Our guest today is the President and Owner of DUNN Capital. Having a deep background in finance and business management, Marty oversees all mission-critical operations of the firm, including the firm’s research and development efforts as well as the construction and management of the firm’s managed futures portfolios.

In our conversation, my co-host Katy Kaminski and I discuss with Marty DUNN Capital’s client-first business model, why he believes that their Adaptive Risk Profile has been a game-changer since its introduction in 2013, and how DUNN Capital has evolved since he joined more than 20 years ago.

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In This Episode, You’ll Learn:

• How Bill Dunn started DUNN Capital
• How Marty minimizes risk down to the base level
• What lessons Marty has learned from his time at DUNN Capital
• Why Marty believes being client-centric is key to DUNN Capital’s success
• How research plays a larger role within DUNN Capital than most people think
• How DUNN Capital has changed since Marty joined
• How Marty views return dispersion
• Why certain “diverse” stock choices are not very diverse
• What makes DUNN’s Adaptive Risk Profile unique
• The one thing that is missing from Marty’s trend following program

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Niels

Marty, welcome back to the podcast, it’s good to have you here. Now you were one of the few people who have been back to Top Traders Unplugged, and it’s been almost four years since our first conversation. So, perhaps as a starting point, and for the benefit of all the new listeners that have joined since, why don’t you give a quick background to DUNN.

But before you do that, of course, I have to be very open about it that I, of course, work for you, and work for DUNN, so that there’s no confusion. So, I’m going to let Katy ask all the difficult questions today, but let’s see how that goes.

Give us a little bit of an update on DUNN and what we do.

Marty

Well, thanks for having me. I’m a little disappointed that this is your first person that’s come back a second time. (Laughter) I feel like I’m honored, to some degree, but I guess since we have such a close working relationship, nobody should be surprised.

Some people think of him as being one of the Turtles, which is a misconception. Bill was not part of the Turtles. He was doing his research independently of that group.

Niels

And many years before that group.

Marty

Quite a few years before…

The reality was that Bill had no idea that anybody else was even working in the space. He was in a vacuum per se. His first large allocation came from a group who had allocated to other people that were in trend following. They understood that it worked.

Bill did not realize that they had allocated to other people like him. He thought he was the only person. To tell the truth, I don’t know that he was completely confident that it worked other than the fact that when he came out of the chute he lost twenty percent right off the bat. So he must have had some confidence level.

The fund was originally started with friends and family – coworkers, basically. He was a defense contractor, Ph.D., an engineer in Physics by trade. When he developed the system he could not find money to trade it.

The people that he worked with had confidence in him and they approached him about an idea that, if they were able to put the money together between them, would he be willing to trade it, and he said, “Yeah.” Then he promptly lost twenty percent (laughter). But, as we all know, the story ends well.

Niels

Sure.

Marty

We’re now well over a billion dollars in assets and we’re still trading the WMA strategy. It’s gone through a number of improvements through the years. The actual algorithm is still in play but we’ve augmented that with a number of other algorithms because I’m a huge proponent of uncorrelated revenue streams.

So, there are different ways to approach trend following. Our idea is, if we approach it enough ways, we end of being able to reduce the risk and increase the return and generate better risk-adjusted returns.

Katy

So Marty, I’m just curious, how did you… what was your path? How do you come into this story?

Marty

I probably have a different path than most anybody else in the industry because I’m a CPA by trade. I worked for a CPA firm in Vienna, Virginia, which just happens to be the same area where Bill formed DUNN Capital.

His next door neighbor was an accountant, and when Bill decided that he needed to get some advice on how to set up his statements and do his tax and track everything, he went to his next-door neighbor who helped him.

That next door neighbor was a partner in a CPA firm that I went to work for. The first job, when I went to work there, was that they sent me to Florida to work on the audit team for the DUNN funds, and that’s where I met Bill.

Several years later I became a partner in the firm. After we had completed the audits that year, Bill approached me about coming to work at DUNN. Long story short, here I am today, President of DUNN Capital and the owner of DUNN.

