214 Systematic Investor Series ft. Andrew Beer – October 16th, 2022

[00:00:00] Introduction

You’re about to join Niels Kaastrup-Larsen on a raw and honest journey into the world of systematic investing, and learn about the most dependable and consistent, yet often overlooked investment strategy. Welcome to the Systematic Investor Series.

[00:00:20] Niels

Welcome back to this week’s edition of the Systematic Investors Series with Andrew Beer and I, Niels Kaastrup-Larsen, where each week we take the pulse of the global market through the lens of a rule based investor. If you’re new to the show, I hope that today’s episode will trigger your curiosity enough to check out the back catalog and listen to past episodes that you may have missed, like my conversation with Rich, last week, where we reflected on what may turn out to be one of the strongest trend following years for a decade or two, but also how different trends can look and how you have to deal with that. 

Also, I must encourage you to listen to the midweek conversation we published with Annie Duke. She’s not only a world champion poker player, but also someone who’s incredibly smart when it comes to decision making, especially during uncertainty. Her new book Quit is full of lessons that we as investors can and should adopt. I really hope that you’ll take an hour out of your time to listen to this.

So, head out and check these episodes out once you’re done listening to Andrew and I today. Andrew, it is great to have you on the podcast. I’ve very much been looking forward to this conversation. How are you doing? How are things where you are today? 

[00:01:30] Andrew

Things are great. Things are great. I’m very excited for the rest of the fall. As you say, it has been quite a big year and quite an extraordinary market. Thank you so much for having me on today. It’s a delight. 

[00:01:38] Niels

No, it’s an absolute pleasure, an absolute pleasure. Yeah, there’s lots of things we are going to dive into today. We have some great topics that you brought along. We have tons of questions that came in. We’ll see if we can get to as many of them as possible, of course. Before we head into any of that, as usual, let me just run through a brief summary of the week. 

There was precious little for the Fed to celebrate this week. The all important employment report has been relegated to second tier stages as the producer and consumer inflation measures takes center stage as the most important measure of the Fed success (or as the case may be with this week’s report, failure), but measures came in above expectations and didn’t really offer any indication that the rate hikes, to date, have been successful. The markets reacted mostly as expected. The 30 year bond, after a brief short covering rally on the day of the CPI release, closed the week just one basis points below 4%, and the two year note is closing the week at around 4.5%.

Fed Fund Futures reset materially higher with the May, 2023 contract indicating a peak Fed Funds rate now at 4.935%. Equity market staged a similar short covering rally, on the day of the CPI release, initially punching through the lows of 2022, but staging a blistering rally to end the day close to the session high.

But investors should be cautious of that kind of market reaction as selling returned on Friday, and the market feels pretty heavy as we head into the weekend. Next week it’s all about housing as the various entities release the housing market index, building permits, housing starts, and existing home sales, with mortgage rates topping 7%. One should not expect up-side surprises on any of these reports. 

Anyway, let me bring you in again, Andrew, just to touch on things that are catching your attention in terms of maybe markets or performance of certain strategies; maybe not your own strategy right now, but we’ll deal with that in a few minutes. But what’s generally keeping you interested at the moment? 

[00:03:52] Andrew

I think there’s a growing realization, to put it in relatively simple terms, of how strange the 2010s were. I think we got anesthetized, or a lot of people got anesthetized by the repeated rounds of monetary easing.

 If you dial it back, I started as a history major, and I’ve always been fascinated with history and how views of things change. If you went back and said, this is what’s going to happen in the 2010s; somebody’s going to find $40 trillion to spend (as Stan Druckenmiller said), and we’re going to go through all of this, and we’re going to go 10 years without inflation coming back. They would’ve thought you were a lunatic. 

I think there are going to be great stories about the end of the 2010s where you’re going to hear about tech guys sitting around in a room and saying, ” We thought we were overpaying when this thing had a 10 billion valuation and four people. Now it’s at 70 billion.” It hasn’t sold a product yet, and somebody is saying, “Are you out of your mind? We should sell it.” Then the guy says, “Where do we put it?” I think what we’re seeing is this just massive multi-year unwind of a very, very, very peculiar moment in history that we’ll look back on and say it was anomalous. It was as strange as the .com crisis. I think that’s part of the reason we’re seeing this major reset across asset classes as people digest it. They’ve been fighting it every step of the way. We’ll touch on it. I think that’s where you guys have had such an enormous advantage this year.

