Windward Investment Management sees itself as a different kind of money manager, one that draws its inspiration from sailing and its acumen more from abstruse theories than from conventional investment concepts.

The Boston-based firm has its share of ex-Wall Streeters on the payroll, but the company boasts that it tunes out the Wall Street noise. Instead, it uses a proprietary investment model based on the behavior of interrelated variables in complex systems. Financial measures such as price-to-earnings ratios, profit margins and the like factor little into the equation.

Windward's unusual approach reflects its unusual staff. Along with the Wall Street veterans, the company is stocked with math whizzes, engineers, managers and entrepreneurs whose impressive academic and professional chops have given them a different take on the game.

The end product is an outside-the-box investment approach mixing active and passive management in search of solid risk-adjusted returns with a keen focus on downside protection. The approach incorporates a broad range of global markets and assets, including equities, fixed income, hard assets, real estate and currencies. The company rebalances its portfolios three times a year (or more, if necessary), and invests in indexes through low-cost exchange-traded funds, exchange-traded notes and registered funds. It might use some individual securities, such as money market funds when it holds cash as an asset.

In short, the company seeks to capture as much of the publicly traded global capitalization as possible.

Each of Windward's three investment strategies--diversified conservative, diversified growth and diversified aggressive--have recorded cumulative gains that have comfortably beat their benchmarks for eight years through the end of 2009 (the period during which all three have been in operation). Two of the strategies beat those benchmarks by phenomenal levels.

The company caters to both institutional and high-net-worth individual investors. Windward's assets are held in the client's name in separate accounts at an independent custodian. The investments are liquid securities listed on U.S. exchanges, and there's no lockup, so investors can sell whenever they want. Clients can access their accounts through the custodian's Web site, which gives them full transparency.

Windward's appeal to wealthy investors is that it offers a hedge-fund-like approach without the hedge-fund-like drawbacks. "Windward is an alternative option without the baggage of lack of liquidity and transparency, high fees and tax insensitivity," says David Spungen, the CEO of Hillview Capital Advisors LLC in New York City, a wealth manager for both institutions and high-net-worth individuals. "We find that attractive."

Spungen says Hillview started putting clients into Windward's portfolios about five years ago. "Today, it's a core position in all of our clients' portfolios," he says, adding that he uses all three Windward portfolios in proportions varying according to a client's needs.

"We tend to use the conservative and growth [strategies] about equally, and less so with the aggressive," Spungen says. "There needs to be particular circumstances for aggressive to make sense."

Overall, Spungen believes that Windward's strategies have performed as advertised. "We've gotten exactly what we expected," he says. "We hired them to be the anchor and counterbalance to other things in our portfolios and to provide good risk control."

Retail Business
With the exception of a husband-and-wife team who occupy a satellite office in Palo Alto, Calif., Windward's roughly 30 employees occupy the 36th floor of an office building in Boston's financial district. The firm manages about $3.5 billion in assets, a far cry from the late-'90s when company founder and president Stephen Cucchiaro was a one-man shop focused on private clients and individuals and had only about $30 million in assets under management.

The firm's institutional business from trusts, retirement plans, foundations and endowments has gained traction in recent years and now makes up one-third of Windward's assets. Clients in this area run the gamut from Major League Baseball and the Diocese of Buffalo to the Institute of Current World Affairs and the bakery employees' pension plan in Philadelphia.

Another one-third of Windward's assets come from multi-family offices and wealth management advisory firms, and the last third comes from retail advisor networks at Charles Schwab, Fidelity Investments and, more recently, Merrill Lynch. Schwab and Fidelity have been particularly fruitful for Windward.

"A good part of my business has to do with those two places as referral sources," says David Elan, a Windward principal who did investment and client portfolio work at Ernst & Young and Goldman Sachs before coming to the firm. "They also come from my own referral network."

Elan says Windward does a good deal of sub-advisory work. "We love being involved with the platforms of other RIAs and family offices."

For individual clients, Elan says, Windward has a $500,000 minimum. The annual management fees are 1% up to $5 million, and decline incrementally further up the asset ladder.

Building The Model
Cucchiaro, 57, the driving force behind Windward's investment model, began developing his investing ideas when he was an undergraduate math major at MIT. His focus then wasn't on the financial markets, but on the more mathematically abstract work of analyzing complex systems.

"Often, the behavior of a complex system of interrelated variables can be chaotic and seemingly random," he says. "We learned that when you drilled down deep and understood the key cause-and-effect relationships that relate each variable to each other, and how we explain these relationships with their time delays, nonlinearities and feedback loops, we then can get tremendous insight on how the systems behave."

