Buying “Best of Breed”

Originally published in the Brandywine Asset Management Monthly Report.

Since the launch of Brandywine’s Symphony program in July 2011, the managed futures industry has undergone one of its more difficult performance patches. Over that period the Barclay 50 CTA index has dropped 3.1% and the systematic traders index has suffered a comparable decline. In contrast, Brandywine’s fundamentally-based, yet fully-systematic Symphony program has gained +6.83% and our aggressively-traded Brandywine Symphony Preferred Fund has gained +31.50%.

Brandywine’s positive divergent performance is the result of the diversified, fundamentally-based trading strategies incorporated in our fully-systematic trading model. Developed over the past 30 years, these strategies produce performance that is uncorrelated with traditional CTAs and the major financial indexes. We believe this recent performance, combined with our longevity and past performance, establishes Brandywine as best-of-breed among systematic CTAs and positions Brandywine among the top CTAs for consideration by both institutional and individual investors.

In addition, while Brandywine’s diverse trading strategies result in performance that is uncorrelated to the BTOP 50 during losing periods for the BTOP 50, our model is also able to exploit profit opportunities when market trends reassert themselves. The following two statistics clearly illustrate Brandywine’s favorable performance profile:

Brandywine Symphony’s correlation to BTOP 50 during Peak-to-Trough drawdowns in BTOP 50: -0.11
Brandywine Symphony’s correlation to BTOP 50 during recovery periods in BTOP 50: +0.46

So what the preceding statistics show is that Brandywine’s trading model is able to preserve profits during difficult market environments, such as the one we’ve been in since the start of trading in Brandywine’s Symphony program in July 2011, but also capitalize on market trends when they re-emerge.

Best-of-breed among investment managers is often defined by assets under management. The larger managers are considered better than the smaller managers. After all, they got large because they became accepted by more and larger investors. But larger does not mean better. In fact, as our CEO points out in his best-seller, “Jackass Investing: Don’t do it. Profit from it.,” there are a lot of investment opportunities available to smaller traders that are off-limits, precisely because of their size, to the largest managers. Furthermore, size does not ensure business continuity. In our 30 years of existence, Brandywine has seen the largest managers, through underperformance, become small again, or cease operations altogether.

That said, today the most significant allocations are being made to the largest CTAs. This is not unexpected. The largest investors want to invest in a fashion that is similar to their peers. They are comfortable putting money with the largest CTAs as their decision has been validated, with billions of dollars, by other investors. If their investment loses money, they are at less risk of losing their jobs than if they had invested with a less well-known and smaller manager.

But this is self-defeating behavior. The largest CTAs are fighting a headwind associated with their large size. There are a substantial number of return drivers they cannot exploit because of their size. Brandywine is aware of these limitations. In the 1990s, prior to a shift by our founder towards venture development investing, we were one of the largest CTAs. Our ongoing research at that time was not just focused on finding the best available trading strategies, but the best available trading strategies that could also be traded in substantial size. Since we became a “re-emerging” manager with the launch of our Brandywine Symphony program in July 2011, unencumbered by size, we have been able to re-focus our research effort on expanding our trading across a wide variety of return drivers. The benefit of this diversity shows in our performance.

Brandywine firmly believes that best-of-breed should be defined by the organization and performance. There was a time in the past when Brandywine was considered best-of-breed based partly on our level of assets under management. But even then we stressed that what differentiated us was more than our size; it was our organizational structure, history, investment philosophy and research approach. Those traits continue with Brandywine today and their virtuous effects are manifested in our performance.

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Hurricane Sandy and Business Continuity

Originally published in the Brandywine Asset Management Monthly Report.

Hurricane Sandy struck at the heart of the U.S. financial markets earlier this week, paralyzing New York City and the venerable New York Stock Exchange. Although “only” a category 1 storm, Sandy cast a wide swath, with tropical storm force winds extending for 1,000 miles. This led to a huge storm surge that wiped out entire shoreline communities in New York, New Jersey and Connecticut. The New York Stock Exchange closed for two days, the first consecutive daily closure due to weather since the “blizzard of 1888.”

Hurricane Sandy over New York City

New York Stock Exchange during the storm

Flooding at the height of the storm

The closure and disruption to financial markets highlighted the need for redundant systems and backup technology to prevent loss of operations caused by natural disasters and other factors. It also pointed out the significance of human factors that could cause business interruptions. The New York Stock Exchange was prepared to open on Monday and remain open throughout the storm, but that would have placed its employees in a dangerous situation. Despite its distributed technology and redundant infrastructure, the actual work of the exchange required people to be present at 11 Wall Street, and the breakdown of transportation and other risks were the primary factor in the decision to close the exchange.

