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."