Later, when he studied for his MBA program in finance at the Wharton School under Marshall Blume, a leading authority on modern portfolio theory, Cucchiaro says he saw how the complex systems he studied at MIT could be applied to the study of global capital markets. "Rather than what the industry does, which is to separate investments into different silos where various experts specialize in either equities, fixed income, commodities, currencies and the like," he explains, "I saw the capital markets as an interrelated system of markets, and that many variables have cause-and-effect impacts across the entire market system.

"I realized that studying the entire global capital markets as a system could provide tremendous insight into understanding true market behavior,"  he continues.

Cucchiaro also realized it would take many years to study his ideas. Instead, he went into the business world and became a consultant. Later, he co-founded a company that was sold to Lotus Development Corp. (which ultimately was bought by IBM) and was president of another company that was sold to Oracle Corp.

But Cucchiaro kept thinking about the theories gleaned from his MIT and Wharton days. "It was a labor of love and a passion I did on my own time from the '70s until I founded Windward in 1994," he says.

Tweaking the Model
Windward follows 44 different asset classes and ranks them from one to 44. It puts tactical overweights on the top ten. The rankings incorporate these assets' expected risk-adjusted returns over 12 months, and part of the risk equation involves evaluating assets that can offset losses that occur during market upheavals caused by unforeseen geopolitical or financial events.

"A lot of risk management used by the industry systematically underestimates true portfolio risk," Cucchiaro says. Windward managers, on the other hand, do a lot more than just manage volatility. Instead, he says, they look very hard at potential drawdowns under the kind of harsh conditions that might seem improbable yet are more likely than people think.

The folks at Windward aren't Debbie Downers expecting the worst by any means. But some of the firm's principals are schooled in deep analysis focused on risk mitigation. "One of the early experiences of my career was modeling nuclear power plants for the NRC [Nuclear Regulatory Commission]," says Windward Executive Vice President Robert Phillips, who holds a clutch of academic degrees in mechanical engineering, math and physics. "The risk of failure is so high with nuclear power that you have to be good at understanding the risks. The same goes with our modeling."

Says Cucchiaro, "Part of our philosophy is to always be mindful that certain adverse situations can come without warning and to always have part of the portfolio hedged against that."

Cucchiaro, along with Phillips and senior investment analyst Eric Biegeleisen, make up the core investment team. Cucchiaro generally will propose ideas and experiments, and Phillips and Biegeleisen will crunch the numbers. They present their findings every Tuesday morning at the company meeting, and the firm's other principals often add their ideas and engage in an often lively debate. "We have that ability in our meetings to be contentious in our discussions and to be simultaneously respectful," Elan says.

Cucchiaro says Windward is focused on analyzing the markets. "It's a constant process and our research models continually evolve."
Still, the events of 2008 gave that process a kick in the pants. During that tumultuous year, Windward's diversified aggressive portfolio lost 20.7%, which bested the 37% loss of its benchmark, the S&P 500. The firm's diversified growth portfolio lost 15.4%, beating the 22.1% loss of a blended benchmark comprising the S&P 500 and the Barclays Capital U.S. Aggregate Bond index (these two indexes being split 60%/40%).

But the diversified conservative portfolio underperformed its benchmark (a 2.3% loss versus a 5.2% gain for the Barclays Capital Aggregate Bond index). This disappointed the firm and, no doubt, investors.

Windward prides itself on risk mitigation and minimizing portfolio drawdowns (peak-to-trough declines), yet the hefty tumble suffered by the conservative portfolio from October 2008 through February 2009 means the maximum drawdown during its advertised eight-year track record (minus 10.4%) is worse than the maximum drawdown at its benchmark (minus 3.8%).

During the same period, the maximum drawdown rates at both the growth and aggressive portfolios were significantly less than the maximum drawdowns at their benchmarks.

The problem, say Windward executives, is that even though they saw the precursors of the credit unwind and positioned themselves to profit from it in 2008, they weren't properly protected against the steep downturn in global equities, and they kept a lot of holdings in place because they figured they had enough hedges to protect themselves.

"In retrospect, we didn't lighten up enough [on equities]," Elan says. He adds that Windward didn't foresee that commodities, gold and real estate wouldn't provide the same kind of diversification they offered after the tech wreck earlier in the decade.
"As a result," says Phillips, "we've gone back to the models and adjusted the portfolios."

Looking Ahead
Windward has made several changes to its investment models to prepare itself for when the next shoe drops. For example, the firm boosted the number of asset classes it follows from 40 to 44, and the number of its overweight positions from six to ten.

The managers have also recalibrated the conservative portfolio by taking out commodities as a strategic position and structuring the portfolio to go to zero percent in equities, if need be. They also adjusted the models for the growth and aggressive portfolios to go to very low percentages of equities in certain situations.

"We feel like we've given ourselves more room tactically so that if the train was coming out of the tunnel and heading right at us we're better positioned to move out of the way," Elan says.

