Tues., Aug. 3, 2010—As has become tradition for the week following our release of the semi-annual top 15 rankings, this week will highlight the top manager in those rankings: Mesirow Financial Commodities Absolute Return Strategy.
With our rankings eschewing the usual “who had the top performance thus far in 2010?” in favor of what we believe is a more sophisticated approach, which measures not just return, but also risk in the form of drawdowns, volatility, assets under management and length of track record, it is not surprising that a manager who focuses on managing downside risk first and foremost grabbed the top spot in our top 15.
While many managers talk about managing risk, Mesirow definitely delivers in that category, with Mesirow's most impressive stat remaining their ultra-low maximum drawdown of just 1.56 percent on a month end basis and 2.50 percent on an intramonth basis. [Past performance is not necessarily indicative of future results]
And while Mesirow‘s 1.84 percent return through June 30, 2010 (the date through which our top 15 rankings were run) and 1.74 percent return through July 31 (July was down 0.45 percent) are sure not to impress those who need instant gratification, these percentages are better than the performance of the managed futures asset class as a whole. The Newedge CTA index is up just over 1 percent through July, while the CSFB/Tremont Managed Futures index is up just 0.26 percent through June in what has been a better year than 2009, but a tough year nonetheless.
For those who follow the trading day in and day out of numerous managers, for Mesirow to have “kept its powder dry” through the past 18 months has been a worthy accomplishment, and worth at least our attention in this managed futures spotlight.
THE MANAGER
Many of you may recognize the name Mesirow, especially if you come down Clark St. in Chicago to get to work, and that is because the managed futures program Mesirow (Mesirow Financial Commodities Management) is part of the much larger and well known Mesirow Financial, a diversified financial services firm headquartered in Chicago, Ill. with offices across the USA and in London, with over 1,200 employees and six divisions of services, including investment management, investment services, insurance services, investment banking, consulting and real estate. Additional descriptions of the services provided by Mesirow Financial can be found at www.mesirowfinancial.com .
As impressive as Mesirow Financial is, we’re not here to talk about them. We care about the commodities group (which we’ll hereinafter call Mesirow), which is managed by the father and son trading team of Thomas C. Willis and Thomas R. Willis and Gary Klopfenstein.
Thomas C. Willis, senior vice president and senior strategist of the Mesirow commodities program, is responsible for research and formulation of portfolio strategy. Tom has more than 30 years experience as a commodity trader and money manager, having started like many other trading legends as a lowly runner for his uncles at the Chicago Mercantile Exchange as a high school junior. For those unfamiliar with the term “runner,” prior to electronic trading a person actually ran orders from phones outside the trading pit into the traders in the middle of the pit, and ran fills back out or upstairs to the clearing firms.
Willis Sr. quickly realized that he was destined to have a career in trading and eventually got his own badge on the old MidAmerica Exchange where he purchased a membership for $2,800. While at the MidAm, Tom met another young trader by the name of Richard Dennis (of Turtle Trader fame) who served as mentor of sorts to Tom and taught him some of his earliest lessons as a trader in the early 1980s.
Prior to joining the firm, he was president of Willis Trading Group, and cofounded Willis-Jenkins Inc. a registered commodity trading advisor in the ’80s. His trading success has been profiled in publications including the Wall Street Journal and he has frequently been quoted in industry publications. Willis Sr. is currently a member of the Chicago Board of Trade and has previously served on various governance committees of the exchange. He received his BA degree in Economics from Valparaiso University (where rumor has it he scheduled his classes on Mondays and Wednesdays so he could trade on Tuesdays, Thursdays, and Fridays when the grain reports came out)
Thomas R. Willis is vice president of Mesirow Financial Commodities Management LLC and responsible for making investment and trading decisions. Tom has more than eight years of trading and research experience, and a lifetime of lessons from the elder Willis. Prior to joining the firm, he was a principal with Willis Trading Group. Tom’s experience includes designing and implementing proprietary trading strategies at CMT Capital Markets Trading GMBH in Frankfort Germany and researcher with the aforementioned Willis-Jenkins.
