My guest today is Martin Bergin, CEO of Dunn Capital Management. Bill Dunn and Dunn Capital were famously profiled in Covel’s book Trend Following and they have a 39 year track record of trend following performance.
The topic is Trend Following.
In this episode of Trend Following Radio we discuss:
- The early stages of Dunn Capital, and how it arrived where it is today
- Trend following with futures
- Volatility within Dunn’s system, and why volatility is important to the overall performance
- Targeting losses
- How history informs system creation
- Adapting to the marketplace and to available technology
- What it means to be 100% systematic with no overrides
- Defining “black box” systems, and the difference between Dunn Capital’s strategy and black box strategies
- Location in relation to Dunn Capital, and why it isn’t necessary to be in a big city like London or Tokyo
- How the core of Dunn Capital has stayed the same while certain aspects of business has evolved
- Decreasing drawdown without decreasing profitability
- Behavioral finance and dealing with biases
- The adaptive nature of trend following
- Predictive vs. reactive trend following
- Dunn Capital’s fee structure
In this episode of Trend Following Radio:
- Why volatility is important to the overall performance of Dunn’s system
- Setting your limit for acceptable losses and sticking to it
- What it means to be 100% systematic with no overrides
- How Dunn Capital’s strategy is different from “black box” strategies
- How to mitigate the drawdown without decreasing profitability
- How behavioral finance deals with biases
- The adaptive nature of trend following
- Why trend following is a reactive, not a predictive system
- Why being on the same side as the customer is a core value of Dunn Capital
“Trend following isn’t a predictive system of investing; trend following is a reactive system.” – Martin Bergin of Dunn Capital – Tweet this
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Michael Covel: Today on the podcast, I have Marty Bergin. Marty is the CEO is Dunn Capital. Dunn Capital – I’d like to say famously profiled in my book Trend Following – started by Bill Dunn, still the chairman of Dunn Capital today. I think you will enjoy this conversation. Marty brings a very, very down to earth tone to what can often be a complicated subject. I hope you enjoy.
Michael Covel: For me, Marty, and we’ve known each other for a long time, and you actually introduced me to Dunn Capital, the concept of Dunn Capital, the man Bill Dunn. I was unaware of this story, and I’m sure you feel the same way even as the CEO of Dunn Capital today, this is just one amazing story. And yes, there are quite a few people that know about this story, but there are quite a few people that don’t know about a story that I believe is 39 years in the making.
Martin Bergin: Yep, almost 40 years. And I don’t know if it’s all that special, I am sure there are people throughout the world, you know people like Bill that start out with nothing, have an idea, and develop an idea and create a business. I mean, this is the American Dream, right? He was originally working as a contractor for the US Government Department of Defense, and sat down one day and said, “There must be a better way to make a living, or at least a more honest way to make a living.” And he had an idea about trading using mathematical formulas to develop trading systems – mainly Trend Following – not knowing that there were other people out there that were actually doing Trend Following. He didn’t know anything about trend following. He had developed this idea on his own and started looking at stocks, and decided that stocks was a universe that was too large to do the calculations in a reasonable amount of time. You’ve got to think back in the early 70s, the computing ability wasn’t what it is today. You had to run things on a mainframe, you had punch cards, you had all these complications that were involved with it. So he ended up learning about futures. And the population was much more limited at the time, there was a handful, maybe 20, futures markets being traded in all of the US, and that population was more manageable. And that’s where he started, and he applied his ideas to that market, and the rest of it is history.
Michael: Oh, you make it sound so easy. I’m looking at the Dunn composite performance, and you’re telling me there is a whole slew of people out there that have performance like this over the 39 years. We’ll have to have those folks on the podcast soon too.
Martin: Well, the people I am talking about maybe aren’t necessarily in our industry. But, you know, there are people in the different industries throughout the world that have developed things and created things. And that’s what makes this country great.
Michael: Well, it is an awesome story, it is an awesome story. Let’s jump into some specifics. And I think for those that are aware of Dunn and for those that will probably learn from this conversation – Dunn, Bill’s strategies, and you being the head of the firm now, – there’s some volatility. And I think sometimes people might look at the performance and they say, “Wow, that performance is awesome, it’s incredible”, and then they say, “wow, but I don’t know about that volatility, or some of those drawdowns”. And I saw a white paper the other day that discussing warren Buffett’s performance. And it talked about his use of leverage, it talked about his higher volatility standing. And that’s not usually associated with Buffett. I wonder if there’s been, from your perspective, an unfair – you know, people can be fair or unfair, – too much of a focus on the volatility without necessarily understanding the strategy and why the volatility has been so important to the performance.
