“You need to protect your emotional capital as well. As a general rule you don’t want to be in a position when your emotions are clouding your judgement.” – Mike Coleman (Tweet)
In the second part of our conversation with Mike Coleman, we explore the different commodity markets and how RCMA trades them, and look back at the drawdowns that Mike has gone through and what he has learned from them. We discuss risk, idea generation, and what it takes to build a successful firm.
Thanks for listening and please welcome back Mike Coleman.
In This Episode, You’ll Learn:
- How correlation plays an important role in what Mike does.
- What he thinks of the current oil market and the outlook for oil.
“We do not use systematic models.” – Mike Coleman (Tweet)
- How they use relative value trading and what that is.
- What process they have for getting an idea into an actual position.
“We don’t have an investment committee that pre-approves trade ideas.” – Mike Coleman (Tweet)
- How they have a different relationship between trader and analyst than other firms do.
“There’s always the expectation that as a trader you are primarily responsible for your idea generation.” – Mike Coleman (Tweet)
- How he defines risk and how he looks at risk management.
- What he has learned from the drawdowns he has gone through.
“You can read about it and intellectually understand it, but until you actually put your hand in the fire and get burned, you don’t emotionally understand it.” – Mike Coleman (Tweet)
- How to get the investor’s confidence in the manager to a place where they don’t drop out at the worst time.
- Why regulatory risk is something that keeps him up at night.
- How his strategy has changed over time.
- If it’s possible to backtest any part of his strategy.
- What the typical investor in his firm looks like.
- What location means for a business like Mike’s.
“Singapore is probably still the best place to run a business.” – Mike Coleman (Tweet)
- What motivates him for the future.
Resources & Links Mentioned in this Episode:
Learn more about the founding father of Singapore, Lee Kuan Yew.
This episode was sponsored by Swiss Financial Services:
Connect with RCMA:
Visit the Website: www.rcma-commodities.com
Call RCMA: +(65) 63322282
E-Mail RCMA: email@example.com
Follow Mike Coleman on Linkedin
“You’ve got to be true to your style.” – Mike Coleman (Tweet)
Mike: In addition to protecting and preserving your physical capital there's also the concept of emotional capital. As a general rule, you don't want to be in a position where your emotions are clouding your judgment. We talk a lot about does it feel like a struggle? Does it feel like we're fighting the market? The general learning over the years has been if it feels like a struggle, if it feels like you're fighting you should probably scale down or get out.
Niels: It's not every day you meet a trained rubber trader who at a mature age in his life decides to set up his own fund management business and ends up building it into one of the world's largest discretionary commodity only fund management businesses. You can imagine that I learned a lot from speaking to my guest today, and I'm sure you will too.
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: You mentioned that briefly when you said that difficult in 2011, markets were highly correlated, etc., etc. I mean when you talk about these ratios, to me it doesn't sound like correlation play a big role, but it probably does somehow. How does it play a role in what you do?
Mike: So, correlation plays a big role in risk because we're running a VAR model. So to the extent that things are getting more or less correlated than a VAR model would be allowing us more risk or less risk. On a more macro level, a challenge always for us, is how do you weight the fundamental analysis against the…
Niels: Statistical side.
Mike: Well, against technicals, and against macro drivers. So we're actually just seeing a great example of it in the petroleum market. So, in the last week petroleum prices, they rallied from $48 to $54 and have dropped back to $50. And fundamentally things have got worse.
Niels: Explain that.
Mike: So, during the course of last week we had US inventories continue to build to levels that have never been seen before. You've had the Saudi Arabian's announce that they've just pumped more oil that they've ever pumped in a month before at 10.3 million barrels a day. You've got the prospect of Iranian production coming back. Yet for some reason investors at the end of last week chose to pick on one slender little piece of potentially good news: that week on week US onshore oil production had fallen for the first time since January by 50,000 barrels a day or something and triggered a short-covering rally that moved the market 10% in 3 days.
Niels: How do you make sense of that? Because if you were systematic, you wouldn't care about why these things were happening. You wouldn't have to worry about it, you'd just say, "Okay, the price is up so you either get stopped out, or you stay with your position, or you reduce it. You don't worry about this." But…
Mike: So if you like, yes, we do a combination of those with the added human element that we worry about it.
Niels: Yeah, exactly.
Mike: So that's a great point about sometimes the markets are driven mostly by fundamentals; sometimes they're driven more by flow. So the art of what we do is to handicap the one against the other. Basically if we have a strong fundamental view and we think that short term the market is behaving, from our point of view, rationally then we might be more inclined to stick with the position.