Willis Jr. became interested in trading while growing up in Chicago, tagging along with his dad to the exchange whenever he could. His interest escalated in High School when he worked as a clerk on the grain floor at the now defunct MidAm. Like his Dad before him, Tom Jr. began his trading career while he was still in college at nearby Lake Forest College. After graduation, Tom took a job with CMT Capital Markets and moved to Germany early in 2000. Ready to set off on his own, Willis Jr. began managing client money in 2003 with his dad serving as a mentor and outside advisor to the program. A couple years later he joined his dad full time at the Willis Trading Group and now works side-by-side with him at Mesirow.
Gary Klopfenstein rounds out the management team, acting as senior managing director of Mesirow Financial Investment Management Inc., chief investment officer of the Mesirow Financial Currency Management division, and a member of the firm’s executive committee. With over 25 years of industry experience, Gary is an integral part of the management team for the Mesirow commodities program, providing general management oversight and strategic direction for the program. He graduated from Illinois Wesleyan University in May 1985, Summa Cum Laude, with a BA in Business Administration.
HOW THE PROGRAM WORKS
The mantra of Mesirow Financial Commodities Management is to generate consistent returns with low volatility across various market environments. But it apparently did not get the memo from the rest of the futures industry on what low volatility means.
Most managed futures programs consider annualized volatility of around 10 percent to 12 percent and drawdowns between 5 percent and 10 percent as low volatility, but Mesirow would consider those numbers dizzying when compared with its program’s remarkably low 1.56 percent Max DD (2.50 percent intramonth) and annualized volatility of just 6.34 percent. Perhaps its mantra should be re-written to say “generate consistent returns with very low volatility.”
Mesirow’s attempt to achieve its goal through rigorous risk management and what the company believes is a deeper understanding of why the markets they follow move the way they do. But where they hang their hat is on risk management, which has been engrained in the brain of head trader Tom Willis Sr. since the beginning of his career on the floor of the old MidAmerica Exchange in 1973.
According to Willis Sr., one of the earliest lessons he learned as a fledgling trader was that the best route to making money was not by trying to maximize returns, but rather by cutting your losses short. In Willis’s own words, “The name of the game is don’t lose money. It’s not how much you make, but how little you lose when you are wrong.” (Intermarket, Vol. 1 No.4 September 1984)
The discretionary, short-term trading strategy employed by Mesirow is based on the decades of combined trading experience and money management by the Willis trading team. Before placing any trades, the Mesirow team evaluates market price action to indentify themes in the markets it trades. This is an important first step that not only allows the trading team to assess potentially profitable trading opportunities, but also to determine which markets are correlated to a singular theme.
For example, in late 2008 and early 2009, Mesirow identified the global deleveraging that drove markets lower as a theme and attempted to profit from that theme through trading in only a few markets (metals, currencies and grains), which the the company believed gave it the lowest risk entry into trades surrounding that theme (direct exposure in stock indexes, for example, was more highly correlated and likely more risky).
In the manager’s opinion, correlation between market sectors typically increases when there is a dominant market force causing that market force to impact multiple markets at the same time. This can cause a concentration of risk rather than diversification of risk, as was seen at the end of 2008 and into 2009. Therefore, rather than trading several markets that are all affected by a singular theme, Mesirow seeks to identify a single market that presents the best opportunity (directional/strong price action) to capture a short-term winning trade while tightly monitoring risk.
TRADING IN 2010
Thus far in 2010, Mesirow has found the macro trading environment conditions to be challenging. According to Tom Willis Jr. “There seems to be an ongoing struggle between inflation and deflation that has made for a frustrating environment in which to trade.” In other words, Willis is saying that recent macroeconomic conditions have made it much more difficult for him to gauge the market and identify an overlying theme for where the markets are headed.
And it is easy to see why Willis is frustrated. All one has to do is open up the op-ed section of the Wall St. Journal to see that there is a definite 50/50 split as to where the markets are headed.
Willis also notes, “Recently we have begun to see a reintroductions of capital into the commodity markets throughout the second quarter and we anticipate that this trend will continue although volatility should remain high. Our performance data has shown that our strategy does well in these markets and we have an optimistic outlook for the remainder of 2010.”
QUANTITATIVE TECHNIQUES
In addition to the qualitative theme analysis, Mesirow uses quantitative analysis to help identify trading opportunities and pinpoint market entry and exit levels. The most commonly used quantitative tools used include directional analysis. which the manager uses to help indentify strength and weakness within market sectors. This analysis helps filter out non-directional markets and can distinguish which individual market components within sectors are best positioned for a directional move.
