Katy Kaminski and I continue our conversation with Marty Bergin, and discuss his philosophy behind DUNN Capital’s success, and why many investors don’t understand trend following strategies. In this episode, we will discuss what investors and trend followers should be focusing on, and what risks excessive regulation may lead to for the industry.

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In This Episode, You’ll Learn:

• How DUNN views it’s expansion into more markets
• Why their NO management fee policy has helped DUNN throughout the years
• How DUNN will adapt to the ever changing market environment
• What investors have a hard time understanding about trend followers
• Marty’s goal over the next ten years
• What Marty fears most in his work at DUNN
• The most important question investors should be asking themselves right now
• Why Marty believes trend following strategies should be more widely available
• Marty’s advice to young investors and aspiring trend followers

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Follow Niels on Twitter, LinkedIn, YouTube or via the TTU website.

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Learn more about DUNN: www.dunncapital.com

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Niels

Now, DUNN is known as a pure trend follower, so to speak, but in your opinion is there a limit, at some point, as to how much juice (for lack of a better word) that you can squeeze out of the market as a trend follower, and do you need to look at other things in order to keep up with the quant mega shops that seem to be doing everything from high frequency to machine learning? What are your thoughts on that?

Marty

Well, so we do look at, basically, anything that comes across our plate. We’ve looked at machine learning. We’ve looked at short-term trading. I’ve been interested in the short term space for years and we keep looking, we keep trying.

I talk about the adaptive nature of our parameters. Well the parameters never choose the short term - just never does. It’s just not profitable for any period of time. There are a couple shops out there that are doing something in the short term space that have done well and consistently well - probably one or two of them. But, for most people, they can make money for a little while and then it just evaporates and the system doesn’t work anymore, and they’re around for five to ten years and then they disappear.

I really feel if you can… The one missing piece in our program is short-term timeframe. If I could find something that worked in the short term time frame, as trend following component, I would love to add it to the program in some way.

We are trading volatility now, which is new for us. We started trading VIX several years ago in the WMA program as a relative value trade, not trend following but very simplistic. We’re basically short VIX most of the time.

We bought a firm that had a volatility trading system and we hired that gentleman to join DUNN. I had been looking for years and years at volatility and trying to find people that were trading volatility. My concern was that most aspects are just the short side of the volatility trade, which everybody made money over the last five years on the short side of volatility. I didn’t want to have… We could do that.

I wanted somebody that was doing something different in volatility but making money. What we’re doing now, and we’re starting to implement this into the WMA so this will replace our current volatility program, is that we’re trading volatility of volatility. So we’re trading the skew…

Niels

The fear of fear.

Marty

…the change, the curve in volatility and with the idea that when volatility does spike that should be a positive for us. Yet, we’re still making money on the short side of the volatility trade. So, you’ll hear more about that.

The machine learning things, it’s a very capital intensive business. It’s hard to compete with the big guys and the same with high-frequency trading. It’s almost impossible, I mean, we can’t compete with the big guys in that type of environment. Yeah, there are other things that we’re looking at and we’re exploring.

We were one of the first people that traded a neural net program, years ago. It worked pretty well. What we found was that you have to retrain the brain, on a regular basis, and the gentleman that had developed the system for us, sadly, he passed away and there was some expertise that was required to do the retaining process and we didn’t have that expertise, so we closed the system down and haven’t traded it since.

Katy

So, going on the same vein here, you’re talking about VIX, you’re talking about vol, what’s your view on markets? I know that’s been sort of the biggest buzz word. I have three hundred markets, or I trade, or how many markets do you have? What’s your view about the expansion into more and more markets and how does DUNN think about this problem?

Marty

Alright, so, DUNN allocates all its risk equally to each market. So, we allocate the maximum risk allowable to each market equally. Then we don’t borrow risk from one market and give it to another or anything like that.

So, from our perspective, adding a market, all that it does is change your mix of markets. So, if you thought sectors were important, which I don’t, but a lot of the people in the industry do, so you add all the currency pairs, and you add anything and everything, all you’re doing is changing the mix of your portfolio and are those markets giving you any value?

