Today we rejoin the conversation with Martin Estlander the Founder and CEO of Estlander & Partners. If you missed the first part, feel free to listen to it here.

In this episode we explore the evolution of the CTA industry, the skills required to run a successful business and finally the fun, less known facts of Martin’s life outside of trading.

Welcome to the second part of our conversations with Martin Estlander.

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In This Episode, You’ll Learn:

• The best rule of thumb to visualize risk in a traditional CTA portfolio
• What Martin has learned from being in drawdowns and the difference between drawdowns before and after 2009
• The effect of volatility in the markets and how this impact CTA performance
• How Martin Estlander manages the emotional roller coaster
• Research processes and research cycles at Estlander & Partners
• How to identify and address systems that were working but now aren’t
• The biggest challenge for Estlander & Partners going forward
• What are investors not asking that they should be asking when choosing a CTA
• Where the misunderstandings can happen for investors when trying to understand the CTA industry
• How to become better at communicating with investors
• Martin’s key traits to success in the CTA industry
• Personal habits that have contributed to the success of Martin Estlander
• How Martin manages failures and improves from them
• The things Martin would do differently if he started over today

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Resources & Links Mentioned in this Episode:

• Learn about Commodities Corporation, the company behind some of the all-time great traders

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Niels

Another topic I wanted to touch upon is risk management, and, I wanted to start by asking you a little bit about how you define risk? What does risk really mean to you, and then how do you go about dealing with it and managing the risk in terms of whatever target you have?

Martin

Yeah, sure, I think the risk management approach that we run is sort of divided into two pieces. And it all dates back to when we were trading options in the beginning and we had real liquidity and we were by the exchange to make markets in all series. From time to time, we had to take on much bigger positions than what was sensible for our little equity pile, and that led to a philosophy where we're really looking at everything from the worst case scenario. We were continuously making sure that we could survive to the next trading day, and that we didn't put on more risk than we were comfortable in holding, and that means both market risk and also operational risk. So you have to be extremely careful with how you operate, and how you make sure that you have backups and integrity checks for everything that you do so that you don't fail operationally. So that's something that our risk manager looks at continuously, during the day, that all the aspects of the process are running smoothly.

Then from a market risk perspective, the way we approach trading is really from managing the left tail of the distribution. The idea, I guess, is that if you have a future distribution of returns, which has a mean which is the volatility of the returns, that distribution also has a left tail, and the classical way of managing to volatility means that you have to make an assumption on the distribution to get a picture of the left tail. In our case we sort of switch it around and we just focus on the left tail, and we let the shape of the distribution, or the design of the distribution determine what the outcome volatility is, so our volatility is very small, and the left tail management is what we focus on. So, for each position, and for the portfolio as a whole, we run extensive simulations of possible future price moves in each and every individual instrument to figure out the worst case scenario, and then we sum up all the worst case scenarios for our positions, and that defines our worst case outcome. We are assuming that when the shit really hits the fan, then we will lose on every single position that we need to control for that event. That's sort of the risk - we call it the Achilles risk, the Achilles heel.

Niels

Martin

Niels

And to the investors, now-a-days, Martin, with all of your experience, what's the best way for investors to look at risk in a traditional CTA? Is there anything they can do in order to visualize risk, meaning, is there a rule of thumb that you would use when you look at a track record, where you would say, "hmmm, it has such and such volatility, so you should expect such and such worst drawdown." Is there anything that you found that gives people a good rule of thumb in that sense?

Martin

Well, I would probably advise people to analyze it from the perspective of which periods, or months, maybe, those that are quite different from other managers and sort of representatives of their particular style and then try to really understand why these are different. So, that's something I would focus on. When it comes to the whole operation, and the business, I would also look into how stable the organization is expected to be and where people find the inspiration to work: how driven they are by money, and how driven they are by other factors, and I think that this is something that is really underestimated today, I think this will be more and more important going forward, when people analyze managers and try to understand the dynamics.

Niels

Sure, I think that is definitely something I'd love to go a little bit deeper with you on in a few minutes, because I think you have a very clear view on these things that one may not come across that often in our industry. Just as a final point on the risk management, is it possible to say, or to give a number, not a specific number, but a ballpark number in terms of how much risk you actually take on in any one opportunity? Is there a kind of a range where you would say, "that's actually how "little" we risk in any one opportunity?

Martin

Well, I think, an average man might risk like 50 basis points on a trade.

Niels

Martin

This is the biggest difference from the past, when you analyze everything from this perspective, it doesn't look all that strange, and, in fact, the drawdown has been, believe it or not, a lot lower than what would have expected in this environment. Probably pointing to the fact that managers have become better and better at managing risk and managing drawdowns.