Niels: Yeah. If you don't mind me asking because it's such a great example, everybody knows and follows, I guess, oil at the moment. Do you mind sharing how you're playing oil at the moment, sort of in general? But also given these kind of counter rallies we see. What do you think about oil? What do you make of all this at the moment?
Mike: Well really since the summer of last year, we've been generally on the bear side of the oil market because fundamentally big surpluses were developing. The OPEC meeting was a real game changer. It essentially meant that the Saudis were going to let the market take care of the price, and, therefore, that would mean prices won't be $80 or $90, prices will be $40 or $50. And we have the strong down move from October through to mid-January. Since mid-January we've had a more two-way market with some quite sharp rallies, and the market's now arguing if you like, is the bottom in?
Fundamentally we would say no, the bottom's not in, but price action wise, we've had to respond to the price action, we've had to manage P&L… and you know I think it's an interesting example maybe, that commodity markets have become more financialised. In particular, in oil, you have the dynamic of the ETF's, and so huge amounts of inflows have been seen in the exchange traded funds, which essentially… you know I think had this… the last time oil prices behaved similarly to today was in 1986. I think if this were happening as it happened in 1986, we would have seen prices below $40 a barrel now.
What's been different this time is because investors who wouldn't normally be able to trade commodity futures had an easy vehicle. To take a view on oil prices, you had a tremendous amount of bargain hunting come into the market, which probably came in at too high of a level, or too early. It stopped the price going as low as fundamentals say that the price should go. So, the net results of that is maybe there's enough money being thrown at it, that a bottom is being created here. However, that will come at the cost of future oil prices because the price hasn't moved low enough to change future production. So, a lot of those canceled drill rigs might well be not canceled. So, it's an interesting... a more equity-like dynamic, so commodity supply-demand analysis and the behavior of commodity markets historically, has been backward looking and reactive. It hasn't really been forward looking, whereas equity markets, people look further forward. So there's a limit to which a commodity can look forward because commodities need to be stored, and they're real, and so on. But, it definitely creates a different dynamic.
Niels: Yeah, you know, I think often you think about discretionary traders and… I guess discretionary traders have often become the stars. Meaning systematic firms, they rarely make it on the cover of the big papers, but a discretionary trader, someone making a big call like Paulson did on US housing, and so on and so forth. They take a lot of sort of the limelight. Some people suspect that discretionary traders in some ways, also make the use of models, like a simple trend following model, would help in many situations to guide discretionary bets, and then you could trade around this. I mean, do you also make use of basic trend following models to guide you as to where the price is heading? Or do you not look at that at all?
Mike: We will consider technical factors on timing, and on setting stop losses or profit targets.
Niels: But technical analysis to me is a little bit different from trend following models…
Mike: We do not use systematic models to guide.
Niels: Right, so more looking at charts?
Mike: Yeah, so we look at charts, and we say, "Okay?" Depending on what the… we sort of refer to it as voodoo science, like we're there with our voodoo dolls as well from time to time. But, you know, what's the fib in actual retracement? You know, where have the moving averages crossed? And so on and so forth. Actually it's a thing we've discussed down the years is, should we make use of systematic models at least to sort of understand the dynamic of what's going on with other people.
Niels: Sure, sure, but the jury is still out, I guess? Or?
Mike: Well, the issue a little bit is you have to be true to your style. If you start trying to overlay your fundamental with a systematic, you run the risk of not really trusting either, and so we tend to… Our competitive advantage our strength is our fundamental analysis, and we'll bet on that, and we'll use our risk process to keep us from losing too much money if either we're wrong, or the market doesn't… usually, we're not wrong, we're either in too early or stay too late.
Niels: Sure, sure. Just a quick question on the markets you trade. You trade a lot of different commodities, but I did notice that you don't trade precious metals. Why is that?
Mike: We don't trade base metals either; it's a function of a need to have a network and understanding. So, I'm a rubber trader who became a petroleum trader; Doug's a grain trader who became a petroleum trader. We don’t have the networks.
Niels: That's very simple; that's very simple. Now, I wanted to round off the trading strategies as a whole. We talked about the directional side and so on and so forth. Maybe you could just enlighten us a little bit about the relative value side. You have the intra-commodity types trading, and you have the inter-commodity trading, can you give some examples for people who may not really understand what that means? What are these kinds of strategies that you employ?