Martin: You know, people’s view of the volatility I wouldn’t say is unfair – it is what it is. What people need to understand that to actually do trend following, you have to be able to absorb losses. That’s the whole secret to trend following – being able to ride out small corrections in the market place where the trend hasn’t actually ended, it has just taken a little vacation. And you’ve got to be able to ride out those bad times to actually be profitable over the long period. And the way we view it, we don’t focus on the actual volatility so much, as we focus on what is an acceptable risk to absorb to do what we’re doing, to make money. And Bill, back in the early 70s, decided that for him, which we’ve basically stuck to until very recently, until January of 2013, we’re always stuck to the same type of volatility target or the same risk target, which is a 1% chance of losing 20% or more in a one month period of trading. Now the idea behind that, is that is if you lose 20%, now your NAV has dropped, the second month you’d lose another 20% – well, it’s not 20% for the original NAV, it’s the 20% for the new NAV. You know, we recalibrate this every single day. But you can go for a whole long time losing this type of money, and never run out of money. You’re basically staying in existence. And that’s the whole key to trend following, is not to blow up and not to be wiped out. We consider this an acceptable risk given the profits that will be made over the long run.
Michael: As you mention that targeting of 20%, that was a specific targeting, and you actually have hit your target consistently – which is only 4 times essentially, – but you did hit that target as Bill planned and desired from early on. That’s what happened.
Martin: Right, it’s just numbers. I mean, if you look at the data and you design the system, and you have the capability of knowing that history provides you with all the data you need to design these systematic systems. So if you process that data correctly and design the system correctly, knowing that the future will never be exactly like the past, it’s a target – you don’t know that you’re going to meet it exactly. But in our history, which is 340 months, we’ve had 4 experiences of over 20% losses. So it’s about a 1.2% of the time we’ve lost greater that 20%. That’s within the statistical norm. So we’re pretty good at targeting. And when you think back in the early 70s, where you’re dealing with punch cards and computers that take a lot of time to process, it’s quite amazing that you can hit a target like that. In today’s world, it’s not so amazing. You would expect it from everybody.
Michael: I think also, as you mention the early 1970s, let’s not forget, that in 2013, your performance was pretty good. We’re not having a historical conversation; you guys are living and breathing it, and still cranking it out, to this day.
Martin: Right, and I think the secret to that is to constantly be adapting what we do to the marketplace and to the technology that’s available today. So, the idea of trend following is not sophisticated. I mean, anybody can sit down and develop a trend following system, the system that actually determines when to be long or short based on the markets. The real trick to it is to design a portfolio and the management of risk – those are the key things that separate them from managers. And that’s where our research has been focused in the last 10 years – for sure, it’s in risk and portfolio development.
Michael: Let me jump in as we’re talking about the systematic. You’re very fond, the firm is very fond of saying “100% systematic: No overrides.” I think for those folks that might be listening, that maybe have a fundamental perspective, or are not familiar with Dunn capital, to say that your approach to the markets is “100% systematic: No overrides”. I can already see some folks with pitchforks lining up to start screaming “Black box! Black box!” But the reality is: the process that you do, the systems that you have, were all developed by human beings, and the computers are simply allowing an automation of what was developed internally, these strategies that were developed by human beings.
Martin: That’s exactly correct. And it really comes down to how you define a black box. There are programs that we would consider a black box. Our definition of black box is that the data goes in one way, a processing occurs internally, and the data comes out the other side, or in this case your orders, or whatever you want to do with the market the next day, would come out the other side of the box. The difference between what we do and a black box is we know given the data that goes in, you could calculate by hand, it may take you days or weeks what the outcome is going to be. I mean, there is a way to go back and verify that everything did what it was supposed to do. In a black box, there is no way to know when that data goes in how it’s going to come out the other side. That would be like a neural net system – which we have traded in the past. That is truly a black box, because given what’s put into the system, you’re never 100% sure what’s going to come out the other side. We do not do that. All our systems are quantitative calculations. We’re fully in control of what’s happening within the system.
