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Managed Futures Spotlight: Covenant Capital Mgmt.

March 15, 2010


If we asked all of the systematic, long term, multi-market managers who made money in 2009 to raise their hands, we wouldn’t see many arms in the air. It was a tough, tough year to be a systematic manager, with decreasing volatility and sharp trend reversals causing managers to revert to the mean somewhat after stellar returns in 2008. But there would be at least one hand in the air, and that one is the focus of this month’s managed futures spotlight: Covenant Capital Management.  

Covenant’s Aggressive program ranked #3 in our ‘Annual Top 15 Managed Futures Rankings’, and in achieving that was also the highest ranked trend follower on our list. [Past performance is not necessarily indicative of future results] Covenant has several programs, including the Original program which began in 1999, the flagship Covenant Aggressive program which launched in January ’04, the Covenant Long Commodity Program, and the Covenant Optimal Program.

The focus of our spotlight is the Aggressive program, which is essentially the same program as the Original strategy, but traded with approximately 1.75 times more positions. The minimum investment size for the aggressive program is $250,000, and will have larger returns and drawdowns (by design) than the Original Program.

About the Manger

Mr. Billington and Mr. Wilford met in 1995 when Scot (this is correctly spelled with one ‘t’) was an executive with a regional investment bank and Brince was a healthcare executive.  A friendship was formed with both Scot and Brince sharing a passion for the markets and critical thinking.  Mr. Wilford was very impressed by Scot’s trading ideas and became interested in having Scot manage some of his money when Mr. Billington was preparing to launch his CTA.  Before too long, the idea of opening a single account turned into business partnership with Scott providing the trading models, and Brince providing the capital and management expertise.

Scot and Brince launched Covenant in 1999 with the goal of having the best risk adjusted returns in the industry.  This proved “easier said than done” right off the bat as the program went almost immediately into drawdown after starting trading in September ’99.  Fortunately for Mr. Billington and Mr. Wilford, they had “day jobs” to fall back on while the program worked its way out of drawdown.

Mr. Billington got started in trading as an assistant trader for a division of J.C. Bradford & Co in 1993, and eventually wound up on the Chicago Board Options Exchange trading floor as an options trader in the OEX 100 options as late as 2002 as they continued to work on the Covenant program.  The drawdown for Covenant right off the bat turned into a blessing, in Scot’s view, as he was able to get a fresh view of the markets and eventually apply some of the trading principles learned on the floor to his own trading.  (Please note Covenant does not actively trade options)  Mr. Billington is the Chief Manager, Head Trader, and is responsible for all system development at Covenant.  Scott graduated from Miami University (Ohio) and is currently on the board of advisors for their Entrepreneurship Department.  Scot lives in Naperville, IL with his wife and children.  He spends his free time playing golf, exercising with his family, and coaching little league sports.  He and his family also enjoy time together at their lake house in Michigan during the summer months.

Mr. Wilford came to Covenant as a veteran of the health care industry where he worked in a number of management, consulting, and finance roles until 2006.  That same year, he switched to focusing his efforts on Covenant full time, where he is Chief Operating Officer.  Mr. Wilford was the sole underwriter of Covenant in 1999 and is currently responsible for all activities of the company including research, development, and testing; as well as accounting and compliance.  Brince recently returned to Healthcare Realty in 2008 where he manages the Acquisitions department.  He is a graduate of Furman University in Greenville, SC; and lives with his wife in Nashville, TN where they enjoy boating on the weekends.  They also enjoy traveling together and are expecting their first child in April.

Other key employees of Covenant include Scott England, who is Director of Marketing and Investor Relations.  Drew Rust, Director of Marketing and Investor Relations West Coast, and Wenyi Li, Director of Research and Technology.

How Does The Program Work:

The stated goal of Covenant is to have the best risk adjusted returns in the industry after 20 years, and that goal tells you a lot about how the Covenant program works. It tells us they are in it for the long haul, value risk avoidance, and believe there will be opportunity for their program well out into the future.  

To the naked eye, Covenant appears to be a classic multi-market trend follower reliant on expanding volatility and several trends per year to make money. But a closer look (and those positive 2009 returns) reveals that there is more going on here than a simplistic trend following approach.

Perhaps the easiest way to explain how Covenant is different is to look at what they don’t do. Most trend following models use a wide net, and try to catch as many trends as they can within that net. While that method is assured of catching any trends that happen, the problem inherent with it is that you will get a lot of bycatch (losers you didn’t want in your net). In contrast, Covenant uses a rod and reel instead of a net and cast in specific spots only, spots which they have identified as good fishing holes which more often than not produce a catch.

Without the fishing metaphor, Covenant does not believe all trends are created equal.  They believe some trends have a much better success of being profitable, and that some have a greater chance of losing.  Covenant strives to identify those trades with a higher than average chance for success and avoid those which have a greater chance of being a loser (no matter the profit potential).   

