For as long as we have been talking about futures trading and managed futures in particular, we have been talking about drawdown periods as a necessary evil for this type of investment. They appear when you are least expecting them, last longer than you would like them to, and generally are about as fun as a root canal (day after day for weeks and months). But all programs not named Madoff go through such losing periods – and it is the ability of investors to have confidence in the program they have invested in through such periods which usually marks the difference between success and losses in the managed futures space.
Along those lines, one of the managers on Attain’s recommended list, Covenant Capital Management, is sitting at a drawdown of about -15% in their Original Program after hitting a bit of a rough patch. They recently sent out a letter to investors, essentially saying that they haven’t changed anything, drawdowns happen, and they have been here before. It’s just the sort of letter which gives investors in the program the confidence they need to stick through the drawdown. This is rather standard fare for such managers (nobody is going to say “run for the hills”), and Covenant adds that they are not announcing the drawdown is over – it may continue. But Covenant did something we haven’t really seen before in their letter: highlighting just what they mean by “we’ve been here before,” with excerpts from some of their past client letters (all the way back 10 years).
When you overlay the dates of their past client letters onto their performance history and read the ancient (in financial terms) text, you can’t help but feel that they actually have been here before, and they were saying then just what they are saying now. Past performance is not necessarily indicative of future results, but to us, the sentiment gained from seeing just how they have been there before is a whole lot better than a general line about how drawdowns always happen, and they expect to come out of it.
A. January 2002 letter, Original Program down -27% : “…we are left only with evidence that we have traded through a bad period for our method of trend following. We remain convinced that our system works, that it will prevail, and that our investors will prosper.”
B. September 2005 letter, after 4 years of 20%+ returns in Original Program: “While superior returns over the short term are welcome, we must remind ourselves that eventually our long-term returns will level out within a range closer to our long-term expectancy. It is important that we continue to expect drawdowns of at least 10-15% during any given year. Additionally, we expect a drawdown of 20-25% every 5-7 years. As our track record clearly shows, we’ve had such a drawdown before, and it will happen again at some point in the future. At the end of January 2002, we were in a -27% drawdown and had lost money in 6 of the preceding 7 months. Since then, we have made 274% in less than 4 years. This is why we insist that CCM should be a >7 year investment, during which there will be many good and bad periods.”
C. March 2007 letter, during a -13.3% Original Program drawdown: “Since its inception the CCM program has endured longer and more severe drawdowns than the current one. To date, the program has always returned to profitability and progressed on to new highs. Although we cannot predict how and when the current drawdown will end, we can assure investors that the model will continue to be traded in the same disciplined manner that has always returned to profitability in the past.”
D. September 2010 letter, after going +19%,+15%, and +23% in the Original Program for the three years of the financial crisis: “We expect for markets to periodically rally as they have lately, that expectation is the foundation upon which the entire trading model is built. What we know for certain is that, statistically speaking, large price moves happen more often and to larger degrees than they should. However, we cannot and do not predict when these price moves will occur. Markets often remain flat or choppy for extended periods of time. During these periods, our trading program will lose money as we await the prolonged trending markets from which we profit.”
E. May 2012 letter, during a -15% Original Program drawdown: “The current drawdown as of May 14 for the Original Program is approximately 14.9% which is still within our expected annual range for drawdowns… We cannot predict the future path of the current drawdown or its eventual recovery. We do know that our trading model has recovered from historical drawdowns and gone on to make new highs.”
We know it hurts when you are in a drawdown, and there is no guarantee Covenant or any other program will go on to make new highs. But in our opinion the above glimpse into the history of the manager’s comments (not just the track record itself) shows that Covenant has been through this time and again. When you look at things through the lens of 13 years of history, the current move seems like just another drawdown to be climbed out of in due time.