By Jonathan Yates
In discussing basketball players who step up in the playoffs and elevate their game to do what it takes to win the National Basketball Association (NBA) championship, NBA analyst Kenny Smith remarked, “The great ones have short memories.” If a player is dwelling on their last missed shot, they will not have the confidence to make the 20 footer at the buzzer to win the championship. Great traders such as Bruce Kovner, founder and Chairman of Caxton Associates, LLC, have clearly established that they possess this invaluable intangible, too.
This quality makes for a great trader as being wrong is actually an integral part of success in the buying and selling of financial instruments. A successful futures trader makes many more losing trades than winning ones. The key is to recognize and concede the mistakes and cut losses. And ride the winners. Since his first commodities trade in 1977 using $3000.00 borrowed from his MasterCard to buy copper and interest rate futures, Kovner has proven himself as one of the greatest traders of all time.
From this initial foray into the commodities markets, Kovner also learned another crucial lesson: risk management. For his first two trades in copper and interest rate futures, Kovner booked $1000.00 in profits. This $4000.00 ($3000.00 initial stake plus $1000.00 profit) soon rose to $45,000.00 in only six weeks when a soybean shortage developed. When the market turned and reverted back to the mean to restore equilibrium, as it always does, Kovner panicked and ignored trading stops along the way down. From there, his position fell back to $23,000.00. He lost half in profits in only an hour’s time. A nice profit of $22,000.00, indeed, from an initial position of only $3000.00 was still the final tally. But a much better lesson in risk management was the ultimate result, observes Kovner. “I closed out the trade and was physically sick for a week,” he remembers. ”In retrospect that was a very good thing. It helped me understand risk and create structures to control risk.”
Even though he was ill after the lost profits, like all the great ones Kovner was able to forget about the negative aspects of the trade and focus on the lessons learned to improve his future performance. After that trade, there have not been too many lessons that Kovner has not mastered in investing for profit. Caxton Associates, LLC, closed to new investors since 1992, is one of the ten largest hedge fund families in the world, with more than $15 billion under management. Kovner has a net worth of about $4.5 billion, according to estimates.
While a secretive man and highly private individual, Kovner has a Rolodex that is the envy of all. He is very active in conservative Republican politics, counting former Vice President Dick Cheney as a close friend. Contacts such as these around the globe allow him a greater insight into government policies that will move markets and in which direction. This directs the trading of Caxton Associates.
Kovner attributes much of his trading success to “stupid governments,” which make bad policy decisions. These state actions result in financial market disequilibria that can be exploited for profit. The most obvious example here is when George Soros became known as “the Man who broke the Bank of England” after he made a $1 billion trading profit during the 1992 “Black Wednesday” currency crisis for the United Kingdom. For savvy macro traders such as Kovner, who was a Ph.D. candidate in Government at Harvard, state action (or inaction) is a constant source of lucrative investing income from currency markets, commodity exchanges, equity bourses etc…. As Jim Rogers, who ran the Quantum Fund with Soros has observed, “A weak currency is the sign of a weak economy, which is the sign of a weak government.”
Like so many other trading luminaries, Kovner received his start with the legendary Commodities Corporation. Bought out by Goldman Sachs in 1997, Commodities Corporation was described by an article in Time magazine in 1981, as “… a rare breed, a cross between a cautious wholesaler and a freewheeling speculator.” Later in the same piece, “The firm’s credo seems to be that any theory is good so long as it makes money.”
This is the approach that Kovner has employed throughout his career. He has owned a seat on all of the exchanges for all of the financial instruments. Spending time on the floor with its intense, physical jostling for position among traders to fill an order, Kovner regarded this experience as an opportunity to understand how the speculative behavior at the basest level of an exchange influenced the actual market for the commodity or instrument being traded.
From the floor up, Kovner was an early trader in Ginnie Mae bonds. The single most important development in macro trading, according to Kovner, was the development of futures markets for currencies and interest rates. The collapse of the Bretton Woods Agreement and the allowing of gold sales in the 1970s laid the foundation for this mega opportunity.
While the 1970s and early 1980s were basically flat for the Dow Jones Average, there were a number of developments that laid the foundation for Kovner and other traders, both macro and micro, to prosper. Commission rates were lowered, which led to more trading volume and deeper liquidity as a result of more investors and speculators buying and selling securities. Taxes, particularly for capital gains, came down, drawing in more investment activities. Creation of IRAs and other instruments encouraged individuals to invest for retirement. Computers became more powerful and abundant, bringing in more trading techniques and increasing the range of research for all asset classes. Barriers to capital flows around the world were lowered. Foreign investment was courted and currency restrictions reduced or removed, allowing for Caxton Associates to trade in and out of more foreign monetary units and in greater size. The end of The Cold war brought billions of new consumers to the free market, all customers for every commodity and every currency (needed to finance trillions more in international transactions).
These experiences in the classroom, on the floor, in “upstairs trading,” (the analytics work with Commodities Corporation) and the forming of Caxton Associates, LLC in 1983, coupled with the changes in the global financial marketplace have resulted in a number of trading lessons for Kovner. “Some markets have very long, quiet periods, “he counsels. “Some markets and some instruments become obsolete. Some markets become arbitraged out. The excess return in them goes away. One of the most important skills you need is to constantly reinvent where you put resources. Commodities markets were quiet for years. Now they are very strong.”
As a result of these micro and macro events, Caxton Associates focuses on opportunities that arise in the market cycles of four assets classes: equities, fixed income, commodities and currencies. Each of these asset classes has their own macro economic cycle. For each, there are also political factors around the globe that affect their pricing mechanisms. Where the asset is situated also factors into the investing strategies and tactics of Caxton. “We trade Asia differently than we trade Europe or the U.S.,” notes Kovner.
The growth of the hedge fund industry and other investment vehicles has also modified the trading activities of Caxton. “I don’t try to outguess the employment statistics on the first Friday of every month, because everyone is watching the numbers come out,” Kovner remarked. “So now you must seek out undiscovered information somewhere else.”