This attempt to identify those trades with the highest probability of success is just one of three main components of the Covenant model which they believe sets them apart from the competition.

Indentify trades that have the highest probability of success: While we may view the Covenant program as a trend following model which looks to profit from market trends emerging, Covenant will tell you that their trading model is based more on the tendency of people to undervalue outliers in the markets, or in their undervaluing of a potential trend. If we think of trends as things which can be bought and sold, Covenant looks to always buy those trends low and sell them higher. Conversely, most other trend followers simply look to buy any trend which emerges (no matter how expensive) in the hopes of selling it back at a higher price. As an example, Covenant believes there is a much better chance of success going long Crude Oil at $30 in hopes it rises to $40, than there is buying Crude at $80 in hopes it rises to $90. For most, this is the same trade, a breakout trend higher which can make $10, but Covenant views the lower priced trade as having a much higher probability of success.  

Covenant strives to only take those trades which their models signal as having the highest probability of success, and in doing so only take a very low 20-25 trades per year. This allows them to “conserve their bullets”, in Scot Billington’s lingo, for when a high probability trade comes along.  

To do this Mr. Billington has developed proprietary filters that prevent trades from being taken during periods of higher than average volatility for that market, preferring instead to enter trends at lower volatility points typically just before the market breaks out of its trading range. 

Take more long trades than short: Covenant has intentionally built a long bias into their trading program with the underlying belief that long trades have a better chance at success than short trades.  According to their research, long positions will out-perform short positions over a statistically significant set of trades.  The logic behind this assertion is strikingly simple, and centers on the fact that there is no cap on how high a market can go, while short trades have to stop moving lower a at some point (they can’t go below zero). 

This short trade avoidance was more than just a bias for most of their track record, with Covenant having no short trades in their model from 2002 to mid-2008.  The huge sell off in 2008 caused them to reconsider, however;  and as a result Covenant reduced the time frame of the volatility filter and reintroduced short trades in a limited scope. Moving forward, Covenant believes somewhere around one in every five trades will be a short trade. With the rest of the industry mostly believing in having a balanced model in which the logic is the same for long and short trades, the unintentional benefit of Covenant taking more long trades than short is that it helps “de-correlate” Covenant returns from those of other trend followers.

Ultra-long term trading philosophy: The average hold time for Covenant is 270 days for winning trades, and approximately 20 days for losing trades.  These numbers are interesting, in that a ‘normal’ trend follower has roughly the same hold time for a losing trade (20 days), but is out of winning trades much sooner (about 120 days on average).  A longer hold time usually brings with it higher risk (you have to give the trade more room to operate), but Covenant’s volatility filter and selection of trades only with a high probability of success appear to have given it the ability to reap the benefits of a longer hold time without the additional risk.  

Holding for a longer period can also help cut down on costs, as there are much fewer trades (only 20-35 per year). Covenant believes they are saving approximately 6% per year on operating costs versus traditional trend following programs thanks to the smaller number of trades.

Covenant takes a systematic approach to market selection and is currently trading the following markets:

Australian Dollar, British Pound, Canadian Dollar, Dollar Index, Euro Currency, Japanese Yen, Swiss Franc, Mexican Peso, Soybean Oil, Soybean Meal, Soybeans, Corn, Wheat, Cocoa, Sugar, Coffee, Orange Juice, Cotton, Crude Oil, Heating Oil, Natural Gas, 30-year Treasury Bond, Euro Bund, Lean Hogs, Live Cattle, S&P 500, Nikkei, Silver, Gold, Copper .

These markets have been selected based on their ability to produce viable trends and changes can be made at any time.  The manager expects to add more foreign markets as assets continue to grow.  Average risk per trade is approximately 1% and stops are used on all trades.  Covenant does not use profit targets for any trades.  Instead, Covenant attempts to capture as much of a trend as possible and exits a position in if a trailing stop is triggered. [disclaimer: stop orders can not guarantee an order is filled at the desired price]

Attain Comments

With Covenant Capital Management’s Aggressive program the top ranked multi-market systematic program tracked by Attain in 2009, we have fielded many calls asking what they are doing different. Considering the struggles of most trend following CTAs, the question of why and how did Covenant outperform its peers is a good one? 

Reason one is their avoidance of short trades, which were generally all losers in 2009 as nearly every market in their portfolio rallied significantly from March onward.

Reason two is their smaller portfolio of markets, which is short on bonds (which caused lots of trend following pain in 2009) and includes the two markets which had significant trends in 2009 (Sugar and Copper).  In fact, over 80% of the program’s 2009 gains were from these two markets. Without those, 2009 would have been a different story.

