What the Professionals Have Done 373
Put another way, if you own a casino, and an individual comes in, has
a few plays that break in his favor, and you quit the casino business at that
point, having lost money at it for the duration of being in the casino business,
then, yes, you are, by definition, a failure in the casino business.
As of this writing, February 2006, the long-term trend followers are in
the midst of a protracted multiyear drawdown, with many funds down well
over 50%. People are saying, “Long-term trend following is dead.”
As you will see in the next chapter, “The Leverage Space Portfolio Model
in the Real World,” this type of drawdown is absolutely expected and normal.
In fact, it may well get worse before it gets any better.
***Given these basic building blocks of allocation, however seemingly crude,
one could (and many, in fact, have) create successful commodity funds.
Merely by risking 1% of an account’s capital on 20 seemingly disparate mar-
kets (or not so disparate, even, given how few markets are available for
some funds because of their liquidity constraints as dictated by their size),
some funds have seen wild success over the years by any measure; and,
peculiarly, with no concern for correlations.^3
One very large, very successful fund that has been around for a gener-
ation has operated that very way since inception and is known for coming
through with nice returns over time, with rather small, perfectly digestible-
to-most drawdowns. Another long-term, successful fund with roughly USD
1 billion currently trades only about a dozen markets with a single model
and three parameter sets per market.
By contrast, one of their close competitors with a similar amount un-
der management, and funds highly correlated to the one just mentioned,
use six to eight models with dozens of parameter sets for each market
and a basket of over 60 markets! As would be expected, their returns
have historically been smoother, but not relatively to the extent one might
expect.
With the majority of the commodity funds, however, that 20% figure
could be 5% or it could be 50%, but at 20% you’ll be right in the mainstream,
right in or near the fattest part of the curve. As for the stop-out amount,
typically this would be the lesser of 2% of an account’s equity or the per-
centage allocated to trading (again, 20% putting you in the fat part of the
curve), divided by the number of markets traded.
(^3) This may not be such a bad approach. Given that correlations do not seem to
maintain consistency with the magnitude of swings, when all cut against you, in
such an allocation model, you are looking at a 20 % loss.