Oldest CTAs in the Industry Have Survived and Thrived
Copyright 2000 Barclay Trading Group, LTD.
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More than twenty years ago--before the creation of the National Futures Association, before stock index futures, and before CTA databases--there existed commodity traders. Few in number and not managing much money at the time, many of these early firms are still trading today.

In 1980, fifteen CTAs comprised the Barclay CTA Index, having been trading since 1976 or sooner. Since then Richard Donchian passed away, Dinesh Desai retired, and Marc Fishzohn gave up trading. The remaining twelve are still in business and most of them are doing very well. Since their inception twenty years ago or longer, several of these firms have posted compound annual rates of return in excess of 20%. (Of course, past results are not a guarantee of future results.)

It is enlightening to compare the performances of some of these seasoned CTAs with their equivalents in the stock market. The top-performing, long-term mutual fund in the U.S. is the Fidelity Magellan Fund. Since its inception in 1964, it has recorded a compound annual return of approximately 20%. Warren Buffet, considered by many to be the greatest investor of all time, has been able to increase per-share book value of Berkshire Hathaway at a compound annual rate of 23% since he took over management in 1965.

It's almost as if there is a barrier for investment returns over longer periods of time--a junction point where skill meets reality--and it seems to lie slightly north of 20%. For more than two decades, a handful of commodity trading advisors have continued to bump up against that outer limit. In order to gain a better understanding of the challenges faced by the earliest firms, we've invited comments from a distinguished panel of CTAs, all of whom have broken the 20/20 barrier: 20%-plus compound annual return over at least a 20-year period. Our panel includes:

D. Keith Campbell, Campbell & Company. Mr. Campbell is the president of Campbell & Co., which has been trading since 1972 and currently, manages approximately $325 million for clients in managed futures.

George E Crapple, Millburn Ridgefield Corporation. Mr. Crapple is vice-chairman of Millburn which has been trading since 1971 and currently manages approximately $500 million for clients.

Steve DeCook, Fundamental Futures, Inc. Mr. DeCook is the president of FFI, which has been trading since 1975 and currently manages approximately $55 million for investors in the agricultural and meat markets.

William A. Dunn, Dunn Capital Management, Inc. Mr. Dunn is the president of Dunn Capital Management which has been trading since 1974 and manages approximately $400 million for clients.

Q: In the 20-plus years that you have been trading, what has been your greatest challenge?

Campbell: Maintaining our discipline. It is one thing to develop winning strategies, but quite another to overcome your doubts during the tough times and to stick to your guns. Another major challenge is finding the proper balance between maintaining one's discipline and recognizing that adjustments must be made in response to subtle market changes. The difficult part is distinguishing between permanent changes, which require adjustments, and temporary changes for which adjustments should probably be avoided.

Crapple: The greatest challenge in our 24-year history was to develop a response to our first, and only, double- digit loss in our oldest diversified account, Nestor Partners--a loss of 17% in 1986. First, we switched from monthly annual incentive profit shares to eliminate the possibility of receiving incentive compensation in a down year for investors. Second, we analyzed how we lost money in the fourth quarter and determined that consecutive losing currency trades lost more money than they should have: the currencies had appreciated against the dollar, and currency positions which were a fixed percentage of fund equity (e.g. a certain number of yen per l million in the fund) became much bigger in dollar terms and increased fund volatility.

We responded to this problem by developing a volatility overlay which automatically adjusts position size as the dollar value or percentage volatility of any position goes up or down. Subsequently we have added short-term tick data systems and an options strategy to our multiple systems approach to the markets. Nestor Partners has not had a down year since 1986.

DeCook: The biggest challenge has been to adjust to the change in the nature of the market participants. When I first started trading, the market composition was about one-third floor, one-third commercial, and one-third public. Back in those days, the public one-third of the market was fairly easy to figure or predict. Now the public is mostly gone, replaced by managed system traders. That sector of the market tends to trade as a group--and a very large group at that. This system trading sector is harder to figure out, and it's also much more dangerous to be trading against.

Dunn: Survival! We've lost over 25% seven times in our almost 21-year history. Our money management has always been designed to handle such losses, but these periods prodded us to examine and improve aspects of our trading which have contributed to our long-term survival.

Q: What has been the importance of research and development to your trading success?

Campbell: It is axiomatic that research and development is critical to the success of any CTA. No advisor can last long on the basis of his or her warm personality or nice marketing material. If all the hoopla is not supported by real-time profits the world will beat a path to someone else's door. That's why we have intensified our research efforts to develop new and different approaches to trading, as well as to improve existing strategies. We currently have six full-time professionals, holding three PhDs, spending 100% of their working days to find better ways to make money. That doesn't mean we are abandoning the trading strategies that have worked for us all these years, but it does indicate that we recognize the world is constantly changing and that we need to stay on the cutting edge if we are to remain at the forefront of the industry.