Bill and I have always had a very close relationship, even when I was at the accounting firm, because I handled a lot of his personal work also. Then when I came to DUNN I kind of wore two hats – not only working with the company but also handling a lot of Bill’s family office things.

So, we worked closely together, so it was kind of a natural fit to step into the role. We had to do something. We had several… twenty employees; what was going to happen if we closed down DUNN? So we wanted to keep it running.

We wanted to keep the legacy alive. I think we’re probably the… I mean there are arguments back and forth, who’s the oldest trend follower, or the oldest managed futures product in the industry, but I think we’re right there.

Niels

Absolutely. I'm wondering a little bit, with you being in this industry for such a long time, what are some of the key lessons that you may have learned that are different from where you came from?

I’m not thinking necessarily of trading methods or anything like that, but it is a little bit of a unique industry; it’s a little bit of a unique business, is there anything or running a business, managing people, culture, whatever it might be, but is there some key lessons that you’ve found to be really important in order to achieve the success that you’ve achieved?

Marty

Well, let me lead off with that I’ve always felt like Bill was my mentor. Most of the key things about what we do are things I’ve learned from Bill. Some of them aren’t even accepted in the industry per se. For instance, we are extremely client-centric and Bill always said that he was on the same side of the table as the client.

He never wanted to be in an area of conflict. Where it comes out is in the management fee - the fact that Bill wanted to have a zero management fee and only be incentive based, feeling that if his clients made money he got paid. If his clients didn’t make money we weren’t getting paid. That’s probably the first thing. The other thing is, from a business standpoint, Bill and I are true believers that it’s the people that make the business.

Yeah, you have to have an algorithm and you have to have the technology behind it, but it doesn’t work without the people. The people do the research, the people do the implementation, the people interact with the clients and you’re only as good as your weakest link in the firm. So, people are really important to us.

I don’t think people understand, in a firm, how much the dynamic can change when you bring in new people. We spend a lot of time researching per se, people that we bring into the firm. It’s a long process. It’s kind of like you develop a relationship outside of the firm, and when you go to look for something or somebody becomes available whether you have any job for them per se, that you just bring them into the fold because you know, at some point, they’re going to add value.

We bring people in and we say, “OK you figure out how to add value to DUNN. If you can add value, we’re all happy, and if you can’t then it didn’t work out and you can move on and find something else to do.

Niels

It’s interesting to me that you make this point, still, in today’s world, I think a lot of people look at our industry (and certainly if you read the papers where it’s all about quants, it’s all about the technology, it’s all about the algorithms that are taking over Wall Street and all the headlines that you see), so I think, sometimes, we can all maybe forget that there is a person behind all of this. In some ways, I think it’s fair to say, that we do things maybe a little bit the old fashioned way in certain things, when it comes to execution, etc., so you kind of keep…

Marty

I think that people forget that the industry is a people-oriented industry. Quants are one thing, but the real world is important in what we do. I’ve seen quants that will develop systems and they will have products in that system that you can’t trade. They’ll be trading raw milk or lumber or some of these things that, the reality of the world is, you can’t trade that in any kind of size.

So, I think it’s important to have people that understand the industry we work in on the research side. Then on the execution side, I just feel a lot more comfortable knowing that there’s a person that’s putting their eyes on a trade before a trade gets executed. Now, they can use all the modern methodologies as tools to execute that trade, but I want somebody to just look at it and go, “Yeah, this makes sense,” and then proceed to execute it.

I like the fact that they can use all the different tools at their disposal on any given trade instead of just having it automatically picking an algorithm, automatically going to the market and executing the trade.

Our research has found that by using systematic execution, automated execution, algorithmic, that you’re basically controlling your slippage. You know what your slippage is, and you know you’re going to have slippage, and it’s going to be about a half a point, depending on how much AUM you’re trying to trade. By using traders and their expertise, there’s going to be times when I’m going to get slippage that’s going to be larger than that, but there’s also going to be times when I have positive slippage.