And that would be good news for both clients and Windward's principals, most of whom have most of their money invested in the company's portfolios. "If clients have a bad day, we have a bad day," Elan says.

Within commodities, Windward recently added the Dow Jones UBS Agricultural Commodities index because it sees ag commodities as less correlated to the equity cycle. Elsewhere, Windward has overweight positions in emerging market bonds and currencies to counter the upside-down nature of the debt cycle where developing markets now have the stronger fiscal positions and balance sheets.

Cucchiaro is also keeping a close eye on China, where he sees bubble risk if the government raises interest rates too sharply to tame growing inflation and causes a correction, much like it did three years ago. "To us, a more benign way to try to control inflation is to loosen their currency's peg to the U.S. dollar and let it appreciate a little bit," he says. "We're not ready to jump off the China bandwagon yet, but we're watching it very closely."

In 2009, Windward's conservative portfolio beat its index, while its growth and aggressive portfolios trailed their indexes. "There will always be times when particular asset classes rally sharply and we have a hard time keeping up with that with our highly diversified portfolio," Cucchiaro says. "But we always hope to catch up with and surpass sharp rallies over time."

Over the long haul, it has. The cumulative eight-year return on the conservative portfolio (net of fees and expenses) was 67.3% versus 52.6% for the benchmark. The growth portfolio gained 86.9% during this period while its index returned 31.1%, and the aggressive portfolio added 113.1% compared with 13.5% for the benchmark.

The Competition
Windward's long-term performance has won it loyal followers and new clients. "When we do asset manager searches, we look at high-octane hedge funds-the Paulsons [Paulson & Co.] of the world," says Albert Holman, founder and managing partner at Chestnut Partners Inc. in Boston. "And when we look at global asset allocators we look at the GMOs of the world. I compare them to what Windward is doing, and in my mind, Steve [Cucchiaro] is the emerging gold standard in global asset allocation modeling and investing. It's a very attractive model, and it's very efficient in that they buy highly liquid indices and ETFs."

Holman's firm does mergers and acquisition work, and part of its repertoire is providing investment advice and monitoring portfolios for clients after they've sold their companies. He has some of his clients' money in Windward portfolios, as well as some of his own money and trust accounts for his family.

As Windward grows, so does its appeal to larger institutional investors. But getting its message through to the consultants who serve as gatekeepers to this world isn't always easy. "One of our challenges is that our strategy isn't a conventional one, and there really isn't a box that pre-describes what we do," says David Cabot, a Windward principal who focuses on the institutional side.

But he notes that some consultants are creating boxes for global asset allocation. Here, Windward competes against a limited number of larger players such as Putnam Investments, BNY Mellon Asset Management, GMO, PIMCO and BlackRock Inc. And the company seems to be holding its own.

"For Windward to win some of those mandates is flattering," Cabot says. Among its recent victories: Doing investment management work for Major League Baseball.

While Windward's investment approach is appealing to some, it's also somewhat limited to others, including some of its customers.  "It would be great if they evolve their strategy to include more products," Holman says. He'd like to see them use a product that adds modest leverage or has higher beta asset classes in areas such as emerging markets.

"The Holy Grail for me is I'll tell you my risk profile and you model what my best return can be, given that," Holman says.

Cucchiaro says Windward has indeed conducted numerous tests and simulations with leveraged and more concentrated, tactical versions of its strategies in different market cycles, in different regions and amid extreme economic and geopolitical conditions.

"The simulations have shown interesting, promising results," Cucchiaro says. "We recently began a live experiment with real money, and we will run this test for a period of time before considering whether or not to introduce a new portfolio strategy based on this experiment."

As for emerging markets, Cucchiaro says the firm has recently added equity and currency indexes from India, Brazil and South Korea into its investment universe.

Charting the Seas
Employees say Windward offers an open, collegial work atmosphere. "It's a flat environment that encourages as much communication as possible," says Louis Crosier, managing principal and a member of the executive committee along with Cucchiaro and Phillips. "We encourage employees at every level to pursue professional development."

Windward works hard and plays hard. On its Web site, it profiles staff members and highlights their athletic pursuits and achievements. Every year, the company takes an annual ski retreat that mixes strategizing and schussing. This year's trip is to Big Sky in Montana.

Cucchiaro's athletic background is particularly interesting. An all-American in sailing while at MIT, he won a gold medal in yachting at the 1979 Pan American Games in Puerto Rico. He qualified for the 1980 U.S. Olympic team, but missed his Olympic moment when the U.S. led a boycott of the games in Moscow that year to protest the Soviet invasion of Afghanistan.

But sailing is still very much in his blood and in his investment philosophy. Hence the name, "Windward."

"Sailing to Windward is very analogous to investing in markets where you form judgments on which way the winds might shift, employ competitive strategies to stay ahead of the competition, and analyze how currents are affecting the race," Cucchiaro says.