Brandywine understands these risks quite well. Sixteen years ago we moved into our current offices, which are located in a 17th century grist mill in southeastern Pennsylvania (you can see photos of the Mill on brandywine.com). Like all mills, we are situated next to a stream, which for 250 years was used to power the water wheel. Fortunately, we are positioned near the headwaters of the stream, and even in the most severe storms to date (including Hurricanes Floyd, Irene and Sandy) rising waters fell far short of endangering our critical systems. While our operations may not have been directly impacted by a storm, our utility providers have been, resulting in loss of our primary power. Fortunately, we are also able to operate on our backup batteries (which provide uninterrupted power) and generator for extended periods. And we have back-up communications providers that are able to handle our telecommunications requirements in the event our primary phone/internet service fails. These systems serve as our first level of defense against business interruption.

Despite these precautions and redundancies, we are still at risk of a complete loss of our facilities here at the Mill and plan as if that is certain to occur. So as an additional level of backup, we operate a separate, autonomous office in Connecticut. This is staffed by one of Brandywine’s principals, Rob Proctor.

Notwithstanding this preparation and redundancies, we still realize there is a risk of interruption to our business. But in the event that does occur, and as part of our ‘belt-and-suspenders’ approach, all data is backed up daily to the “cloud.” This allows us to recover our business and restart operations as soon as one of our facilities is operational. In that event our loss will be limited to our opportunity costs during the time we were interrupted.

In Brandywine’s 30 years of business we have come to realize that although our primary risk is still related to our trading model and risk management, business continuity is also capable of negatively affecting our clients’ portfolios. Putting in place a sound, redundant infrastructure is an essential element in producing positive returns for our clients.

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Opportunity and the Control of Risk

Originally published in the Brandywine Asset Management Monthly Report.

Profit opportunities are not spread evenly over time. The key to successful trading is to capture profits when opportunities arise and to protect those profits when opportunities wane. This is illustrated by Brandywine’s historical performance.

The Brandywine Symphony program’s fundamentally-based (yet systematically-applied) trading strategies look for opportunities on a continuous basis. When the program launched in July 2011, many of Brandywine’s sentiment and event-based trading strategies recognized and captured opportunities that resulted from the stock market, currency and interest rate turmoil that dominated the second half of 2011. The result was a 6-month gain of +7.90% for Brandywine’s Symphony and +37.88% for the more aggressively-traded Brandywine Symphony Preferred Fund. This strong performance was especially beneficial to our investors due to the fact that both stock markets and other managed futures traders suffered losses over that same period.

Opportunities for Brandywine’s global trading strategies have been more limited during 2012. But Brandywine has responded well to this environment by preserving the profits earned during 2011. And not only has Brandywine preserved profits, but reduced volatility at the same time. This is exemplified by the fact that our average daily volatility over the past two months has fallen to just 2/3 of our longer-term average. This is also reflected in our decreased trading activity as our trading strategies wait for profit opportunities. (This is another characteristic that separates Brandywine from trend following managed futures traders, which tend to increase their trading frequency during losing periods, as their positions get “whip-sawed.”)

So where does that leave us now? One way to answer this question is to look at the historical tested performance of Brandywine’s Symphony program and estimate when the next set of profit opportunities are likely to appear. One way to measure this is to look at the average length of “quiet periods” such as the one we have been experiencing. Since 1999, the average quiet period has been 168 trading days. The current quiet period is in its 152nd day. While this doesn’t mean that we are on the brink of a new round of profits, it does put the current period in perspective.

A second way to view current opportunity is to compare Brandywine’s actual performance to its target performance. Brandywine’s Symphony program is targeting 12% annualized returns with an 8% annualized standard deviation. After performing above target from July 2011 through February of this year, the 3 month drawdown in March – May brought the performance to 7% below trendline. This is now in line with the 7.5% average of the 12 largest underperforming periods over the 12 year test period starting in 1999.

Brandywine’s aggressively-traded Symphony Preferred Fund targets returns and risk that are between 3x and 5x that of our standard Symphony program. As illustrated in the chart below, the Fund has performed below target since April. While we must state that PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE PERFORMANCE, research indicates that our current drawdown is once again entering the range in which to expect a rally.

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Is Past Performance Indicative of Future Performance?

Originally published in the Brandywine Asset Management Monthly Report.

Every investor is aware of the disclaimer that “PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE PERFORMANCE.” It is mandated by regulators to be written on all materials that contain performance information. At its basic level what this means is that you (and the people with whom you’re investing) CANNOT predict the future. Evidence of this abounds. As people have learned, just because John Paulson produced billions in profits from 2007-2010, that didn’t mean he’d produce the same result – or even profit at all – in 2011 or 2012. A primary reason for this unpredictability is that many investment managers and traders follow a singular or concentrated investment process or thesis. When that process or thesis is correct they profit. When it’s not, they suffer losses. They are not truly diversified.

