, because I think there's something, and this is more towards the business side. We've talked about research, we've talked about models, but I also think there's something important about the business side. You've touched a little bit upon it in terms of culture and maybe we'll talk a little bit more about that. But obviously one of the things about DUNN is that you're also one of the very few firms in our industry that has made a business succession plan. That basically takes place over a 10 year period, and where you will take full control of DUNN and what I wanted to ask you is a little bit different. Ownership of a firm, unlike a large institution, do you think it's important that ownership in our line of business is associated with an individual? Someone where you could say, "the buck stops here", and who are obviously involved with the nitty gritty in terms of the research and product development, is that important, from your point of view?
Marty: It's important at DUNN. Bill and I have a saying where DUNN is a democracy, but only one vote counts. There are some advantages to that because you are able to act quickly. It also gives everybody a comfort because there is one person they have to look to. Either it's the right person or he wrong person. Bill and I think that so far it's been the right person, because we have a low turnover. People seem pretty happy when they come to work for us. We don't advertise for employees, we basically hand pick people that we run across in our lives, either in our business lives or personal lives or whatever, that we think would be a good fit. We bring them in and then we let them figure out how they are going to help us become more successful. That's kind of the philosophy we've had from the beginning. The transition plan, I think was tough because when you have somebody like Bill who is self-made and has built such a successful and well respected firm, it's part of him, so to pass that on down to somebody else is...it's a real credit to him to be willing to do that.
The reason we chose the 10 year period was we wanted a transition that would be seamless, basically. And Bill and I have worked together for a lot of years. I came to work in '97 and we were working together for almost 10 years before that. When I say work together, basically I was brought into the accounting area, but I became the CFO and I also handled all of Bills personal stuff at the time, so we know each other well. There's a mutual respect and trust that goes along with it. Bills still...when he's in town he's in the office every day and part of the agreement is, even after the 10 year transition, he still stays employed. We just celebrated his 80th birthday this week, so, you know, at the end of the 10 years he'll be in his mid-80s and I suspect that he'll live a long and prosperous life. Everybody in his family has lived over 90.
Niels: Yeah, I think it's important to stay active. I was listening to another pod cast with Michael Covel, the other day, who had Harry Markowitz on, and he's 86, but apparently he's committed to a book deal that takes him into another 5 of 6 years, so I think staying active even at that age is probably a good thing.
Marty: That would be a book worth reading, wouldn't it?
Marty: You know Bill and I we're 3 1/2 years into the transition and I think both of us, we would like to have a better environment for trend following, given that, I think we're doing OK.
Niels: Absolutely. You touch upon another thing which I think sets you apart to a large extent, which is the culture, which is very strong. It's very close, as a family as you described. But I think another thing that has set you apart, to some of the larger managers, is of course you have chosen to be away from the busy pulse of the financial centers of the world.
Marty: Yeah, and that was Bill. When he left DC he came to south Florida. As he would tell you, the only thing we require is communications. Either by computer or telephone, and we can be located anywhere in the world. As long as we have power and communications. He chose a warm climate, close to water, wanted to be on the east coast because of the time differences. At the time he was only trading domestic futures contracts in Chicago, so he didn't want to be on the west coast. So this is where we ended up, and we've been here ever since. We own our own building at this point, so I don't think that we are going anywhere anytime soon, but never say never.
Niels: You also have another slightly different approach, and that's your fee structure. I guess it goes to what you said very early on about Bill maybe wanting to find a more honest way, so I guess ultimately what you've done is you've fully aligned yourself with your investors, tell me a little bit about that?
Marty: Yup, so we're 0 and 25, we don't charge any management fee, and our in-house funds probably have the lowest expense ratio of anywhere in the world. It's usually just a few basis points, the only thing that we charge the fund is the audit fee and the registration fee. So we feel like, if the investors are making money, we make money and if the investors are not making money then we don't want to feel like we're continuing to take money out of their pocket. We think that's the most honest way to do it. If you're just starting out as a CTA it would be almost impossible to work that way.
We're blessed by the fact that we have a good history and Bill has accumulated significant net worth, and we're able to fund the operation of the company during bad periods. So, there are two things that we feel are important to investors, one is the fee structure and two is the fact that 50% of the money that's here at DUNN is proprietary money. It belongs to Bill and the employees of DUNN, and we trade, other than the small portion of research money we might be trading, everything else is traded exactly in the same program that is available to the investors.
Niels: We've touched upon, a few times, in our conversation the fact that the CTA industry is at a difficult juncture at the moment, and there certainly are some challenges out there, and it could be interesting to hear a little bit about where you think your challenges lie, but I actually wanted to go in a slightly different direction, because in the 20 plus years that I've been involved, what I've noticed is that it used to be a very US dominated industry, but what's happened in the last 10 years is that a lot of the European managers seem to have sort of taken over and created these massive success stories, I guess, and attracted a lot of AUM in the industry, why do you think that is? What do these European managers have that appeals to investors today do you think?
Marty: That's a good question. I don't know that much about the regulatory environment in Europe. I can't imagine that it's any better than it is in the US. So then the next thing that I have to fall back on is they're doing a better job in creating investment vehicles that are profitable.