Niels

So if we just stay with this theme for just a little bit, and now, maybe, you and I have not been in the industry long enough to have experienced this before, but clearly it would have happened before, if we go back even more decades, but knowing what we know today, do you think there is something that you have found, during this time, that the next time it happens would put you in a stronger position to maybe even profit from an environment like this, or is it just one of those things that these kind of strategies just can't do well in?

Martin

I'm sure that there is a lot that has to be learned during this one, if nothing else, I would advise investors to balance the volatility exposure, based on the environment. In a situation where volatility is really high and it's going to come down, obviously there are short volatility strategies, but many investors don't really want to touch those, but blending in some of that would certainly help out. And then it's hard to beat a long win in that environment like that, so being more on the stable long term, long side in risk assets is also a good way of coping with a situation like that.

But, if you look more at our particular strategy, which is really mint and will remain, sort of pure in its profile, I guess, if this is such a huge increase in volatility and then it's deep in falling volatility, then we will either need to change our approach, which I doubt we will do too much, but certainly we will make some adjustments, so that the situation like this will be smoother next time. Whether we will see it during the next 20 years or not, I don't know, but it's not unlikely, the previous similar event was in '74 and it was 40 years ago.

Niels

Well let's hope, Martin, that we will have that conversation in 20 years’ time, even if we have a few more gray hairs.

Martin

(laugh) See if we have any hair.

Niels

(laugh) Any hair indeed. Now, you talked a little bit about it early on in our conversation, namely the emotional roller coaster that we all go through during times of drawdowns, not just because of performance, but it could also be the pressure that we see from investors etcetera. Tell me a little bit about how you balance that. I know you touched upon it a little bit, because I think that is one of those things that will be really helpful for people, both on the investor side, but also for people who are, maybe somewhat early in their career, and maybe they are going through their first really long drawdown, at this stage, so just talk to me a little bit about what you found over the years, that tends to work for you to not be discouraged by these situations.

Martin

Well yeah, the risk is that the answer will be a very, very long one, but I will really try to cut it down and shorten it I would certainly stress a few things, the first being that of really understanding what the drivers are in the business. It is important to have a clear picture of what it is that the strategy is doing; what drives the strategy, and then relate what is going on to the actual environment. Based on that, judge whether you are doing a good job, or whether you are delivering what you promised to your investors, or whether your manager is delivering what he is supposed to deliver, if you are an investor, and really mirror it against what is really going on and what you expect. If you have that well defined, and (you are) clearly sticking to your plan - clearly sticking to your game plan, and doing what you are supposed to do, and you can now argue that to everybody: to yourself, to your partners or employees, your clients, your investors, then, at least for me, that makes life a whole lot easier.

I guess we humans, what typically causes the most emotional pain has to do with some sort of being afraid, and the more you understand what you are doing and the more you are disciplined in what you are doing, the less you have to be afraid of, what's going to happen, what the future is going to bring. Just stick to your plan and be very clear, very transparent in what you are trying to achieve and what it is you are doing. I think that, at least for us, that's been extremely helpful with the communication, with the investors. If you do a good job on that, then you can actually gain a lot of confidence from both your investors and your partners and your employees, and you can strengthen your case.

So, understanding what you're trying to accomplish, and sticking to your plan is really important. Then, on a more personal level, again, where emotions play a big part in our daily lives, in every decision that we make, every thought we have, it's important to separate the emotion from the rational thinking, and if you can keep those two separate, I'm not saying that it's easy, but that's certainly something that one can practice. And if one can keep those apart, then it's so much easier to deal with it as well, and it really reduces both stress and concern and maybe even makes it easier to see things as they really are and make judgments based on that. So I think that's sort of the two main parts - a bit philosophical but that's how I view it.

Niels

No. I think it is important to get this, and to get a little bit deeper, because these are the things that, you know, maybe a lot of people are not asking when they come to see you because maybe they are asking you these questions, but I think what you are saying, and I think this is an important point, is that being a rule based, or systematic trader actually also fits very well into what you are saying, because it allows you to, maybe in an easier way, to separate the emotional side from the pragmatic, disciplined implementation of the investment strategy, and maybe, at the end of the day, this is why we still see firms in this particular industry having been around for more than 30, 40 years and still going strong.

Martin

Yeah, I fully agree. I fully agree.

Niels

Now on a more positive side: research, that's always a fun topic. I would love to hear a little bit about how you go about research, what's a typical research cycle, if there is such a thing? What does it look like? And, what you are looking for in your reviews, because, I guess, investors want you to innovate and do research all the time, on the other hand, not all investors like change, so how do you balance that?