Some people go so far as to interpret this observed unpredictability to mean that it is futile to try to pick winning investments. This belief has manifested itself in the drive for people to simply buy an index. But that action itself is based on the belief that the index will continue to perform in the future in a fashion consistent with how it performed in the past. The reality is that every decision is based on a prediction. As Mike Dever shows in his best-selling book Jackass Investing: Don’t do it. Profit from it., no investment performs in the future simply because that’s how it has performed in the past. For example, in his opening chapter, which you can read here, he shows that there is no magical “intrinsic” return for owning stocks. Every potential investment is based on at least one sound, logical “Return Driver.” The key to understanding future performance is in understanding the validity of the underlying return drivers.

While understanding the return driver underlying a trading strategy will provide an indication of the validity of that trading strategy, it will not provide an indication of the predictability of future returns relative to past performance. That is because any one return driver, no matter how valid historically, can become invalid as a result of changing circumstances. For example, prior to the introduction of the Euro, many traders employed convergence strategies based on the fact that other European currencies were soon to be replaced by the Euro. That strategy obviously became invalidated when the Euro came into existence. This is an example of a “transient” trading strategy. Transient strategies abound. When the U.S. Federal Reserve commits to holding interest rates low, traders can profit from the strategy of borrowing short and buying long, taking advantage of a “locked-in” yield curve. When the Swiss National Bank pegs the Swiss franc to the Euro, traders can employ reversion strategies in the belief that any deviation from that level will result in the rate reverting back to 1.2 CHF to the EUR (although an argument can be made for a conflicting transient strategy, that of buying CHF in expectation that Swiss National Bank resolve will ultimately wane, and when they ‘give up’ the peg, the value of the franc will then rise sharply against the Euro).

There is a way, however, to improve the probability that future performance will approximate past performance. That is to employ numerous trading strategies that are both:

  • unrelated and
  • sustainable

This is the approach used by Brandywine.

Brandywine employs dozens of individual trading strategies, based on unrelated and sustainable return drivers, to trade across more than 100 global commodity and financial markets. Supported by our actual trading of many of these strategies in the 1990s, and our extensive back-tested results both prior to and after that period, we have confidence in the validity of the return drivers underlying each of the trading strategies. Although any given trading strategy may produce a somewhat volatile return stream, we have a high level of confidence the character of that return stream is repeatable.
For example, the chart below displays the back-tested results of one of Brandywine’s sentiment-based trading strategies. Because we are displaying back-tested results, the following disclaimer is required:

HYPOTHETICAL PERFORMANCE RESULTS HAVE MANY INHERENT LIMITATIONS, SOME OF WHICH ARE DESCRIBED BELOW. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN. IN FACT, THERE ARE FREQUENTLY SHARP DIFFERENCES BETWEEN HYPOTHETICAL PERFORMANCE RESULTS AND THE ACTUAL RESULTS SUBSEQUENTLY ACHIEVED BY ANY PARTICULAR TRADING PROGRAM.

ONE OF THE LIMITATIONS OF HYPOTHETICAL PERFORMANCE RESULTS IS THAT THEY ARE GENERALLY PREPARED WITH THE BENEFIT OF HINDSIGHT. IN ADDITION, HYPOTHETICAL TRADING DOES NOT INVOLVE FINANCIAL RISK, AND NO HYPOTHETICAL TRADING RECORD CAN COMPLETELY ACCOUNT FOR THE IMPACT OF FINANCIAL RISK IN ACTUAL TRADING. FOR EXAMPLE, THE ABILITY TO WITHSTAND LOSSES OR TO ADHERE TO A PARTICULAR TRADING PROGRAM IN SPITE OF TRADING LOSSES ARE MATERIAL POINTS WHICH CAN ALSO ADVERSELY AFFECT ACTUAL TRADING RESULTS. THERE ARE NUMEROUS OTHER FACTORS RELATED TO THE MARKETS IN GENERAL OR TO THE IMPLEMENTATION OF ANY SPECIFIC TRADING PROGRAM WHICH CANNOT BE FULLY ACCOUNTED FOR IN THE PREPARATION OF HYPOTHETICAL PERFORMANCE RESULTS AND ALL OF WHICH CAN ADVERSELY AFFECT ACTUAL TRADING RESULTS.

This strategy is based on a sound, logical return driver. When investor sentiment in individual global stock markets reaches extreme lows, usually as a result of a rapid sell-off, Brandywine looks to buy if prices fail to extend to new lows. The chart shows the back-tested performance of this strategy assuming a constant position size and no compounding of returns. Over the 21½ year period profits totaled $1.3 million (based on $500,000 allocated by Brandywine’s Symphony program to this strategy, which provides Brandywine with our targeted 12% annualized return). Over the test period the strategy proved to be a strong performer, with a nicely sloping uptrend in cumulative profits. Since the start of actual trading in Brandywine’s Symphony program in July 2011 (evidenced by the vertical line in the chart below, which is an extension of the prior chart), this performance has continued.