So, we only add a market that we feel gives us a value from a correlation standpoint. If there’s a market that’s trading, that’s on a regulated exchange and has enough volume that it is easily traded. If it’s uncorrelated to the other markets in our portfolio, and we don’t look at just the markets in the sector, we look at all the markets, then it’s an advantage, for us, to add that to the portfolio.

Now, we’re not going to add markets just for the sake of adding them. I think that for a lot of people, that trade a lot of markets, it’s purely an AUM issue because they can raise capacity if they can spread the trades over more and more markets. I don’t know how they can trade three hundred markets. I don’t even see how people trade one hundred markets. We trade fifty-four, we’re looking at going to fifty-seven, maybe fifty-eight.

Katy

So, no bitcoin? Just kidding. (laughter) That was just a joke.

Marty

It’s funny you say that because I wouldn’t be opposed to trading it, but I’m not going to trade it right now. (laughter) I’d never say never.

Niels

Yeah.

Katy

OK.

Marty

I don’t see… First off there’s not a real market there. The margin requirements are absolutely ridiculous. I think you have to be three times the notional level of the currency you’re trading. Why would you want to do that? What are you going to do, borrow money to trade it? Our leverage is… we aren’t paying interest (laughter). We’re receiving interest on our leverage. That’s one of the nice things about the industry we’re in.

Niels

I just want to jump around a little bit and ask maybe something that you might not be asked that many times and that is, when you think about the business side of things, there is definitely a tendency that some of the people in this space are becoming very institutionalized. They’re either being bought by bigger institutions or part-owned by bigger institutions.

Marty

Well, they’re publicly traded, some of them, right?

Niels

They are, yeah.

Marty

They actually present public financials.

Niels

So, what do you think is the advantage or disadvantage of being your own privately owned company, where you decide, versus having access to these larger institutions and the resources that they have? Have you ever thought about that? Because clearly the institutional investors they find comfort, let’s face it, they find comfort in the big numbers, right? The fifty PhDs, the two hundred people, etc., etc. So, I just want to hear your view on that institutionalization, even on the manager side.

Marty

Clearly, smaller gives you more flexibility. I think the other thing is that the institutional investors need to look in the mirror and ask themselves a couple of questions. If you’re a huge firm, what’s your priority? Your priority is to the shareholders, and the investors, and the owners. It’s not with the investor, it’s not with the person who is using your expertise, it’s the investor that invested in the firm that they care about. They don’t care about the guy who is buying their product.

If I’m on the other end of that equation, that bothers me. The big houses make more money off the management fee than they ever will off of the incentive fee. They know that, and that’s… their overhead is huge. They’ve got to have that consistent flow of capital. The reality is, is that true? Probably not.

If the owners of that firm took all the money they made, over the years, and kept that available to put back into the firm during bad years, they could easily do it. That was Bill’s philosophy.

Think about it, DUNN went five years without collecting fees. Who paid the bills? Bill DUNN did. He didn’t have to do that, but he thought that was the proper thing to do. Also, with the idea of long-term, he’s reaping the benefits of that today because twenty percent of the AUM we manage is our own proprietary AUM. Who do you think… Most of that money, the proprietary money, is Bill’s.

So, the growth of his capital far outweighs the fees that he’s made over the years. It’s phenomenal because you’ve seen our returns. My feeling is we should be able to double people’s money every five years. That’s the goal. Well, if you take the incentive fee out of that, we don’t charge ourselves a fee, think about that growth. It’s compounded. Compounding is a wonderful thing.

Niels

One of the eight wonders of the world, as Warren Buffet says.

Marty

It’s absolutely true. All of our employees, I would say most of them, invest the lion’s share of their investable assets with DUNN. Why wouldn’t they? It makes perfect sense.