[00:05:25] Niels

Yeah, I completely agree. I think you’re right in terms of the bubbles, et cetera, et cetera (as for people who have listened to the podcast before). My own view is also that we’ve come to the end of this carry regime that lasted for 20 years, but it came at the end of globalization. I actually think we’re heading into, or we have started, de-globalization and everything that comes with it. You also allude to, I think what we’ve lost during those 20 years is our imagination of what markets can do. And I think we have to reimagine that and be aware that things may not be how they have been for quite a while. As I’m sure both you and I have seen, many of the people who actually sit on top of the portfolios today and manage these portfolios have never experienced inflation or bear markets of longer character. 

Anyways, [we have] enough to talk about very shortly. I just want to give a quick update on the trend following side. This week, very similar as we saw in Q3, the first couple of weeks of Q4 have started with a continuation of the down trend in fixed income markets spiced up with an extra boost from all the fallout of the failed tax cut policies in the UK.

We’ve also seen a continuation of the long dollar trade, and again, we’ve seen some increased volatility in the currency markets surrounding the British pound. Equities have been relatively muted but I think that, maybe long-term, trend followers are slowly starting to build up some short exposure or stance in this sector.

Grains are trying to stage a comeback to the upside, while precious metals and their bullish dreams got crossed this week, with gold and silver near the lows of the year. But all in all, trend followers have had a positive first half of October. My own trend barometer closed the week at 45. That’s actually relatively neutral.

Although these numbers that I always quote are as of Thursday night, Friday seems to be a good day. I just need to look at Andrew’s product, then I know it was a good day for everyone in the CTA business. It’s going to be my new Friday indicator. But the BTOP 50 Index was up 1.19% as of Thursday, up 20.85% for the year.

SocGen CTA Index was up 1.2% for the month so far, up 27.62% for the year. SocGen Trend up about a percent, up 36.86% for the year. The Short Term Traders Index was down two basis points, up 12.97% for the year. In the traditional world MSCI World Index is down eight BPS for October and down 26.46% for the year, and the World Government Bond Index, another down month, down 1.38% so far, month to date.

Anyways, now as I mentioned, we have quite a lot of questions that came in. I think we need to have a little bit of context before we jump in there. I’m going to, start out with some of the topics that you mentioned, Andrew, but before we get to that, I’m just wondering, and I don’t want you to necessarily recap the same sort of journey story that you’ve done on so many other places, but you said you started in history and you ended up in managed futures. I am curious how the hell that worked out. Can you just shorten the gap a little bit between history and managed futures? 

[00:09:12] Andrew

Sure, first of all, thank you everyone in this space for having had a spectacular year because we’re obviously riding on your coattails. We approach the managed futures space from the opposite direction of everybody else. We were building a fund in Europe, it was a UCITS fund, and we were asking, what’s the best diversifier we can get to reduce equity risk and to protect capital? We had this dream of: can we replicate the golden age of hedge funds? (That was 2000 through 2007) Can you not go down if there’s a bear market and then go back to making money? So, we wanted to have some equity exposure in it. 

You’ve seen a lot of products out there that have a match of equity exposure and something. When we looked at managed futures, (again, I’m not a managed futures guy and that should be absolutely obvious to everybody at this point). But we thought, “God, that’s two incredible characteristics.” It’s got no correlation, so it drives down our beta. (That was actually important to the mandate.) But, look how well it did during the .com crisis and the GFC. 

This is around 2015, and there was all this talk of bank swap products, and GSA was out there with a 50 basis point product and sweeping in money, and there was talk about commoditization, and Winton was waving its arms and saying, ” We’re not going to do trend anymore.” We looked at these other ways of implementing and we couldn’t really find anything that we liked. What we really wanted was something boring and index like, but we needed to be able to do it in, also, a very, very cost efficient way. 

