Our next guest is a partner in a firm that has enjoyed 40+ years of trading success with a 35+ year continues track record of their WMA program.

The track record of the organization, DUNN Capital Management, is world-class. The legendary Bill Dunn offered partnership to our next guest and he replied, “I’m happy with where I am.” Bill’s response will make you laugh.

Please enjoy my conversation with, Marty Bergin.

In This Episode, You’ll Learn:

• The Story of DUNN Capital and the Evolution of the firm
• How Marty began working with the firm and how he became a partner
• The company culture of DUNN Capital and why it’s so important to their success
• An overview of the DUNN WMA program
• How the Value At Risk (VAR) approach separates DUNN Capital from other CTAs
• Why DUNN Capital manages all tasks in-house
• About the 40 year+ track record of DUNN Capital
• The big research upgrades taking place in 2006
• About the change to using two separate "Trend Following Models"
• About the adaptive risk profile (ARP)
• DUNN’s approach to diversification across sectors (for example; 23% in agriculture and 13% currency allocation)

Resources & Links Mentioned in this Episode:

• Learn about DUNN Capital’s methodologies and awards.
• Q&A with Bill Dunn

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

Learn more about DUNN Capital

IT’s TRUE 👀 – most CIO’s read 50+ books each year – get your FREE copy of the Ultimate Guide to the Best Investment Books ever written here.

And you can get a free copy of my latest book “The Many Flavors of Trend Following” here.

Learn more about the Trend Barometer here.

Send your questions to info@toptradersunplugged.com

And please share this episode with a like-minded friend and leave an honest rating & review on iTunes so more people can discover the podcast.

Niels

Welcome to another episode of Top Traders Unplugged. Thanks so much for tuning in today. I really do appreciate it. On today's show I'm talking to Marty Bergin, the President of DUNN Capital Management. DUNN Capital is one of the oldest and most successful systematic managers in the world, and Marty shares his insight on the evolution of DUNN, and talks about some of the key research discoveries that has let them stay on top of the CTA industry through the last four decades. For those of you who are new to the show, I just want to let you know that you can find all of the show notes including a full transcript of today's episode on the TOPTRADERSUNPLUGGED.COM website. Now let's get started with part one of my conversation. I hope you will enjoy it.

Niels

Marty, thank you so much for being with us today. I really appreciate it.

Marty

Thank you for having me.

Niels

Before we dive into today's small structured discussion, if you like, I just want to start out by saying that it's a really great honor for me to have you on today's pod cast. It's very rare, in today's world to find someone who, not only has been a pioneer in the investment management industry, but who has also been so successful as DUNN Capital has been, and even more so, to find someone who can say that they have done it over a 40 year period. And if I'm not mistaken, October this year actually marks the 40th anniversary of Bill's trading career, and the 30th anniversary of the WMA Program.

Marty

That's correct. I appreciate the compliment. Of course most of that is deserved due to Bill Dunn's efforts and I'm just here riding the coattails and trying to continue the success.

Niels

Marty

OK well, I think we only have an hour so, I'll try to give the reduced version.

Niels

You take as much time as you want. (laugh)

Marty

(laugh) Bill, after he got his degree...you know he served in the military, he was actually a boot camp instructor at one point, and once he got out of the military, he used his GI Bill to go back to school and get his graduate degree. When he graduated he went to work for the government and was working in the Washington DC area, and was what we would call a Beltway Bandit, in other words he was working for the defense industry. And he came to the realization that there had to be a better way of making a living. (laugh)

So, he knew that there was a way of looking at markets and using mathematical or statistical data to determine when to buy and when to sell. And his whole philosophy was based on price data. So originally he was looking at equities, and you have to remember, back in the '80s...or back in the '70s when he started this, you didn't have personal computers, you didn't have the computing power that you have today, and it became very clear that the population of equities was much too large to accumulate all the data, process the data and then act on the data within a brief time frame. So, at the time there were only about a dozen commodity contracts being traded, and he found futures and thought, well this is perfect.

So in the '70s he would actually sit down with punch cards, computer punch cards, he and his son Daniel who is employed with us today, would punch the cards, enter all the data, they would take it down to either the library, or they would rent time on a main frame, and they would run the cards through the system to come up with the prices that they were going to execute on the next given day. And we still have a set of the punch cards that were used in the mid '70s on our wall in our conference room. So it's kind of some nostalgia.

