FM: Some people claim managed futures’ ability to be negatively correlated to equities in poor equity markets has to do with the long-term bull market in bonds and that may not be the case in a rising interest rate environment. Is this something investors should be weary of?
BE: It sounds to me that what they are doing is they’re looking at the fact that trend-following has been profitable, which probably irritates them anyway — [Trend-following] really only has a record of 30 or 40 years— then they are looking at what the biggest economic factor [was] in that time? Well we have had these declining interest rates and they say one has to cause the other. I just don’t see it. In analyzing my own performance I can’t find a pattern where I am making an unusual amount of money in the interest rates and not the other stuff. So I would be very skeptical of that idea that all the money in trend-following comes from the behavior in one group of markets.
I want to mention that this whole question of risk control it is not a completely objective question. I wanted to invent a science of trading that I at least partially completed; I certainly haven't done everything that I set out to do. When I was a young man I wanted to devise objective risk systems. In other words, once you have a system, what is the right size to trade, period. After years of working on this I convinced myself that it did not have a unique answer. You need at least one subjective piece of the puzzle to put it together, and that is an individual’s risk aversion. Now that is subjective. There is no rule that says how averse you should be to risk, that is an integral element of your personality. But unless you know how averse to risk you are or unless you can impute risk aversion to your clients, you really can’t settle the question of how big you should trade.
FM: Is there a risk that managers end up measuring themselves instead of the markets?
BE: Every strategy has a finite capacity. It is possible for a trading strategy to get oversubscribed and no longer work. That hasn’t happened with trend-following but the game has gotten harder.
FM: Every few years after a rough period someone says trend-following is dead.
BE: I lived through the death of trend-following a half dozen times and, like Mark Twain’s death, it was highly exaggerated.
FM: You have a fascinating background. Tell us how you went from a PHD candidate at the University of Chicago to trading futures.
BE: My interest in futures trading dates back to high school, as does my first collaboration with Rich Dennis. At the University of Chicago I specialized in mathematical logic and had a great opportunity to pursue my interests in the philosophy of science and the history of ideas. The latter were influential in shaping my approach to trading. In 1973 my advisor and I were having disagreements about the direction my dissertation was taking, and Rich suggested I take a little time off and come down to the floor to trade. I didn’t go back [to school].
FM: Many of the turtles have gone on to great success as well as some of the C&D traders, even though their strategies have evolved into something quite different than the original. Was there something much more basic in the lessons that allowed so many to succeed and create new strategies?
BE: The turtles were stringently selected and highly talented. They also received training, practice, and guidance. They got a good start from us, but they deserve most of the credit for their ongoing success. The successful turtles have branched out widely, but my trading has also changed; it’s evolve or perish....
As I recall more than half the course revolved around developing the right attitude, guarding against debilitating emotions, how to think about risk, and how to handle success and failure. Teaching the turtle system itself doesn’t take very long. I was saying you need less than 12 degrees of freedom in a system; versions of the turtle system had three or four. We spent a lot of time talking about our theories on how to control risk; that was actually the bulk of the course. Attitude, emotional control, discipline; those things are harder to teach. All the turtles learned the system and learned the strategy; that was the easy part, but some of them brought the right attitude and right mental set to it and they prospered and became very rich. Others had a more halting career and did not succeed as well. They had the same training, but maybe they did not have the same emotional make-up.