Martin

The research process, certainly, is continuous, but it's not as innovative every day as some of the other days, it varies, but basically it's continuous all the time and it's extremely important to do that. When it comes to our approach we really take the view that we only research phenomena and drivers that we understand from fundamental or philosophical perspective, and, although we have a lot of very, very talented, very strong academicians on the team: PHDs in the different areas, we do not do a lot of quantitative number crunching. We are more driving our research based on phenomenon and drivers that they see in the market place, and we think we have a clear understanding of why we could make money, or why they would be beneficial for the portfolio. We do use strong, quantitative methodologies to implement them and test them, and do everything that we can just to avoid over fitting of the models.

Niels

Sure, and speaking about surprises, but I think, generally, also it falls under research, how do you notice if something that's already inside the model stops working, or at least stops working the way you expected it to work, kind of a yellow or red flag? That's a difficult thing, certainly in my experience, how do you go about that, or maybe you haven't had to deal with it in many instances?

Martin

Well certainly, we've had red flags flash, and we've had to take action. It's hard to give a general answer to that, because so many of the components and pieces are quite different from each other. I guess it has to do with having a clear understanding of what it is that one is trying to achieve, and whether the premise for that are still in place. If that changes then one needs to take action. Say we had one short term strategy in one particular market that did extremely well for a while, and we increased the risk to that and then we had to really monitor the slippage and the profile of those trades, and at some point it turned out that we had become a bit too big in that market for that type of strategy, and the market had learned what we were doing and profitability really dropped quickly and we had to take very quick action to reduce exposure to that particular model. The shorter you go, in your trading, the shorter the half-life of the models. The longer the models, I guess the easier it is to see them as robust, and not having to react to them.

Niels

Now, I would like to leave the subject of the technical side, so-to-speak, and move to just a couple of other areas in our discussion. One of the areas is looking at the business side or the industry as a whole, and I wanted to ask you something that has recently come to my own attention, talking to some of your peers who have been around for quite a long time, and that is succession planning. Some of the people that I have had on, have been already going through their business succession plan, such as DUNN Capital, for example, and Sunrise Capital Partners, is this something that you've started to think about, having spent more than 20 years doing this, or is that not something that is quite on your radar just now?

Martin

Well, it's been a target for quite some time, to make myself completely useless at the office (laugh), or unnecessary is probably more to the point. I have seven really great partners and they can run the business without me. The way we are structured today is that I have a CEO that runs the business, and a COO that runs the operations and the financial side, Risk Manager, Portfolio Managers, and really, I'm just trying to help out where I can and bring some inspiration and lead the team to some extent, help out with the research and ideas. My role is more that of helping out, rather than leading and driving, at this stage, so we've worked with this already for a long time and it's doing really, really well. Some of the other guys, they are so much more efficient, and they are so much more capable, and I don't want to stand in their way, and try to do things that they do. So, it's been very natural. If I wouldn't go into the office next week, they would hardly notice.

Niels

Now, we've touched upon, a couple of times, during this conversation about the industry as a whole, and the change in environment, which has certainly put some stress on the CTA industry. What's the biggest challenge for your firm now, do you think. Where do you see the biggest, I wouldn't say struggles, but what's the biggest challenge in a situation like this?

Martin

Well, I think certainly the fact that the drawdown has been long and investors are turning away from the strategy, I guess that's a big challenge. It will change, it's just a matter of when. From a running the business perspective, it's just to make sure that we run the business according to the environment and are exposed according to this. So that we'll certainly be as fit as possible when it turns around and investors will again turn back.

Another thing that is quite noticeable is the fact that investors, in particular the largest investors, they listen to the consultants and the consultants they seem to have a quite short list of managers that they favor, and they only favor the really big names, and so there is a big consolidation going on right now. But we see that cycle already changing, a lot of investors are starting to look for diversifying strategies and other approaches. And notice that some of the managers get quite large and that it's good to find other names that they can build into their portfolio, but that certainly has been the trend as we know, strong consolidation and the consultants increased all of the consultants when there are new big investors coming into the markets have been driving this development. I think that's another chance, but it's natural. It happens in any business, and we just have to adapt to that and live with it, and make sure that we can be in the waiting and show that we can add value to the investors. I think that will work out in the long run.

Niels

Speaking about investors and, maybe investor types, during your career you've been in hundreds of due diligence meetings and conversations, what do you find, that investors are not asking you, that they should be asking in doing there due diligence?