Reason three is their volatility filter, which (from what we can tell) kept them out of several false breakouts being triggered after significant portions of the move had happened and volatility was high.

Reason four is good luck.  Mr. Billington admits that perhaps there was a certain amount of luck that allowed them to post 20%+ returns while most of their peers struggled not to lose more than -15% for the year. We’ll award him 10 points for honesty, but also repeat the old line about there being no such thing as luck, luck is when opportunity meets preparation.

So whether it was luck or skill, there is no denying that Covenant outperformed in 2009 [Past performance is not necessarily indicative of future results] and is deserving of accolades for doing so in what has been widely considered one of the toughest environments for systematic multi-market programs in history. Many other managers took long trades in Sugar and Copper, but weren’t able to avoid losses for the year, so there was more to it than just picking those winning trades - avoiding the losing ones was just as important if not more so.

From the portfolio perspective, Covenant’s ultra long term trading philosophy and long trade bias are characteristics most other trend followers do not have, making them good portfolio candidates even if you are holding an underperforming multi-market systematic manager who is trying to grind his way out of a drawdown.

While similar, especially during up trends, Covenant is also quite different from other trend following programs.  We sort of view them as a hedged long commodity play, which can give you exposure to significant trends, but won’t necessarily see big losses during down trends for commodities. Covenant should outperform in years such as 2009 when the long side was better than the short side, and underperform if we see an extended down trend in commodity prices (Crude Oil going from 80 to 60 one year, then 60 to 40 the next, then 40 to 30 the year after that, for example).

Playing devil’s advocate for a minute, Covenant is currently managing approximately $180 million across three programs, but nearly $150mm of these assets are traded in the Covenant Capital Management Long Commodity Program that was primarily built out of special request for a large institutional client.  The remaining $30mm is spread out across the Covenant Original Program ($26mm) and the Covenant Aggressive Program ($3.5mm).  In a perfect world, we would see more assets under management for the Original and Aggressive programs highlighted here.

Another worry; due to the ultra long term nature of the program new investors should expect it to take at least 12 months before their account performance matches the managers composite, as Covenant will not enter into existing trades for new clients.  So, for example if you happened to start Covenant last year just after they entered their Sugar and Copper trades, it is possible that your account would have significantly underperformed the composite.

And finally, in a perfect world Covenant would not have a long bias, and would apply the same logic (mirrored) to both long and short trades. It is hard to nitpick about the very thing which allowed them to outperform their peers last year, but we’re worried what could happen if there is an extended deflationary period, commodity glut, or the like – which depresses commodity prices for several years in a row.

All in all, no one can take the great 2009 away from Covenant. The positive returns while nearly all other multi-market; non option selling programs struggled showed they are doing more than just casting their net and dealing with whatever gets caught in it. They showed they are being selective on when they trade, which markets, and which direction. Absent a slow and steady commodity sell off over the next several years, we expect good things from them moving forward and will be looking to add them to our recommended list shortly.

John Cummings


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Feature | Week In Review: S&P 500 hits 17 month high, managed futures sideways | Chart of the Week


Word that China was considering more measures to cool down heating economic conditions hit home with several commodity market sectors during the last week. The announcement came on the heels of another round of stronger economic reports which seemed to splinter the recent U.S. Dollar versus commodity trade dynamic. The metals sector was one area that was singled out by Chinese government officials who indicated they would not add to their gold reserves after the strong recent rally. Gold -2.95% led the break followed by Palladium -2.84%, Silver -1.92% and Copper -1.10%. Platinum +1.86% found support from industrial forces.   

The feeling of a possible slowdown in Chinese demand also filtered into the energy area along with continued worries that current supplies are very plentiful. Natural Gas futures -4.20% led the sector lower followed by RBOB Gasoline +0.70%, Crude Oil -0.32% and Heating Oil futures -0.16%.              

Improving news about Greek sovereign debt and indications the EU would come forth with aid if problems worsened helped the continentals bounce back during the week. The Swiss Franc +1.59% led European the rally followed by the Euro +1.09% and British Pound +0.42%. The U.S. Dollar index lost -0.82% followed by the Japanese Yen -0.38%.  

Commodity and Food products were mixed during the past week as grains and some soft’s found pressure from improved crop and harvest conditions in the Southern Hemisphere with long term weather patterns drying out. In the grains for the week Corn ended -2.88% followed by Soybeans -1.82% and Wheat -1.66%. Livestock activity was mixed with Live Cattle adding +2.31% on tight supplies and Lean Hogs off -0.55% on slack domestic demand. Soft sector price action was mixed with Sugar -11.97% and Cotton -2.38% hampered by ideas of better crop prospects due to improving weather.  Cocoa +1.92%, Coffee +1.61% and OJ +1.44% found support from positive currency differentials. 

