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Michael Dever
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Founder, CEO & Director of Research for Brandywine Asset Management and author of "Jackass Investing: Don't do it. Profit from it." I have been a professional investor/trader since 1979 and have experience in stocks, managed futures, commodities, mutual fund arbitrage, market... More
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Brandywine Asset Management
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Mike Dever
My book:
Jackass Investing: Don't do it. Profit from it.
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  • Winning With Defense

    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.

    Feb 06 11:37 AM | Link | Comment!
  • Analysis Of The Drawdown

    Originally published in the Brandywine Asset Management Monthly Report.

    Brandywine employs a wide variety of trading strategies, each systematically applied, to trade across more than 100 global financial and commodity markets. The intent of this broad strategy and market diversification is to enable more consistent performance across a range of market conditions. Brandywine's Symphony Program was able to accomplish this over our first three years of trading, earning consistent returns while managed futures traders suffered their longest drawdown on record. And when trend following futures traders did have positive periods, more often than not, so did Brandywine. We also posted profits during the most difficult stock market environments, such as the third quarter of 2011. So what made the past four months different?

    A number of Brandywine's trading strategies exploit extremes in market sentiment, pricing relationships between various markets and fundamental production data to enter into positions that are often independent of market trends. In the event trends develop that are contrary to those positions, Brandywine also employs momentum strategies designed not only to independently produce profits, but also to "hedge" that fundamental and sentiment exposure by offsetting a portion of those positions.

    As most of our investors and readers are well aware, the last half of 2014 contained some significant market trends, such as the collapse in the oil market and the relentless rise in the value of the dollar. These were ideal conditions for trend followers to profit, and at first Brandywine also benefitted along with them. During August 2014, a month when trend followers performed quite well, Brandywine's Symphony Program posted its second strongest month on record. But one person's sunrise can often be another person's hangover.

    Towards the end of August, those same market trends began to signal opportunities - based on logical return drivers and decades of historical testing - and trigger additional counter-trend positions in Brandywine's sentiment, fundamental & arbitrage-based strategies. As trends continued to move against those positions, our momentum hedges did help to balance the portfolio and offset a portion of those losses. The result was that the cumulative loss over the last three months of the year was only slightly greater than the single month loss in September.

    However, due to the number of strategies indicating those counter-trend positions and the allocations assigned to them by our portfolio allocation model, the aggregate position sizes indicated by all strategies remained counter to the prevailing trend over that period, which, by definition, created the losses.

    Going Forward

    Brandywine believes strongly in the value of true portfolio diversification and the benefit of maintaining balance - over time - across the strategies and markets in our portfolio. This belief is at the core of our portfolio allocation model and is designed to provide our investors with the best possible long-term risk-adjusted returns. While we continue to believe that it is the long-term that matters most, we understand the benefit in reducing short-term "pain" as well.

    Fortunately, there are ways for Brandywine to reduce the probability that future drawdowns will match or exceed the current drawdown, while still preserving our long-term performance. That is because, by design, Brandywine's research philosophy requires the regular evaluation of the validity of the return drivers underlying our current strategies and Brandywine's portfolio allocation model easily accommodates, and our belief in continuing improvement requires, the addition of new trading strategies into the portfolio. This is a process we've discussed numerous times in these reports over the past few years.

    So addressing the source of the current drawdown doesn't require an overhaul of our trading model or research process, but a continuation of the process already in place. We have been students of the markets now for more than 35 years and have developed a library of potential trading strategies based on our trading experience. We are especially focused now on an evaluation of the existing strategies that contributed to the drawdown, as well as the completion of the development of additional strategies designed to thrive on aggressively-trending markets.

    There is of course no way to protect against losses under all conditions. Every investment program has market environments where it is more likely to lose than to gain. And while Brandywine's Symphony Program has generally performed well across a variety of market conditions, the drawdown of the past four months has served to remind us of the need for continuous improvement. As always, we are committed to this process.

    Jan 08 3:22 PM | Link | Comment!
  • Drawdowns - Omen Or Opportunity?

    Over the past three months, Brandywine's Symphony Program suffered its largest drawdown, -11.36%, since the start of trading in July 2011. Drawdowns are a natural part of trading and Brandywine's Symphony Program is no exception. But for most investors, they provoke discomfort and prompt a series of questions. We know this because over our decades of trading (and yes, prior drawdowns), we have fielded a number of questions, as well as asked a number of them ourselves. In this report we'll present some of those questions and discuss the current drawdown, as well as future expectations, in the form of a Q&A.

    What caused the loss over the past three months?

    Brandywine's Symphony Program incorporates a variety of trading strategies, each based on a sound, logical return driver designed to produce a positive return over time. And since inception these trading strategies, in the aggregate, have been solidly profitable. But during the current drawdown period, September through November, a disproportionate number of those strategies incurred losses while very few produced sizable gains. Specifically, a majority of the losses were caused by fundamentally-based strategies and those we describe as directional arbitrage or that employ intermarket relationships. In our due diligence questionnaire we prepared three years ago, we identified rapid downtrends in markets as being the worst environment for those strategies. With crude oil dropping more than 40% in an uninterrupted downtrend (and 10% alone on the last day of November), and other commodities such as silver, cotton and currencies [such as the Australian dollar] mired in 10% to 30% drawdowns, those strategies hit their "perfect storm" over the past few months.

    Other futures traders had some of their best performance in years, why didn't Brandywine?

    Since the inception of Brandywine's Symphony Program in 2011 we have consistently stressed that Brandywine's unique approach to research and trading would produce returns that were non-correlated to all other investment indexes and investment managers, including CTAs. This non-correlation was exhibited in full force in November and over the past three months. After lagging Brandywine's performance for the three years leading up to the start of our drawdown in September, the BTOP 50 and Newedge CTA indexes each rallied approximately 8%. Despite the strong performance differential, Brandywine has still outperformed those indexes since inception. Even better, because of Brandywine's non-correlation to those indexes, adding Brandywine to a portfolio that contains CTAs results in both increased returns and reduced risk (yes, even measuring Brandywine's performance from the low point of the current drawdown).

    What are your expectations going forward?

    When Brandywine suffered a drawdown in mid-2013, we stressed in our monthly report our belief that it was an excellent time to consider investing or adding to an investment with Brandywine. That belief turned out to be prescient. In the 12 months following the Brandywine Symphony Program's drawdown in 2013, the Program produced a solid positive return of +15.83% and the aggressively-trade Brandywine Symphony Preferred gained a substantial +65.33%.

    While prudence and regulations require us to state that PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE PERFORMANCE, history leads us to expect similar strong returns going forward today. This expectation is based on our historical testing and actual trading performance. In fact, in the 12 instances (both tested and actual) where Brandywine's Symphony Program fell by more than 8% (on a gross, end-of-day basis), the following 12 month return has averaged more than 18%. Of course, Brandywine Symphony Preferred, trading at three times standard risk, would produce substantially greater returns; although as we must also state THERE IS THE RISK OF LOSS AS WELL AS THE OPPORTUNITY FOR GAIN WHEN INVESTING WITH BRANDYWINE.

    Dec 09 1:02 PM | Link | Comment!
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