Planning for the Uncertainty of the Future Hedge Fund World Middle - - PDF document

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Planning for the Uncertainty of the Future

Hedge Fund World Middle East 2010 Dubai, UAE

* It is an honor and pleasure to address such a knowledgeable group of interested professionals. I hope to provide you with a better understanding of the benefits of including Managed Futures in investment portfolios. Managers are always trying to position their portfolios to deliver attractive returns for their investors, but this is a very difficult task because it involves, among other things, anticipating and dealing with future market behavior and applying the best strategy to capture good returns. Investors are constantly seeking investment vehicles to deliver good returns, and they are probably mostly evaluating the past performance of prospective investments over a hopefully long past, some

• f which, again hopefully, included some difficult markets.

The main problem with planning for the future is that we don’t know what it will be! This morning I’d like to review with you some particularly difficult markets of the past and ask if Managed Futures could have been helpful. __________________________________________________________________________________ * This is a summary of remarks given by Dr. William A. Dunn at the Hedge Fund World Middle East 2010 conference in Dubai, UAE on March 2nd, 2010. Please refer to page 9 for Dr. Dunn’s bio.

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S&P Correlation to Alternative Asset Classes S&P Correlation to Alternative Asset Classes

Correlations with the S&P 500: 2001-2009

Source: Center for Int’l Securities & Derivatives Markets (“CISDM”) CTA Index www.casamhedge.com

Managed Futures Futures Mortgage-Backed S&P 500 Equity Long/Short Merger Arbitrage Technology Emerging Markets Event Driven Equity Market Neutral Convertible Arbitrage Fixed Income Arbitrage Distressed Securities Global Macro Equal Weight Hedge Fund

Source: The Center for International Securities and Derivatives Markets (CISDM) Full information may be found at www.casamhedge.com

Let’s start by looking at how the performances of various asset classes correlates with the S&P. Please note that:

• 7 of the 13 asset classes have correlations of 60% or greater, and the next three have

correlations greater than 40%.

• Managed Futures is in a class by itself with a negative correlation of 18%.
• The data only goes back for the last 9 years which is as far back as the source could go given

the limited history of several members of the alternative asset classes. Also note:

• The source used for Managed Future’s performance is the Center for International Securities

and Derivatives Markets (CISDM) CTA Index.

• Information on the CISDM CTA Index can be found at www.casamhedge.com.
• Throughout this presentation:
• The S&P Index will serve as a proxy for a portfolio’s performance.
• The CISDM CTA Index will serve as a proxy for a Managed Futures program’s

performance.

• The DUNN Composite performance is net of all pro forma fees and expenses.
• The DUNN WMA Program is the current investable portion of the DUNN Composite.

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Example #1 Example #1 – – Tech Bubble Tech Bubble

S&P 500 CISDM CTA Index DUNN WMA

January 1998 – December 2004

The previous chart took a broad look at performance correlation over the past nine years. However, it is interesting to note the performance correlation during difficult, i.e., negative periods for the S&P. Thus, let’s examine two relatively recent difficult periods. The first difficult period is the “Tech Bubble” that began in late 2000. This vicious bear market lasted about two years and devoured over 40% of the capital at the peak. This was a very upsetting experience, and no one could know how long it would take to recover… ASSUMING managers and investors had the confidence and courage to stay the course. During the plunge:

• The S&P lost 43%.
• Managed Futures delivered a return of +38%.
• The DUNN WMA Program delivered a return of +209%.

We know that Managed Futures are non-correlated to the S&P. However, when we begin to study S&P down markets, we find that Managed Futures become even more uncorrelated to the S&P in down markets and have historically provided investors with a true hedging opportunity.

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Example #2 Example #2 – – Sub Sub-

• Prime Crisis

Prime Crisis

December 2006 – December 2009

Our second example examines the more recent “Sub-Prime Crisis”. This plunge in the S&P was both shorter in duration and more painful as investors watched the S&P plummet over 50% from the peak in just 18 months. During the plunge:

• The S&P lost 51%.
• Managed Futures delivered a return of +18%, which more than compensated for lagging

performance in the shoulder periods giving an overall return of +29% vs. a loss of 15%.

• The DUNN WMA Program delivered a return of +81%.

Before turning to another feature of Managed Futures it should be mentioned that:

• These examples are generalizations of analysis that could be done to evaluate the benefits of

Managed Futures with some other Alternative Asset Class.

• To conduct a specific analysis, one would need to substitute the track record of the particular

Hedge Fund and Managed Future program of interest, both of which are investable, in place of the index proxies we have used here, which are not investable.

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S&P Correlations using All Months & Negative Months S&P Correlations using All Months & Negative Months

Correlation with S&P 500 to Alternative Asset Classes From least to most correlated - 2001 through 2009

Striped Bars = Negative S&P Months Solid Bars = All S&P Months

(Note: Negative months occurred in 42/108 or 39% of the time)

Managed Futures Futures Global Macro Equity Market Neutral Convertible Arbitrage Convertible Arbitrage Merger Arbitrage Technology Fixed Income Arbitrage Equity Long/Short Event Driven Emerging Markets Distressed Securities Equal Weight Hedge Funds S&P 500 S&P 500 Mortgage Backed

Now that we have examined two specific and significant examples of correlation in S&P down markets, let’s take a broader view of correlations in all markets vs. correlations during S&P down

• markets. For the purpose of this comparison, we are viewing correlations of various asset classes in

all months (during the last nine years) vs. their same performance correlation in months in which the S&P suffered a loss. As we can see, the correlation for all asset classes decreased, while the performance correlation of Managed Futures became even more dramatic increasing from a negative correlation of 18% to a negative correlation of 44%. Again, the data confirms that Managed Futures serve as a true non-correlated investment alternative, and the empirical data shows the non-correlation benefits of Managed Futures become even more pronounced during S&P down months.