It's an interesting period of time, and throughout the years, the whole concept is that everything is 100% statistical. We don't use any fundamental data in decision making, and it's all purely based on price data, because there's no subjective knowledge in price data. Everybody knows what the price is. We trade in highly liquid markets, so the prices is being determined every minute of the day, and is very easy to value where your positions are at any given time.

Niels

And did Bill...starting out at the time where he started, did he know early on that he wanted to turn this into a business and not just a hobby, and I'm also curious about how you, and I know you have a completely different background, how you got curious about this and what you saw in Bill, and in DUNN Capital that obvious later made you join them.

Marty

Yeah. So when Bill started out the whole idea behind it was to make money for himself and other people. And he actually went to co-workers and friends and family to put together the first seed capital that was used for trading. Those investors, which are in their 70s, 80s now days, are still with us today. They joined in back then. They set up a little partnership, and started trading. At the time Bill didn't realize that anybody else was doing such things. If you think back in the '70s, it was before the regulatory bodies were even put in place.

Niels

I guess I can only think of Keith Campbell, around the same time, doing this.

Marty

There was, actually there was a few other players out there. One of Bill's very first clients was somebody that had found two or three people doing what Bill did, and they knew that what Bill was doing worked, but of course Bill didn't know if what he was doing worked. (laugh) And that was the first sizable investment that he got, and from that point on the rest is history. I think all along Bill's idea was to find some other way to make a living besides what he was doing. So I think he always planned on this being his future endeavor.

The way I got involved was, I'm a CPA by trade, and I was in northern Virginia working for a CPA firm that just one of the founding partners of the firm was Bill's next door neighbor, and helped Bill set up all of his accounting procedures for the partnership when he started trading. So that's how I got to know Bill. Of course at that point Bill had already relocated to Florida. I went and worked there, and the first audit engagement I was on was to audit funds for DUNN Capital Management.

Niels

When was this in time? I know you joined in '97, but when was this in time?

Marty

Oh, it was in the mid to late '80s. I was a green accountant with a couple of years of experience and I worked at that firm until I became a partner, and once I became a partner, Bill approached me during one summer, and asked if I'd be interested in joining the firm. My

comment to him was that I had a really good thing going, so I wasn't sure that that would really be the right move to make, and his response to me was that's fine, I'm not sure you can really handle it. (laugh)

Niels

And here we are today, the President of DUNN Capital.

Marty

Yeah, I came down to visit, of course I already knew all the players because I had been down many times, and it took me about 20 seconds to say yes. Mainly because of the quality of the people I'd be working with. That's the key to Bill's success, is that we've always been a small shop. We take a lot of time and effort in picking the pieces that make up the team, and they all have to fit together. Not just from an intellectual standpoint but also from a personality standpoint. So we have a great group of guys and gals. It's almost like a family. You work together as much as we do in such a tight knit group, you have to have the personalities that blend.

Niels

Yeah, absolutely. You kind of took my next question by going down that route, so I appreciate that. Could you tell me, if we look at DUNN Capital today before we jump to the next area I want to talk about. So today you run the WMA Program, could you just give us an overview of the aim you have in that program? I know you also do other things with that location, and other programs, but for today's conversation we are going to be focusing on the WMA Program.

Marty

Yeah, so we basically have to different versions of the WMA. The original WMA is geared to the risk profile that we've always targeted since the inception of the firm, which is a fairly high volatility, high return type program. What makes us a little different than I think most of the people in the industry is that we target VAR, we don't really target volatility, although, once you establish your VAR, you can kind of back into what the volatility is. When I say VAR it's basically a value at risk measure. We look at one month period, or 22 days of trading. When we first started Bill had set up the VAR as a 1% chance of losing 20% or more in any given month.

Now the reason we approached it that way is we didn't want to give up any of the upside profitability. A lot of people in this industry have reduced the volatility of their programs, but in doing so, they also reduce the upside profit. And by doing what we are doing, we can still maintain the upside profitability. We don't give that away even though we are able to reduce our drawdowns. So, it's been a significant change for us. It's only one number in the system, but I think, going forward, it's going to be significant in our returns.

