Durable Trades Create Durable Business
Chesapeake Capital Corp. was founded in 1988 by Jerry Parker, one of the original "turtles" trained by Richard Dennis. The firm has a track record that is remarkable for its longevity but also for the fact that in 22 years of trading the flagship program had only two negative years-most recently in 2005, when it lost 0.69%. Last year, a very challenging one for trend followers and a losing year for managed futures as a whole, the Chesapeake program eked out a positive return.
This commodity trading advisor has a long-term orientation in several ways. Besides the lengthy track record, most of the executives have been with the firm for over a decade, some for almost two decades. The strategy is classic long-term trend following.
What makes for a durable CTA business? We present insights from Brian Broadway, who joined Chesapeake in 1995 and is chief financial officer and a principal, and Rick Rusin, chief operating officer, who moved from another CTA in 2008.
Chesapeake has close to $1 billion in assets.
Opalesque Futures Intelligence: Why do people care about the length of a track record?
Brian Broadway: A long track record means that you've been through numerous market cycles. Our team has traded through crises, bubbles and crashes, so we understand how to negotiate those events successfully. And there is not much turnover in the organization. Our head of trading has been here for 18 years and head of research for 19 years. We have experience working with each other and are good friends. When a team has worked together that long, communication is easy.
OFI: How do new hires fit in?
Rick Rusin: When we're hiring, in addition to assessing skills we spend a lot of time interviewing to make sure a new hire is a cultural fit with the organization, because the culture of the company is very precious and somebody who does not get along could reduce our productivity. We have plenty of possibilities. Richmond is not a CTA hotbed but we're known in the industry and have a good reputation, so we get a lot of unsolicited resumes, many from people living in Chicago or New York. Richmond offers a high quality of life, especially for families with children.
BB: Stability and commitment in leadership is what drives the organization forward. With a stable management team that understands the nuances of what the firm does, we can train new people.
OFI: Please describe the strategy.
BB: We're a systematic long-term trend-follower trading in a broad set of markets. This is all we do, a pure strategy-no short term systems, no mean reversion. There aren't many CTAs like us. Bigger firms tend to have other strategies besides long-term trend-following.
OFI: What are the pros and cons of your strategy?
BB: We focus strongly on capital preservation and aim to make positive returns every year. Trading long-term offers the best opportunity to achieve this goal. Drawdowns along the way are part of a robust long-term trend-following system, because you will have drawdowns in the midst of a greater trend. When we put a trade on, we let it run till the system indicates there is no more trend. This is a characteristic of our style of trading and we want clients to know that.
RR: The trend in the CTA industry is to use shorter and shorter term trading strategies, to go to higher frequency trading. Many CTAs that were not previously short term or high frequency are migrating in that direction. Chesapeake is the only firm I know of that is going is opposite direction. Our trades are longer term than in the past. So we're going against the herd. Because our strategy is long term, it does not have the technological, slippage and commission issues high frequency trading has.
OFI: Does that mean you don't need new trading technologies?
RR: You have to assess computer capabilities constantly in any technology-driven business, although our trading needs are not as critical as a high-frequency trader's. It is a race to keep up with technology and decide how to take advantage of it. We have to always ask whether a product can make the strategy work better. But once you assess a new technology, you may decide that you don't need it.
OFI: When you say long term, how long do trades last?
BB: Winning trades can go on for over a year but losing trades tend to be a lot shorter. If a trade does not begin to display the trending behavior we expect, then hard stops kick in and we're out quickly. About half the trades don't make money but the losses are small thanks to the stops. The distribution of returns from our trades shows a fat tail to the right (positive) side, meaning a lot of our profit comes from a few trades. This is a basic characteristic of trend following: You let your winners run, fully develop over time, and cut your losses.
OFI: How did the strategy do last year?
BB: We made money in 2009, unlike many trend followers. The difference is that we trade the whole range of commodities, including commodities like coffee or cocoa that big CTAs often do not trade. This commitment to market diversification and the purity of the strategy we apply across markets distinguish our approach. Our risk exposure is 50% financials and 50% commodities. In 2009, if you did not trade some of the commodities you did not perform as well.
OFI: Would this strategy continue to work as the assets grow beyond the $1 billion mark?
BB: Our assets under management was over 1.7 billion in June 2007, before we got hit by the ATM syndrome like everybody else. We had good performance at the peak AUM. Given the liquidity of the markets we trade and the long-term nature of our strategy, none of us sees an issue if we double or triple assets in next six to 12 months.
OFI: Can the business operations handle asset growth?
BB: We've made a huge commitment and built institution-quality infrastructure that would cause no issues if our assets doubled tomorrow. Also, our relationships with service providers allows seamless growth. We have a third-party administrator, NAV Consulting, to do independent daily NAV calculations and reconciliations, in addition to our own back office. We would not have to add to the infrastructure.
RR: It is not that dissimilar to growth in any business. There are periods when assets can increase a lot without changing operations at all because capacity was built in to accept more money. That's the case with us now. On the other hand, if the number of clients increases, we may need more people to take care of customers and make sure their accounts are handled properly.
OFI: What are the challenges?
RR: The challenges are political-all the many regulatory changes that are now under discussion could cause changes in the CTA business model, particularly for CTAs that manage private funds. Depending on what happens in Washington, we could end up with dual regulators, each with their own different requirements! We're monitoring that closely.