Mike: Yeah, okay, so some points about our approach to relative value trading... So, it's important to know that we're not trading statistical correlation. So when we enter a relative value trade the legs of the pair-trade need to be first order related. So, there has to be some real meaningful, physical linkage between them. So for instance you might find a very strong statistical correlation between rubber and crude oil, but it's clearly not a first order impact. So we wouldn't trade that as a spread. Because that correlation will last until it doesn’t last, and you won't know why it's going to break down because you might guess why it exists but it's very difficult to know why it exists. Whereas if you trade gasoline against crude oil, they're directly linked, you change the price of gasoline, you change the price of crude oil and vice versa. So, the second thing to note about our approach to relative value trading is that we don't assume mean reversion. So, a lot of people look at commodity spreads and basically treat them on a mean reverting statistical basis. That's very dangerous because indeed many commodity spread relationships do mean revert, until they don't. A great example was the spread between Brent and WTI, which for many, many years was a very tightly bounded spread. It has to do with the relative cost of importing Brent crude oil into the US against the cost of using domestic crude oil. So that spread moved over -2 to +2 dollar a barrel range, forever. People got very comfortable with statistical mean reversion approach to that trading and then beginning in about 2007, as you started to grow the onshore North American production.
First of all off the Canadian tar sands, and then more laterally off the US shale, suddenly you started to overwhelm the delivery logistics in Cushing, which is the delivery point from WTI. The markets diverged because the conditions that had lead to mean reversion didn't exist anymore. That spread went all the way to -25, so that's by way of preamble. So then we sort of break the world down into, as you say, several different types of generic relative value trades. First one is; you said intra-commodity which is calendar spreads. So, same commodity, same market, different place on the time curve.
Niels: So July corn versus December corn for example?
Mike: Yeah, and that's the sort of bread and butter of commodity markets, so the calendar spread and the care we charge, it's very deeply fundamental. Generally oversupplied markets are in contango, generally undersupplied markets are in backwardation, and the severity of the contango and the backwardation are very closely correlated to the level of oversupply or level of undersupply. Therefore, it tends actually to go quite closely with the directional to the extent that long the near, short the forward, or as bond traders would say, a curve tightener. It's called a bull spread. Short the near and long the forward, or a curve steepener is called the bear spread. Again, that's only 7 times out of 10, not 100 out of 10. Then the next broad category is inter-commodity which are different things but closely related in our case. So, the crack spreads, gasoline against crude oil, heating oil against crude oil, the products against themselves, so gasoline against heating oil. So, you've got a set of relationships around refining economics. By analogy, if you crush a soybean you get soybean oil, and soybean meal, and so you have a crush spread, where you trade soybean against its products. Then you have a… you can think about sort of supply site substitutions. So, are you going to use WTI or Brent? Are you going to use sweet crude or sour crude? Rather than cracking crude oil, are you going to crack fuel oil? If you're generating power, are you going to burn nat gas or are you going to burn coal? And then there are sort of consumption supply economics, robusta coffee, arabica coffee, so when Nestle is making the gold blend, how much cheaper robusta are they going to blend in with expensive arabica? Is a vegetable oil maker going to use more palm oil or more soybean oil? So there's a whole range of relationships in the inter-commodity space.
Niels: Sure, and of all the strategies that you run, are they any that you would say are more core? Where you put more risk budgeting towards…?
Mike: We're very opportunistic. It's the way the cookie crumbles. Sometimes markets… you know, crude oil in December and January, there was no point being relative value. It was all about that the price couldn't be $80 or $90 anymore; it needs to be something under $50. Then there were other times when there isn't particularly a strong directional move, and then it's more about relative value. I was just doing some work actually, over the life of the fund, approximately 55% of our return has come from directional. Last year it was 58% from directional, so last year was a bit more of a directional year than others.
Niels: Okay, sure, sure. Talk to me a little bit about sort of the trade idea generation to implementation into the portfolio. What's the typical process for something like that? I know you're opportunistic, so obviously I'm sure ideas could come and go. What's a typical process you have to go through in order to get an idea into an actual position?
Mike: Ours is very simple, because we have a risk committee. The risk committee meets once a week and the traders present their current positions and their ideas, and the risk committee decides how much risk it's allocating to each sector and each trader. Then it's up to the trader to decide how he's implementing that. We don't have an investment committee that pre-approves trade ideas. So, the trader is given his risk budget, and within his risk budget and his mandated sphere of operation, it's his call. Then he obviously reports it back and gives us his thinking. So, we don't sit there and say, "No, we think that's a terrible idea, don't do it."
