Winning with Defense

Originally published in the Brandywine Asset Management Monthly Report.

A record 120 million people watched the New England Patriots defeat the Seattle Seahawks in Sunday night’s closely fought Super Bowl. While there were many highlights, it is the “2nd and goal” from the one yard line with 20 seconds left in the game that will forever be etched into the minds of Seahawks fans. Instead of handing the ball to star running back Marshawn Lynch, Seahawks coach Pete Carroll called for a quick slant pass to Ricardo Lockette. It is often said that defense wins games, especially the big games like the Super Bowl, and Sunday night proved no exception. Instead of a game-winning touchdown (or at worst an incomplete pass that leads to a touchdown run by Lynch on third or fourth down), undrafted rookie safety Malcolm Butler intercepted the pass and ended Seattle’s chance for a repeat Super Bowl win. One ‘fatal’ mistake resulted in the New England Patriots taking home the Super Bowl XLIX trophy.

We repeat this play-by-play – at the risk of boring those 120 million people who watched the real game – because we’d like to stress the point that defense is perhaps even more important to successful investing than it is to winning football.

Avoiding Disaster
Brandywine’s Symphony Program is currently in its largest drawdown to date, with a
-13.94% peak-to-trough drop in value, and our aggressively-traded Brandywine Symphony Preferred is down more than 38%. While we would love to avoid all drawdowns, the key is to avoid disaster – the investing equivalent of a goal line interception. As we’ve discussed in many of these reports over the past few years, Brandywine attempts to constrain our drawdowns and improve our odds for a rapid recovery by creating a balanced portfolio that employs broad portfolio diversification across both trading strategies and markets. So, although our current drawdown is our largest, it is still within a manageable range.

But while this balanced, diversified approach improves our probabilities of avoiding disasters, it can never eliminate drawdowns. The current drawdown, which began in September, is a great case in point. Over the past five months, global markets became much more correlated with each other, as the sharp rally in the dollar and the over-supply in the oil markets triggered a succession of related market moves in bonds and commodities. The majority of Brandywine’s fundamental, sentiment and arbitrage-based trading strategies were on the wrong side of many of these moves – which is essentially the definition of what causes a drawdown. Despite this, our monthly losses have been better contained each month, as both the trading strategies and portfolio allocation model adapted to the changing market conditions. And because we have avoided disaster-sized losses, we are still “in the game” and able to apply the same game plan going forward as what made us successful in the three years leading up to our current drawdown.

From the start of trading in Brandywine’s Symphony Program in 2011, we have stressed how our systematic Return Driver based approach to trading, which includes a heavy dose of fundamental inputs, will produce returns that are uncorrelated to not only all conventional investments (such as stocks and bonds) but also to other futures traders. This is reflected in our non- correlation to the S&P 500 of 0.15 and even lower correlation to the BTOP 50 managed futures index of 0.09. A specific trade example of this non-correlation took place on January 15th, when the Swiss National Bank abandoned its support for their currency’s peg to the Euro. The majority of trend followers were caught short and suffered losses on this move. In stark contrast, Brandywine’s trading strategies recognized that despite sustained central bank intervention the Swiss Franc continued to rise against the Euro. As a result, Brandywine was net long the Swiss Franc and profited from its sharp advance on that day.

“Stay the Course” or Modify the Game Plan?
There is almost never second-guessing when a team is blowing away the competition or when an investment manager is minting money. The second-guessing only takes place when losses are incurred. While we at Brandywine have certainly scrutinized our performance closely over the course of our current drawdown, with an interest in identifying where and why the losses accrued, we are fortunate that our investment philosophy provides us the path to improvement, without the need to second guess. That is because our model was designed from the start to enable – actually require – us to develop and incorporate any additional trading strategies with the intent of further diversifying the sources of our returns. Also, as we continue to collect more real time trading and performance data, our portfolio allocation model will benefit by being able to use that information to improve the portfolio balance across both trading strategies and markets. While buying drawdowns is often difficult to do emotionally, we continue to believe that the current drawdown presents a great opportunity to initiate or add to an investment with Brandywine.

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