What we’ve found is that net/net it’s zero to positive. So, it adds value to the firm. My traders are highly experienced, so they’ve been around for a long time. We run a 24-hour desk. Some people are surprised by the number of traders that we have as a firm, but you got three shifts that have to be manned, six days a week, so you’ve got to have the manpower.

Katy

Marty, what is one of the things that you would say that people tend to underestimate about DUNN? You guys have been around for a long time. What is one of the things that you think that people should know and understand about your firm, to understand some of your edge?

Marty

I think one thing is that people underestimate our research capability. Small firms are naturally not going to have as many people on research. You see the big firms and they will advertise that they have a hundred PhDs and they have this huge research machine.

You lose something in the disconnect of having that many people in research. One of the things Roberto Osorio, whose the head of our research department, is very proud of is the fact that he codes. So, a lot of firms, what happens is that the research guys turn over the coding to software developers and they say, “Oh, this is what I want.” Well, something gets lost in the transition.

Katy

Lack of transparency in the process.

Marty

Oh, absolutely and the fact that Roberto can code when he wants, and then, if we want to have somebody recode it in a more streamline basis, at least we have a baseline and we can compare the two codes and make sure everything is operating the same. That has… In our view, that adds value. The other thing, just because you have a small number of people, it’s the quality of the work not the quantity of the work, per se.

The way I feel about it, sometimes, is that it’s frustrating because there’s a lot of things in the queue that we’d like to look at that we don’t have the resources to look at. Someday, maybe, we’ll have more and more people. But I also find that if you’ve got too many projects going at one time things kind of get… it just gets cluttered.

Katy

Complexity increases a lot, I imagine.

Marty

The complexity does increase. Our business is such that the tools that we have today, as opposed to fifteen or twenty years ago, it’s already a complex business. The things we’re doing, from a risk management standpoint, and the timelessness of data today, and the efficiencies, are leaps and bounds above what was being done in the past, which I think is what makes the industry better.

We have been able to do some things that I think other firms haven’t been able to do. It’s hard for me to talk about what other people are doing because I don’t have the time or energy to delve into other programs and figure out what it is they’re doing that’s different than us. But I do believe that our adaptive risk profile has set us apart.

I have to believe that because it just doesn’t make sense that our risk-return, or sharp ratio, has improved year, after year, after year, over the last ten years, in comparison to the industry. The industry’s risk-adjusted returns have gone down, since the credit crisis, and ours have been going up. A lot of that has to do with several things that we’ve implemented more recently. But, I would say the most significant, at least over the last year, was the ARP which is the Adaptive Risk Profile.

I would venture to say that people that traded much less volatility than we did, did not fare as well as we did during that period of time. That’s exactly what we were expecting with the research. It’s proved that it has worked. So, I guess it’s smarter not… you know, work smarter, don’t work more.

Niels

Right, yeah,

Now you eluded that you have been with DUNN for a long time. In fact, you’ve been with DUNN for more than twenty years, but still, that’s only less than half the time of the firm history. What would you say has, and how has DUNN changed during the time that you’ve been there?

Marty

You also understand that I worked with Bill and DUNN for a number of years before I came to work, so it’s been over twenty-five, almost thirty years that we’ve worked together.

How has it changed? We’ve become more sophisticated. We’ve strengthened the research into the business. We have started reaching out to investors, allocators, trying to get our story out, but, more importantly, trying to educate the investment community. Bill’s adage was, “If people were smart enough they would find us; if they weren’t smart enough to find us I don’t want them as an investor.” OK that’s, that’s very…

Niels

That’s one view.

Katy

I think he wasn’t alone with that. The world has changed, yeah?

Marty

It was a wild world back then, and I think these guys were all independent guys, and they all viewed it the same way. There are other firms, especially in the last twenty years, who have reached out and they’ve basically accumulated all the assets in the industry. If you aren’t pro-active, if you aren’t working to educate the public about what we do…

My feeling is I don’t have to market, per se. I don’t have to be “salesy.” I think DUNN’s mission is to educate people. Once people are educated they’ll see the value in what we do. I think our performance will stand on its own and we’ll get our share of assets.

