Originally published in the Brandywine Asset Management Monthly Report.
Over the last week of September, Brandywine’s slight monthly profit reversed to a moderate loss, with Brandywine’s Symphony Program closing the month down -1.48% and the aggressively-traded Brandywine Symphony Preferred Fund closing down -5.47%. In contrast to July’s large sell-off, over the past two months Brandywine Symphony’s performance has fluctuated in its tightest range of the past year, as shifting sentiment and other conditions have resulted in the various strategies within the Program partially offsetting each other’s positions. Interestingly (and illustrative of Brandywine’s non-correlation to other investments), over that period the S&P 500 posted its largest trading range in more than three years.
The Psychology of Investing
“It was the best of times, it was the worst of times…” is not just the opening line to Charles Dickens’ A Tale of Two Cities, it is also an apt description of the emotions facing investors and their investment managers.
When Brandywine’s Symphony Program was hitting new performance highs in August 2014, it was the “best of times.” Over its first 38 months of trading, Brandywine’s Symphony Program had posted a Sharpe ratio of more than 1.0, in line with our high expectations. This resulted in our aggressively-traded Brandywine Symphony Preferred Fund being awarded the top Macro Fund by HFM Week (in the under $1 billion category).
But paradoxically, it was also the “worst of times” from the standpoint of what was to come. Over the ensuing 13 months (thorough September 2015) the Program and Fund suffered through their longest and deepest performance drawdowns.
This stark comparison illustrates why successful investing is such a difficult pursuit. Just as the best of times emotionally do not ensure future profits, it is often the worst of times that are the best time to invest. Take for example, March of 2009. Global stock markets had suffered through one of their most difficult periods since the Great Depression of the 1930s. Stocks had lost half or more of their value in the preceding 18 months. The news programs were filled with reasons why things would get worse before they got better. Very few people were comfortable putting money into stocks at those lows. Yet as we all know that was precisely the best of times to put money into stocks.
While individuals and even many institutional investors often succumb to these emotional swings, the most successful investment professionals have processes in place to counter, and even exploit, the negative effect of potentially damaging emotions. This is exemplified in Warren Buffett’s oft-quoted comment to “be fearful when others are greedy and greedy when others are fearful.”
Brandywine’s Approach to Controlling and Exploiting Emotions
Brandywine was founded in 1982. Over the past 33 years we have become quite familiar with the emotional swings that come with trading. Brandywine’s Symphony Program is built on that experience and the result is that our approach is designed to both manage and exploit emotions.
Our primary approach to managing emotions is to trade pursuant to a systematic trading model. Although discretion is used during the research and development of our trading model, its daily application is 100% systematic. The result is that there is no urgent impulse for Brandywine to “do something” when we’re suffering losses. We will certainly use the experience to guide us in our future research, as we want to learn from our difficulties in order to continually improve our potential future performance. But we won’t make changes on the fly, as the effectiveness of our trading model is based on its consistent application over time.
We exploit emotions by employing, as a portion of our portfolio, trading strategies designed to capture the emotional swings of market participants. This includes both periods when emotions are building and contributing to market trends, in which case some of our strategies attempt to profit from those trends; and times when market sentiment in specific markets hits what is historically an unsustainable extreme, at which time we enter into (generally shorter-term) counter-trend positions.
Of course, as we’ve seen over the past year, there will be periods where despite the positive expected returns from our strategies a majority of them will ‘get it wrong’ at the same time. That’s essentially the cause of any drawdown. However, the past two months have started to exhibit a different behavior. There has been much better balance between strategies that have performed well and those that have not. Our tight performance range is one result of this. Our currently moderate margin-to-equity ratio is another. But regardless of the short-term performance, we are confident that the best way to recover from a drawdown and to profit over the longer-term is to continue with the consistent application of our trading model.