Hawksbill: Improving on a Classic by Daniel P. Collins:
Tom Shanks, as a member of the famed turtles, received a great opportunity and learned his lessons well by understanding that systems need to evolve, improve or perish. He has honed this gem of knowledge to a system much different than the original, but one that shines just as brightly.He was a professional blackjack player in the late 1970s, which is how he met Blair Hull, who later offered him a job as a research programmer at Hull Trading. In 1984, Shanks served as operations manager of Hull’s Options Research service. He left Hull in 1985 to work for Richard Dennis and Bill Eckhardt at C&D Commodities, where Shanks and two other turtles, Paul Rabar and Jiri Svoboda, began to program some of the principles they were being taught. “All of those trend-following principles were thoroughly confirmed in our testing,” Shanks says.
By mid-1986 Shanks was trading the turtle method for Dennis and affiliated clients. In 1988, he took over the program as a registered commodity trading advisor (CTA) and would change the name to Hawksbill Capital Management. “There was an effort to market a group of turtles as a CTA, but Rich wound down the effort in the spring of 1988,” Shanks says. “Our trading approach doesn’t resemble the systems that we were taught initially except that it thoroughly and consistently embodies the principles of trend following that we were taught,” he adds, referring to his Santa Rosa, Calif. based CTA.
It is hard to believe the valuable turtle trading method was let loose without restrictive contractual obligations, but Shanks was free to trade it for clients. “We had signed a non-disclosure agreement that we would not share it with the world,” says Shanks, but adds that he was free to manage money with the systems he was taught. “Generous is a term that is fully applicable to Rich and Bill. No question their generosity was boundless. I, and I suspect, all the people who had the good fortune of learning from them feel profound gratitude for their generosity.” When he started, it was a game of high returns and Shanks delivered, earning more than 200% in each of his first two years. “I initially was using the same leverage that we used with Rich and that proved to be a little heavy for what the market was looking for,” Shanks says. “We were swinging for the fences more than we should have been. The markets definitely changed and they continue to. The systems that worked so successfully in the ‘80s degraded tremendously in the ‘90s, so we continued to evolve.”
One evolution that has come full circle is the use of discretion. “We initially were encouraged by Rich to use what he termed ‘flair’ and to bring our own sense of the markets and our personalities to trading, and that was a license to use discretion. Later Rich came to believe that discretionary trading was ‘sub-optimal’,” Shanks says. Hawksbill added a discretionary overlay in early 2008, but it only accounts for 10%-15% of its trades. “We had been burned by some poor discretionary trading in the 1990s, so we backed off of it.”
Now discretion is more controlled and positions are liquidated systematically. “Once we put the trade on, it is on autopilot. We are not tempted to stay in a trade that isn’t working,” Shanks says of his discretionary overlay. “If we get an aggregate position that is uncomfortably large because our systems all are getting in at the same time, we can liquidate some of the systematic trades [or] put on a risk control trade in the other direction.” The overlay uses a combination of fundamental, technical and risk control measures. It paid off in its first year. “Broadly speaking the first half of  profits were attributable to system performance and the majority of the profits in the second half of the year were due to discretionary trades,” Shanks says.
It also helped in 2010 when Hawksbill did well in all its sectors, but earned the bulk of returns in fixed income. Hawksbill returned 96.23% in 2008, was down 15.28% in 2009 and earned 57.61% in 2010. Shanks credits their shorter-term program that was added in 2007. He distinguishes it as the modern era of the program. In that time, Hawksbill has had an average annual return of 33.27% with a worst drawdown of 24.67% and a Sharpe ratio of 1.02. “We have become more short term in the last few years and our short-term and intermediate-term systems did very well last year. My sense is that we are on the shorter end of the trend-following universe.”
All three strategies run independently and can take opposing positions. “We trade [each] signal regardless of what the other signals are doing,” Shanks says. “These three systems work in concert as a suite to produce a better risk-adjusted return than any of the three does separately,” Shanks says. Shanks has learned a lot from the masters, the most important lesson being that he must continue to learn and improve.
Tom Shanks studies the crude oil chart on a screen in his office at his home overlooking the Sonoma Valley in Santa Rosa, Calif. It’s late October, and Saddam Hussein’s dreams have caused market upheavals. Momentum is falling and Shanks, out of energy due to volatility, says he wants to sell crude. His discipline says no. Shanks and his former teacher, Richard J. Dennis, never found evidence that momentum was a valid indicator. “One thing Richard always taught us was do the hard thing,” he says. He steps back from the trade.
Shanks, a former Dennis “turtle,” researcher, blackjack player and American College of Switzerland graduate, heads Hawksbill Capital Management. Hawksbill is a type of sea turtle. But unlike a real turtle, Shanks is fast: In a business growing more risk adverse, Shanks is willing to pull the trigger. “I’m somewhat aggressive, but not out of line,” he says. “I’m less risk adverse than a lot of people. It also reflects a very high confidence in what we’re doing.” Maybe that’s why he’ll leverage up to 70% margin to equity.
“But we won’t get in a position like that without substantial profits,” he says. “And I certainly wouldn’t take on a large position if I was even on the year. I’d be a lot more conservative.”In a year when most former Dennis proteges are posting stellar numbers, Shanks tops the list, a 260% return through November. He manages $ 40 million.
“The best thing I got (from Dennis & Co.), aside from, obviously, the systems and psychology, was their sense of the importance of statistics and how careful one had to be in drawing conclusions from research, how easily one could be led astray from drawing conclusions from research,” Shanks says. The Dennis structure is deeply ingrained in Shanks’ trading. He traded under Dennis 3 1/2 years, ending in 1988. The last several months ended with a 47% drawdown, but only after two years of 100%-plus returns.
Shanks resumed trading in late 1988. His first full year of managing money, 1989, ended with a 55% return. But it was a roller coaster ride. He was up some 40%, only to have a 55% drawdown over four months. He rallied the last two months with returns over 110%. This year has been kinder. The largest monthly drawdown, almost 11%, was in May. “Nothing has changed significantly (between 1989 and 1990), it’s just basically the markets,” especially for trend followers, he explains. “You have to expect drawdowns, and sometimes you have to expect drawdowns from standing starts. This might be the second year out of five that I didn’t get stuck with 20%-30% (drop) right out of the shoot. It happens, and you get more conservative . . . you wait until the markets come around, because they will. I’m absolutely confident they will. There’s a lot of talk that the trend follower is dead …but I don’t believe it.”
He says his system is 95% Dennis’ system and the rest his “own flair.” “I’m a long way from someone who follows the system mechanically,” he says, “but by far, the structure of what I do is based on Richard’s systems, and certainly, philosophically, everything I do in terms of trading is based on what I learned from Richard.” Some of those lessons on risk control include trading in proportion to the bankroll and diversification (he trades 24 commodities).
He’s closemouthed about other Dennis risk management lessons (a sort of turtlesque oath) but says they have a set amount they will risk on any position. “We know from the outset exactly where we’re going to get out in the worst case,” he says. “Frequently when a position takes off, you build in substantial profits, to the extent that you put those profits to risk. Your stops don’t move up as fast as your profits do. As your profits grow, the risk of giving them back grows too.” Why not take them faster?
“I’ve seen over and over again in research that if you try to take profits too quickly, it just kills you. It upsets your system expectation,” he says. “It’s the natural thing to do. Richard taught us that the inclinations that come naturally are almost always wrong.” For example, the adage of cut your losses and let your profits run is counterintuitive, he says. “I still to this day don’t do the hard thing nearly as much as I should,” he adds. “It’s too hard.”