Longtime fund-of-fund manager Marc Goodman says it is a matter of human nature. “We have found over time that even sophisticated investors who understand the logic of having a more volatile instrument that yields you higher rates of return and/or performs better when the rest of your portfolio is hurting, and have this great macro vision of their portfolio, when your component is down they revert back to being a micro thinker and say
‘I can’t live with the volatility,’” he says. “It is illogical but it is human nature and I have seen it in some sophisticated investors.”
Billington says that when he talks to allocators about Optimal and they hear about 50% and 75% drawdowns, “they throw up on themselves, but as soon as the conversation turns from their clients’ money to their own money, they get very interested.”
“At Covenant, we have a very good estimate of what our optimal level is. And we are trading a little beneath optimal level so we are getting the most return for each extra unit of risk we take,” Billington says, adding, “ If you attempt to do that yourself through notionalization, you don’t know what that amount is. You don’t know if you are risking too much or too little.”
He adds that if you are allocating $2 million to trade as $10 million, “You are going to pay a management fee on the nominal account size, not the notional. You are going to pay a management fee on the $10 million.”
Be not afraid
In the end Covenant is offering a program that has the potential to change people’s lives by taking a different view of investing.
“In my mind, managed futures needs to not be afraid to stand up and say for anybody interested in making money, ‘come look at us,’ because you can’t go down to the Mercedes dealership with a Sharpe ratio, you are going to need money,” he says, “There are lots of people who say, ‘I don’t care about making money, I have lots of money.’ And they are correct. But this is also the safest way to invest. You could put $3 million in the optimal program or you can put $30 million in the stock market. You have a hard time convincing me that that $3 million is a greater risk.”
Next month we will run our annual Top Traders of the Year feature but Covenant already is on the list for the third time. Not only did it earn strong returns in all its programs but it is offering a new way to think about investing and risk.
The Optimal program is not for everyone but it deserves a look. Investors owe it to themselves to examine Covenant’s research and perhaps not accept at face value the common investing wisdom of the day. Most alternative investment disclosures include a qualification that you should not put money at risk if you are not prepared to lose it. If the investment is a risk it should offer an appropriate upside.