So, that's very… and that's the function of us being a small team, we know each other very well. So, basically what each trader is doing is he is following the commodities that he's responsible for, and his primary responsibility is to find the best ideas. The world we grew up in is very different from let's say the classic capital markets model, banking model, where you have analysts feeding traders with ideas, and the traders, essentially being tactical executors of analyst generated ideas. In the model that we grew up in, to the extent that we're even analysts at all, their job was to help the trader in his research. So, always the expectation was that as the trader, you're primarily responsible for your idea generation. In a way, we find it a little bit bazaar. Why would a trader with 30 year’s experience take guidance from a 5 year analyst?
Mike: We'll take ideas from a 5 year analyst, so it's a bit back to front, in our way of thinking.
Niels: So the traders obviously have a lot of room to do what they feel is right. So the question I have here is, are the traders… and I'm not entirely sure how many on your team you regard as…
Niels: Okay, so are they very different types of traders? I know they trade different markets, but are they also different in their style of trading?
Mike: Yes, everybody has individual styles. Some people are naturally more relative value while other people are more directional. For instance in my trading career, I'm much more of a relative value trader. I'm not a great directional trader. Doug, my partner, is a very strong directional trader. Typically somebody will be one or the other. It's very rare to find somebody who's… I guess to use a soccer analogy, you know, two footed players are quite rare, yeah?
Niels: Sure, no that's very true.
Mike: So part of the thing we're looking for, at the minute... It's a small trading team, but always if we were adding to the trading team, there'd be balanced criteria around what's the style of the guy we're adding? Will he complement and fill the gap we currently have. If we think that the team at the minute is a bit more relative value than it is directional, maybe we need to add a guy who's stronger directionally. That would become a factor at team expansion time.
Niels: In managing the sort of risk side (maybe jumping a little bit here) but just in managing that, do the traders have specific stop losses that when they put on a trade, or… ?
Mike: No, no, so we don't require stop losses on trade initiation. So, our whole risk management process is really about managing the whole portfolio. We start to require stop losses when the whole portfolio gets into drawdown… is hitting drawdown triggers. Then we require the traders to get very specific on, what are you cutting? What do you want to hold? Where are you cutting?
Niels: Sure. Now, you mentioned that you were involved in the risk management side. So I just wanted to jump to that area and just ask you, in general, how do you define risk? Is it just the VAR that for you is your measure of risk? Or are there any other types of risks that you look at?
Mike: We have a sort trade parity process, so we have our VAR model. To catch the tail in the VAR, we run a stress test, and a stress model. Then we have our P&L de-risking triggers. So, P&L trumps stress and VAR; stress trumps VAR, if that makes sense?
Niels: Right, can you say that again?
Mike: So P&L overwrites everything. So, if we're losing more than 5% for the week, or more than 5% from high water, we are cutting risk even if we're only 50% invested against our VAR and our stress tests. Secondly the stress test overrides the VAR, so we have a stress limit of 10%. So, it's conceivable, and it does happen where you might have a day where the VAR against our VAR model was only 85% invested, but against our stress model was 11%. In that case, we would cut risk. We will tolerate being over VAR, so as long as P&L and stress are okay, we might allow the VAR to go over target rather than to arbitrarily take profit on a position or reduce the position.
Niels: Sure, sure. Now, in the systematic space, and I'm just curious how that translates into your world, a lot of people focus on how many winning trades do we have compared to how many losing trades. Do you even know that, and do you follow that from a perspective?
Mike: We follow it at the strategy level. So, not each individual buy and sell, but each individual… so every trade we do goes into a strategy, and every strategy is part of a theme. So let's say a theme might be that we are bearish petroleum. That then might be expressed in that we are bear spread the calendar, we are directionally short, and we're short gasoline, long heating oil, because it's winter and heating oil demands relatively better than gasoline. So, that would all be thematically, a big part of that theme is that we're bearish oil prices. Then the individual strategies then are various ways of expressing that. We have a win to loss ratio over the life of the fund of about; I want to say 7 out of 10?
Niels: Wow, that's high.
Mike: Yeah, but the danger for us is because our positions are fundamentally based and so on, the danger is when we're wrong, we tend not to be a little bit wrong. So, therefore the downside risk management is very important. In 2011, for instance, win-loss ratio dropped to 3 to 7, 3 win to 7 loss. Which again is a measure of how difficult the environment was. 2012 even though we lost money, it was back to 5 out of 10.