Katy

So, given that, what are some of the things that you think are important to adapt to the changes in this environment? I know you’ve moved into the 40X space over the last few years. What are some of the things, as a smaller manager, that’s more of your own business? What are some of the things that you are doing to adapt to this? What do you see are the changes that are going to be necessary to be made, going forward?

Marty

Well, so the 40 Act has been a huge deal for us. The USIT fund in Europe has been a huge deal for us. They’ve both done probably better than I would have expected especially given the tough environment. The one thing is I would like to have more control over things. When you partner with people you basically are giving up control of that aspect of the business. All that I do is trade, which actually, I prefer.

I don’t have to worry about all the other things, but I’d like to have a little more control over how it operates because my name is attached to it. So, it’s our reputation and the 40 Act and the USITs and those products, they all have a management fee. There are expenses that have to be paid, that as much as I find it distasteful, there’s no way around it.

The one thing I am really happy with is the people we’ve found to partner with in those spaces because we have been offered many times to trade for people in each of those spaces over the years, but they were never what I considered or Bill considered to be client-centric type vehicles. The people we did end up partnering with, they really do it the right way. They keep the cost to a minimum for the investor.

Katy

So, you’d say some of the adapting is really learning how to find the right ways to partner with others and develop the right products?

Marty

Yeah, it’s finding the right partners because, if I was bigger firm and had AUM, we’d go out and do our own. But, we don’t have that capability so you have to find the right people to partner with. It took a lot of years and luckily we didn’t have any false steps which damaged our reputation.

You think about it, it’s taken forty plus years to develop the reputation that DUNN has. It’s on my watch now to make sure that reputation stays positive. That’s a lot of responsibility because it takes five to ten minutes to destroy the reputation.

Niels

Yeah.

You talked about the educational side and the focus that we have on education. What do you find that investors have the hardest thing… What’s the hardest thing for them to understand about what we do, and where do we need to, not just as a firm, but maybe as an industry, where do we need to focus?

Marty

Yeah, it’s everything. The bottom line is that what we do is not like anything they’ve ever been exposed to in their lives - the lumpiness of our returns. It’s the only investment, I would say, in most people’s portfolio, that has this… You can’t time trend following. The reason is because, when it happens, the trends come in. If you wait until you see the trend, you’re too late to the game and you’ve missed the opportunity.

So you have to be there during thick and thin, during the good times and the bad times, in order to take advantage of those good times. Evidence has shown us, historically, that trend followers, or at least DUNN, has always gotten to new highs, always gotten to new highs.

There’s never been a point of time where we’ve just started going down and continued to go down. There’s always a new high-water mark. So, if you stay the course, you’re going to participate in those new high-water marks.

The fact that we trade a higher volatility gives people the opportunity not only to perform as well as equities but even better than equities over the period of time, but it also allows people to allocate less money to get the same bang for their buck because if you’re trading at a very low volatility, you have to allocate such a large portion of your NAV to get the value of the uncorrelated nature of our strategy.

The fact that we have a higher volatility allows you to allocate less. We always talk to people about allocating a percentage of their risk, not a percentage of their AUM. We advocate twenty to twenty-five percent of their overall risk which, in most cases, is less than twenty or twenty-five percent of their AUM, which people like to hear that.

The problem is that people who allocate too little, they get involved in the strategy, but when they need it the most it doesn’t provide them any benefit because they don’t have enough risk allocated to that type of strategy.

Niels

The other thing that’s interesting, I think, is that a lot of investors… And they don’t realize that this goes with equity investments as much as it does with these types of investments. I think this was from a book that I read from Tony Robbins, actually, where he had gone back and looked at, if you had been invested in equities for the last twenty years, your average return was something like eight percent, but if you took out the best ten days only, of those twenty years, it almost halfs. It’s the same thing with trend following, if you take a long-term trend following track record over many years, if you take out the best ten months, I ‘m sure you’re going to see a somewhat similar picture in terms of the outcome.

Marty

Yeah.