Another commonly used quantitative technique used by Mesirow is to indentify entry and exit points via capital flow analysis (also known as market momentum). An example of this would be a market that has accelerated in price on heavy trading volume (usually a confirming signal) or price action on light trading volume (usually a signal the move may be a false one). The manager may identify a market level based on trading volume as an opportune place and time to enter the market (either in the direction of the move or against it), believing these types of area typically represent an area of ‘immediate gratification’ as the market will quickly signal whether the trade will be profitable or not.
While the program could technically look at any futures market for an opportunity, the Willis father/son combo likes to stick to what they know best, with approximately 75 percent of trades taken by Mesirow in so-called traditional commodity markets (agriculture, energy, metals, softs) and 25 percent in financial futures (currency, stock index, treasury futures).
As mentioned above, risk management is the hallmark of the Mesirow strategy and the basis by which the Willis team has based their entire trading careers on. Mesirow manages risk across the following dimensions:
• Price levels: There is a predetermined entry/exit level for every trade, including a stop loss being employed for every trade. [Disclaimer: stop orders cannot guarantee a fill at the desired price]
• Theme concentration: As mentioned previously, Mesirow theorizes that markets are often highly correlated around a singular theme, and that trading multiple markets that are moving according to the same theme adds to concentration risk rather than adding risk lowering diversification. As such, the manager attempts to identify only the best one or two opportunities per a given theme, typically having between zero and seven positions on at any given time. (Other managers of similar size may have as many as 35 positions on during trending periods.)
• Time in position: Mesirow looks to capitalize on short-term opportunities, period. A typical trade lasts from 2-5 days, with the team looking for the ‘instant gratification’ mentioned above. According to Mesirow, they rarely, if ever, end a trading session with a losing position in the portfolio.
• Trade structure: While the program predominantly uses futures, options will be used occasionally if they present a better risk/reward profile. For example, if risking $3,000 on a long trade in sugar, if the at-the-money current contract call is trading with no time value or volatility premium (it is merely trading 1-to-1 with the underlying), Mesierow may purchase the call instead of the outright futures. In this way, it gets the same directional exposure (the call option will rise in value equally with the futures), but the company cannot get stopped out on a spike move lower. It has set its risk at the option purchase price, and can let the trade go as long as needed until it is profitable.
TRADE EXAMPLE
The following is an example of an actual trade from mid-2009 as described by the manager:
“Throughout April and May of 2009, markets were characterized by a commodity rally and U.S. dollar weakness as large amounts of speculative capital flowed into the commodities markets. As the USD strengthened in June, commodity markets became vulnerable due to large speculative interest and retraced 40 to 50 percent of their recent gains. The one exception was sugar, which held its gains and eventually moved toward new contract highs. When commodity strength resumed and the weak USD theme reemerged, sugar had been identified [by Mesirow] as the best opportunity as it was well positioned for significant price appreciation [based on its own strong fundamentals and involvement I the weak US $ theme].
Once Mesirow had identified sugar as being directional and the best way to trade the weak USD theme, the next step was to find an opportune point within that directional move to enter the market. Using the aforementioned quantitative tools, the trading team identified a key support in the market on June 23 as sugar had accelerated from 1,600 to 1,675 on low trading volume. If the market were to countertrend retrace back to this level of support, it would represent an opportunity to enter the market.
On July 8, the sugar market, which had risen to 1,800, pulled back to 1,677 which is when Mesirow entered a buy order. A stop loss was placed at 1,650 and a target exit of 1,820 was set. The market did indeed resume the underlying directional move after the buy order was placed and the position was sold shortly thereafter at 1,820, which represented a 70bps [0.70 percent] profit to the portfolio. While sugar continued its directional move beyond 1820, Mesirow employs a disciplined process that is happy taking aggregating small winning trades. This philosophy allows the manager to tightly manage risk and protect capital.”
NEW PROGRAM
Mesirow Financial Commodities is also happy to announce that it has added a new member to the team: Terry Good. Good will be managing the Mesirow Financial Commodities Systematical Directional Strategy. Good comes to Mesirow with 25 years of trading experience in the futures markets both on and off the trading floor. His strategy is an algorithmic trading model specifically designed for the treasury markets including U.S. 30-year bonds, 10-year notes, and 5-year notes. S&P 500 futures are also traded as a diversifier.