Martin

Certainly, the sources of inspiration for the team, how the organization is finding its innovation energy, and how it sticks together, and what role does the corporate culture play. A lot of the due diligence meetings have been so technical and focused around things that are quite obvious and evident. Today's technology and today's structures and regulations, they are quite stable in most cases. Very few people understand the more corporate culture piece of the equation which I think is very important. I would certainly put that as number one in terms of where the questions are going to go in the future.

Niels

And what do you find that investors have the most difficulty in understanding regarding these kinds of strategies, because, as you say, clearly they ask a lot of technical questions, but do they really understand the answers they get, do you think?

Martin

I think there are quite a few investors who have a struggle with their actual drivers of the strategy, which is natural. It's not easy to grasp it, and these strategies are, in many ways, not intuitive. On the contrary, their a bit counter intuitive in how they work and when they work. That makes it difficult for investors to grasp. It's so much easier to listen to the story about why a company's cheap and why it's valuable and why won't you buy a particular stock, or won't you sell a stock. From a fundamental perspective, that's so much easier to understand than trying to look into their drivers of the relationship between shorter term volatility and longer term volatility, and how that expands, and how that is being diverted, and other physical parameters around that. So, I think that is something that investors are struggling with. You know, it's all up to us, how we can communicate it. We need to become better and better at being able to educate and illustrate what we are trying to say so that they understand it. So, one should definitely not blame the investors. One should just look in the mirror and make sure that one can improve on that part as well.

Niels

Yeah, and I think it's partly what I want to achieve with doing these pod casts, because I think that, in many respects, when we sit down and we have these meetings, most if not all of the conversation is all about how we do things and what we do in the first place, but actually, one question that I've never been asked is why you do it. And I think that actually that's probably the most important question, and it goes a little bit towards your point about culture, drivers, vision, and so if people don't understand why we do what we do, it's perhaps difficult to understand what and how.

Martin

Yeah, very good point Niels. I think you're doing a great job with these pod casts and I'm sure that some of the interviews that you are going to make are going to be extremely helpful for listeners and for investors, and maybe for managers as well.

Niels

Let's certainly hope so. Last topic that I wanted to touch upon before we finish or the last section is what I call "general and fun", which is something a little away from the typical questions that people might ask. Which is basically just tapping into your experience, and that is, in your view, what does it really take to become a good trader or in your case CTA, what are the key traits that you need to have in order to succeed?

Martin

Well, that's a very, very good question and a very important one to think about for everybody. I think it goes, not just for trading, it goes for anything, and that is that you really have to have passion for what you are doing. You really have to enjoy it, and if you do that, whatever it is that you do, then you'll get good at it. But you won't get good at it unless you really work hard and, in most cases, it really takes hard work, and you can accomplish that hard work with the energy that you get from passion, from being passionate about what you do.

I think that's the most important thing for anybody starting out in the business, or being in the business - every day ask yourself, is this what you really want to do, versus something that you do because somebody else thinks it's cool, or it's great, or you maybe do it because you want to make money and even that could be dangerous, because you could easily lose your drive for making money: either you don't want to make money any more, or maybe you've made enough money, or whatever. I think it takes something more than just a willingness to make money. One really has to be fascinated about the financial markets, and the fact that it's a new day every day, and that there's new excitement every day, and you can never solve the problem about trading completely, you can always find a good approximation with your strategies, and always improve.

Niels

Sure. Now, I have a feeling that I know the answer to this question, but I'm going to ask it anyway; is there any personal habit that you have, that you believe has contributed to your success?

Martin

Oh Niels (laugh), I guess one has to be stubborn and persistent, and like to work hard.

Niels

I would have guessed you would have said your meditation, actually.

Martin

(laugh) Yeah, well, that came on a bit latter. I've only been involved with that for 7 or 8 years. As for me, it's helped a lot. Again, the drivers in the market is our human mind, and the way we design our systematic strategies are, in a way, it's as you've already said yourself, to take out the emotional part of it so that you can be systematic, and you can rely on your game plan not on your emotions, then you have an advantage, and that goes with everything.

Niels

Now, you've been around for a long time, Martin, and so there's been ups, successes, victories, but I'm sure there's also been times where you would say you failed, maybe you didn't use that word, but where things didn't pan out exactly as you hoped or planned, what's been your biggest (and I use the word) failure; where do you think you failed along the road and what did you learn from it, because failure, I think, is probably often the things we learn the most from?

Martin

Yeah, of course, you're right, you're right. Obviously I've failed many times and there were many things that could have been done better, but one thing to learn is to always analyze whatever happened and try to improve and then make sure that when you've taken that out of it you just leave it behind and go forward, and look forward, and try to do it better next time. It's hard to pull out any particular concrete example, because it's hard to put it in its right context in a short period of time, but clearly, dealing with your failures is one of the most important things in any business, and learning from them and just going on, and keeping your eyes on the horizon and looking forward, and make sure you don't do the same mistake twice.