Speaking about those periods, you mentioned it, it kind of drives me into the next sort of area that I just wanted to touch upon, which is drawdowns in general. Not so much the specific drawdowns, but really more about what do you learn? What do you take away from the drawdowns you've had over the years? And what have you perhaps changed as a consequence of being in a drawdown?
Mike: Yeah, I think like many experiences in life, you can read about it and intellectually understand it, but until you actually put your hand in the fire and get burned you don't emotionally understand. But burning yourself is not a good idea. So, I think we learned the hard way, the basic lesson that you really don't want to compound negatively. When you're in a hole, stop digging. So, in 2011 we didn't stop digging quickly enough, and that's very basic but we had to… because prior to 2011 our risk process was always… the P&L de-risking figures were all around the week, not losing more than 5% a week. And it wasn't a complete we wash the slate at the end of the week. The risk process calls for as you lose money you de-risk, and you don’t add risk back until you stop losing money, and you're feeling comfortable. But we'd never given consideration to peak to trough draw. So is there some level at which you should, regardless of how your P&L is this week or this month, is there some level where you should…
Niels: Be more aggressive in your cutting of risk.
Mike: Yeah. So we, after 2011, we've developed some peak to trough metrics that reflect that.
Niels: Sure, sure, and I also guess we talked a little bit about it, but I mean I also guess emotionally dealing with it, I guess that's something you learned from I guess?
Mike: Well again it's a learning lesson. It's something we talk about a lot, the idea that in addition to protecting and preserving your physical capital, it's also the concept of emotional capital. Everybody's got different levels of emotional capital to spend and how quickly they spend it, but as a general rule you don't want to be in a position where your emotions are clouding your judgment. We talk a lot about, does it feel like a struggle? Does it feel like we're fighting the market? And a sort of general learning over the years has been if it feels like a struggle if it feels like you're fighting, you should probably scale down or get out.
The beauty of running a fund relative to a physical commodity book is that in the fund you're in control of when you take risk. You are deciding each day do I want to take this risk, or don't I? In a physical business, you get the risk given to you by your need to maintain your customer. You need to maintain market share both with customers and producers. So, a big part of what… in my role as risk manager is to keep reminding the traders of that. You're in control. If it feels too much like hard work today, don't fight it. There will be other opportunities next week or the week after. Don't get sucked into a war of attrition that you don't need to fight.
Niels: Why do you think… clearly we as managers feel the emotional side of drawdowns, but something inside us I guess makes us overcome these periods and believe that over time if the strategy is sound it will come back. And you know, for many, many, many people it can be said that they always come out of their drawdown. If we just take the analogy to the trend following space, how often have we heard that trend following is dead just because it's in a drawdown, and rightly... So then a year later it's at a new peak. So, why do you think it is so difficult to convey this to investors? Because what we've seen, and what you've seen as well is they always tend to jump ship at the worst possible time.
Mike: Well I think again, it's asymmetry of knowledge. So, they don't see what you're doing day to day. They can't have the same confidence in you as you have in yourself. Then I think that there is that most of the people managing money, it's not their own money. They have a future responsibility to somebody else, and, therefore, that overrides… The decision becomes, "Do I stick with a merchant commodity fund because I'm pre-convinced (Mike and Doug) haven't suddenly become stupid, that they aren't blowing the fund up because they've had a nervous breakdown or something. Therefore I'm probably sticking with them and trusting that they'll work their way through this. But the consequence is if I do that I might lose my job."
Niels: Sure sure, no no, I mean this is the thing. I mean it takes years of data and analysis for people to become convinced and comfortable with an investment strategy, but it only takes a few months of bad performance for them to jump ship.
Mike: Again which is, you can sort of… you understand I guess why many people when they get to a certain size deliberately dial the risk down, because why take that chance?
Niels: Sure, sure. Have you ever been tempted to do that?
Mike: No, because philosophically again, you have to be true to your own process and style. So from our point of view we wouldn't give money to a commodity strategy personally for a bond plus return. Commodities are intrinsically very volatile, and therefore ideally the allocation that's coming to you should be from the higher risk seeking part of somebody's portfolio. It shouldn't be a base load to a normal portfolio.
Niels: No, that's very true. Now, last question on risk. What keeps you awake at night Mike? Is there anything when you look at the whole universe of different types of risks that you think more about… where you say, "Hmm, I wouldn't…"
Mike: Regulatory compliance. So in my case I spent 32 years living with market risk, that's the sea we swim in, that's the life we've chosen, and by definition if you've been… You know the first 5 years sorts out people who are comfortable living with market risk from people who aren't. So if you're still doing it after 15-25 years, then you're comfortable with market risk. Yes, you know that you're not going to win every time, that unexpected stuff is going to happen, but that's the life you've chosen. You've got your risk management processes to take care of that, and so on and so forth. Regulatory risk is becoming… that's something where you fill the form in wrong, and you might get a big fine. That's a whole different arena.
