Making the Case in Hard Times

Chidem Kurdas forwarded me her article today about a presentation I gave a few weeks back at Superfund’s offices. As you read the article below keep in mind a quibble I have: it’s not a matter of this month or the next month being a so-called trend follower’s market – doesn’t work that way. The ups and downs are part of the game. If you go around saying “now” is “not” the time for trend following, next month could be a huge trend following month. You can’t predict performance or the unexpected events that drive that performance. Here is the article:

By Chidem Kurdas, New York Bureau Chief
Tuesday, June 27, 2006 11:15:37 AM ET

NEW YORK (—This is not a trend follower’s market, Michael Covel said at a talk sponsored by Superfund, a trend-following vehicle run by Quadriga. The commodity trading advisers he regards as among the best trend followers have suffered large losses in recent weeks.

Major markets remain choppy and devoid of clear-cut trends, as adverse an environment as possible for the strategy. “If markets don’t trend, trend followers can’t make money,” as Mr. Covel put it.

But he was there to praise trend following, not to bury it. His point: Managers like Bill Dunn of Dunn Capital Management Inc. in Stuart, Fla., take big risks and therefore take big losses in unfavorable markets, but also win big over the long term.

Mr. Dunn has a 28-year track record with an annualized return of 24% a year despite steep drawdowns that average 35.7%, recouped on average in seven months, according to Mr. Covel’s book, Trend Following (Financial Times Prentice Hall, 2004).

Mr. Covel argues that the investment approach of systematically following rules as to when to enter or exit a trade is better than methods that rely on predictions of the future. But to watch your money go on steep rides and not to head for the exit, you must have steely nerves.

Investors are half the problem or half the solution, he said, describing instances when investors took the money away at the worst possible time, locking in losses and forcing the fund to shut down. When losses are due to particular market conditions, it’s a better bet to wait until the market turns and the strategy recovers.

Managed futures, including trend followers, is a volatile investment but not the most volatile, according to data compiled by Rydex Investments. In the past 10 years even the S&P 500 stock index has had sharp ups and downs.

Valere Costello, chief executive of Invesdex Ltd, Hamilton, Bermuda, pointed out that volatility varies across managed futures managers. Invesdex offers a platform of futures managers for investment through separately managed contracts. One group of funds made 4.3% in May and 7.3% year-to-date.

In the past five years this portfolio has performed well during periods when other strategies and benchmarks have not, gaining when the S&P 500 went down and in times of uncertainty, like after 9/11 in 2001, according to Mr. Costello.

When equity markets enter a sustained downfall or credit markets go into crisis, managed futures can become a savior. The sector as a whole returned 21% in the crisis-ridden year of 1998. Then it lost 4.7% in 1999 while the S&P 500 gained 21%. Last year the strategy was flat.

Mr. Covel’s trend-following heroes include Keith Campbell of Campbell & Co., Towson, Md., and David Harding of Winton Capital Management, London. But perhaps the strongest argument for riding out nerve-racking drawdowns that are due to temporary market conditions is the business Mr. Harding helped create prior to Winton.

That would be AHL, one of the main investment pools of the $54 billion Man Group and a basis for the company’s structured notes. As of the end of March, annual average return for the past five years was 10.7% for AHL versus 7.3% for RMF and 4.1% for Glenwood, two well-regarded funds of hedge funds that also are part of Man Group.

The 22-year-old futures program, the world’s largest, carries higher risk than the funds of funds, according to Man Group. It is routinely subject to quick, double-digit drops. But it also yields significantly higher returns over time.