We’re not for everybody, and I don’t want to be for everybody. But, I feel like we embrace investors who look at this space as a core asset holding. They understand how correlations interact with their portfolios and the value of correlations and they’re going to be long-term investors.

We don’t want hot money. We aren’t looking for people that are timing the space. We’re looking at people that understand why there’s value in investing in this space. They’re going to keep it for long terms of time.

Niels

Exactly. That’s the other secret, right? The way to really get the benefit of trend following, in particular, is to have the long-term horizon.

Marty

So, this is what I’ve learned in the most recent past. We launched a 40 Act fund with Era funds, and I have spent more and more time in front of RIAs, and there’s a couple of lessons I’ve learned. One is that people equate zero correlation with negative correlation. They don’t understand the difference, per se. And I try to explain that zero correlation, all that means is when you see what your stock portfolio did today you can’t make any reference on what we did. That’s zero correlation.

A lot of people say, “Oh, it’s zero correlated. My stocks went down. You should have gone up.” Well, no.

There’s no correlation, there’s no connection between the two, and it’s a big problem because most investors in the mutual fund space can watch the nightly news and know exactly what each of their portfolio (everything that they’re invested in) did, except for managed futures. They’re like, “How could you not make money today, or how were you able to make money when nobody…” Yeah.

Katy

I have a question too, one of the biggest challenges we’ve had in the industry has been return dispersion for investors too. It’s that you have one fund up, another fund down, it seems that there’s a lot of difference in terms of how performance has not been very consistent across managers in the space and that creates a lot of confusion for the investors.

How has your experience been with this? Have you encountered… Do you have some thoughts about how DUNN sees that and how you have fared in this sort of change in the industry, and what do you think drives it?

Marty

Gee whiz, Katy, you’re the expert in this area. You’re the one that should know these answers (laughter). This is my opinion, which you can tell me whether you agree with my opinion or not.

Katy

I want your opinion.

Marty

I think it really has to do with time periods that people are looking at. There’s always a sweet spot for your period of time you’re looking back over. I think one thing that has worked well for DUNN is that we don’t put any restrictions on what’s available to the program from a time constraint. It can go as short as a week and as long as four or five years if it chooses that.

Now, the parameter selection process is automated, it happens weekly, but it doesn’t matter that it happens. It’s not imperative that it happens each week. We can go eighteen months without any real difference in return, so it’s not sensitive to the parameters.

I think it’s important that you allow the system to evolve between shorter time periods and longer time periods given whatever the investment environment is. That’s the only reason I can see why… Well, that’s one of the many reasons why, I think, we’ve been able to manage this environment well. Between the ARP, between the uncorrelated revenue streams that we have, and the adaptive nature of our system, we have an exit strategy that has been implemented over the last five to seven years. All these things have made us better.

Katy

Yeah, I mean it’s been a very… If you think about it, the reason that I’m interested is that you’ve done very well for your investors over the last few years and it has been very challenging. Quantitative easing, very low trends…

Marty

It’s been one of the most difficult environments that I have ever seen in what we do. I thought this was going to be easy, and you look at the post-financial crisis and it has just been a hard road for trend following systematic managers. What’s happened is the central banks have created this environment where everything is correlated across all the markets. So, in reality, I ask myself, “Do we have diversity?”

What is diversity? So, people are investing in their stock portfolios. They go to a mutual fund, “Oh, we’re a diverse mutual fund. We have a hundred and fifty holdings. Nobody has more than two percent of the AUM, all these stock names, pretty diverse, right? I would proposition no. If all those stocks are highly correlated aren’t you truly only invested in one thing?

That’s the same thing that happens in the managed futures space when all the markets become correlated. It’s a lot harder for our markets to become correlated because it’s the softs, it’s the energies, it’s the metals, it’s the currencies, it’s the interest rates, it’s bonds, it’s equities, across all geographical areas.

