So how did your career begin?
I started off in the banking industry. I worked for a bank in California under the chief financial officer and I directed the management of the investment portfolio, which was primarily a mortgage-backed securities portfolio. Late in 1988, I joined Hal Lindquist and Jeff Stephenson. Hal had formed an advisory firm, as well as a broker-dealer concern. So I came over to assist in the growth of his advisory business.
For banks?
Yes, we focused on issues like asset allocation, relative value analysis, hedging ? all of the particulars that a portfolio manager of mortgage-backed securities would want assistance in. And we've continued to operate both the advisory business, which offers advisory services to these institutions for a fee, and the broker-dealer, which executes transactions on behalf of those institutions that want to deal with us as a dealer.
So how did you evolve into traders?
All along, all of us ? and there are three principals here, in addition to a variety of employees ? had an interest in trading. Hal's background is in trading and risk management on Wall Street. My background is in portfolio management, but I always did a little commodity trading. Jeff Stephenson, who is the third principal and a certified public accountant (CPA), had an interest as well. So we were all interested in developing a way to trade the markets that wouldn't interfere with the other businesses that we were pursuing.
Did you focus on fixed-income futures?
I did, but each of us had our biases. My own interest has always been in the fixed-income markets ? fixed-income futures. Hal's always traded meats, grains and metals, a variety of things. We were doing some trading on behalf of clients back then in one form or another, but not in any systematic way. We knew that we wanted to maintain a commitment to the commodity markets, and in particular, we wanted a place to trade our own money.
So what was the next step?
We spent the better part of a year developing a systematic trading system that would pretty much be automatic. That way, we could continue to run our advisory and dealer businesses, which required that we spend a fair amount of time out on the road, and still have these systems trade our money for us.
When did you start the trading?
We first began trading our money using the system in early 1992. During the first few years, from 1992 through about 1995, we only traded our own money, and we had a respectable performance. Certainly enough that we were pleased with it. We continued to add capital. Then, when we discussed our work with friends and associates, we started to receive some outside interest. In addition, we had been releasing the news of our results to the various ranking services, so we were getting some media attention about our returns.
So it was up, up and away?
No. We considered marketing our money management at that point, but we found that people weren't really interested in putting in money with a new start-up Commodity Trading Advisor (CTA) with less than three years' track record. So for about the first three years, we didn't have any marketing effort, and we received very few calls.
What happened then?
After we crossed the three-year mark, we found a lot of the services picked us up, and we started getting calls. And from there we've grown, particularly in 1997. At the beginning of 1997, we were trading around $10 million, and by the middle part of the year, we had grown to nearly $50 million under management.
What steps did you follow to develop your systematic approach to trading?
We started with some basic ideas about how we thought trading models should behave. We had very strong ideas about appropriate money management controls, portfolio diversification, those sorts of things. Coming from a portfolio background, we focused on determining the mix of the commodities we would trade. The first cut really wasn't so much building systems as it was defining a portfolio of commodities. The goal was to achieve the most diversification we could across those markets that were liquid enough according to our parameters.
How many markets was that?
Initially, we picked 10 markets to trade. We still trade 10 markets in each of the programs that we trade, although the mix has changed a little over time. The next step in building the systems was to look at how the models should behave. What sort of performance should we expect to see? It was important to confirm that we weren't just fitting models to historical data, but that we were actually embedding our ideas about trading into our code.
What about the potential for curve-fitting?
That's one of our key issues. We wanted to make sure that we weren't optimizing our trading system, and that we were building a system whose expected future performance would be consistent with past simulated performance. Looking at the numbers, I think we've achieved that over the last few years.
Did you work with just your own ideas about trading?
One of the early things we did was to buy every book available on trading models, and we programmed and tested everything we could. We studied different approaches to commodity trading until we came up with a set of relatively simple principles. We programmed those and turned the systems on, and we've been trading those models ever since.
It's a big jump from reading every book you could get your hands on to actually trading the models. What were some of the issues that you dealt with between those two steps?
When we first decided to do this, we gathered the data of the markets that we thought we could trade, based on their size, and then all markets beyond that. We figured that would be a representative sample of markets in general.
What did you end up with?
We wound up with a basket of 30 to 40 different commodities. Of those commodities, we picked the markets that traded best across a variety of models. So now, we have the best 10 to 15 trending markets, regardless of what system you're using.
- My background is in portfolio management, but I always did a little commodity trading. Jeff Stephenson, who is the third principal and a certified public accountant (CPA), had an interest as well. So we were all interested in developing a way to trade the markets that wouldn't interfere with the other businesses that we were pursuing.