Niels

Absolutely. Martin, did you always know that you wanted to be an entrepreneur. You seem to have been an entrepreneur since the very beginning of your career. Was that always something you knew?

Martin

(laugh) No, I can't say so, no. I never had a normal job, that's for sure. I'm not sure I'd be fitting in a big organization either, so, no, I didn't know that. Clearly my family has been entrepreneurs, and there are a lot of entrepreneurs around me, so it's been very, very natural for me. You know, I enjoy it. One of the best things about being an entrepreneur is that you can choose the people that you work with and they are such an important piece of life, and you spend such a lot of time at the office and working, so if you can have great people around you then that's really important, and I've been extremely fortunate on that part, and without the team, and without the great friendship and all the inspiration and energy you get from the people that you work with, you wouldn't last too long.

It's one of the most important pieces of the business is to build the team in a proper way and find the right individuals and then try to jointly find the inspiration for what you do and make sure that you share certain values, and not just among you as individuals, but also share those values as a firm, and if you get the values between the individuals to fit in a certain way, and in particular if you get the company values to fit the individual values, you find a lot of inspiration and a lot of fun and it's very easy to work together, and in particular, in difficult times.

Niels

That is so true. That is so true. Now we're almost there, Martin, but I just wanted to ask you as well. If you were starting over today, based on all of the things that you have learned, is there anything, in particular, that you would do differently?

Martin

A lot of small, technical details could have been done differently. There are many things I need to be very humble about, as it were, shortcomings, but I guess the big picture is that I always love what I did, and I love what I do, and I'm really passionate about the business and the markets and the organization. So, in the big picture, I wouldn't do it much differently, but a lot of small things that could have been done better.

Niels

Now, if you could ask one of your peers, for example the next guest that I have on Top Traders Unplugged, if you could ask them a question, what would that be?

Martin

Oh (laugh), I guess it would be very interesting to hear their story and their drivers and inspiration and motivation, and that would lead to tens or hundreds of questions. I guess it would probably have to do with where they find the inspiration.

Niels

Yeah. No, I think it's a very important area you've touched upon today, and not many people go in that direction, so I really appreciate that. Now, my last question to you, Martin, and again, you've actually already shared some personal things, which could qualify to this

answer as well, but, I always tend to ask, if my guest could tell us a fun fact about themselves that is not usually known by other people?

Martin

(laugh) so you want to have some fun fact about me?

Niels

Yeah, if you have one that you can think about that other people might not know about you, that could be fun, and if you don't that's fine as well.

Martin

Yeah, well, on the top of my mind right now is this sailing racing, running a sailing team of individuals where everybody has to make a lot of commitments and efforts to be there every day, and I demand a lot from them: what is it that makes them come every day, and what is it that makes me go there every day? I don't know, it has to do with really trying to be devoted and inspired in what you do, but the funny thing is, for me, it comes from somewhere I don't often understand why I do it, and why the inspiration and where it comes from. It just appears, and I wonder, and maybe I'll figure it out one day. We have a saying here, where we are, that you have a big fire under your ass. And that's why I'm running around all the time like a maniac. The fire I have under my ass is certainly a little bit too big.

Niels

Sure, well in that situation it's a good thing to be on the water, at least, then at least the fire is contained to some extent.(laugh)Now before we finish our conversation, I really do appreciate all of the time that you have given us today. Where is the best place that our listeners, people who want to learn more about Estlander & Partners, where's the best place to reach out to you and learn more about your firm.

Martin

Come and visit us. Everybody is welcome with open arms, either in Helsinki and in Vaasa, or on our web page, or drop me an email or give me a buzz, anything goes - whatever technical media or way one prefers. We're always here.

Niels

We'll make sure that all of the information will be on the show notes page of this episode of Top Traders Unplugged, and thank you so much, Martin, thank you for your generosity with your time, and thank you for sharing, and being open about your own experiences, and insights about your firm, your strategy, and of course our industry as a whole, I thoroughly enjoyed it and I hope we can connect at a later date and get some updates on all the great work that you do, and I wish you all the best of luck with your sailing and competitions you are heading into later this summer.

Martin

Yeah, well thank you. Niels, it's been a pleasure talking to you. I think it's a great thing that you are doing, and certainly very, very good questions and inspiring questions, so thank you very much.

Niels

You're very welcome, take care, and all the best.

Ending

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