For 15 years I’ve been the guy who’s focused on hedge fund replication, but we’re not dogmatic about what we do. It’s about getting to the right outcome. What we basically realized was, look, you’ve got this incredible return stream there, but we have absolutely no idea how to predict who’s going to do well next year. We don’t have a $25 billion bat where we can walk in and say, we’ll give you a billion dollars, but do it at a very commercially reasonable price.

 So, me and the two terrific quants that I worked with, sat around for a good part of six months figuring out can we do this and how can we do that? Low and behold, we created a product in a UCITS form. Then several years later, we went into the US ETF market but with a very different thesis. It would be interesting to talk about because we actually felt that there was… I’m known as somebody who’s sort of a jack of all trades, but I spend a lot of time thinking about industry dynamics. How on earth is it that private equity firms raised $25 billion funds, and you got 10 guys who are doing this.

So, it was really about the ETF world. It was about some of the things we talked about in terms of the 2010s, and how people were building portfolios, and how that would change over time, and what allocators (who had been going through the same kinds of thinking that we’d been going through) would ultimately need. That’s ultimately why we launched the ETF in the US. 

[00:12:23] Niels

What happened to the UCITS product? 

[00:12:25] Andrew

It’s still there. Yeah, we manage it for a US firm called SEI. It’s up and it is absolutely crazy because it’s entirely replication based. It’s the top performing multi-strategy (by a wide margin). It’s the top performing, multi-strategy UCITS hedge fund product since we launched. And we hit our seven year anniversary. Basically, we were clocking along at about 6% per annum during the good years. This year we’re up seven. 

[00:12:55] Niels

Great.

[00:12:56] Andrew

It’s entirely because we loaded this thing with a 40% allocation to managed futures. So, it’s an astonishing product that was really just built… But again, it was the same ethos. SCI wanted us to build something for their own portfolios. They didn’t care about selling it to the outside world at first. It was all about that we want to be able to take 5% of our portfolios and look back in five years and have something that can make mid to high single digit returns during normal periods, and then preserve capital or do better in a bad period. 

So, it’s out there. That’s why I was in London. That’s why I was in Zurich a week and a half ago, and then Madrid, is that I was talking to people about it.

[00:13:37] Niels

Fantastic, good stuff. 

Today we are probably mostly going to spend our time talking about your CTA replication product DBMF. 

So, in terms of the topics that you sent over you, you talk about you’re trying to solve a different problem than others in the space. Is that something we need to flush out a bit more or do you think we’ve done that in your introduction there? I just want to make sure I cover all your points.

[00:14:05] Andrew

We’re trying to be above average. And we’re trying to be consistently above average. One of the great value investing quotes came from Howard Marks and somebody said, “How come you guys are always in the top quartile?” And he said, “Because we never leave the second quartile.”

And what he meant was, we do a little bit better by buying things cheaply and then if we have a margin of safety, we won’t go down as much during the worst of the times. All of our products are designed to do that. The only effective way we’ve found to do that is to squeeze out fees and expenses where we can and try to marginally outperform.

So, that’s it. It’s a very, very different ethos. It’s about, if we could create a fund the hedge fund product where you and all of your brilliant peers would work for 50 basis points and, each take 5% or 10% of the capital, and we could put 50 basis points on top and deliver something in an ETF world with perfect transparency, that would be an earth shattering product. But I don’t see the industry doing that anytime soon. 

[00:15:11] Niels

Okay, fair enough. You also write about how you decided that this was likely to work. I’m curious about that. Then I want to transition, in a little bit, to the mechanics of how it’s done, before we start answering a lot of the questions that came in.

So how did you get to the point that this is the way to do it? 

[00:15:33] Andrew

The way we started was that we have our risk models. They’re expansions of sharpe returns based style analysis. Again, as a non quant, if you told me in 2007 that you could take a statistical model with a whole bunch of factors, just look at recent returns of a pool of managers, and be able to figure out, with great accuracy, are they long or short this position, or long or short that position. It didn’t make sense to me. It’s too abstract, it’s too weird. I can’t think in eight or ten dimensions. 