But, after the financial crisis and the central banks were all working in tandem, yeah, those markets became very highly correlated. That is the most difficult time for us to make money is high correlation, low volatility. There are no trends. Everything is trading sideways. Because of low volatility, people tend to want to put more positions on because they’ve got to get to their risk targets.

This is what started our research on the Adaptive Risk Portfolio because that doesn’t make sense to do that. So, we’ve now incorporated that into our model so that we don’t do things that don’t make sense.

The thing that’s the most encouraging that we’ve seen in the last quarter of the year and is exciting to me is the correlation matrix is broken down. Everything is starting to break apart; you’re starting to see European bonds move different than US bonds, Asia moves differently than the rest of the world. These give us opportunities to make money.

All we need are opportunities, and the winners are always going to outweigh… The winners are big, the losers are small, that’s the whole point of trend following.

Niels

Katy

Well, I mean, Marty is exactly right is that high correlation low vol is a challenging environment, but we can also add the fact that interest rates have been very low too. So, we haven’t had the carry moving directionally a lot of assets.

So, he’s exactly right in that if you’re focusing on being adaptive to those environments and adjusting your risk and implementing that into your process that is really trying to think proactively in how you can handle those different types of environments without blindly saying, “This is a model that worked,let’s execute it.” So, it sounds like that’s the direction you guys went. In that you were looking at adaptive risk and better thinking about correlation…

Marty

You hit on it. I hate to admit it, and I think anybody in our space hates to admit it, but a lot of the returns, back in the ‘70s and ‘80s were driven off of interest rates. Let’s face it.

Katy

It was up to eighteen percent.

Marty

When sixty percent of your assets are held in cash and are earning interest, that could be quite a nice little hurdle. Now, I will tell you, from DUNN’s perspective; we’ve always excluded that in any of our model development. So, we’re OK working in a zero interest rate environment.

All the backtesting that we do, and the out of sample testing that we do and the development of our systems are assuming, basically, a zero rate environment. We don’t plan for any money to be made on our excess cash.

That doesn’t mean we don’t look at… Clearly, futures are more dynamic in the interest rate environment of the older days. The other adage is that managed futures can’t make money in a rising interest rate environment. That just doesn’t make any sense to me. I’ve heard people that will look at me and say, “Well, you’re crazy. Doesn’t it make sense to you? It’s obvious.”

Well, no, because futures prices build interest rate into it. It’s a very simple concept. It’s saying, “In the future, the bond price is going to go up or down by this much based on the projected interest rates.” Either the interest rates move the way you expect it or they don’t. If they don’t, then the price of the futures moves differently than what was projected.

People try to make it too complicated sometimes, and start doing this evaluation of interest rates and how you should be, “Oh interest rates are going up, you should be short bonds.” Well, no, if interest rates don’t go up as fast as you think they’re going to go up then you should be long bonds because that’s the right trade.

Our system is still holding. All the European bonds are still long. We’ve gotten short the U.S. bonds. The other thing that we’ve seen in looking at our simulations and our out of sample data, in our live real trading is that we never take positions on the short side as strong as the long side positions. It just doesn’t happen. I think it’s because people’s perceptions about interest rate are off kilter. So, I think people always think interest rates are going to go up faster than they do. They never go up as fast as people think.

Katy

They’re afraid they’re going to go up faster.

Niels

I think, actually also, when you do research, and if you look at certainly the simpler trend following systems, what you do realize, and this could be tied into the thirty year interest rate cycle that we’ve had, but when you do that, actually, eighty-five or ninety percent of the returns come from long sided trades, whether that’s because it’s easier to capture because short sided trades can turn very quickly, this and that.

But, I agree with Marty that there shouldn’t be any concern that there’s a particular environment where trend following doesn’t work unless there are no trends.

Marty

Right. So, to me it makes perfect sense why most of the trends are on the long side. It’s inflation. The economy is always growing, prices are always growing, and everything is going up. It just doesn’t go up in a straight line.

Ending

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