The other program that we offer is just an institutional version of WMA, where we basically have 1/2 the VAR. This is the original system.

Niels

And how much do you run in this combined program?

Marty

Well, so in the high volatility program there's $300,000,000 allocated, a little bit more than that, and in the institutional product, which we only opened up to outside investment a few months ago, it's $100,000,000.

Niels

OK, fantastic. But as I said, I know you also do other things, so obviously the total for WMA is significantly higher than this. The next topic I want to briefly touch upon, which I think is important for people to understand is a little bit about how you've organized yourself as a company, because clearly things are changing in our industry, and technology allows companies to do some things in house, some things are done outside, how have you gone about doing that? Do you do everything in house today, or do you tend to outsource some of your functions?

Marty

So, we handle everything in house. Part of that is because it's the culture of the firm, the other part of it is we really haven't found any outside providers that we would have a comfort level with, that they would do things to the standards that we would expect. Now that makes it a little difficult sometimes because we are different than most firms. We do all our all administration. We do all our own accounting, we prepare our statements, we send everything out, we do all our own trading. In this world, today, where people are looking for third party administration...you know there's even talk now about having custodians holding the cash. I think it's a choice that people need to make. One of the things that we're able to do is things are much more timely. The investor can deal directly with us. They don't have to go to a third part to have anything done. The cost is significantly less because we don't pass through any cost to the investor to provide these services. They aren't that difficult.

When I hear the industry or the regulators talking about forcing firms to implement some of these procedures to protect the investor, it worries me a little bit, because what they're basically doing is talking the choice out of the investors hands. I think the regulators should be more focused on looking for the bad actors and handling that type of activity as opposed to putting restrictions on managers and how they do their business, which then creates a more costly environment for the investor. Our feeling has always been, as long as everything is disclosed to the investor, you let the investor make intelligent decision based on the information they have at hand.

Niels

Absolutely. Plus the fact that at the end of the day investors, they buy people, and if they don't trust the people they shouldn't invest with them in the first place. I guess a lot of this regulation and forcing people to use these external service providers, which in some cases are fine, but it does seem to concentrate a lot of the assets with a few service providers, and that in itself creates, perhaps, other problems that regulators haven't really thought about.

Marty

Well, first off there is no way we could foresee what was coming, that was for sure. I haven't found anybody that knows the future, and anybody that tells you they do they're lying to you. Basically our research grows out of knowing that nobody has a holy grail to trading. And that there are things that can be done, or we believe that there are things that can be done to improve what you are doing. And as technology has advanced it's given us the tools and the speed to do things that we weren't able to do back in the '70s, the '80s, the '90s. I also think, in DUNN's case, we became somewhat complacent.

Historically we were one of the top two CTAs in the world with assets under management and even performance, and we went stagnant. We didn't make a lot of changes to the system for a number of years, and I think we kind of got behind. In '06 we had the most significant change that we had done and that was where we moved from..oh geeze...it was kind of an overview of everything. We went back and just re-evaluated the way we approached the markets in total, and before '06 we looked at every market as an individual market, and we basically designed our system with a market by market basis. We determined our trading signals in each individual market, and then we put the whole portfolio together after the fact.

In '06 we took a totally different approach. We said, you know nobody cares about what happens in each individual market, all we care about is what happens to the portfolio as a whole. So we started looking at the markets from a portfolio as a whole basis, and we started designing the models for the whole portfolio. And therefore every market traded within the same model. And we even did it as far as our parameters selection process on a portfolio whole basis. That made the systems much more robust, and we also expanded from just the financial markets to all the commodities within the WMA program, because before that there wasn't the volume and you didn't have electronic markets, you didn't have the ability to trade real size in a lot of the commodities.

Niels

Marty

Well, we basically had three models for each market and they were contingency based, so we would determine before the next day what prices we would buy and sell at. And then if we hit that price, each model had its own price, we would either buy or sell during the day given those prices. After the changes we were trading upwards of 100 different models and what we did is we combined the models and just came up with a strength: either +1 or -1 of that market, and then we would trade on the open of each day. We already knew what we wanted based on the prior days activity.

Niels

Niels

Marty

Niels

Marty

Well, I think what you are referring to is when we switched to two Algo classes.

Niels

Sure.