Niels

I think that also… That’s something that people find hard to understand that the benefit for them is to make an investment and then don’t think about it for the next ten, twenty, thirty years. That mindset… Because in today’s world, with the internet, everything is instant, the whole time horizon in our lives has become very short. With the public… With investments in general, whether there’s quarterly reporting, there’s monthly reporting, people even look at daily returns and get excited about it, but it’s not very important in the big picture.

I don’t know about you, Katy, you’ve been around for a long time. What are the challenges you see?

Katy

I think trend following works when things happen. These are usually things that we don’t expect and it’s more interesting when things happen that we don’t expect, what so ever, like oil going to a different level than we would have every expected, stock markets losing as much as they did in ’08. It’s precisely these really challenging, unexpected environments that trend really catches something, some inefficiencies, some movement in the markets.

If you think you’re going to determine when those are. People tell me that all the time and I’m sure Marty has heard it a thousand times or maybe a million. If you try and time when things are going to happen that you don’t expect it’s going to be challenging for you.

Marty

If people expect it, it wouldn’t happen.

Katy

Exactly.

Marty

Because they would have been prepared for it and it would have been a very gradual change. They call it unexpected for a reason.

Niels

You’re the co-author of your own book with Alex. Knowing what you don’t know is really, really important as an investor and accepting that you just don’t know what the future holds.

Marty

So, my goal, over the next ten years, is to get people to understand that trend following should be the core investment in their portfolio and then they can use everything else to build around it. Boy, is that a concept.

Niels

That’s great.

Marty

There probably aren’t many people that look at it that way, but that’s the way I view it.

Niels

Sure.

Katy

Why not invest in everything: every asset class, and every move, that’s no reason not to capture multiple risk premia instead of one or two.

Marty

And as diverse, and the number of uncorrelated markets that are traded within a systematic trend-following strategy is so much farther advanced than ninety percent of the other financial products out there.

Niels

Yeah. Add liquidity, add transparency, there are a lot of good things…

Marty

There’s a lot of positive.

Niels

There’s a lot of positive, yet people have… Certainly, it’s been a challenge for a lot of people to accept it.

Katy

I know what I want to ask. This is maybe me being a little risk averse here, but what are the things that you’re afraid of? It’s always fun for me to hear what would you think is a black swan or a tail risk, something that we would worry about in our industry. What keeps you up at night?

Marty

Regulation, the regulator.

Niels

Yeah.

Marty

When I first, basically, took over the day to day operations of DUNN, we allocated one person, maybe eight to ten hours a month to compliance. I now have two people working full time in compliance and another one that’s part-time in compliance. It’s absolutely ridiculous the amount of compliance that we’re put through and I would say it has absolutely no value.

It has no value to the industry; it has no value to the public. It’s just a way for government people to say they’re doing something. It’s not going to stop the bad actors. Bad actors will still commit fraud because they’re not going to fill out the paperwork honestly. They’re not going to report things honestly.

I wish they would spend more time responding to complaints and less time doing what I consider busywork.

Niels

I think on top of that also, we come across that in our work day to day in part of our education, even in a conversation like this we have to be very careful not to overstate the benefits. We have to always say this is a risky investment and you can lose a lot of money etc., etc., which is true. But, at the same time you see other people selling other investment related products, financial newsletters using headlines of “Make X-thousand percent on bitcoin,” and what have you, and they kind of get away with these things.

In a sense, regulation can be damaging to the industry in many ways. It can also be damaging to our ability to educate if we are so restricted as to what we’re allowed to say. So, it goes on many different fronts. But, it’s interesting and we, obviously, have to adapt to how it has to be done and stay away from those areas.

Marty

Yeah, wouldn’t be a nicer environment if you were allowed to basically say what you think is honestly true and then the regulator’s job would be to come in and say, “You said that you could do this and you didn’t do it, so you have done a bad thing.” If you put outlandish guarantees out there and you don’t perform then you should be punished for that.

Niels

Sure, but even talking about what you have actually delivered, and you have the proof for, you’re not allowed to.

Marty

Well, you can do it; you just have to point out every negative thing that has ever happened.