But as pleased as we are with the past performance (both tested and actual) of this strategy, and as confident as we are in its sustainability, we realize there have been, and will again be, hostile environments that will result in losses for this strategy. While we expect this strategy to profitably contribute to the long-term returns of Brandywine’s Symphony program, we are totally uncomfortable projecting its shorter-term performance. Also, as good as this past performance looks, if we were trading this strategy on a standalone basis, note that it would have suffered a $353,000 loss (on the $500,000 allocated to the strategy) from April 2000 through January 2002.

However, this drawdown only poses a problem if this strategy is viewed in isolation or used as the only strategy in a portfolio. Adding additional trading strategies, each based on a different sound, logical return driver, reduces the probability that the portfolio as a whole will face an adverse environment. For example, the chart below shows the tested past performance of one of Brandywine’s event-driven strategies. This strategy trades interest rates based on inflation factors and reports. As the chart illustrates, with inflation seemingly in check throughout the 2000s, this strategy was presented with very few trading/profit opportunities. But during the same period during which the previously-displayed strategy produced its $353,000 drawdown, this strategy produced a significant profit, gaining $340,000 from April 2000 through January 2002.

Because the two trading strategies shown above are based on disparate return drivers, the correlation of their returns is zero. As a result, by simply combining the two trading strategies shown above, we can create a portfolio with performance that is better, and more predictable, than either of the strategies alone.

This is the simple premise on which Brandywine’s Symphony program is built. By combining dozens of independent trading strategies, which each produces profits and losses independent of the others, Brandywine’s Symphony program is able to earn the average return of each, while dramatically reducing drawdown and, here’s the most important benefit, increasing the probability that our future performance will match our past performance. This is because Brandywine is not dependent on any single market environment or condition to produce profits. Instead, our overall performance is the result of the combination of hundreds of strategy-market performances, each one of which is based on its own distinct return driver, independent of the others.

While the concept of true portfolio diversification is simple, its execution is not. Brandywines’ Symphony program is the culmination of more than 30 years of research and trading by Brandywine. We pioneered the use of fundamentally-based trading strategies in a 100% systematic portfolio. Perhaps most important, is the method Brandywine developed to allocate capital across its trading strategies and markets. Unlike most portfolio modeling formulas, which are designed to produce the best risk-adjusted results, Brandywine developed a portfolio allocation model with the primary goal of producing predictable performance. The effectiveness of this approach is evident in our results, where our actual performance continues to perform in line with both our past actual and tested performance.

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Correlated When it Counts (and Uncorrelated When it Doesn’t!)

Originally published in the Brandywine Asset Management Monthly Report.

One Contributor to Brandywine’s Strong Finish in July
Brandywine’s Symphony program kept pace with the strong performance of the BTOP 50 managed futures index throughout the first three weeks of July. But the big differentiator was the final week, when Brandywine gained while the index fell. One reason for this non-correlation is Brandywine’s use of sentiment- and fundamentally-based trading strategies to trade in stock indexes and directional arbitrage strategies in currencies. The result was that during the middle of the week of July 23rd, Brandywine’s Symphony program shifted from a net short to a net long position in the global stock index markets, enabling Brandywine to profit from the strong month-end rally in equities (this occurred following the statement by European Central Bank President Mario Draghi that the central bank would do whatever was necessary to preserve the euro). While Brandywine had no advance notice that Mr. Draghi would be making that statement, some of our trading strategies recognized that the environment was ripe for a catalyst to trigger short-covering and a market rally. In contrast to Brandywine, trend-following CTAs remained short stock indexes (and net long the dollar), which contributed to their month-end losses.

Benefits of Brandywine’s Fundamentally-based Trading Model: Non-correlation and Consistent Returns
As we stated in last month’s report, Brandywine’s non-correlation is not a result of chance. It is by design. Based on Brandywine’s 30+ years of research and trading experience, Brandywine’s Symphony program incorporates dozens of fundamentally-based – yet systematically applied – trading strategies to trade across more than 100 global financial and commodity markets. Many of the trading strategies employed by Brandywine were developed more than two decades ago and their continued strong performance today proves they are based on sound, logical “return drivers” that have withstood the test of time. (Click here to view a graphical illustration of Brandywine’s allocation across trading strategies and markets).

There is a reason all CTAs are mandated to state that PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE PERFORMANCE. No performance is 100% predictable. There is no better example than that of the U.S. stock market. From August 1982 through March 2000 the S&P 500 Total Return index averaged 19.47% annual returns and suffered just one losing year. But for the subsequent 12+ year period, ending in July 2012, it averaged returns of just +1.25% and suffered two major drawdowns, one that exceeded 50%. The first 18 year period provided no predictability regarding the performance of the second period. There is no mystery why this is so. The reason is quite clear. The performance of U.S. stocks is dominated by one return driver. As Mike Dever shows in his best-seller, for periods of less than 20 years, stock prices are driven primarily by people’s enthusiasm for owning (or not owning) stocks. When people are enthusiastic, prices go up. When they are not, prices stagnate or fall. An “investment” in the U.S. stock market provides no true portfolio diversification. You can read a complimentary copy of that study as it was published in Mr. Dever’s book here: http://bit.ly/xrz2Ur.