Marty

Niels

Marty

Right, so that's what we called the adaptive risk profile. And what I was explaining before is now, instead of targeting the same VAR every single day and adjusting accordingly to that target, we now adjust the VAR that we're targeting every single day. Basically we're looking at the market volatilities and the correlations, that is what we're using to size positions, but when we look at the ARP, or adaptive risk profile, what we're looking at is whether it's a good environment for trend following or not, and the better the environment, the higher the targeting mechanism is the lower that we determine the trendiness of the market to be, the lower we adjust our target. And, as an example, currently we're trading at a VAR of about 14, and like I said, when we're at the top we're trading at a VAR of 20 and we should get there at about 5% of the time going forward. This would be a reduced trending market.

Niels

And that number, is that derived from looking at all the markets in the portfolio and measuring the trend strength by market and aggregating that into a number?

Marty

Yeah, basically we're looking at three things, we're looking at each market, whether it's determined that it's trending or not, and then the correlation of that to other markets and the volatility of that given market.

Niels

Marty

53 markets.

Niels

So that stayed relatively stable in the last..?

Marty

Yeah, we added the meats and we dropped OJ out, and basically we look for two different things...well three different things: we want a market that is traded on a regulated exchange; we're looking for markets that have high consistent volume over time; and we're looking for markets that are uncorrelated to what our current portfolio is. So if it can give us diversification, it can be traded with low risk, and the viability of being able to get out of the position when needed, if all three of those things are aligned, then we can add that market to the portfolio.

Niels

And the 53 markets, they cover then all sectors, so you are fully diversified, compared to many of the large managers where they seem to be more concentrated in financials, I guess you are fully diversified over all the sectors.

Marty

Oh yeah, so we have 23% allocation just in agricultures. We only have a 13% allocation to currencies, and I think the larger managers are forced to trade more and more in the currency market, because that's the biggest market in the world.

Niels

In a sense it goes back to the point that you were raising before where you were starting to talk about the last four or five years, and I would love to hear your opinion about it, and that is has the last four or five years been all about sector weights, meaning that the people who have been overweight in equities tend to have done much better than the people who were fully diversified. With you will maybe be the exception to that rule, because you are diversified and you have done well.

Marty

Niels

Yes, this is obviously the interesting bit, because a lot of people have kind of diverted away from trend following. When doing trend following, you said that you have two Algos groups, just again, ballpark, how are they different? Is there anything, for example, some people use moving averages as a way of identifying trends, some people use price breakout channels, is that the kind of difference from an overall design point of view, just looking at the Algos?

Marty

Well, so, let's just look at what happens and I can show you the difference in the two pretty clearly. The original Algo which was something Bill designed in the '70s, we still trade the original system. That system is always in the market. It's either long or it's short. It's never out. It's a full rehearsal program. The other Algo is an Algo that is either long, short, or flat. The second Algo also has a function in it that acts as a stop loss function, so that's really the difference between those two Algos. The entry and exit points their different, but you know everybody's is different.

Niels

Do the algorithms rely on a feed of intra-day data, or are they in the day data reliant?

Marty

We're purely looking at high, lows, and close.

Niels

And when you talked about position sizing, and adjustments and trend strength, determining how convinced the models are, how does that work? Because that implies that you would, maybe not every day, but you would adjust your positions once you're in a trade, that it's not a static position size.

Marty

Right, so at the end of every day, we determine what position we want to be in given the data. We look at the positions we are currently in, and then we have a small threshold so that we're not buying one lot, selling one lot, selling one lot, and we adjust every day.

Niels

Interesting. So you mentioned that you have the two models and in terms of other performance drivers in your system, would you say that time horizon or system design, meaning your Algos being very different from others. Is there any of that that plays a role in the performance, which clearly has been superior to many of your peers?

Marty

I'm convinced it's risk management and portfolio development. I find it hard to believe that the actual Algos in trend following are really that much different than what everybody else is doing. But I could be wrong.

Niels

I think that there are certainly a lot of things to be said about, if you can identify the markets that are trending, and getting a full position in those markets, at the same time not having a full position in the market in the stock in ranges, I do think that has a significant impact on performance, and that, in a sense, is very much sort of the holy grail of what we are all trying to do.

Marty

Yeah, the only thing is you have to be careful. I agree with you and I think the key there is...

Ending

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