Niels

Sure, right, absolutely.

Marty

Fair and balanced, is that what they call it?

Niels

Something like that, something like that.

Marty

They should take a look at their portfolio and see if it’s out of whack. I suspect that most people are very, very overweighted in equities. Not only because of performance but because they are actually are starting to chase the tail of the dog - getting out of the poor performers and putting more money in play at equity levels. The reality is they should be doing exactly the opposite.

I’m not saying that this is the year that you’re going to see something bad happen in equities because to tell you the truth I’m not one of these people that thinks everything is so overvalued. When I look at the political environment and I look at the tax environment, and I look at deregulation and things of that nature, it makes sense to me that equities are going up. Of course, I don’t rely on my opinion because I’m wrong more often than I’m right.

But, it’s like anything else, these equity markets will break, and the longer it runs it means the more damage is going to be done on the other end. There’s going to be a lot of people that are going to say, “Oh, how could this happen?”

Niels

Yet, a lot of what’s happening is that investors are being pushed into more risky investments.

Marty

Oh sure.

Niels

Which is the tragedy of this, if and when it happens.

Marty

The idea that you can get better dividend returns than you can in bond markets. It forces people to make hard decision and, whether they understand the risk or not, this is where they need to be to get the returns that they were hoping to get.

The managed futures industry hasn’t helped itself because it struggled over this period of time too. It seems like the only game in town has been equities.

Niels

And bitcoin. (laugh)

Niels

Katy

I think when everybody thinks that something is going to happen that’s when I get nervous because I think if they think that something is going to happen then it never does. Usually when we become complacent, and we say, “Well, it’s not going to happen now, it will be fine.” That’s when something happens.

The problem is things can change on a dime and underlying systemic risk can be there that we didn’t understand until after the fact. So, find my perspective, having trend following is really a way of, not hedging, but having a strategy in your portfolio that likes divergence, that likes change, that is meant to adapt to a new environment.

Marty

Right. You know, it’s funny because we’re all coming at it from the perspective of data. Ninety percent of the investors don’t understand… To everybody at this table, this makes such perfect sense because all the data shows it’s true, but people don’t understand data.

That’s OK, we just keep educating and we keep doing things like this and people keep listening. The message is getting out there. Look at the growth in the industry. Look at the growth for DUNN. I haven’t looked at the numbers, but our AUM has gone up significantly over the last five years. Our AUM has consistently gone up year, after year, after year, and it’s not just growth of capital.

Katy

It’s new people too, isn’t it, new investors?

Marty

New people, new types of people and that’s exciting.

Niels

And, adding to that, is that frankly, we’re not the ones who grow from a large ticket from a pension fund, so it’s actually many people joining in, which is, obviously, a good thing, because it means, as you say, that the message or the audience is becoming…

Marty

Now that we have daily liquidity products we are seeing, on average, two hundred thousand dollars every day of new money flowing into DUNN. That’s net new money. Then that excludes the big tickets that come to the door. That’s just average people that are putting money in the program.

My, and I’ve said this in the past, but it really bothers me that strategies like this are not available to Mom and Pop in the average public. The fact that you’ve got to have a lot of money, that you have to be an accredited investor to have access to this type of strategy, is mind-boggling to me.

You hit on it earlier: transparency, liquidity. This is a product that was made for the mutual fund market. Everything that we hold can be traded in twenty-four hours. We could liquidate the whole portfolio in twenty-four hours. There’s nothing that we’re doing that isn’t being done on a regulated exchange. There’s no over the counter transactions, there’s no private equity, there’s no real estate. There’s ETFs out there, today, are invested in real estate. Who is valuing that on a daily basis? Give me a break. Good luck liquidating that portfolio.

Niels

Right. It is great that so many more people are able to participate and, as you said, we’ve certainly seen that, as have our peers. That’s the good thing. The mutual fund space, even though there still may be things that you would like to see improved about it so that people could get even cheaper access, but that’s been a big growth in that area. As in Europe, there’s been a big growth in the USIT space which again, makes it easier for people to participate.

