Dear Limited Partner / Investment Committee,
We are writing to inform you that the profit/loss for December 2012 was +0.99%. These recent results put our full year 2012 gains at +10.27%.
To quickly recap and refresh your memory of 2012, our year started off to a blisteringly positive start, most likely attributed to the massive liquidity injection from the ECB stimulus. However, our performance turned south in the middle half of the year, giving back all our prior gains. Fortunately, this extremely frustrating time mostly dissipated in the last few months, due to some very beneficial positions in some international equity markets and a solid improvement in our “rare trade” position. Cumulatively, 2012 in effect nearly erases our poor performance from the year prior and puts our since-inception returns at -1.02% annualized. And with 2012 winding down to a close, one cannot help but (rather stereotypically) reflect back on both the positives and the negatives we have encountered.
The main successes we have had have come in the area of research and education. Substantial new improvements were made to our “core” models, which we feel will pay off greatly in coming years. Secondly, as we have previously mentioned, our newly developed and implemented overlay strategy is performing well. However, we prudently continue to devote only a small part of the portfolio size to this, letting the strategy “prove itself”. If it turns out as well as we expect, the compounded profits will make it a more substantial risk-weight in the portfolio. Lastly, our most proud breakthrough of the year has come in the form of a portfolio-level risk management algorithm that should vastly decrease the drawdowns in our core portfolio. As there are really very few new ideas out there (even if you develop and generate them independently and in isolation, odds are someone somewhere has had nearly the same thought), we have always felt ok with standing on the shoulders of giants. As such, my findings usually tend to at least relatively coincide with other’s. Interestingly, this new work seems to be very novel as I have never come across anything similar in my years of education and research into other’s techniques.
Finally, a few caveats. Although these developments are very encouraging, do not expect unrealistic results overnight. Nothing works overnight and in pie-in-the-sky degrees. These improvements should provide incremental benefits over the course of a long track record. Also, please note that these research findings are not style-drift, technique-shifting changes, nor are they over-tweaking optimizations either. Rest assured our core philosophies and beliefs as to how markets work and how one can succeed in them remain exactly the same. Moreover, we view these improvements are part of a build-out of a robust, stable, consistent, and obviously profitable trading framework.
Now the bad: Although our performance has been solidly positive this year, it has not been without mistakes, faults, and failures (as any venture has, whether they like to admit it or not). We have suffered some sharp losses over the year and our equity curve is still far flatter more volatile than we would like. This has been primarily due to the poor management of our “rare trade” position. As discussed previously, we have had a large position in our portfolio for well over a year now. In our opinion, the position was, is, and will continue to be a very sound opportunity to be in, and was not an error in analysis. The real cause for this massive black eye to our long-term record comes from the lack of granularity in position size options. Due to the extremely large contract size of this multi-leg structure, the risk, volatility, and variability of even one single unit has been far larger than we would have liked or wanted for our account size. In a perfect world with exact position precision, we would like to have put this trade on at one-fifth the size, or 20% of the exposure of the most minimally-available unit. As a result, we made the risk management mistake of putting on the one large unit and “rounding up to 1” rather than simply passing on the trade. Furthermore, this mistake is one that larger account funding should prevent in the future.
Needless to say, we have deeply and intrinsically learned our lesson. We also hope you all realize the cause to be singular and temporal and non-systemic, nor structural in any way to the way we trade.
(Due to length, Part 2 of my year-end letter will be posted later this week. Please tune in!)