Crapple: We believe research and development has been critical to our ability to adapt to changing market environments. Using one system per market was extremely successful for us in the 1970s. However, the introduction of multiple systems per market in the late 1970s was important in reducing volatility in periods where the markets were not trading as well as they had in the past.

Other major improvements in our trading method have come in response to losing periods such as the volatility overlay, tick data systems and options strategy already mentioned. The analysis of new markets and their inclusion in our portfolios has been enormously important. I will mention international interest rates and stock index futures in particular. Our research team has developed new products as well as improvements to our futures trading methodology, such as an international stock fund with a currency hedging overlay and an emerging markets stock fund where country allocations and fully invested versus cash decisions are made on a totally systematic basis.

DeCook: I don't think that research and development has been as important to me as it has been to some of the others in this group. At FFI, we do trade on information, and that is where the research aspect comes into play. Today, there are so many more sources of information than there were 20 years ago, and that information is instantaneous. It's harder to determine what the facts are, and it's harder to determine what is pertinent and what is not. We have developed many sources of "grassroots" information that are not widely available, and we have come to value that much more than the systematic research compiled by agencies. As discretionary traders, we consider trading more of an art than a science, so research is helpful but not determinative of our success.

Dunn: Research and development has been essential. Without it the likelihood of our survival would have been considerably less. Adapting to a changing environment requires an open mind and the willingness to expand resources to explore new ideas and technologies.

Q: Trading and marketing are two critical areas that all successful CTA firms must master. What advice on these areas would you give to new firms that are just starting out?

Campbell: Don't second-guess yourself. Trade your system. Be patient. "It takes twenty years to become an overnight success."-Eddie Cantor. Be humble. "Pride goeth before a fall."-- King Solomon. Make money. Marketing? Performance sells. Avoid selling performance. Sell the concept. Sell the sizzle, not the steak. Warn people in advance of certain drawdowns and suggest them as buying opportunities. Lou Holtz says there are three things you must convince a buyer of: Can I trust you? Are you excellent at what you do? Do you care about me? The three most important characteristics of any success in any business are: Integrity, Sincerity, Persistence. Once you can fake them, you have it made.

Crapple: My advice for new CTAs: In trading, I would first emphasize accuracy and good back office discipline. Daily reconciling of tickets to brokerage firm runs is basic.

Second, risk control in the portfolio must reduce the risk of major loss. No one can tell a trader how to avoid five losing trades in a row. What can be done is to trade a widely diversified portfolio and limit maximum risk in any one market and in the portfolio as a whole.

DeCook: My advice on trading is: "Dance with the one that brung ya." In other words, figure out what it is that makes you good or special, and stick with that. Don't allow yourself to be diverted and distracted by a "new and improved" trading method--unless of course it is a natural outgrowth of something you already do well. Change for change's sake is not necessarily good.

In the marketing area, be who you are and don't let hot money lure you in a different direction. There is no other way you will ever be comfortable marketing yourself or letting anyone else market you. Find your niche in this industry, get comfortable, and stay there.

Dunn: Build a good system and they will come. Concentrate on system performance, and sales will eventually take care of themselves. Of course, getting the first account is crucial to the creation of a real money, real time track record. The best source of funds for new CTAs is people who know them well and trust their character and trading/research ability. I started in 1974 with $337,000 from family and long-time friends.

Q: There has been a tremendous amount of marketing to pension funds in the past few years, but with limited success. Do you believe that managed futures will ever gain widespread acceptance within the pension community?

Campbell: Ultimately managed futures will gain acceptance within the pension community. Obviously performance will play a role in determining how quickly that happens. I have seen a number of independent thinkers within the pension community, but few independent doers. Until the system rewards managers for performance, rather than risk avoidance, it will be a long haul.

Crapple: If managed futures historical results are restated proforma for hedge fund fee structures, returns from the long-established CTAs compare very favorably with returns from established asset classes and are essentially non-correlated with returns from stocks and bonds. Nonetheless, the U.S. pension fund community has been slow to stick a toe in the water and among those who have, several have pulled their toes back out.

I believe part of the problem has been timing. Institutions started to test the water at the beginning of a period of sub-par futures performance, which I attribute to market conditions. In 24 years, we have seen other similar periods. If the industry can put together two or three years of good performance with reasonable volatility, I believe the pension community will participate. It is particularly hard to sell a new concept when stocks and bonds are booming and the new concept has under performed stocks and bonds in the recent past. The pension community in the past has embraced real state, oil and gas, foreign stocks, LBO funds and venture capital funds. These all entail purchasing assets. Our business has no inherent return. It is manager oriented. Hedge funds are gaining acceptance in the pension community, and managed futures is very similar.