This strategy uses intraday data to analyze changes in market velocity as a function of price and time in order to capitalize on short term, impulsive market movements and has a low correlation to other asset classes such as the equities and bonds. Tight risk controls are built into the model and it uses short-term, intraday intervals for exit levels as well as small position sizes to help minimize losses. Mesirow anticipates the strategy will be available to clients by early fourth quarter of this year.
ATTAIN COMMENTS
We view Mesirow as a great program based on the following: strong manager background and pedigree, Grade-A facilities and back office, and the impressive under 2 percent max DD since inception (61 months); and Attain has been honored to be one of only two firms able to offer the program outside of Mesirow Financial.
Mesirow looks to have successfully combined the floor savvy and expertise of a legendary Chicago trading family with the risk management and execution skills needed to be successful in managing hundreds of millions in client assets. This is a rare combination in discretionary programs run by former floor traders, who are infamous for taking big risks that just as often turn into big losses as big profits, and it speaks volumes to not just the mental discipline of the manager, but also their trade execution and processing (some CTAs have trading errors larger than the 2 percent max DD Mesirow has had) [past performance is not necessarily indicative of future results].
But while we like the entire Mesirow track record, we are most impressed with their flat 2009 performance, as that has proven to us that they are indeed implementing the disciplined risk management tools outlined above. In a 2009 conversation with Tom Willis Sr. he noted, “All it takes is a few good trades over the course of one or two quarters and we’ll be right back on track to hitting our performance goals. … in the meantime, it is all about managing the risk.” Given Mesirow’s stance that it is better to keep your powder dry at times, it is very important to target a 2 to 3 year investment window with Mesirow (or any investment for that matter).
RESERVATIONS
Willis’s comments have been spot on thus far in 2010, as performance has improved steadily with 3 positive months in a row in April, May and June, before pulling back slightly in July at an estimated -0.45 percent. While, it is encouraging to see some positive returns we would like to see more positive stretches out of this program. For most of 2009 and into 2010 it has been 2 steps forward, followed by 2 steps back. It is our hope that Q2 performance is a sign of good things to come. Another issue for investors to consider is that this program has grown rapidly over the past 18 months, and is now managing $883 million in client assets. While the pace of growth has been controlled, it is worth noting that the program is over twice as large as it was this time last year.
Seeing this growth first hand, Attain has been closely monitoring Mesirow’s ability to trade at these much larger levels, and is happy to report that we have seen no ill effects on their management of accounts at Attain. And according to Mesirow, they have not had any execution issues thus far and have planned for the continued increase in assets by diversifying their execution across a range of different platforms and firms.
Despite the assurances, the concern remains that the performance has flattened out as assets have risen. But knowing that there are programs which manage several times what Mesirow does (in the billions) and having met with the managers, we take them at their word on that front. The way to see for sure will be their return to double-digit annual gains at some point in the future with the larger assets under management.
In conclusion, the Mesirow program is a prime candidate for nearly any managed futures portfolio based on its low volatility (in can be added to a large portfolio without much of an effect at all on portfolio-wide volatility), low historical max DD (even if it sees a new max DD five times its historical one, the DD would still be less than -10 percent!), and strategy type (shorter-term/discretionary is a nice complement to the longer-term/systematic programs which make up most managed futures portfolios).
The final attractive piece is that the programs can be traded with very little cash outlay, given their average margin to equity ratio of 5 percent. Investors at Attain have allocated between $100 thousand and $200 thousand in cash to be notionally traded at the $800 thousand trading level [Disclaimer: the use of increased leverage can substantially increase the risk of loss (in percentage terms)].
In the end, Mesirow provides access to a tried and true commodity trader who has a knack for controlling risk, and at what we feel is a bargain price (either in cash or the nominal minimum amount). While there are other programs which can provide the background, the low risk, or the bargain price, it is rare to have all three in a single program.
IMPORTANT RISK DISCLOSURE
Futures based investments are often complex and can carry the risk of substantial losses. They are intended for sophisticated investors and are not suitable for everyone. The ability to withstand losses and to adhere to a particular trading program in spite of trading losses are material points which can adversely affect investor returns.