Managed Futures

After a slow start to the month for Option Trading managers, we are starting to see some positive momentum from the Diversified traders while stock index traders are currently mixed.  Leading the way thus far has been Crescent Bay BVP which is ahead +2.82% - the program has been struggling to find its way through the financial crisis; however is starting out 2010 on the positive side (+0.62% through February).

Other Option Trading estimates for the month are as follows: ACE SIPC -2.32%, ACE DCP -0.15%, Cervino Diversified Options +0.02%, Cervino 2x 0.00%, Crescent Bay PSI +0.28%, FCI OSS +1.68%, FCI CPP +0.38%, HB Capital +0.24%, and Oak Investment -8.01%.

Agriculture Specialty managers are currently posting mixed results with Rosetta Capital Management leading the way +2.55% while NDX Capital Abednego and Shadrach are down slightly (-0.64% and -0.37% respectively).  Meanwhile, Spread Trading specialist, Emil Van Essen is down -0.73% for March – Emil Van Essen has been profitable in each of the past 3 years averaging an annualized rate of return of 39.00% with a maximum historical drawdown of -35.90%.

Last week was a slow week of trading for multi-market CTAs as choppy market conditions prevented most managers from gaining or losing too much ground.   Accela Capital Management Global Diversified continues to be the top performing multi-market program at +1.97% est.  The program was down slightly for the week, but it still holds a healthy lead for the month.  Next in line is Clarke Capital Worldwide at +0.65% est., followed by Clarke Capital Global Basic at +0.56% and Robinson Langley Capital Management at +0.54% est.

Other multi-market programs in the black this month include Clarke Global Magnum +0.25% est., Mesirow Financial Commodities Absolute Return +0.24% est., Mesirow Financial Commodities Low Volatility +0.08% est., and Dighton USA Aggressive Trading +0.07% est..  Programs at breakeven include Sequential Capital Management, DMH, and 2100 Xenon Managed Futures (2X).

Unfortunately, there are a couple more programs in the red list this week.  Programs posting negative results thus far include Hoffman Asset Management -0.35% est., Integrated Managed Futures Global Program -0.43% est., APA Modified Program -0.74% est., APA Strategic Diversification Program -0.83% est., Quantum Leap Capital Management -1.63% est., Dominion Capital Management -1.84% est., GT Capital CTA Dynamic -2.34% est., Covenant  Capital Management Aggressive -2.52% est., Futures Truth MS4 -2.76% est.,and  Futures Truth SAM 101 -6.93% est.,

Shorter-term traders also struggled last week.  The slow upward crawl of the stock market is kryptonite for Paskewitz Asset Management Contrarian 3X Stock Index which is down -8.30% est.  Weeks were the market slowly trades in one direction day-after-day is when PAM struggles the most.  

Finally, the 2100 Xenon Fixed Income program is down -0.42% est. this month.

Trading Systems

Trading Systems had a relatively slow week of trading last week.  Most day traders did not have enough intra-day volatility to get trades off, while swing traders saw relatively few trading opportunities as well. The top performing program for the week was swing trader Strategic SP, which was up at +$1325 per contract. Strategic NQ +$560 per contract and Strategic ES +257.50 also had a nice week of trading.  Other profitable systems include Rayo Plus DAX +442.50 Euros per contract, MoneyBeans S +235.84 per contract, AG Mechwarrior ES +$152.50 per conract, and MoneyMaker ES +$32.50 per contract.

Systems with losing weeks include BetaCon 4/1 ESX -20 Euros per contract, Clipper ERL -$120 per contract, Waugh CTO ERL -$400 per contract, PSI! ERL -$530 per contract and Ultramini ES -$1110.00 per contract.

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.

Past performance is not necessarily indicative of future results. The performance data for the various Commodity Trading Advisor ("CTA") and Managed Forex programs listed above are compiled from various sources, including Barclay Hedge, Attain Capital Management, LLC's ("Attain") own estimates of performance based on account managed by advisors on its books, and reports directly from the advisors. These performance figures should not be relied on independent of the individual advisor's disclosure document, which has important information regarding the method of calculation used, whether or not the performance includes proprietary results, and other important footnotes on the advisor's track record.

The dollar based performance data for the various trading systems listed above represent the actual profits and losses achieved on a single contract basis in client accounts, and are inclusive of a $50 per round turn commission ($30 per e-mini contracts). Except where noted, the gains/losses are for closed out trades. The actual percentage gains/losses experienced by investors will vary depending on many factors, including, but not limited to: starting account balances, market behavior, the duration and extent of investor's participation (whether or not all signals are taken) in the specified system and money management techniques. Because of this, actual percentage gains/losses experienced by investors may be materially different than the percentage gains/losses as presented on this website.

Please read carefully the CFTC required disclaimer regarding hypothetical results below.