Michael: There’s a couple of different issues that I’m looking at here that I wanted to talk to you about. And they don’t necessarily go in any particular order. There are so many novel and unique things from my perspective that I think you and Dunn Capital, the directions you go in. One of them I believe is location. So many successful funds, managers, they’re in the big cities. It’s London, it’s New York City, it’s Tokyo, it’s Singapore. And you’re at a pretty interesting location. It’s a heck of a nice location, but it’s pretty interesting – it’s probably not expected by most people.
Martin: Well, it’s another thing we can credit Bill with. To do what we do doesn’t require us to be in any special location. I mean, all that we’re required to have is communications, and power. And as long as we have those two things, we can operate anywhere in the world, literally. We collect data on an ongoing basis, we power our computers to do all our processing, and we need communications to communicate back in the orders and to do all our trading. Bill decided that what was important to him was being in a warm climate, at the time that we moved to Stuart, Florida, which is where we are – we’re located right on the East Coast. Our offices overlook the St. Lucie river, it’s a beautiful location, our employees like it, it’s a nice town, it’s quiet, it’s got everything you would want, so it’s good for us. Bill was looking for the East Coast, he was looking for a warm climate, he was looking for something on the water, and close enough to civilized world that he could go to the opera if he wanted to – and we’re just north of Palm Beach. So it has everything that he wanted at the time. And it’s been great for us, and we’re happy to be here.
Michael: I think it says something about the environmental thinking, because sometimes people do get caught up in just the fund itself. I think every time that I’ve visited Stuart and come to your offices, you always walk away with this sense that everyone’s grounded. It’s not this high flying – you don’t walk into your office and people are jumping up and down and traders screaming, there’s nothing like that. And I think that can be surprising for some of the audience. They might expect that, but the reality of a successful fund like yours – that’s not what goes on.
Martin: No, we’re built for the long term. So we’re not looking for short term satisfaction here. And our employees are the same way. One of the other interesting things about us is the longevity of our group of employees. People who work here are considered a family, they honestly enjoy it, they enjoy the area, and become part of the team. It’s very unusual for us to have somebody that comes onboard and then leaves shortly thereafter. And we don’t advertise either. We basically hire through experiences. We run across somebody and we’re impressed by them, and we think they would be a good addition to the team, and we bring them onboard and figure out the rest of it later.
Michael: So you’re basically saying, Mike Covel, please don’t send two million resumes to our offices, is basically what you’re saying.
Martin: Exactly. Yeah, you probably won’t get much of a response.
Michael: So let me shift here slightly. This is kind of a two-fold question, I’ll let you answer it how you want. I’m fairly certain that the core signals in your trend following programs had been very standard or consistent going back many decades. However, you do have quite – and I was speaking to Danny in your office about this – there have been many different directions and advances that you guys have taken on in the last bunch of years. Why don’t you kind of explain that concept of where the core is still important, but you have continued to evolve.
Martin: Well, I think that’s an area that maybe we neglected at one point. In the early 2000s, we had been one of the top performers for years, and we had 1.5. billion dollars under management, and I think we were fairly happy and comfortable with the way things were going. And we kind of had dropped back somewhat in our development. We started looking at more exotic things, things that weren’t going to be incorporated into trend following, like the neural net system and some other types of programs – we looked at a genetic… genomic trading system. In doing that, we kind of lost focus on what our core competency is. And we went a number of years without doing any significant research in the trend following or the portfolio development or even the risk management type of areas.
In 2004 we kind of refocused and started looking more at risk management – of course, at this point we’re in a fairly significant drawdown, we had just begun a fairly significant drawdown, and that drawdown went on. It took us a few years to implement the research that we had just started in the 2002-2004 timeframe. In 2006 we actually did implement some things we had in development, which helped us, and from that time forward, we’ve moved consistently forward. And the returns have shown that what we are developing has improved. The proof is in the pudding, right? You develop these things you can tell everybody in the world, you know what you’re doing research wise, but it can’t be validated until you can actually prove it in performance – which I think we’ve done. But what it did, it told us that you got to stay focused on this, you’ve got to constantly be doing research, and you got to constantly be looking at what you’re doing, and why it is that you’re doing what you’re doing. And what is your goal, what is the thing you would like to be able to accomplish? And is there anything out there that may help you do that? People get smarter and smarter all the time, and the computing ability gets better and better all the time. And what we’ve found is, problems that we couldn’t solve 5 years ago, we can solve today. So we got to keep rehashing what the issues are, what the problems are, what’s our goal would be, and then as time passes, we may be able to find answers to these things.