Niels: No, yeah that's very true. I wanted to jump to another area that I don't know exactly how it plays out in your business, so maybe there isn't so much to talk about, but maybe there is? And it's just research in general. I mean do you as a business, do you have people who do research? Meaning, and the best example I can think of is that as things change, whether it be China playing a bigger role, whether it be technology as a whole. I mean do some of these strategies that you employ, do they also change and therefore you need to kind of do separate research in order to keep up or learn new things?
Mike: I think, let's say that in the business of analyzing commodity fundamentals, to the extent that changes. It changes with shifts and supply in demand patterns. So, it's become… having good intelligence in South America has become much more important in the last 10 years than it was previously as Brazil, Paraguay and Argentina have become much bigger soybean producers. Therefore, where you focus your research efforts, where you focus your networks that evolve over time, and how that information is collected changes over time. So, for instance in petroleum now, you have this company Genscape that uses helicopters and infrared cameras to see inside oil tanks, so you can see how full the tanks are in Cushing and so on.
We don't view ourselves as a research-driven organization, so we buy in a lot of our research. What we think our competitor's advantage is, is in what does it mean? So, typically what will happen is, let's say we're looking at the next year's US soybean crop. Typically at the beginning of the growing season you'll start with a range of expectations around what the crop size is going to be. As the growing season goes on, those expectations will narrow and change. What we're trying to do is basically say, "Well okay, here's what the market's pricing at the moment, and do we think the consensus is right?" If the consensus is wrong… So if the bean yield isn't 43 but it's 40, what does that mean for the price? So, we're trying to come up with where we think the yield is actually going to be and what does that mean on price? We're not sending agronomists into the fields in Iowa to count the pods or anything, and that's not our competitive advantage.
An interesting question that we spent a lot more time thinking about, really since the events of the global financial crisis, is the interpretation of macro data. So, what does the Fed policy mean for oil prices? And again, that's an art, not a science, so we talk to macroeconomists. In 2005, and 2006 we'd have never thought of talking to a macro economist. Today we talk to macroeconomists fairly regularly.
Niels: Sure, sure. Are there any of your strategies that can be backtested? I mean are there any…?
Mike: No. Well, I shouldn't say no. I'm saying no because we are non-quantitative guys! So, actually you could do regression analysis on… and lots of people do, I was just reading a piece of research today that was looking at the level of contango in WTI time curve with the stocks, you know with the days of cover that's in inventory. So, people do that, and they say, "Well okay, today we've got 430 million barrels." Which is… you know the US consumes 20 million barrels a day, so we've got 20 odd days of cover, and so that's quite high, and therefore plotting on this linear regression… you know the time curve should be 150, not 130. So there are people who do that analysis; we don't.
Niels: No, no, that's fine, that's fine. I wanted to ask you just a couple of questions on the business side if I can call it that. And that is just to better understand, so what's the typical investor in your fund? What do they look like? Obviously you're somewhat unique in the bigger space, and you can go back in time and look at it.
Mike: Yeah, so today is not represented.
Mike: So let's say over the period 2006 to 2012, typically we would have had about 20% of our AUM was coming from sort of large institutions such as Sovereign Wealth Funds, Endowments. Actually maybe not as much as that, we were 70% fund the funds, 10% institutional, and 20% family office, and high net worth, including ourselves. Today we are 58% ourselves, 22% pension funds, and about 5% fund the funds, and the balance, family, office, and high net worth investors. At our peak, we were attracting every sector of investors.
Niels: Another question I get from listeners probably more frequently now. First of all in your fund, I'm not even sure what the margin to equity is, but I imagine that you have quite an amount of spare cash if you're using futures? What do you do with your cash today in a world of zero interest rates and potential more risk with governments and their ability to repay an ever growing debt?
Mike: So, your question on margins or equity, typically we'd be running somewhere between 5 and 15 with an average of about 10. So, yes we have lots of excess cash. We've never done anything very exciting with that cash. We always took the view that we're a fund that's targeting a 20% return, anything incremental we might make by taking some risk with the cash is not worth it. So, prior to 2007 we used to sometimes buy T-bills. Since 2007 we just keep it in bank accounts with strong banks in Singapore. The interest contribution, of course, is much lower. Between 300 and 400 basis points of our return in that period, to '05 to '09 was interest, today it's close to zero.