But there is a solution that increases the probability that future performance will approximate past performance (although, as we state above PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE PERFORMANCE). That is to create a portfolio that is “truly” diversified across multiple return drivers. Original research conducted by Brandywine in the 1980s led to the Brandywine Benchmark trading program, which traded a diversified portfolio across more than 100 markets and dozens of trading strategies based on disparate return drivers. In further confirmation of the efficacy of those trading strategies, we observed similar performance in the walk-forward testing when we updated the performance of those trading strategies during the 2000s. And now after 13 months of trading in Brandywine’s Symphony program, we’re seeing the continuation of that performance. You can see the past performance of Brandywine’s Symphony, the Brandywine Benchmark trading program and walk-forward testing at brandywine.com.

Earlier this year, due to rapid advances in natural gas extraction by energy companies as a result of the development of “fracking” and the exploration of “shale gas”, natural gas production in the United States reached new highs. As a result, natural gas prices reached multi-year lows. This triggered Brandywine’s fundamentally-based counter-trend strategy to begin buying natural gas as prices dropped well below $3 (MBtu). In a multi-strategy program such as Brandywine’s Symphony, this initially had the appearance of Brandywine “taking profits” on its short position.

The reason for this? The performance of Brandywine’s Symphony program is based on the performance of dozens of independent return drivers. Not just one (such as trend following). Some of these return drivers attempt to capture short-term counter-trend moves based on market sentiment or fundamental pricing relationships in a market or among multiple markets. Others are based on market reactions to events, such as government reports; while still others look at commodity market action in relation to repeatable seasonal activity, such as planting and harvesting periods. As a consequence, no single return driver or individual market dominates the performance of Brandywine’s Symphony program. This results in:

  • true portfolio diversification,
  • non-correlation to other CTAs and traditional investments, and
  • future performance that more closely approximates past performance.
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Jackass Investing “Poor-folio” Award to Spanish and Italian Market Regulators for Short-Selling Ban

As European stock markets continue to exhibit weakness, Spain’s stock market regulators today banned the short-selling of stocks for the next three months.  Earlier in the day, Italy’s stock market regulators re-instituted a temporary ban on the short selling of financial stocks.

“Selling short” is the process of selling a stock first (by borrowing the stock from a broker) and then buying the stock back at a later date (and returning the stock to the broker) with the expectation of profiting from a decline in the stock’s price.   “Going long” is simply the process of buying a stock with the expectation of profiting from a rise in the stock’s price.

This type of short selling ban by governments is nothing new.  Government regulators in many different countries have often reacted to adverse stock market conditions with similar directives.

This type of action is usually taken by regulators during times of severe market declines with high volatility.  Government regulators think that extreme volatility is a disruption to the orderly functioning of the market, so they often decide to “do something” in order to appease their constituents.

However, it is unrealistic to expect the stock market to only go up, so the prohibition of short-selling during market declines is fundamentally irrational.  Conventional investment wisdom assumes that asset classes are long-only investment vehicles, so it has become accepted that being long is “good” while being short is “bad”.  This is ridiculous.

During extreme market moves to the upside (such as the rally in the US stock market following the March 2009 low, for example), should governments institute long-buying bans to curb extreme market volatility?  Of course not!  You will only see governments act to try to prevent stock market declines, not rallies.

As with most government actions, short-selling bans fail to produce the desired outcome, and oftentimes exacerbate the situation that regulators are attempting to “fix”.  Short-selling bans often have unintended consequences.  As I discuss in Myth #10 of Jackass Investing, short sellers provide the stock market with liquidity when they step in to sell short stocks that become over-hyped by emotional buyers.  In addition, short sellers must buy back stock in order to close their positions, so by instituting short-selling bans, governments essentially remove a source of liquidity during times when the markets need it the most.

Don’t just take my word for it.  Numerous academic studies have also shown the ineffectiveness and potential damage due to short selling bans and have confirmed the positive contribution of short sellers to market efficiency.  In fact, contrary to the intent of governments when instituting such bans, studies have shown that banning short selling reduces liquidity and increases volatility.

“Market Declines:  Is Banning Short Selling the Solution?” by Federal Reserve Bank of New York, September 2011

“Shackling Short Sellers:  The 2008 Shorting Ban” by Boehmer, Jones, and Zhang, September 2009

“Spillover Effects of Counter-cyclical Market Regulation:  Evidence from the 2008 Ban on Short Sales” by Abraham Lioui, March 2010

The belief that short selling destabilizes markets is a myth.

As a result of their ineffectiveness and misguided beliefs, I am awarding a Jackass Investing “Poor-Folio” Award to .  .  . the Spanish and Italian market regulators responsible for instituting short-selling bans.