The way that we looked at the space was that we looked at the swap products. I wrote something talking about how there was too much dispersion. They weren’t doing nearly as well as the hedge funds they were supposed to be commoditizing. I looked at GSA and things like that and I thought, of course, everyone wants it because they’ve been up 20% a year for three years running and people think it’s going to continue. Then we looked at things like persistence of returns in the space. 

Again, I’ve been doing this for a very long time. If you’d asked me, at the end of 2019, to pick one hedge fund, I would’ve told you Renaissance Institutional Equities Fund, and they suddenly went down 30%. So, I’m very humble about my ability to make that prediction. What we did is we then said, all right, it’s actually an interesting space. There’s a lot of daily data. We can look at… There’s mutual funds, there’s UCITS funds, there’s daily reported indices like the SocGen CTA Index. You’ve got the Trend Index. 

We started to look around, and the non-quantitative part of it was to go out and talk to allocators. Because my belief in hedge funds is that, generally, it’s always the big trades. If you had to sum up managed futures this year, I’d say they got inflation right. You can break that down into a series of trades at different times. There was no managed futures fund that was betting on deflation and has made money this year.

Then what we do is, the way that we end up modeling things is not trying to get to three decimal places. We want to get the broader things right. When I talked to allocators and I said, “Look, if you had to figure out the positioning of these guys today, do you need a lot of these incremental positions? Do you need 65 contracts to do it?” 

A lot of the feedback I got from allocators was no, it’s 10 positions; it’s 8 positions. There may be a point in time when you really need the British pound, but most of the time you don’t if you’ve got the yen and the euro which, I think, has been the case this year.

So, the way that we do our analysis is to basically try to set up naive models where we’ve changed things around a lot to test for robustness. We took hundreds and hundreds of combinations of different futures contracts; we looked at lots of different window lengths; lots of different data pools. What we found was that the results were surprisingly good. It’s not perfect, it’s an approximation. As long as we had diversification across the major markets… If somebody said, “Can you replicate managed futures with the SPY or something?” Of course you can’t.

But if you have exposure across different asset classes and you have the biggest, most liquid instruments in those, if you get within an 82% – 85% correlation and you can implement it, you create something that’s almost like a synthetic index. For most allocators, that’s hideously boring because they want to assemble their own cars from it. From our perspective, we wanted something that was almost a naive representation of the biggest positions, the biggest trades that we could then implement efficiently on our own. 

[00:19:39] Niels

Now, I’m going to go off a little bit of my own script because some of the things you say are leading me to ask you some questions, for example.

So, maybe just for my benefit, I know of course you have fixed income, you have currency, you have equities. I know you trade oil, I think you trade gold. Is there a lot of other sorts of commodities in there or is that sort of pretty much the universe? 

[00:20:03] Andrew

Yeah, it’s really 10 major instruments. 

[00:20:06] Niels

Okay. Fair enough. 

[00:20:08] Andrew

It’s twos, tens, and thirties. It’s gold and oil,  S&P, EAFE and yen and euro. 

[00:20:19] Niels

Okay, very interesting. You mentioned this thing about getting correlation right. I think, for sure, you’ve proven that. Again, I’m not a quant like yourself. 

[00:20:32] Andrew

If you’re not a quant, I’m definitely not a quant. 

[00:20:34] Niels

But what I have learned in the last 30+ years doing this is that, because a lot of people tell me when I go out, and I say, “Okay, we’re a trend follower,” and they would say, “Don’t worry, we already have one trend follow. We’re fine, No problem.” But then once you start digging into things a little bit, you realize there’s a big difference between one trend follower to another. 

Of course you have overcome that by replicating an index. I’m fully aware of that. Correlations don’t necessarily explain performance. You can have high correlation but your performance can be very different. How do you adjust for that? Is it the correlation you just want to get right? Or is it the performance of the index you want to get close to? If I can formulate it like that. 

[00:21:27] Andrew

Yeah, I came into the world of working with quants 15 years ago, and if I couldn’t understand it on a napkin, I didn’t do it.