A perfect example of this is in January 2013, we implemented a new risk management type tool, where I explained to you earlier, that we would target this 1% chance of losing 20% in a month. Well, that changed in January of 2013. Now we are actually changing that targeted number on a daily basis, and we’ve come up with a methodology for doing that. That was something we had been looking for for years and years, and the idea behind it is you’re in trend following and you can look at our track record, and you can see the significant number of drawdowns we’ve had – we had a 60% drawdown over a 4 year period. That’s a significant drawdown, and that’s something that would scare the investors away. We understand that during the time that we were in it, we weren’t the only trend followers struggling. It was one of those periods when everybody was saying trend following was dead. Then 2008 comes along, and everybody blows it out of the water, and people re-think their thoughts about trend following.
So how do you decrease the drawdown without decreasing the profitability? A lot of people in the industry, their answer to this is to lower the volatility, where they don’t have the drawdowns, but then again, they don’t have the profitability. So they’d limited both the upside and downside. That’s not our goal. We want to make money. We want to make as much money as possible, given the risk we’re taking.
The idea is, how do I mitigate the drawdown without losing the upside. And by targeting this risk number using a proprietary method that looks at the correlations of our positions, we look at the volatilities of markets, which is standard in any kind of risk targeting. The third thing is we have a proprietary calculation that determines whether we think it’s a profitable environment vs. not a profitable environment for our trading system. And that’s the key number, and during times when it’s tough, we tend to ratchet down that targeted number. It could go down to single digits. Then when times are good we ratchet it back up, but at no time does it go over the 1% chance of losing 20% or more in a given month. That’s the maximum. And our simulations show that we will be at that level going forward about 5% of the time.
Now, what this has done, it has cut the overall volatility of the program from, say 38% to 24-25%. It has cut the drawdowns down by 25%, so the drawdowns aren’t as deep as they used to be. And yet, we will still have the same projected annualized returns that we’ve had in the past. So that’s a significant improvement – it’s just one number that’s changed in our whole process, but it can have a significant effect on performance.
Michael: Let me go a slightly different direction and circle back. So I had Daniel Kahneman on my podcast recently, and obviously he won a Nobel Prize for behavioral economics, behavioral finance. I always think that what’s interesting about some of the work in behavioral finance is the application. And I think what’s interesting – and I don’t know if Bill spoke about this or you guys talk about it around the office, but your work, what the firm does, seems to be such a fantastic application of everyone in the last decade talking about behavioral economics. How do human beings, using these systematic approaches that you’re talking about, and following a system “religiously”, seems like it really is a great application of what the professors have been looking at in the universities.
Martin: Hmm, as far as behavioral economics?
Michael: Well, in the sense that everyone wants to talk about the biases that human beings have. When I look at the strategies that have been developed at Dunn Capital, they seem to be naturally, even if it wasn’t designed that way, maybe it was just designed looking at the numbers, but it seems to naturally deal with those human biases that we all have. I mean, the people that make the wrong decisions in the market – your systems put yourself in the position to profit where most people don’t want to take those traits.
Martin: Well, why it works, I don’t know. I can’t comment on that in detail because I don’t understand enough about it to give an educated opinion. But what I will tell you is that we don’t care about people’s ideas or people’s philosophies, or what’s going on out there politically, or anything else. The only thing we care about is the numbers. People always ask me, “Well, what happens if there is a recession?” And I say, “I don’t know, and I don’t care. All that I know is that my system will adjust accordingly, and we’ll probably profit from it”. The only thing our program needs to work is some type of market movement in a consistent manner. Where we get in trouble is when the markets aren’t consistent in one direction of the other, which tends to happen during environments where central banks and governments are trying to manipulate the markets – which is what we’ve seen in the last 3 or 4 years. Given that environment, we’re pretty impressed with what we did last year, because we were still able to make a sizeable return given the particularly poor market environment. Our competitors, most of them weren’t able to do the same thing. But, there will be times when our competitors will do better than us, but over the long term, we think we’ll do as well as anybody, if not better than most.