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Benefits of Brandywine’s Fundamentally-based Trading Model: Non-correlation and Consistent Returns

Originally published in the Brandywine Asset Management Monthly Report.

Brandywine’s non-correlation is not a result of chance. It is by design. Based on Brandywine’s 30+ years of research and trading experience, Brandywine’s Symphony program incorporates dozens of fundamentally-based – yet systematically applied – trading strategies to trade across more than 100 global financial and commodity markets. Many of the trading strategies employed by Brandywine were developed more than two decades ago and their continued strong performance today proves they are based on logical “return drivers” that have withstood the test of time. (Visit brandywine.com to view a graphical illustration of Brandywine’s allocation across trading strategies and markets).

Diversification Examples
Perhaps the best way to explain the fundamental source of Brandywine’s non-correlation with “traditional” CTAs is to present some specific recent trade examples. In this section we’ll present three specific trades as examples that contributed to Brandywine’s differentiated performance.

The strategies that produced these trades, because they are based on “return drivers” that are distinct from trend following futures traders, also produced differentiated returns throughout the past year. These are three examples out of hundreds of potential examples of Brandywine’s unique trading model and performance. Exposing them is intended to provide you with a better understanding of Brandywine’s diversifying value when included in a portfolio of traditional CTAs.

Fundamentally-based Counter-Trend Strategy in Natural Gas
Although Brandywine is not a trend-follower, we do believe in the efficacy of trend-following. (Mike Dever discusses the value of trend following in chapter 7 of his bestselling book, Jackass Investing: Don’t do it. Profit from it. You can read a complimentary copy of that chapter here: http://bit.ly/wX2ONc). As a result, we have always been skeptical of buy-low, sell-high counter-trend strategies, UNLESS they are based on some sound fundamental principal (are not just a mathematical curve-fit). One fundamental concept that does make sense is using marginal cost-of-production concepts to trade low-priced commodities from the long side in a counter-trend fashion. A trading strategy based on this concept originated at Brandywine in the early 1990s and the strategy continues to perform positively today.

Earlier this year, due to rapid advances in natural gas extraction by energy companies as a result of the development of “fracking” and the exploration of “shale gas”, natural gas production in the United States reached new highs. As a result, natural gas prices reached multi-year lows. This triggered Brandywine’s fundamentally-based counter-trend strategy to begin buying natural gas as prices dropped well below $3 (MBtu). In a multi-strategy program such as Brandywine’s Symphony, this initially had the appearance of Brandywine “taking profits” on its short position.

By the end of April however, Brandywine had established a net long position. As natural gas is just one of more than 100 markets traded in Brandywine’s Symphony program, the risk exposure of this trade to Brandywine’s portfolio was moderate, amounting to less than 20 basis points. Throughout May and June, Brandywine incrementally-traded this position several times. The chart below shows the long positions held by Brandywine over the past two months relative to the price of natural gas. The long position (right axis) is risk-based, such that a position of 4 had twice the long exposure as a position of 2. As is evident in the chart, as prices fell our long exposure increased and as prices rose Brandywine took profits on those long positions.

Brandywine’s Fundamentally-based Counter-trend Strategy in Natural Gas
(Long Exposure Relative to Natural Gas Price)

The end result was that during June this strategy produced a net gain of more than 30 basis points for Brandywine’s Symphony program, and it did so in a fashion that was completely uncorrelated to the returns of the other trading strategies employed by Brandywine. This strategy is also expected to be profitable on the majority (in excess of 70%) of its trades, while being selectively “in-the-market” less than 25% of the time. Historically, this strategy has a zero correlation to trend following CTAs.

Directional Arbitrage Trading in Currencies
A second group of strategies that contributed to Brandywine’s profits in June were “directional arbitrage” strategies employed by Brandywine in the currency and interest rate markets. These strategies look at forward curves and price differentials among currency and interest rate markets to establish directional trades based on biases in the data. As these strategies are based on return drivers that are unrelated to those that drive trend-following performance, the performance of these strategies is, on average, uncorrelated to that of trend-following CTAs. There are times, however, where performance can be highly negatively correlated. The last trading day of June was one example of this negative correlation. On that day trend-followers in the currency and interest rate markets suffered greatly as established trends in those markets reversed violently. Brandywine’s directional arbitrage strategies were well-positioned for this reversal and profited. This contributed to Brandywine’s +0.38% gain on June 29th. June 29th was not a one-day aberration however. Brandywine’s directional arbitrage strategies also contributed to Brandywine’s overall positive performance over the past 12 months.