Niels: Sure. I mean you mentioned Singapore, which is something I just wanted to ask you about. Location freedom in our business is obviously very strong. You're based in Singapore; you have some presence in London as well, but what does location mean for a business like you now that it's become fund management rather than physical trading of commodities? And let's disregard the fact that you also have a physical trading business.
Mike: Yeah, so Singapore is probably still the best place to run a business. So in terms of the tax regime, the relative cost of quality office space, availability of talented people, so on and so forth. Singapore is a fantastic place to run a business. In terms of the strategy, we trade it's a great place to trade things like rubber and palm oil. It's a great place to get a good sense of the pulse of what's going on in China or in India. It's a terrible place to be time zone wise for trading grains and petroleum, and therefore we've always split the trading team between Singapore and Europe. In terms of fundraising, Singapore is still weaker than London or New York. So it is easier for people to raise money in Europe than it is sitting in Asia.
Niels: Yeah, but at your peak days, what was the geographical distribution of assets actually?
Mike: It was about 75% Europe, about 20%... 70-75% Europe, 15-20% Asia, and the balance of some South America, some Cayman.
Niels: Okay, before we go to the last section, I wanted to ask you, I mean you've obviously been in many, many different types of due diligence situations, whether it be conference calls or meetings. With a strategy like yours, what do you think that potential investors fail to focus on or should be focusing on when they come and want to really drill down to get a handle on you, and your strategy, and so on?
Mike: Well I think we've always had the challenge, and it's a bit like you prefaced our conversation with: the world of commodities and fundamental approaches to commodity trading are not areas most general investors are familiar with. So, when an investor comes in to do due diligence on an equity long-short fund or a bond fund. He's very comfortable; he understands what the manager's doing. When he comes in to see us for the first time, we have to try and explain to him what we're doing and does he have the time and the inclination for that process? We would say that a key part is how does the risk process work? Because you are trading leverage, and why it's not scary. Commodities scare people because of their volatility. So, what we're trying to get over is, here's our approach, here's our risk process, and this should give you more comfort around what we're doing.
Niels: Now the last section Mike, that I wanted to talk to you about is, I call it general and fun. It's a little bit just to get people to better know you, maybe a little bit better and get some good advice from your side as well. But I wanted to ask a question initially, we talked about a little bit why you, during the difficult time, kept going. You didn't want to leave the business at the time of a drawdown, and so on and so forth. Now, today you're at a new peak in terms of performance, so you've done and delivered what was one of the driving forces of staying in the game. But drives you today? What motivates you to continue to do what you do at this time?
Mike: Well we have a vision of a… we want to build a commodity franchise that encompasses a commodity asset management business, but we also have a physical trading business. There's a great synergy between those businesses, and so the physical business can give the… and does give the fund business great insights into what's... that visibility and into real time supply in demand, and so on and so forth. A successful fund management business with a decent amount of assets is a great free cash flow generator. That free cash flow can help build a physical business. So, there's a… from our point of view we want to grow both pillars of this commodity franchise. It's mutually reinforcing.
Niels: Sure, and in doing that… I guess at some point succession planning must come into the conversation with you and Doug. I mean are you thinking about that?
Mike: Yes, so suddenly… a year ago when we changed the name of the business, so the fund management business prior to March 2014 was called Ashland Analytics. We purposely changed the name RCM Asset Management to build on the franchise idea, but more importantly we also changed the ownership structure at that point. So firstly, we gave the two senior traders equity in the business. So, Chandrakant Bhima now owns 10% of our RCM Asset Management, and Alistair Jones owns 5%. We also sold 30% of the business to the holding company of the physical business, so that the guys who… the senior management team of the physical trading business then have a direct stake in the success of the asset management business for which they are providing information on demand. So yes, very consciously we felt that we wanted to extend the ownership of the asset management company to our senior traders because we do want to build something that outlives me and Doug. The physical business has its own very experienced management team there. So yeah, we want to build something that endures beyond us as individuals.
Niels: In your career, I mean you said earlier on that you like laying down on the couch reading books. Which books would you recommend people to read? Either to improve them as an investor or a trader or just as a businessman?