Marty

Yeah, maybe the regulators, over time, will start accepting this type of strategy as not being scary to them and see the advantage of it and start allowing for further investment - for instance allowing, in the 40X space, to invest directly in the softs and some of the commodity products that you can’t get access to today without going through a Swap.

Niels

Which only adds more cost and complexity.

Katy

And complexity.

Marty

It adds more cost and people write negative things about Swaps are scary, you know. People have to understand that the only reason that we do these things is to get access to markets that aren’t available under normal routine, and you want to have access to those diverse markets. It gives you more opportunity to make money and actually programs with Swaps are better for the investor than the programs without Swaps.

Katy

From investors who have only stocks and bonds, you want to be able to give them access to everything that they don’t have.

Marty

Absolutely, and the restrictive nature now is you can only directly invest in financial futures which is equities, and bonds, and currencies, which they already have exposure to.

Katy

So Marty, one final thought, if you had something to impart to a rising star or an investor in our space, what would you have to say about the managed futures industry?

Marty

I guess that I’m excited because I’m excited that it seems like we’re hitting our stride. We’re just getting to that point where it’s accepted. More and more people seem to be excited about the space.

When you’re given how much of a struggle it has been over the last several years, that’s kind of amazing because this would be the point in time, normally, when everybody says managed futures is dead, trend following is dead, it will never happen again, and yet that’s not the conversation that we’re having. So, I’m really excited about the fact that we seem to have that little bit of foothold and we’re starting to move forward and the onus is on us, as an industry, to keep that going through the education and keep preaching the message.

I think the other thing that is troublesome is that it seems like all the money is going to the big people and I really wish the second tier, and maybe even the third tier managers could… There could be a way for them to get capital to invest, that people would give them the opportunity to trade for them.

I don’t know how that’s going to work. I look at these smaller managers as an opportunity to find talent, but it’s becoming harder and harder. Most of these guys, the truth is that they’re not going to survive because the big allocators are going to continue going to the big houses.

I’m going see, as a second tier manager, having an AUM of less than two billion, I’m going to start seeing inflows because the performance attracts attention, and we’re big enough that people are comfortable to allocate.

But the people that are below us, it’s going to be a real struggle for them. I just hope something happens, industry-wide, that allows them to have more access to capital.

It just came to me what my second point was related to earlier in the broadcast, and that was retail investors and RIAs, related to 40 Act, the other thing is volatility they don’t understand. I kind of approached this later in our conversation, actually, but the fact that it’s always been thought of as volatility is a bad thing. The higher the volatility the more risk, the more concern people had.

But, we’re slowly getting the message out there that the higher volatility that’s offered by DUNN allows them to allocate less money to get the same bang for their buck. Therefore it helps their portfolio by allocating to something with a high volatility like we are; it lowers their overall volatility in their portfolio because of the no correlation aspect. So, they can allocate a third of the amount of money that they might have to allocate to somebody else who trades at a low volatility.

That’s one of the misconceptions that people have had. It hasn’t been very difficult for them to get to understand that, and when they do it’s like the light bulb goes off and they instantly think, if I’m going to allocate to this space I want to allocate to you because it's more cost effective.

Niels

Great, great, well, on that note let’s wrap up this fascinating conversation recorded live here, in Miami. Marty, thank you so much for being on the podcast and for sharing your thoughts and experiences with Katy and me. It is so important to have practitioners, like you, share these ideas because when ideas become conversations that lead to action, that’s when real change happens.

To our listeners around the world, let me finish by saying I hope you got a lot of value from today’s conversation and if you enjoyed this as much as Katy did in making it, I hope that you will share these episodes with your friends and colleagues so that the conversation can continue.

From me, Niels Kaastrup-Larsen and Katy Kaminski, thanks for listening and we look forward to being back with you on the next episode of Top Traders Unplugged. In the meantime, go check out all of the amazing free resources that you can find on the website.

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