Event Trading in the Dollar Index
Another unique category of strategies employed by Brandywine are event-based trading strategies. These were developed based on the discretionary trading experience of Brandywine’s founder in the 1980s. The return driver underlying these strategies is based on the fact that various events, such as the information contained in government reports, can trigger significant market moves or trend reversals in affected markets. Under certain conditions that short-term market reaction is predictive of future market direction. Brandywine’s event-based strategies are designed to capture those moves. One such trade, a short position in the U.S. dollar, was triggered following the release of the Employment Report on June 1st. Based on this event and subsequent market factors, Brandywine entered into a short position in the U.S dollar index. As this was an event-based trade, and not dependent on trends, this short position was entered into within days of the market top set on the morning of June 1st. Brandywine remained in this trade at the end of June. As a result of being in this trade, the collapse in the dollar on June 29th provided differentiated profits (compared with the major CTA indexes) for Brandywine’s investors.

Brandywine’s Event-based Trading in the Dollar index

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The Downside of Non-Correlation

Originally published in the Brandywine Asset Management Monthly Report.

Brandywine employs dozens of individual trading strategies to trade across more than 100 global financial and commodity futures markets. The majority of Brandywine’s strategies are based on fundamental, arbitrage, sentiment, event-driven and other non-trend-following approaches (all systematically-applied). As a result, Brandywine delivers returns that are uncorrelated with traditional trend-following CTAs. (Unfortunately), this non-correlation stood out in May, when the major CTA indexes posted gains while Brandywine lost.

Brandywine’s allocation across trading strategies and markets

As you might suspect (by the fact that trend-following CTAs profited in May), Brandywine’s losses came from trades made by our fundamental, sentiment and arbitrage strategies, while Brandywine’s trend following strategies produced profits.

Brandywine’s profits since the inception of the Brandywine Symphony program in July 2011 are the result of the fact that five out of the six strategy-types employed produced profits. Interestingly, the most profitable strategy-type (comprised of five individual trading strategies) was trend-following. So despite the fact that trend-following CTAs have struggled over the past year, that strategy-type has proven to be the most profitable for Brandywine. What this indicates, is that even within trend-following, Brandywine is doing something different.

Brandywine’s drawdown in perspective
Brandywine’s current drawdown began in March 2011. Over the past three months the cumulative decline has equaled -5.51%. This drawdown, in both magnitude and duration, is about as “average” as it gets. Over the 21½ year test period prior to our start of trading last year, the average of our 21 largest drawdowns (a “one-year event”) was -5.49% and the average length was 3.2 months. This doesn’t mean that our current drawdown is at an end, but it is dead-center among expectations based on our back-tests.

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Recent Articles

I’ve recently co-authored several articles and excerpts from my book that have been published on Yahoo Finance, ETF Guide, Seeking Alpha, Motley Fool, Free Money Finance and other publications. Here are some of the links:

The Myth of Expert Advice – Part 1
The Myth of Expert Advice – Part 2
The Myth of Expert Advice – Part 3
The Myth of Expert Advice – Part 4
The Myth of Expert Advice – Part 5
Buy-and-Hold is NOT a Sound Investment Strategy
The Fatal Flaws of Buy-and-Hold
Why Experts are so Wrong
Buy When There’s Blood in the Street
The Downside of Buy-and-Hold
What Drives Stock Market Performance?

Please visit the Jackass Investing Press Page for a full list of articles, interviews, and reviews.

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Recent Press

My book, Jackass Investing: Don’t do it. Profit from it., has been the subject of several recent interviews and reviews.  Here are the links:

The Wall Street Journal This Weekend – with Gordon Deal
millionairecorner.com – by Donald Liebenson
shortroadtoretirement.com – by James Pelczar
themarketcapitalist.com – by Dominico Johnston
cxoadvisory.com – by Steve LeCompte
seekingalpha.com – by Alan Brochstein

Please visit the Jackass Investing Press Page for a full list of articles, interviews, and reviews.

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Jackass Investing “Poor-folio” Award to President Obama and other Critics of Speculation

In this political environment, high energy prices remain a hot issue. Policy-makers, often driven by politics and emotion, are once again ramping up their attacks on “evil” speculators for driving up the price of oil and gas.

In fact, President Obama, in a Rose Garden press conference on April 17, 2012, along with certain members of Congress, has blamed high oil prices on “speculation” and called for greater federal oversight of oil markets. The President’s proposal is intended to root out market manipulation and speculation. After all, we need to blame somebody for such high energy prices. Right?

Well, if speculators are to blame for high prices, then they must also be praised when prices are low; but you will never see a politician taking such a stance. Why not? Because an attack on speculators for low energy prices obviously does not fit their political agenda.

President Obama’s proposal to increase CFTC enforcement of the energy markets due to high gas prices is at best silly political pandering, and at worst, creates divisiveness and encourages attacks against market participants. It’s as ridiculous as if he asked for an increase in the budget of the SEC in order to clamp down on “investors” who have earned profits in their 401(k)’s over the past couple of years as a result of the bull market in stocks. It just doesn’t make sense.