Michael: So, adaptation. What I find so fascinating about trend following is just the adaptive nature. So here we are, we’re talking about up until today and the early 2014, we’re talking about the last 40 years of Dunn Capital. But as you look ahead as the CEO of the firm, there’s got to be a certain sense of comfort to know that the trading strategy will adapt to what none of us can foresee into the future. You can turn on the news shows and they’re talking about Russia amassing troops on the Eastern border of Ukraine. That’s not what Martin Bergin is thinking about at Dunn Capital. You might be thinking about it personally or catching the news, but from a trading standpoint, your decision making, that’s not coming into play.
Martin: No, because the markets will absorb that information, and it will then be picked up by the price data, which our system will then incorporate. Now, the one thing you got to understand is trend following isn’t a predictive system of investing; trend following is a reactive system. We’re reacting, we’re not leading the market in anywhere. We’re just taking what the market gives us, and we’re just following along, hoping to take advantage of those types of trends. It’s a pretty simple concept. The part that is not simple is being able to do it and survive over a long period of time.
Michael: Yeah, I think you guys have the long period of time down pretty good. I think what’s also really interesting – I remember, one of the first times I met Bill, he was talking about his fee structure and not having a management fee, and I think that’s still the same. You can expand on that. But I think what’s interesting too is the way that your capital in the firm is side by side with investors. So it’s pretty easy for investor in Dunn Capital – and I’m not giving a sales pitch here, I just think this is purely from an interesting observation standpoint, – how a business has been developed, how it runs. You guys are side by side with the investors, very transparently.
Martin: Well, it goes back to the philosophy of Bill. When he was going into this business, you know, one of the first comments I made to you was, he said: “There must be a more honest way to make a living”. So originally he was what we would call a “beltwhite bandit”, people that lived in the Northern Virginia area outside of DC. You have a huge population of people who make money off the government, basically as consultants, and doing the work for the government.
So the concept that Bill came up with was he wanted a business that put him on the same side of the table as the customer. So here we have an investment business, where we’re trading exactly the same product that the investor is trading, our client is trading, and at the same time the client is only paying us when they’ve made money. And it has to be new earnings. So if we make money for them and then they lose money, after we’ve made money and collected a fee, we’ve got to make those losses up before we can collect another fee. So it’s a win-win situation, we’re always on the same side of the table as the investor. And we do that because we think it’s the most honest way to approach the business. And if you think about managed futures, managed futures is probably the most honest investment in the world because you’ve got 100% transparency. You’ve got complete liquidity. In a fee structure like ours, you’re only paying fees when you’ve made money. We don’t charge a management fee. And that’s not to say that there’s something wrong with people who charge a management fee. The only problem is if it’s not fully disclosed or it’s not clear to the investor what the fee structure is. But otherwise, people can design their business any way they want – that’s part of the process. You develop your business the way you want to develop it, and then go out there and operate. The investor can choose to invest with you or not, it shouldn’t be up to the investor to pick and choose where they want to put their money. And the investor has to be educated, there’s no question about that. But at every step of the way, we always ask ourselves: “If I am the investor, if it’s me, what would I expect, what’s fair?” And basically, everything we do is designed to be fair. And we view it that way in every aspect of our lives and our businesses, whether it’s inside of Dunn Capital or outside of Dunn Capital.
Michael: As a longtime observer, I have to say that watching Bill, watching your firm, watching you, it has influenced me a lot. I know some of the involvements that Bill has taken on in his life outside of trading, and it’s all very inspirational. And I really think that for a young person out there, if you want to study or look at a firm that was built from scratch and has really had this longevity and has had a certain kind of ethos, I think Dunn Capital is a worthy investigation. And it doesn’t mean send Marty your resume, because then he won’t buy me lunch next time I come to Stuart.
Listen, it was good chatting with you today. If people want to read up some more, they can always find you guys at DunnCapital.com, but I appreciate you taking this time today, Marty.
Martin: Thank you.
Michael: And we will catch up soon when I make it out of Asia, or when you make it to Asia. Your coming to Asia this year right?
Martin: Well you know we are going to be opening a fund there shortly so we may be making a trip there.
Michael: We’ll circle back and meet in Singapore.
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