DeCook: We think managed futures will eventually gain credibility within the pension community, but it will take a long time, even from this point. The conservative nature of the pension decision-making process is at odds with the traditional reputation of futures trading and futures traders. We must first successfully distinguish ourselves as managed futures, and then prove to the pension community over time that the "managed" adjective adds value that is worth paying for.

Dunn: Pension funds are too big and the fees they want to pay are too low to attract the few good CTAs with long track records (greater than 10 years) who would pass their due diligence tests. Even if fees were not an issue, minimal acceptance by the pension community (say 1% of assets) would greatly exceed the capacity of the acceptable CTAs. The potential return on total pension assets contributed by managed futures would be very small relative to the risk taken by pension funds who favor more traditional--although not necessarily less risky--alternatives. We would be glad to have a few small (under a billion in assets), forward-thinking pension clients paying normal fees, and I think we will one day, if we don't earn our way to capacity first.

Q: What do you believe to be the greatest challenge facing the managed futures industry today?

Campbell: We're still struggling to overcome our negative image of being "high risk" and somewhat unseemly. Broadbrush journalism is constantly associating us with "unmanaged derivatives" such as Orange County and Barings. We need to provide products that the market wants. If we want to be considered a mainstream investment, we have to be a mainstream investment. If we can't be mainstream, we at least need to package our products in mainstream wrappers.

Crapple: I believe the greatest challenge facing the managed future industry is to gain acceptance as a mainstream investment category. I don't believe this is consistent with CTA charges in excess of hedge fund charges or public fund charges which result in broker payouts higher than any other product. Also, I believe the investment category has to show volatility similar to other investments. I don't care how high a CTA's historical rate of return is if he's likely to hand me a 40% or 50% drawdown sooner or later.

DeCook: The greatest challenge for managed futures will be moving increasing amounts of equity into limited markets. It remains to be seen whether the various futures markets can grow as fast as we managed futures participants want them to. As agricultural traders, position limit and liquidity problems have been a concern to us for several years now and have already effectively eliminated some markets for us. I'm pretty sure this will be a growing problem for our colleagues as well, no matter what markets they trade.

Dunn: As a trader, coping with the loss of liquidity and diversification provided by the previously robust agricultural markets presents a great challenge. As a businessman, reducing the burdensome micro-management of the regulators is the greatest challenge. New entrants to the CTA community face serious impediments to survival because of the intimidating barrage of paperwork and regulation. The industry's greatest challenge is to convince the regulatory agencies to turn their considerable energies toward the detection and punishment of fraud and away from detailed instructions on how to present performance information.

Q: Over the years, you have seen many changes to this industry. Which do you believe have been the most beneficial? What changes, if any, have been detrimental?

Campbell: The most beneficial change has been the gradual emphasis on managed futures versus the old transactional business which had a "gambling" reputation. While we are still tainted by the association, managed futures has come to be considered a viable investment category that can reduce portfolio volatility as well as enhance returns.

Crapple: I believe the most beneficial changes in the industry is the trend toward lower overall expenses. When we did our first public future fund in 1978, we charged a 6% management fee and a 20% quarterly profit share, and the sponsor charged commissions at 80% of retail rates and kept all the interest. Substantial investor-friendly progress has been made since that time. Another beneficial change is the increasing realization that risk control is critical to being a long-term participant in the managed futures business.

A detrimental change is that many of the traditional futures markets have been substantially deserted by individual investors, increasing the percentage participation of professionals. The trending quality of many of the traditional commodity markets decreased during the late 1980s and early 1990s, but in 1994-1995 these markets have come back to life to such an extent that we are now offering our World Resource Portfolio, which will have the heaviest commodity weighting of any of our portfolios.

DeCook: Most of the changes to the managed futures industry have been beneficial. The proliferation of different types of traders has, of course, been good for everyone. There are also several reporting services now, each of which has a little different twist, and this dissemination of information about our industry has made our business more public and more credible within the investment community. The managed futures industry has legitimized the commodities trading business, turning perceived "cowboys" into sophisticated, risk-aware money managers.

Dunn: Beneficial changes in the industry have been the opening of new global markets in financial and energy futures and new foreign exchanges. Detrimental changes have been the heavy hand of materialistic regulators dictating what information may be provided to whom and in what formats rather than vigorously pursuing their anti-fraud role.

Copyright 2000 Barclay Trading Group, LTD.

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