Trading the S&P from a 3D perspective
Eric Dugan was taught to work hard from an early age, which led him to not turn down opportunities regardless of the position or the hours. This habit allowed him to snag a tremendous opportunity at an early age.
“My entire career I worked. My Dad is a former marine who instilled a strong work ethic,” Dugan says. “The reward of a job well-done is to have done it. He always made sure I was working. It didn’t matter what it was: picking tomatoes in the field [or] working at the Meadowlands sweeping parking lots from midnight to 4 o’clock the next afternoon. I worked crazy hours, and I worked all the time.”
So when a friend of his — knowing his penchant for crazy hours — called with an opportunity working on an overnight trading desk, he jumped at the opportunity. “I interviewed and was offered the position as an execution trader on the Pacific Rim desk for Monroe Trout,” Dugan says. “I Loved it and never looked back.”
Dugan had studied finance at the University of Rhode Island and already had an interest in trading. He loved the competitive environment of the trading room. “Physically, psychologically and mentally, you had to be able to bring your A-game every day,” he says. “Although we traded a system, you still had to be in the right frame of mind.”
Within a year he was named Pacific Rim session manager responsible for all trading decisions made between
5 p.m. and 3 a.m. He made sure all of the traders were placing trades according to the rules of the system and would go over each trade with Trout every night. He was the only trader given discretionary authority.
Dugan worked out of Trout’s Bermuda trading desk for most of his time there and after seven years he was getting a little tired of the hours and of living on the small island. He would go on to trade a year on the European desk (2 a.m. to 10 a.m.), which allowed him to learn the forex markets. But he was ready to move on and took a job at another fund. “I left in 1999 and joined global macro discretionary fund Willowbridge. It was very different than what we were doing with Monroe,” he says.
While at Willowbridge, he ran their short-term systems and helped develop systems. After a difficult period in 2006-07, Dugan decided to launch his own fund. “I went out on my own and in 2008 I had an ‘aha!” moment,’” Dugan says. “[I realized] I can accurately predict when the S&P 500 is going down on a daily basis. I literally said to myself — it sounds kind of ridiculous — I can save the world, [if] I can build a product [that] accurately predicts when the market is going down.”
The idea was a long-only equity product where he would simply get out of a trade when he saw a short signal. “I am just going to get out — why step in the way of a train?”
He launched a passive long-only system and it worked. “In 2008, I was up 3%, the stock market dropped just under 50% [at the peak sell-off], 38% on the year.”
Feedback was good though some folks did not believe it. They asked, Dugan “Why not get short?” This led Dugan to launch the Defender program in 2011. It was basically the same passive systematic approach, but when his system indicated weakness, he would go short instead of simply getting out.
It has averaged nearly 5% a year in the biggest bull market of all time. “We have been profitable 70% of the time the S&P has been down in a month,” he says, adding, “This during the greatest bull market in history.”
The Defender program was down 1.68% in 2017 and has earned an average annual return of 4.9% since launching. The system uses mean reversion, pattern recognition and short-term trends. “We would love to make money in a rising market, but when you have the lowest amount of volatility in the history of the market and a Sharpe ratio greater than ever in its history, [I am not displeased] to be unchanged on the year,” he says. “That is one of the reasons I launched the capture program in 2014, which is a daily trend-following program that is meant to capture moves in either direction.”
In 2014, Dugan added the Capture program, which is also global macro but attempts to capture more of the equity market upside. It earned 1.5% in 2017.
Tom O’Donnell is a managed futures and equity market veteran who jumped at the chance of working with Dugan after seeing the product. “I was just blown away when I looked at the live track record of Defender,” O’Donnell says. “I don’t know of any other manager trading just the S&P who has shorted this bull market and made money. I know a lot of managers long the market, but how many of them have shorted the market during this bull run and made money?”
Dugan wanted a product that works in all volatility environments. The Defender is a global macro multi-strategy approach that is more defensive, looking for weakness in the stock market.
“The Capture program is a global macro daily trend following program,” he says. “We are very happy to be able to pull out 1.5% with no overnight risk in the strongest market in history with the lowest amount of volatility. Both of 3D’s programs are expected to perform even better in higher market volatility.”
3D has developed systems that exploit correlations in the global markets. “That is a great part about being with Monroe and working those hours,” Dugan says. “All these equity managers are sleeping. They don’t have the edge that 3D has. I spent the better part of my career, working overnight, having a deep understanding of what is moving the markets.”
You don’t often consider a program that trades just one market completely systematically as global macro, but for Dugan it makes perfect sense.
“By global macro I mean using the entire global [marketplace] to make systematic decisions on the S&P 500,” Dugan says. “We are not discretionary but [if by] global macro you are talking about fundamentals, everything is translated through price and time; whether it is a GDP number, a housing number or a Fed decision.”
Dugan views global macro as using all the markets in the world, which he learned from working on the Asian desk for Trout. “When people say we are not diversified, we say that we are trading the most important market in the world; the one where everybody has the most risk,” Dugan says. “We are diversified. We are not correlated to the stock market. We are not correlated to the managed futures benchmarks or even hedge funds. We are using more than 20 different instruments as global inputs to generate our signal. We are using euroyen, aussieyen, gasoil, bonds and bunds; multiple asset classes over multiple times zones are being used to identify opportunities in the S&P 500.”
Working on the Pacific Rim desk for so long allowed Dugan to see all the factors outside the United States affecting trade. “It starts in the Pacific Rim; it is a three-legged race. If you look at the largest down days, or up days, a lot of them start overnight. The world is one big, dynamic, macro global flow chart, everything is connected. And more now than ever before,” Dugan says.
While 3D looks across global markets to find its systematic inputs, its focus on the S&P 500 makes it more accessible to investors. “Managed futures has been a tough sell. 3D only trades the E-mini S&P 500, which is the most accepted investment,” O’Donnell says. “I don’t know of any investors who don’t have exposure to the U.S. equity market. If we take it on face value that the S&P 500 is already an approved investment, if I was still at the Virginia Retirement System, I would be looking at 3D as an alternative active equity manager or an equity overlay, not necessarily a CTA. The risk that is being managed is clearly equity market risk.”
The lessons Dugan learned from Trout include not only a global outlook, but the discipline to stick with your system and to not miss any opportunities. “The persistent implementation of a system is non-negotiable,” Dugan says. “You follow a statistically significant pattern that is logical, that is persistent, that is symmetrical (it has to work on the long side and the short side). What I learned from Monroe is you can’t just sell the market because it is raining today. We had a hurricane coming in and people wanted to get out of the stock market, it doesn’t make sense. There has to be a logical reason why.”
Perhaps most important is to follow your rules. “Your system means nothing if you don’t follow the rules,” Dugan says. “A lot of [traders] think it is an easy concept, just do what the system says, but people have feelings on which way the market is going to go; to those people I say go start your feeling fund somewhere else, that is not what we do here; we follow rules and we follow the system signals. That was non-negotiable with Monroe.”
In addition to following the rules, with systematic trading you can’t miss any opportunities. “Monroe told me, ‘Eric, there may be nothing going on in the world, but you better believe that if you are in right field and you have gone through 82/3 innings without a ball being hit to you, you better be prepared to have your glove up because the last pitch of the game you could have a line drive screaming at your head, and you better be ready.” That was said to me 25 years ago and I have never forgotten it,” Dugan says.