William (Bill) Dunn launched his long-term trend-following commodity trading advisor (CTA) in 1974 after earning several degrees and embarking on an impressive research career. He came into trading from the academic world after earning a doctorate in theoretical physics from Northwestern University, and conducting operations research and systems analysis studies for various branches of the U.S. military. He has held fast to an aggressive approach to trading that has produced impressive and consistent returns, and he has helped launch and market numerous other managers. A $100,000 investment in 1984 in Dunn's WMA program (his longest running program) would be worth more than $4 million today.
After close to 40 years at the helm of the trading firm he founded, Dunn is making contingencies for the next 40 years. He has a succession plan in place. We spoke to him along with the firm's president and Dunn's successor, Marty Bergin, about the past, present and future of DUNN and managed futures.
Futures Magazine: Bill, you were one of the original trend following CTAs. Talk about how the industry has evolved since you started in 1974.
Bill Dunn: DUNN began in 1974 shortly before Congress established the CFTC and before the NFA was formed, so the regulatory oversight has increased. Industry assets have grown. The number of markets traded has expanded to include financial instruments, and in the beginning, we only traded on the U.S. exchanges. Now, we trade 24 hours a day on exchanges located around the world. Investors have more available information and choices. Technology also allows for much better risk management. I initially ran the WMA system using punch cards. Now, we are able to update the system daily and more closely monitor and control risk.
FM: Early on some traders designed retail managed futures products, you didn't. Explain why you took the direction you did?
BD: I am not only a trader, but also an investor, and I have always tried to manage the business from the investor's perspective. That is, I often ask "what would the investor want or expect?" And that's what I do. Early on, I was philosophically opposed to the retail structure, because I didn't think those products were investor favorable due to the fees and costs. I was also concerned that the retail investors would invest without understanding futures, and so they would pull out at the wrong time.
FM: Managed futures in general, trend following in particular, has proven itself as a valid asset class/ strategy but it is still not widely accepted in some circles. Why is this?
BD: Probably this is because managed futures is not understood well by the public. Absent education, it is difficult for investors to stick with a system through a drawdown, and so volatility is an impediment to those that chase returns, or who are greatly troubled during the drawdowns. Many people take cues from the mainstream media, which may encourage emotional decisions and often the mainstream media doesn't present managed futures. However, our industry should have done a better job educating the media and the public.
FM: What should the industry do to education the public?
BD: It might have something to do with some of the gatekeepers who don't understand managed futures and don't want to talk about it.
Marty Bergin: The big investment banks aren't at all interested in managed futures or how they work other than the fact that they can set up allocations to them as long as they are getting a percentage of fees on the other side. But I don't think that anybody in the industry understands how managed futures works other than our small subset.
FM: Is it a matter of educating the public so that they demand these products in retail formats?
BD: We can't force our product on anybody. They have to willingly want it and they have to be curious enough to look into what they don't know. The providers need to know what is available out there for their clients; they [have a] relatively narrow curiosity coefficient.
FM: You have marketed, developed service agreements and strategic partnerships with emerging CTAs. Talk about this and the strategy behind it.
BD: Over the years, we have been approached many times with those who have a system, or sometimes just an idea. Provided the system or idea has merit and is testable, we give it consideration. Often, these are people without the resources to adequately test their own system, or perhaps they are lacking in practical experience and knowledge and they seek to partner with DUNN. About a third of our payroll is devoted to research and development, and we are adept at analyzing and testing new systems. Most of the systems or ideas do not pan out and are never implemented, but some do, and when they do, we may include that system in a DUNN pool and offer it for managed accounts. Our strategy is to provide the best options for investors. So, when we find a system we believe in after rigorous review and testing, we make it available to our investors.
FM: Has the industry been too meek in asking only for a 10% allocation of an investor's portfolio?
MB: That is absolutely true. Dunn has always preached that 10% of a person's diversified portfolio should be in managed futures. The 10% is incumbent on the volatility of the program. If you look at a program with Winton's volatility it really should be more like 30 or 40% of the portfolio should be allocated to it. We should have been more aggressive than we are as far as preaching the portfolio allocation. Managed futures should not be a stand-alone investment for people…also long-only equity investments should not be a stand-alone strategy, which it has been for years and years and look at what its gotten people today.
FM: What other managers are you currently working with?
BD: Our current CTAs are Commodity Futures Services, LLC which trades the IPATS system; Keck Capital Management, LLC, which trades the Keck system; Kelly Angle, Inc., which trades the Genesis system; and Revolution Capital Management, LLC, which trades the Mosaic system.
