Mesirow & the Art of Controlling Drawdowns
The father-and-son team of Tom C. Willis and Tom R. Willis, co-managers of the Mesirow Financial Commodities Absolute Return Strategy, have compiled a remarkable track record of risk-adjusted return. Their maximum drawdown is around 2%. That is orders of magnitude lower than other CTAs'. The Mesirow fund has a high Sharpe ratio (more than two) and has been profitable almost 75% of the months, according to data from Attain Capital.
Here, co-portfolio manager Tom R. Willis discusses the mindset behind this defensive global macro strategy. The Willis team joined Mesirow Financial several years ago and this appears to have worked well out for all concerned, as Mr. Willis and Aaron Ochstein, Mesirow senior vice president for client management, explain.
"It's a different environment, where huge pools of money can overwhelm buyers and sellers on any given day. We factor that in."
Opalesque Futures Intelligence: Why did you join Mesirow Financial?
Tom R Willis: It's a great fit for both sides. Mesirow's customers wanted commodity exposure, so the firm decided to enter into this space. Prior to Mesirow, my father and I had a commodity trading advisor business called Willis Trading Group. He's been trading since 1971 and is one of pioneers of the CTA space. My father and I wanted to be part of a group that could bring us the institutional investors that seemed to be beyond our reach. That was one advantage of joining Mesirow. The other real benefit is that Mesirow takes care of many functions; from IT to compliance to human resources. With our discretionary strategy, we need to concentrate on trading. Mesirow allows us to do that.
OFI: How does commodities trading fit into Mesirow Financial?
Aaron Ochstein: Mesirow Financial has very deep expertise in investment management, specifically in alternatives. The firm manages more than $40 billion; of that about $36 billion is in alternative assets, ranging from commodities to private equity. The largest group is currency management with roughly $20 billion. We're one of largest currency players in the world. Mesirow has also been in the fund of hedge funds business for a very long time and has about $13 billion in funds of funds. Four years ago Mesirow decided it would be good to have commodity products for clients who want that.
OFI: What led Mesirow to the Willis team?
AO: We're a conservative firm and wanted to ensure any product we offered had the return and risk characteristics we like. Gary Klopfenstein, who heads the Mesirow currency division, knew Tom Willis Sr. for many years and was familiar with the trading strategy. It met Mesirow's requirements.
OFI: What's distinctive about the Mesirow absolute return strategy?
TRW: Our program is a way to get exposure to commodities while removing a lot of the volatility that people worry about. We strive to eliminate many of the ways the market can hurt you. We generally risk only 25 to 30 basis points on any one trade and look to be nimble and get in and out of the market without causing ripples or much slippage. That puts a cap on the amount of assets we can manage in this program. We've known that from the start and have been working to develop other programs.
OFI: How much money can this strategy take?
AO: Our commodities group currently manages close to $1 billion. The absolute return strategy has been very successful but has limited capacity. This fund will probably be closed when it grows to $1.2 billion or $1.3 billion. We have other strategies in place and expect to launch other programs in the near future.
OFI: Which markets does the absolute return program trade?
TRW: Our strategy is global macro with a focus on commodities. We trade seven sectors. About 75% of profit and loss comes from traditional commodity sectors, in particular grains, energies and metals. The other 25% comes from financial futures, evenly split between futures and options on fixed income and equities. We have a small currency exposure, less than 5%.
OFI: What's the thinking behind the trading?
TRW: We try to identify themes that are driving the market-we analyze economic data, look for general market consensus, study individual market and sector fundamentals. We seek to understand how prices relate to events and the themes driving the market. Once we feel we're clear about what's going on, we determine the best way to take advantage of a theme.
OFI: Are you a trend follower?
TRW: No. We are directional, that is a similarity. But there are fundamental differences. One is how we look at winning trades vs. losing trades. Trend followers expose themselves to moving markets a lot and have a high percentage of losing trades. They make a profit from two or three winning trades that overcome the many losing trades. They might on average have winning trades only 30% or 40% of the time, but the big winners overcome the losing trades. The down side of that approach is that you can have significant drawdowns.
OFI: How do you differ?