A primary purpose of markets is to allow participants to hedge or transfer the risk of price changes. Functioning energy markets require the participation of both hedgers (such as the large oil companies or the airlines) and speculators. Without speculators, the hedgers would be subjected to the risk of extreme price swings, which would adversely affect many businesses. The bottom line is that markets benefit from the participation of speculators.

As I discuss in Myth #11 of Jackass Investing, commodity prices are no more volatile than stock prices, and many commodities are much less volatile than many stocks. In fact, most commodities (including crude oil) are less volatile than many stable, large cap stocks, such as Exxon Mobil, Berkshire Hathaway, and GE. Speculation serves to reduce market volatility.

One prior ill-conceived politically-inspired regulation was the U.S’s ban on the short-selling of financial stocks in 2008. As I show in Myth # 10 of Jackass Investing, this resulted in both greater volatility and lower prices for those stocks relative to the market during the period the ban was in effect.

President Obama today is attempting to portray speculators as wild gamblers driving up the price of oil for their personal gain and at the expense of the “American People.” This is no different from regulators who in 2008 blamed speculators for driving down the price of financial stocks. Neither argument is based on fact. Speculation cannot affect the long-term price of markets. That price is set by end user supply and demand. If those end users think speculators have temporarily pushed prices out of line, they can take advantage of that “artificial” mispricing; much like Southwest Airlines (NYSE: LUV) did by locking in low fuel costs prior to the run-up in prices in 2008.

As I mention in Myth #14 of Jackass Investing, government regulations will NOT protect you. The road to a “poor-folio” is often paved with good intentions; however, the “best intentions” of politicians are intended to benefit them, not you, the rational investor.

As a result of their political pandering and blatant mistrust of free markets, I am awarding a Jackass Investing “Poor-folio” Award to . . .

  • President Obama
  • Members of Congress who support his politically-motivated call to, essentially, criminalize speculation
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Jackass Investing BANNED by Google

When I wrote Jackass Investing: Don’t do it. Profit from it., I did expect to get some virulent opposition to its content from those who have long preached conventional investment wisdom. After all, in the 20 investment myths exposed throughout the book, I show why they are wrong, and back up my case with more than 100 studies. But I didn’t expect to get it from Google.

After six months of word-of-mouth promotion, during which time Jackass Investing became the #1 best-selling mutual fund book on the Amazon Kindle (ahead of Common Sense on Mutual Funds, co-written by the capo of conventional investment wisdom, Vanguard founder John Bogle), I decided to test the waters of paid advertising. Google ad words provided an obvious test market opportunity. On February 12th I posted my first Google ad for the book.

After seeing positive results after spending just $20 per day, I added a second set of ads, doubling my spend. Whereas the first ads took people to the book’s page on Amazon.com, this second set of ads took people to the book’s web site at www.JackassInvesting.com. That’s when the fun started.

At 11:02pm EST on February 16th I received an email from Google saying that “We noticed that one of your URLs was recently flagged as against policy” and that they would no longer run the ads. I was already in bed at the time (it was an early night) and saw neither this email nor the two that followed until 6am the following morning.

This first email was followed by a second one hour later that said “We have re-reviewed your site and determined that AdWords Site Policy issues no longer prevent ads from running for the site.”

OK. So whatever evil I committed in my sleep was apparently re-evaluated and confirmed to be “non-evil” by Google (who’s informal corporate slogan is “Don’t be evil.”) … that is until 4:19am the same night, when I received a third email arrived with this dire statement:

“It has come to our attention that your Google AdWords account does not comply with our Terms of Service and Advertising Policies. As a result, your account and any related accounts have been suspended, and your ads will no longer run on Google. Please be aware that you are prohibited from possessing or creating any other AdWords accounts, both now and in the future” and this statement appeared in red on my Google page:

“Your Google AdWords account has been permanently suspended for repeated violation of AdWords or Landing Page and Site policies in this or a related account.”

(Looks scary doesn’t it):
Google AdWords Ban of Jackass Investing and Mike Dever

I’m not sure what happened to change things between midnight and 4am, as even now, 10 days later, I’ve gotten no answer. So now my book Jackass Investing, and I, Mike Dever, have been banned and deemed inappropriate by Google; the same company that, by the way, for years severely censored its search results in compliance with Chinese authorities, and for years knowingly took hundreds of millions of dollars in advertisements from illicit Canadian pharmacies (which Google admitted to while paying a $500 million fine). But they won’t accept $40 per day from me to advertise www.JackassInvesting.com.

This certainly won’t bust my book’s marketing efforts – after all, word-of-mouth will beat paid advertising any day – but it does make for an interesting story. Someone should write a book about it . . .

Jackass AdWords
GoogleAss Advertising
Jackass Googling

If you’ve got any ideas of your own, let me know.

UPDATE Feb 29, 2012: Looks like I’m back up-and-running with Google (did I have them on my update list to get these blog posts?). After a 12-day suspension, Jackass Investing ads are running again on Google. You can all stop calling me “Dr. Evil” now. Here’s the email I got from Google:

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