According to the 2011 fourth quarter Barclay Managed Funds Report, the WMA program, three of our current strategic partners, one past strategic partner and one of our past employees with his own system are all represented in the top 20 CTA performers of 2011. Also, three of the above were included in the top 20 CTA performers over three years, and four were included in the top 20 CTA performers over the past five years. I think we've done a fairly decent job in reviewing and developing systems with our strategic partners.
FM: Do you see a lot of promising new managers out there?
BD: Not a lot but occasionally. If we have enough information to make us curious and it looks like it would be interesting we are open to taking a serious look at it and kicking the tires and seeing if it works. If so, maybe we can work out a deal where it works for everybody. We are being approached by three or four people a month. They approach us because they know we have a history of start-up opportunities.
FM: Back in 2009 we spoke about how the strong performance of managed futures in 2008 — as opposed to almost all other investments — should bring managed futures into the mainstream. While we have seen some growth, it has not been as strong as one may have expected. Why?
BD: The public is slow to make a change even after 2008. The mainstream media, big banks, large financial institutions, government and the financial news networks generally push the equity industry. This along with the recovery of the stock market and recent Federal Reserve policies has kept everyone invested in equity strategies. It's hard to buck the trend.
Managed futures is new to many institutions, and the due diligence process is very slow. Capital will flow to the large players first, as a safe place to test the waters. I would suggest this is already occurring as evidenced by the AUM (assets under management)growth experienced by the larger managers. We expect capital to flow to the smaller managers as investors better understand the industry and available options and systems. Also, as comfort grows with large managers and the true value of a managed futures strategy is understood, more retail products will include managed futures to protect against black swan events and improve risk adjusted returns.
FM: What needs to happen for managed futures to truly become a mainstream investment?
BD: Managed futures needs to be easily available in a structure that does not overly burden the investor with fees and costs. This could happen by inclusion of managed futures funds on the platforms by the major investment banks.
FM: Why aren't we seeing managed futures being offered on the platforms of a lot of the major investment banks?
BD: What I see is [their attitude seemed to be] '2008 was unusually bad [for traditional investments] and we did awful and [managed futures] did great so let's not pay attention to them.' They are just not informed about them and they are hesitant to do something a little different despite the obvious evidence that it could be quite attractive.
MB: I can't say they've got their head in the sand because we are talking to one of the biggest ones in the world right now and may be making an announcement some time in the near futures, so they are looking. One of the big hurdles we run into has to do with the fees. We are not interested in going on a platform if they are charging an investor so many fees that the investor doesn't make any money. It is just now starting to get acceptable and it is from competition that platforms are lowering their fee structure to where it makes sense for an investor to invest that way. For mutual funds you have a bunch of big brokers out there that you have financial institutions telling their clients this is something you want, this is what you need. But they are not telling their clients that managed futures is something they want or something they need, which seems odd when you consider the non-correlation advantages of doing that allocation but they are not sold on it I guess because they are not educated.
FM: Over the years managers have become more risk averse. Fewer managers target huge returns with the drawdowns that go with that gearing but you have stuck to a pretty aggressive approach. Why?
BD: Again, DUNN's focus is on the investor, not on how to increase AUM. If I believe in our systems and I expect drawdowns, why would I change our approach when a drawdown occurs?
Our goals are aligned with those of our investors. We are compensated by incentive fees only. There are no management fees. So, there is no advantage or motivation to reduce our volatility just to increase AUM. We do not try to control overall volatility, but rather we focus on the probability of losing money. So, we target the left tail of the distribution of returns — not overall volatility — and we control the probability of losing a large amount of money over a short period of time. Our risk model targets a 1% chance of losing 20% or more in any rolling one month trading period. This has been the risk profile since DUNN's inception in 1974. We are not opposed to adjusting the risk target to accommodate an investor's request, but so far, no one has made that request.
We do a good job of making sure investors understand what to expect before they invest. So, our investors are more likely to stick with us through the tough times.
FM: You have been at this for nearly 40 years talk about the transition plan you have in place. Is this particularly important for a trading business, which is so linked to trading principals?
BD: The DUNN transition plan is long-term and immediate and was shared with our investors when implemented. It is long-term in that control of DUNN is transferred to my successor, DUNN president, Marty Bergin, over a 10 year period, although I will continue to be involved with DUNN indefinitely. And it is immediate in the sense, that in the unlikely event of an unfortunate accident, plans are in place for the continued and uninterrupted operations of DUNN by my successor, Marty, whom I have worked with for over 20 years.
