During the last two decades, as managed futures have attempted to move from a niche investment product to a mainstream one, the space has changed — and not necessarily for the better. Aided by a distribution and sales network that rewarded low volatility and convergent strategies, and one that produced better Sharpe ratios as opposed to absolute returns, managed futures has been pushed to justify its inherent volatility that is more due to its divergent nature than underlying risk.
Scot Billington, co-founder of Covenant Capital Management [along with partner Brince Wilford] has reversed the process and decided to embrace the early tradition of managed futures by targeting outsized returns. And they’re not apologizing for it.
In February 2014 Covenant launched its Optimal trading program, which mirrors it original program, launched in 1999 and its aggressive program, launched in 2004 but at several times the gearing: 4X the original and 3X the aggressive. In just under a year the Optimal program delivered with an eye popping return of 226.67% (see “Hitting a grand slam,” below).
Covenant’s core strategy is a diversified long-term trend-following approach, which has earned a compound annual return of 19.84% in its aggressive program since Feb. 2004 with a worst drawdown of 20.41%.
“The underlying philosophy of the Optimal program is that the industry has been institutionalized,” says Billington. “Most of the money allocated, whether alternative- or equity-based investments, are done through fiduciaries whether they are institutional pooling, pensions or brokers, and these fiduciaries have a different set of goals than somebody whose money they are managing. In a quest to reduce volatility, which theoretically reduces risk, you have seen a squeezing of profits and volatility that doesn’t necessarily reduce risk.”
The key term there is “theoretically,” as numerous low volatility strategies have produced higher losses than theorized without the ability snap back with high double-digit (or even triple-digit) returns.
The idea came to Billington after asking an institutional fund manager about access to very aggressive programs. The manager had none to offer, which he saw as odd. “What is the point of investing? It is to profit; and to profit a lot,” Billington says. But outside of private equity there were no vehicles. “Where is the program attempting to make me a lot?” he asked.
He looked around and saw it didn’t exist, which looked like a vacuum to Covenant. After all, it is the way most managers trade their own money. “Why am I not offering this to other people? With that you are going to have a product that is very unique,” Billington says, adding, “There is going to have to be some education around that. We have to get out of the mindset of percentage drawdown and think more about dollar drawdowns. Because with a super high return program, the key advantage is I can get the same punch, the same potential long-term return for far less of an initial investment.”