TRW: We come to the market from a completely different angle. Rather than go for a high percentage of losing trades and a few big winners, we try to find a high percentage of winning trades. The result is generally lots of small winners - we constantly aim to grab 75 to 100 basis points a trade. Since inception, close to 60% of our trades are winners. We don't stay in the market for a significant time - we're exposed only two to seven days on average. If a trade is unsuccessful, it may be closed within the same day. This is a defensive approach. Our priority is to not allow the market to erode our capital. Preserving capital provides a huge edge over the long term.
OFI: Do you use models?
TRW: Our other major difference from trend followers is that they're systematic while we're discretionary. But we do have price models to assist us in determining market trends, models to assist in determining entry points and models to determine risk. These all help in deciding trades. But there is no specific model generating signals that tell us what to do. This is a top-to-bottom discretionary strategy. It relies on our understanding of how the models relate to the price action we see and our interpretation of how the models fit together.
OFI: Does a discretionary strategy require more expertise than a systematic one?
TRW: Strategies are so differentiated in managed futures that you need skilled managers whether the strategy is discretionary or systematic. Skill drives returns. There is no substitute for understanding of price. This is not something one can replicate, a skilled manager has to put the time in the trenches and live through market cycles. That's what we have done and we will continue to apply our skills to products we develop, targeting similar risk-adjusted returns.
OFI: Have markets become crowded?
TRW: No question that over the past 10 years money flow into commodities accelerated tremendously. Our strategy takes advantage of capital flows. Money flow is a new fundamental variable and in some ways the most important fundamental. It overwhelms price. If a manager doesn't have that as a filter in their strategy, they will have a difficult time. It's a different environment, where huge pools of money can overwhelm buyers and sellers on any given day. When something happens that raises fears, everybody runs in the same direction and gets in each other's way, which creates big volatility counter to the direction of the trend. We factor that in. That's why we're exposed to markets for only short periods. Once we identify a spot where we think we can make money, we structure a trade that will allow us to profit very quickly so we can then begin to reduce our exposure. We feel that the longer we are in the market, the more likely we'll get hit by a massive move against the trend.
OFI: Are there other changes in the environment?
TRW: Markets have become very correlated. Generally over the past three or four years we've seen a single theme pushing all markets up or down, whether the theme is inflation, deflation, stronger dollar, weaker dollar, weaker or stronger equity markets; one force pushes a market and other sectors react to it. Rather than expose ourselves to the same idea across seven sectors and 25 to 30 markets, we feel that we have found the best way to take advantage of the environment; we identify the market that is leading the others in one direction and create a concentrated position around that. At any time on average we only carry two positions.
OFI: What's the advantage of being discretionary?
TRW: We managed to avoid a lot of landmines in the last year and a half. Being discretionary and the way we constructed our strategy helped. Money going into long-only commodities is causing sharp price movements. The market is not as cut-and-dry as it used to be. It is dynamic and as managers we need to be dynamic so we can position ourselves properly for the next evolution of price.
OFI: Why did managed futures disappoint in 2009 and in part of 2010?
TRW: It's been a challenging environment. There are the two camps; one worried about deflation and lack of economic growth, the other about government stimulus becoming inflationary down the road. Markets went back and forth between these views for a while because of all the uncertainty. The mishmash of information causes choppiness. Once there is consistent data as to whether we face inflation or deflation, investors will have more confidence.
OFI: Were there other reasons for market choppiness?
TRW: Another major problem is that investors have become very skittish because of what happened in 2008. The result is less committed capital in the markets. Money flows are inconsistent, leading to choppy markets. It's not just the issue of concentrated pools of capital, the bigger issue is that money moves around a lot more than it used to. But we are confident that we have created a defensive strategy and that's one of the primary reasons we've been positive this far in what has been a difficult 2010.
OFI: How did you make money in recent months?
TRW: There is always a divergence between markets that are tied to economic growth versus those that are driven by sector fundamentals. The equity market, equity futures, energy, industrial metals are related to growth. They're demand driven. In August and September, we played crude oil and copper on the short side. By contrast, grain has its own fundamentals, like the bad harvest in Russia. We played grain on the long side.
OFI: What do you see happening in the near future?
TRW: We see volatility becoming a little more predictable as we move further from 2008 and investors get more comfortable. That will lead to greater opportunity within this space.
"We have other strategies in place and expect to launch other programs in the near future."