FM: Do you think that there is too much emphasis on certain risk measures like Sharpe ratio and Value-at-risk? Has the pendulum swung too far toward risk aversion?
SD: There is a lot more risk aversion but I don’t pay attention to those risk measures. I know what the Sharpe ratio is but if you asked me to explain it right now, I couldn’t. I don’t use things like that. If something is going wrong, I want to know why it is going wrong. If something is not adding up I need to get out. Sometimes I may like my position but need to get out or lighten up whether I want to or not. No matter what you are talking about, risk is a top priority.
The [allocators] don’t want you making 50% because if you are good enough to make 50% you can have a bad year and lose that much also, which scares them to death.
FM: You traded in an era where Commodity Corp. would drop you if you averaged less than 15% over three years; now people are targeting less. Is it a hard transition?
SD: It is not hard to get used to because it is a self -imposed risk control. Whether some fund is risk- averse or not, I still have my own rules as far as limiting exposure to losses in the market.
FM: When you launched your new CTA in 2004, it was mainly to take advantage of money flows created by the growth in investments into long-only commodity indexes. Are the opportunities still there to take advantage of these money flows?
SD: Not so much anymore. Once somebody figures it out then it doesn’t work anymore. It worked pretty good for a couple of years then everyone figured it out. Because of a new paradigm, today I am not doing much of that. For example, five years ago the lead month always would go to full carry to the next month as you approached first notice day. Now look at May corn trading 30¢ over July. We have such a demand structure for ag commodities, led primarily by China, that those rules don’t work anymore. We have a different demand structure in the market, which wants and demands the lead option; we have relatively low inventories of grain available; and that big monster China is lurking in the background ready to buy anything, whether it is foodstuffs or raw materials. So, the idea of the lead option always being cheapest because of fund roll just doesn’t work anymore.
FM: When you started this there weren’t as many folks trying to get in front of the roll. Has it become a more difficult trade? Are spreads moving toward full carry much earlier or not at all?
SD: In some cases not at all. At one time, the full carry used to happen just before first notice day. That moved back into the middle of the month or during the Goldman roll, which was the fifth to ninth business day of the [preceding] month. And now if it is detectable at all, it’s maybe before that. It might be the first of the month a full month before first delivery day. Everyone is continuously trying to get ahead of the crowd and by the time you get to the point that you expect a big roll, it already has been done and there is nothing left there anymore.
FM: Does this create greater risk?
SD: It takes away the possibility of a bear spread working at all. Thinking that way can be expensive. I don’t anticipate that roll [much anymore].