I’ve had phenomenal teachers as they’ve done this. One of the things I’ve learned is that building models is a very human undertaking. Your observation about the dispersion between returns is what we experienced in most cases. We looked at building our own trend models. Let’s start with basic literature and try to build it. 

What we found is we had this huge dashboard. If we started turning dials in different ways, we get wildly different outcomes. When we looked at individual funds, and we spoke to guys (sometimes who’d been invested in them for 10 or 20 years), what we found is that a guy who had made his name in commodities 15 years later was still going to have a bigger commodity event than the guy who’d entered the space at a different time from a different direction.

What we found, though, was the way we do. So, what we’re looking for is that you can turn the dials and it doesn’t change it much. So one of the exercises is if gold and oil were perfect, but natural gas and (I don’t know), pick another metal, and you had completely different results, that would set off alarm bells. Our strategy has always been about trying to get the big trades as right as we can, and avoid getting fooled by the data. For me, it’s been a learning process in terms of what the human side of that is.

Now, one of my partners, we call him our former math professor guy, I think he proved bubbles exist mathematically. So, we can all breathe a sigh of relief that bubbles are real. We didn’t imagine them. But he also went to Wall Street. So, when he joined us, over a decade ago, there was no razzle-dazzle in models that impressed him. So, he was always just focused on the simplest, most straightforward way of getting to the most robust outcome. 

If you take a model like what we have, we get fooled sometimes. The model gets fooled sometimes. It didn’t happen in DBMF, but in our UCITS version we don’t trade crude oil. We go into March, and the model is looking for crude oil because it knows you guys are long crude oil, but it can’t. What does it do instead? It says I’m going to find the closest thing I can find, which is a short treasury position. Okay, that was great until there was a moment a few days after the invasion when oil went up and people said, “Forget it, Fed hikes are off.” We gave back several points of performance. Not having oil this year, that strategy has underperformed by probably 600 basis points. It’s up 21, not 27, or something. Again, our job as humans who are overseeing the models is to try to design them in a way where we don’t have those periods where the index, or the target, or whatever goes up 10, and we’re down 10, and we’re explaining it to people. If the target’s up 10, and we’re up eight, we’re okay. But usually if the target’s up 10, we’re up 12 to 15. 

[00:25:06] Niels

Sure, okay, okay, very interesting actually. But by the way, why don’t you trade just crude oil in that product? I’m curious. 

[00:25:13] Andrew

Interesting question, when we launched it there was a hard prohibition on putting commodities into a UCITS fund.

Now people use certificates and we are in the process of potentially coming into that market with a few more tools at our disposal. But back then people weren’t really doing that. Honestly we didn’t need it. So, we launched in November, 2015, and we’re really happy in 2016 (the back half of 2016) that we didn’t have crude oil because it looked like it was just an exercise in whipsawing and dashed hopes. 

[00:25:57] Niels

In a sense, you touch on something quite interesting. Certainly I would say, because we (as a manager), go through this as well where we will be different from the index. So, even though we are trend followers, we might perform very differently to even an index. 

Within the indices that you replicate, and in the SocGen Trend Index where you find the bigger managers, many of them (I would say) have gravitated into trading hundreds of markets, not just the classic 50, 60 markets, like we do. There’s certainly been periods where I’ve had to explain the difference in performance. 

There’s no doubt that the markets you trade do have (at least if you’re a manager),quite a big impact, or potentially can have a big impact, on your performance. It’s not just the models; it’s not just the timeframe, et cetera, et cetera. Actually, if you were (for example), in electricity, or Dutch nat. gas, or whatever it might be… 

[00:26:58] Andrew

Lok at Trans Trend,  my God, congratulations. 

[00:26:59] Niels

Yeah, right, but it goes both ways, right? Those types of firms have also had very quiet periods where the rest have done better. What my point is, it goes both ways. I’m interested and intrigued if you think that actually for you (and maybe it’s because you have a whole index that you need to replicate), that it won’t be such a big issue and that you can replicate through (let’s call it) the very liquid sectors mainly. It’s intriguing to me. 