Niels: But your performance, though, this is the interesting point. When I look at these performance records, your performance says the opposite, and in a sense that leads me to...are European managers perceived to be more scientific than maybe the classic US trend follower? I don't see any evidence necessarily that 50 PHDs are better than one or two PHDs, but maybe perception is just so important. Marty: Well, the studies have shown that there is definitely no correlation between the number of scientists or PHDs you have and performance. That's for sure. I suspect, or it's my feeling, especially in today's environment, is there's much more money being allocated to these types of strategies in Europe than there is in the US. Secondly, if you're allocating in Europe, you're probably are going to be more driven to allocate to a European manager than you are a US manager. There are absolutely concerns from an off shore investor about allocating in the US. The US is becoming more and more aggressive in these areas. Their regulatory environment is becoming more and more aggressive, their tax environment's becoming more aggressive, the political environment is becoming less receptive to foreign investment, foreign people profiting from things in the US. All this is driving the investor away. This is just a normal function of government and regulatory bodies, where they just overdo it to a point where they drive companies out of business, and then they look back at themselves and wonder what happened.
I think we're as good as anybody else out there. There are some European guys that are doing quite well though, and they have lots of money under management. I think 2013...the last 4 years have been tough, and I think people are taking another hard look at have they really made the right choices or not, and maybe this environment will weed out some of the weak hands.
Niels: Yeah, no definitely. Now the last section that I wanted to talk to you about is a little bit outside the normal topics that you might come across. But I know a lot of people who are listening today are also people who aspire to be the next DUNN Capital, so just based on your experience, what would you say to them? What does it take to become a great trader or great CTA in your opinion?
Marty: Well, people don't want to hear this, but at this point I'm not sure they can. Given the environment today, Bill couldn't have done what he did. He would have been in violation of all kinds of regulatory barriers and things that are put in place. You need a lot more capital just to deal with all the issues than you did before. So, this is what I would say for somebody starting out. What you need to do is you need to have the trading system or at least the ideas of the trading system that is profitable, that actually accomplishes what your goals are. That is what you need to go around and show people and try to convince somebody to come in and provide the capital. Because that's the biggest hurdle. If you can get the capital, the rest of the stuff will fall in place.
What we used to do, and we did this most recently with Revolution Capital Management out of Colorado, who's a short term trader, they've been fairly successful, we just separated our alliances here this year because they've grown to a level where they can be independent and function on their own, but what we would do, is if we found somebody that had a really good idea, we would offer our services, and basically help them, provide them capital, back office, just resources, so that they could actually get a system up and running, build a track record, and then attract new capital. The regulatory environment that's there today, you really can't do this anymore, because it raises all these questions: who's in control, and who's doing this, and whether your position should be aggregated, is this person really competent enough per the regulator to be doing these types of things? So, it's made the environment a lot more difficult for the new guy to get help, for the new guy to start out. What you do is you go to work for somebody, and if you have that independent spirit where you want to break off and go on your own, I guess maybe that's what you do.
Niels: Did you personally always know that you wanted to be...because I think it's only fair to say that as a CTA, you are obviously a fund manager, but you are also an entrepreneur. Was there anything inside yourself when you were starting out that said that one day I want to also have the entrepreneurial experience?
Marty: Oh, absolutely. Being a CPA, the whole idea of a CPA is having your own firm or being a partner in a firm. I was a partner in a firm before I came to work here. So I think I've always had that desire. Once I got involved in the financial industry from an audit or from and accounting standpoint, that was by far where my interest lay. So, I have no regrets about the choices I have made in life, that's for sure.
Niels: No, absolutely. Now Marty, if you could ask a question to my next guest here on Top Traders Unplugged, one of your peers not doubt, what would you ask them?
Marty: What are they going to do to differentiate themselves form everybody else in the industry? I think that's what everybody out there is trying to do right now.
Niels: Yeah, no doubt. It's definitely a big theme. But this has been a great conversation, but before we finish, Marty, where's the best place for people to find out more about DUNN Capital?
Marty: Oh, I would go to our website. You can just Google it. You have to actually register, but it's not a big process. You put in your information and check off that you're a credited investor then you get an email with the password to get you in. That would be the best place to get information. Once you get there, then you can open up a communication. If you have questions, or want anybody to contact you, or you're interested in doing anything with us. But there's loads of information on that website.
Niels: Fantastic Marty. Marty, thank you for ever so much. It's really been a great conversation and you're story is truly inspirational and I really appreciate your openness and your willingness to share your insights and your views, on not just your strategy, and on DUNN, but also on the industry as a whole. For my part, I can say that the listeners can also find a lot of details about our discussion in the show notes for this episode on Top Traders Unplugged. I hope and look forward to connecting at a later date and see what other great things you're up to at DUNN Capital.
Marty: Thank you very much. I appreciate it and it's been a pleasure for sure.
Niels: Thank you so much Marty. Take care.
Marty: Alright, take care.
Ending: That's all for this episode of Top Traders Unplugged. We'd love for you to be a part of our community, so head over to TOPTRADERSUNPLUGGED.COM and let us know what you thought of this episode in the comments section of the show notes. Take action, get involved and suggest who you would like to see as a future guest on the show, or how you think we can improve. Constructive comments will be rewarded with 30 days of free access to our premium member area. So head over there now and we'll see you next time on Top Traders Unplugged.
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Date posted: 03 Jul 2014no comments