A business succession plan should be less significant with systematic traders as the inputs and formulas do not include who is in charge. However, I can understand why this is an issue important to investors, especially for traders overly prone to tinker with their systems when there is a draw down, or where perhaps there is a concern where the new leadership will have a different perspective. Systematic trading is engrained in the DUNN culture, and our employees are heavily invested in DUNN funds, so it's unlikely DUNN would ever stray from its systematic, investor focused style. Nonetheless, this is an important issue to investors, so there is a DUNN business succession plan in place. I've asked Marty to address a few of your questions below dealing somewhat with some of the ongoing and future issues.
FM: DUNN has recently offered its WMA program through a UCITs structure. Why?
MB: The UCITS structure seems favored by European investors, and we were able to partner with ML Capital to structure a futures UCITS fund offering with much lower fees and costs than are normally associated with a platform. Even with the UCITS offering, DUNN still does not charge or collect a management fee. With a minimum investment of $150k, and procedures in place to ensure that individual investor are fully qualified, we feel comfortable with the UCITS platform and approach.
FM: Are U.S. based retail products the next step? If so will you need to change your risk profile?
MB: We do not plan to roll out a direct retail product other than our current funds that are available to accredited investors with a minimum investment of $100,000. We are, however, looking to partner with one or more financial institutions to offer some DUNN systems on their investment platforms, thereby making our trading systems accessible to their clients through in-house allocations. We don't anticipate the need to change our risk profile.
FM: Could you create these retail products on your own?
MB: DUNN would never enter the market of a mutual fund because we don't want to invest the money in the infrastructure. We like the fact that we are a leaner [operation], we don't have any administration people, we are just focused on what we do well and we want to keep doing that. To be involved in any product that is available to the general product would have to be through a partner.
When we are talking about being on a bank platform, it is not a 40 Act product. We haven't talked to any banks that are putting together a mutual fund. We are talking about [them] marketing us to their high net worth clientele.
FM: What is your opinion of the growing list of managed futures products being offered through the 40 Act structure?
MB: I think it is a good idea as investors can increase diversity, lower overall risk and thereby, increase risk adjusted returns. The idea that managed futures should not be available to the general public is wrong. Why shouldn't the average person be able to pick an investment strategy that targets risk and has the ability to generate profits in both bull and bear markets while controlling the down side? This would need to be a diversified product with a reduced volatility target. I'm not saying the average retail investor should open an account with DUNN, but, I do think DUNN has a place within a 40 Act structure.
FM: The futures industry has handled the failure of brokers without too much trouble in the past but may be facing one of its greatest crises in MF Global. First off, how serious of a problem is this?
BD: The MF Global situation is incredibly serious. We have always taken the position that our industry has little or no counter party risk. This appears to be no longer true.
FM: What is your opinion on what happened?
BD: I don't yet know exactly what happened.
FM: What would you like to see the industry do to gain back its confidence?
BD: The confidence factor will be greatly influenced by the ultimate resolution of the MF Global debacle. Hopefully the CME, or others involved in the MF Global collapse will make the investors whole. I would like the exchange to stand behind its member firm as it may have done before it went public. On a smaller scale, more traders will do what we do, which is not rely on one broker but trade through multiple brokers, and only retain the minimum required funds at the broker.
FM: We really have not heard any voice representing the managed futures space. Do CTAs need such a voice?
BD: There has been some vocal opposition raised in the bankruptcy proceeding on behalf of futures investors. Perhaps the CFTC will eventually take a strong stand on behalf of the investors. Time will tell. Historically, the managed futures space has lacked a strong, unified voice. Perhaps that is one of the reasons the general public seems largely uneducated on the benefits of managed futures. Perhaps now this will change and be a positive result of the MF Global situation.
BD: Somebody will emerge as representing the industry. The managers of the industry. That would include customers of futures products. We would not want to be up front in something like that. We are low key, that is why we are in Stewart and not New York or Chicago.
FM: Where do you see the managed futures industry heading in the next five to 10 years?
BD: Undoubtedly the MF Global debacle will result in further regulatory oversight of (probably) limited utility. This will likely eliminate many of the smaller traders who won't be able to keep up with compliance requirements. Over time, I think more of the general public will realize the importance of including managed futures as part of their portfolio and we will see greater market penetration on the retail investor side. Although, until the overall managed futures education process improves, investor allocations will continue to grow at a slow pace.
I like to think DUNN is going to become a larger player in the managed futures industry. The industry without a doubt will grow over the next five to 10 years. You can only look at the non-correlation and the positive performance and keep it down for so long. It can only improve.