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Five Minutes with Dan Stern

Dan Stern Dan Stern is founder of Stern Investment Advisors.

Daniel B. Stern is managing member of Stern Investment Advisors, LLC in Chicago, which he started in August of 2004. He has been in the trading and financial services industry for 35 years, beginning as a soybean trading at the Chicago Board of Trade, where he is still an active member. In 1988 he became a member of the Chicago Board Options Exchange (CBOE), where he was a market maker in the S&P 100 index. (He does not trade futures and options for Stern Advisors, however.) Stern is also licensed to sell life and health insurance as well as variable annuities and long-term care insurance. Stern spoke with JLN editor Sarah Rudolph last week about his newest ventures as an investment manager.

Q: Both you and your father, Lee Stern, have been in the trading industry for a long time. When did you start?

A: My father became a member of the CBOT in 1949 and still trades. I became a member in 1974 trading grains, which I still do. I was a CBOE member for 20 years, from 1988 to 2009. However, because of the settlement between the CBOT and the CBOE, I had to give up my exercise rights in 2009. I’ve been in the securities business going back to the 1980s. I was at Morgan Stanley until 2004 and then I started my own investment advisory firm.

Q: How do you pass along what you’ve learned trading at the CBOT and the CBOE to your clients?

A: For one thing, trading gives me a lot of respect for how hard it is to make money. You make so many decisions in a day’s time that it makes everything else look kind of easy. That’s particularly true in options, because risk management is really the key there. I have to figure out the best time and place to take a position and consider the risk/reward. My motto is “Get in smart and get out stupid.”

Q: What does that mean, “Get out stupid”?

A: Sometime you do a trade that is very smart strategically, and maybe you don’t quite reach your goal, but the trade moves very fast in your direction. For example, this month I was long March and short May corn. The trade reached my profit objective by March 1st and I took a profit. Normally I would not take a profit until about March 10. However, the trade moved in my direction faster than I anticipated. If I had not gotten out of the trade so early, I would have been very concerned about the risk/reward aspect.

Q: How did your father, who is actually the longest-tenured trader at the CBOT, pass along his knowledge and/or love of trading to you?

A: I just listened to him talk about his day at work. Then when I turned 16 I went to work for his clearing firm and learned the business that way, so when I was fortunate enough to own a membership, it wasn’t as difficult for me. I had already learned about out-trades and back office procedures, and who the firms were, who the traders were, how to check trades.

Q: Can you tell me a little bit about Stern Investment Advisors? And your other ventures, such as your fund of funds?

A: My thoughts about starting my own firm developed while I was at Morgan Stanley. Morgan is a wonderful firm; however, their focus is on stocks, bonds and fixed income. My world has been that plus the alternative investment space. Also, I wanted to be able to pick whichever managers I thought were best for my clients, and you can’t do that when you work for a wire house, which I understand and agree with.

Besides stocks, bonds and mutual funds, I also got involved with the hedge fund world and with premium finance insurance, which involves third parties who agree to pay the premiums for very high net worth people. I have experience with private placement insurance, too. In 2007 I became bearish on the stock market. Every time I sold stocks I just would go into cash. Finally I decided to start a fund of funds. The managers would be non-directional and have a very small relationship with the stock market. I identified various strategies such as forex, fixed income, options and special opportunities to invest accordingly for my clients. I’m also working closely with three people, not employees, who are advising me. We have a very good group: four people, including me, with great backgrounds, who are not shy about sharing their opinions with me. I respect all of them.

I started my fund in June of 2008. In two and a half years of experience I have obtained the equivalent of 22 years of experience in this environment. A lot has happened in the investment world since ‘08, including the fallout from the Bernie Madoff scandal (though I never invested with him) and the SEC decision to ban short selling. Try to be a hedge fund without being able to short stocks! It made things difficult for many managers because of that. Furthermore, liquidity in the options arena dried up.

I’ve been on a winning streak now for six months. It’s a combination of improving the manager lineup and proper allocation on my part.

Q: How do your investment strategies differ at the fund of funds vs. your individual trading strategies?

A: Outside of convertible arbitrage, which I understand but never traded, I have used all these strategies myself at some point. I’ve never worked for a fund of funds, I’ve always traded and managed my own money. That gave me a good idea what managers go through. If I see a manager who is doing poorly but is clearly skilled, I give him some rope, but if I see an options trader who should be making a profit or breaking even but is losing money consistently, I will then have to decide whether I want to continue with him. I believe that one of my strengths is that, because I have traded these strategies, I can understand and analyze them myself.

That’s why I don’t have many managers who are quants. I can’t identify why they are making or losing money or whether they are taking too much risk or not enough. I think I currently have only one manager who is a quant. A very credentialed manager.

With options traders, I know what they do, and I understand managers who have a macro approach. I understand the underlying philosophy. I know fixed income as well. I have one manager who trades closed-end funds, who is not a quant.

Q: There is a lot going on in volatility products. What are your thoughts on those?

A: The volatility products are tremendous, a great idea. The world loves volatility, and the ability to hedge your portfolio against volatility is spectacular. Our products are about managing risk, and volatility products are a great way to buy that insurance. You can guard against the market by being long volatility. In 1987 you had two ways to manage risk: either sell your stocks or buy puts or sell the S&P 500. That didn’t work so well. Now we have more ways to manage risk.

The VIX contracts are also geared toward a variety of markets, such as energy.

Q: You also trade single stock futures [at OneChicago]. How is that business doing these days?

A: I started trading single stock futures in the last 12 months. I was on the joint venture committee between the CBOT and the CBOE that created OneChicago, which was originally owned by the CBOE, CBOT and CME. We got bought out by the CME, so now CME and Interactive Brokers are the owners along with the CBOE.

My contention when we created OneChicago was that single stock futures would be a terrific market for managers, because instead of buying a stock they could put up 20% margin and just roll the contract like a futures contract. It’s an interest rate game, too. And you can do exchange for physicals. That’s what I did in the grains so I’m familiar with that style of trading.

OneChicago has been very busy of late. From what I understand, single stock futures are doing well. You can also get involved in the stock lending business through single stock futures. It’s interesting because there are opportunities to get returns on a retail level that weren’t avail before, by loaning your stock certificates.

Q: What was it like to be in the industry throughout all these enormous changes?

A: Well, I get all these kids calling me “Mr. Stern” now, and if my dad’s not in the elevator I guess they’re talking to me. When I got started, it was all about standing in the soybean pit with traders all day long and going home with no position. Life was simple and wonderful.

Now you trade at night and there is a lot of information you have to absorb, and it’s a technology-driven market. You can’t see the marketplace, so you have to do a lot of guessing. The scalping that used to take place is for all practical purposes over. It’s much more difficult, but it means you have to be that much smarter – be on your toes.

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Rudolph is managing editor of John Lothian News (JLN).