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Correlation Comparisons Correlation Comparisons – – All Alternative Asset Classes All Alternative Asset Classes

In the previous slides, we concentrated on the benefits of Managed Futures’ non-correlation to the S&P. However, it is highly unlikely that an institutional portfolio would include only one of the alternative asset options as a hedging tool. Thus, it is both appropriate and reasonable to consider how the performance of Managed Futures correlates with other alternative asset classes. Again, looking back over nine years (the longest period of time with sufficient data available to examine) we can view the data and see that against every other alternative asset class (with one exception) Managed Futures remains the least correlated asset, and is highlighted in green. In addition, the statistical study shows that the DUNN WMA Program, which is highlighted in blue, is even more uncorrelated. The most correlated alternative asset class is highlighted in red.

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Historical Performance Historical Performance

Compound Annual Rates of Return DUNN Composite: 17.3% CISDN CTA Index: 12.1% S&P 500 (Total Return): 11.1% Annualized Standard Deviation DUNN Composite: 35.3% CISDM CTA Index: 15.0% S&P 500 (Total Return): 15.5%

S&P vs. CISDM CTA Index vs. DUNN Composite

January 1980 – January 2010

Correlation to S&P 500 DUNN Composite: -0.06 CISDM CTA Index: -0.01 Compound Annual Rates of Return DUNN Composite: 17.3% CISDN CTA Index: 12.1% S&P 500 (Total Return): 11.1% Annualized Standard Deviation DUNN Composite: 35.3% CISDM CTA Index: 15.0% S&P 500 (Total Return): 15.5%

Here we have plotted the S&P 500 Index (in red), the CISDM CTA Index (in green) and the DUNN Composite (in blue) over the past 30 years. The two previous examples of recent bear markets, which we have just examined, are highlighted in red circles.

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S&P Monthly Losses of 6% or More S&P Monthly Losses of 6% or More

Jan 1980 – Dec 2009

• Avg. S&P Monthly Return: -9.3%
• Avg. CISDM CTA Index Return: 2.9%

DUNN Composite: 9.8%

Crash of '87 Asian Crises Bear Market 9/00 – 2/03 Sub-Prime Crises Tech Bubble 9/11

Over the last 30 years (Jan. 1, 1980 through Dec. 31, 2009) the S&P has experienced a monthly loss

• f 6% or more on 23 occasions.

The average monthly performance for the S&P during these 23 negative months was -9.3%. By contrast, during these same negative S&P months:

• The Managed Futures Index experienced a positive return in 20 of the 23 months, providing an

average return of +2.9% vs. the S&P average of -9.3%.

• The DUNN Composite also experienced a positive return during 20 of the 23 months.

However, the DUNN Composite performance exceeded the CTA Index by producing an average return of +9.8% vs. the S&P average of -9.3%.

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Conclusions Conclusions

Managed Futures deserve serious consideration when discussing portfolio asset allocations.

• Of all of the alternative asset options, Managed Futures provides the greatest degree of non-correlation.
• In S&P down markets, the benefits of Managed Futures are even more uncorrelated.
• Over the last 30 years, the Managed Futures Index has provided a slightly greater return than the S&P with a slightly lower

annualized standard deviation.

• During the same 30 year period, the DUNN Composite has outperformed the Managed Futures / CISDM CTA Index

by 43% (+17.3% vs. +12.1%).

• During the last 25 years (Nov. 1984 – Feb. 2010) the DUNN WMA Program has outperformed the S&P Index by 34%

(+14.08% vs. 10.52%).

WILLIAM A. (“Bill”) DUNN, Ph.D. Founder and Chairman

Bill Dunn earned his Ph.D. in Theoretical Physics from Northwestern University in 1966 and did two years of post- doctoral research and teaching at the University of California, Riverside and Pomona College. He left the academic world in 1968 and spent seven years in operations research and systems analysis for the Navy, Coast Guard and Department of Defense in the Washington, DC area. By 1974, Bill had educated himself in his spare time in the methods of technical trading of futures portfolios, founded DUNN Capital Management (DUNN) and begun trading. In 1980, DUNN moved from the Washington, DC area to its current headquarters in Stuart, Florida. Today, all DUNN programs continue to employ 100% systematic, quantitative trading models (originally designed to benefit from long-term trends) that process daily price input data and produce trading orders. The trading orders are constantly monitored, but the orders are determined solely according to the systematic trading models without discretionary fundamental inputs. The result is a DUNN’s Composite track record that now spans 35 years and has produced a return of over 18% per annum, net of all fees and expenses.

DUNN CAPITAL MANAGEMENT, LLC

309 SE Osceola St # 350 Stuart, FL 34994 + 772-286-4777

www.dunncapital.com