Mike: I don't read! My reading is… It's interesting, as you know Singapore just went through the loss of its founding father, Lee Kuan Yew, and there was a little piece that caught my eye, which is very typical as Lee Kuan Yew as a man, where he said when his wife of many years was incapacitated and so on, that he would… she'd studied English literature, and he would read to her, her favorite books, Jane Austin, and so on. But he said for himself personally, he'd never waste time reading a novel. The only thing he read were non-fiction that could… that he could profitably use in the business of governing Singapore. I'm the complete opposite, I read for pleasure! My great passion is military history, so I love reading military history books, and I read novels for relaxation. For military history, I think I talk a lot, and the guys sometimes look at me funny, but the concept of time and space, and defense and death. So give yourself time and space, don't get backed into a corner. So I'd always recommend to people read those very famous British military strategist of the interwar period, a guy called Liddell Heart, Basil Liddell Hart. He developed the earliest theories of combined… how to use tanks basically. The British, not being honored in his own land, the British took no notice but Guderian and Rommel read Little Heart. So, the blitzkrieg was actually conceptually developed by a British military strategist! So, more broadly I actually found quite useful, I read several years ago, some books on the sort of physiology of traders by a guy called Daniel Levy, which I thought were very useful. They were about the importance of preserving emotional capital and so on.
Niels: Sure, sure. With that interest in terms of sort of a military strategy, I think on your next flight back to Europe, which I think is not so far away, if you haven't seen it already I'll recommend the Imitation Game which is obviously about how the British broke the enigma code of…
Mike: I've seen that!
On a more broad topic, many traders tend to be very mono-focused types of individuals. I've always thought that it is important to have a hint of land as people say, not to be just your job. So, I do enjoy reading fiction and so on.
Niels: Sure, sure. Now I know you mentioned earlier that you have children who are grown up now, but if you could pass on just one of your own skills to your children, what would that be and why?
Mike: They'd tell you lots of my weaknesses! I think intellectual robustness.
Niels: Mhm, what does that mean?
Mike: So the ability to argue, counter argue and not be crushed or to be able to be beaten in an argument and to come back and just… I guess just flexibility… I'm not articulating that very well.
Niels: No, no that's absolutely fine. Now, can you tell me a fun fact about yourself Mike? Something that even people who know you don't perhaps really know about you?
Mike: Well one, well you've met me personally so this probably makes more sense to people who've never met me in person. So to see me, you'll get a sense of this because, for those of your listeners who don't know me, I'm a big guy. I was a rugby player, and I look like a former rugby player. I once, in my high school days, amongst my other extracurricular activities, I was the lead Obo player in the school orchestra.
Niels: Wow, that I wouldn't have expected!
Mike: So that's normally one that gets people laughing. I was also an altar boy until I was 18.
Niels: Ah okay, there we are! Now I asked earlier about one of the investors who come to see you, potential investors who come to see you, what do they miss in terms of asking you the right questions? So I have to turn that on myself as we wrap up as well. To give you justice, and that is, what have I missed in our conversation today? What are the things that we should also make sure we touch on if anything, before we end our conversation? To make sure we do justice to you and your firm?
Mike: I think that 2 hours and 9, coming to 10 minutes, I think I've only myself to blame if there's nothing we've touched on that's… so I think we've come quite along.
Niels: Okay, great stuff. Now, before we do finish our conversation, can you tell us where the listeners can learn more about you? What's the best way to get in touch and learn more about RCMA?
Mike: Either contact myself, or my colleague Yiquian for all marketing and investor relationships handled out of Singapore.
Niels: Sure, great, and we will of course, on the TOPTRADERSUNPLUGGED.COM, and we'll put all the details for that. So I think there's only one thing left for me to say and that is to thank you Mike for your time! It's been a great conversation! I really appreciate your transparency and your willingness to share all of this experience. That has been very unique and a big learning curve for me as well. As I said, the listeners can find all the details on your firm and our conversation today in the show notes on TOPTRADERSUNPLUGGED.COM. So I hope Mike, that we'll be able to connect at a later date and get an update on all the great work you're doing, and I wish you and your firm all the best!
Mike: Thank you very much Niels!
Niels: All the best, take care.
Mike: Okay, bye bye.
Ending: Thanks for listening to Top Traders Unplugged. If you feel you learned something of value from today's episode, the best way to stay updated is to go on over to iTunes and subscribe to the show so that you'll be sure to get all the new episodes as they're released. We have some amazing guests lined up for you, and to ensure our show continues to grow, please leave us an honest rating and review on iTunes. It only takes a minute, and it's the best way to show us you love the podcast. We'll see you next time on Top Traders Unplugged.
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Date posted: 20 Apr 2015no comments