"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.