What do you get when you combine the resources of several bright investment engineers with a managed futures legend and the resources of his 35-year old institution? Something special.
Even before Michael Mundt founded Revolution Capital Management in 2004 along with partners Mark Chapin and Rob Olson, he approached managed futures legend Bill Dunn about developing trading systems.
“We thought he was a bright guy,” was Dunn’s initial reaction to Mundt. “He bounced ideas off us, he was giving us some real time trades and we gave him help and told him we would be a lot more interested if you concentrate on the short term, so that is where it went,” says Dunn, who has an exclusive deal to market Revolution’s Mosaic program.
Mosaic launched in October 2006, nearly two years after the launch of Revolution’s initial Alpha program and has returned 107.2% in that time. The Alpha program started out as a long-term trend following program and has produced a compound annual return of 20.78% since January 2005. Mundt has added medium and short-term strategies to the program while working on the more aggressive and shorter term Mosaic program.
Revolution’s goal — with encouragement from Dunn —always was to create the shorter-term strategies, but getting it right was more difficult than creating the longer-term strategy, even for a couple of rocket scientists, which Mundt and Olson qualify as with degrees in aerospace engineering.
Mosaic is a systematic pattern recognition strategy that trades 56 markets and has an average holding period of 3.6 days. Signals are generated following the close. Each market receives a score between -1 and 1. The strength of that signal determines the size of each trade. A score of 0.2 might initiate a small position and if that score rises the next day, Revolution would add to that position.
Positions will usually be put on at the open, but traders have discretion based on how liquid a market is at the time.
Creating successful short-term trading strategies that are non-correlated with trend following is difficult and involves more than simply applying the same principles to a shorter time frame. “We had the right ideas but we were looking at it from a purely black box point of view. That was a detriment,” Mundt says. “It was when Dunn started to point out the impact of trading and our realization that what we were finding was great on paper, but the trading cost would have taken up three fourths of the profit [that we worked on changes]. We had one conceptual breakthrough as far as how to keep the basic idea but reduce the trading cost and from there it all kind of fell into place.”
The breakthrough involved making the system more responsive to events. “Instead of telling the system to work all the time, looking at those times when it is going to work and not to try and force it to be in a market that doesn’t have any predictability,” Mundt says.
From 2004-06, when times were difficult for long-term trend followers, many short-term strategies marketed as a diversification to trend following failed. Dunn says that Mosaic tested “very well” in this period. “It really was [non-correlated] and some of the other [programs] that claimed they were, weren’t.” Revolution had strong returns during the reversals in February and July 2007. “There were periods where trend followers got just creamed in the last two years and Mosaic was off the charts great,” Mundt says, “Most important, it proved the non correlation with trend followers. When we are having negative months, trend followers are doing well and that is exactly what we hoped would be the case.”
Also critical is the computing power to test such approaches on numerous markets and a world class execution desk. Olson says due to the short-term nature of Mosaic, Dunn’s sophisticated and experienced trading desk is critical. “Without that model, this would not be possible,” Olson says. Mundt adds, “Dunn’s stable of traders and 24-hour desk has been a necessity in deploying Mosaic. Execution is a huge part of a system that trades this fast. You need to minimize slippage.”
Revolution still operates Alpha independently from Dunn but focuses most of its energies on Mosaic, which has grown to $111 million under management and has a capacity of $1 billion without any changes according to Mundt.
“Alpha was grown more organically. It is aimed at the high net worth investor whereas Mosaic is aimed at the institutional investor interested in building their own mix,” he says.
When asked to describe the relationship, Dunn says, “It is a mutual admiration society.” He plans on creating a fund with a 50/50 allocation between Mosaic and Dunn’s long-term approach. “This is pretty effective on its own but it is much better in conjunction with us. It will be special,” Dunn says.