[00:27:44] Andrew

So, going back to how our objective is different. Do you mind if I segue a little bit and talk about…

[00:27:50] Niels

You can do whatever, yeah, absolutely. 

 [00:27:52] Andrew

I’ve been writing about liquid alts for about 15 years. Back to your point about somebody saying, “I want trend, and I’m going to pick Bob to do trend.” That is, from an allocator’s perspective, that’s insane. If a pension plan does that, they’re making a big mistake, but generally they won’t. They’ll pick four guys. They’ll say, this guy’s a short term specialist, a medium term specialist, he’s a counter trend guy, he’s a machine learning guy, and they’ll put together a package.

The whole assembling of funds, the entire objective of assembling of funds, the entire objective of manager selection is to beat a benchmark. No one in a pension plan is saying, “We’re putting together these four guys and we think they’re going to do 20% per annum when the index does zero.”

Abbey Capital’s whole business is built on finding the right guys so they can do ‘enough better’ than the overall space to then justify their fees and add a little extra for clients. So, these were all institutional products. You need people who will assemble their own cars. Everyone is offering a different part. 

The retail, in the wealth management world, is very different because their big constraint (I’m a huge believer that incredibly smart people, if you layer lots of constraints on them, it ties their hands behind their back), but if you’re a wealth manager and you decide you want 5% in managed futures as part of a diversified portfolio, you’re probably not going to put five guys in there. You could. You could go into the mutual fund world and you can say, I’m going to pair what you guys do with Man AHL, et cetera, et cetera.

But the experience of sitting down with a client, when the client sees one US large-cap allocation, one this allocation, one allocation, and then you’ve got this smorgasbord of underlying funds. What happened early on was people just picked one fund. The people who were picking the funds were not, generally, experts in this space.

So take AQR. I think AQR did something phenomenally positive for the US mutual funds base by launching their product in 2010 with 120 basis point expense ratio. Alpha Simplex came in as well. Compared to the first version of products, where you’re a sophisticated hedge fund guy, you don’t want to deal with the rough and tumble retail crowd, we’ll build something. But basically they were 300, 400 basis point products, which was just so incongruous with where the wealth management world has been going. So, AQR and Alpha Simplex did something phenomenal and they said, “We’re going to basically offer an institutional quality product at reasonable fees.”

And that’s why Cliff talks about that, “We’re the fair fee guys.” The problem was that the guys on the other side thought that if you’re in 2015 and you say, “What do I do? I’ve gotta fill this 5% bucket.” Why wouldn’t you pick AQR? They had done this in line with the overall space, they’re the smartest guys in the room, and they were the biggest fund. 

Their mutual fund went to 14 billion. I think it was 40% of the overall managed futures space at the time. When people want to diversify they said, “We’ll give four to AQR and one to Alpha Simplex. I looked at that, and this has happened in several different areas, but from an allocator perspective it’s insane. What you’re basically saying is, “I want a 5% position in emerging markets, and I’m going to give it all to Alibaba.” It could work , or as you say, you could go through a long winter. Then what happened is AQR, very, very soon, underperformed the index and they went down.

So what do allocators do at that point? You’re the guy who’s made a 5% allocation. This thing is torturing you every quarter. You’re hoping it’s going to come back because you’ve endorsed them. You’ve said, “We’ve not only found this great area, we found the best guys to do it.” You’re sitting across from clients and you want to talk about anything but that 5% allocation.

So this 5% allocation becomes 30% of your time, for years. Then, if I sell it and then go into Alpha Simplex (which a lot of people did), then Alpha Simplex went through a bad period, not nearly as bad. This musical chairs, or this hamster wheel (on the allocator side), we started writing about over 10 years ago. The constraint is on their side. 

What we felt, in the ETF world (going back to the world changing), not diversifying was the right call for 10 years – just sitting in stocks and bonds. They went up every year. Back to your point about that they didn’t look correlated. “Oh no, no, no they’re inversely correlated… But they’re going up together every year. There’s this massive wind underneath them, lifting them both up. What we thought was that, at some point, the ETF world would be looking for ways to get exposure to managed futures as a strategy, and that means index. And by the way, in the mutual fund space, you’ve got plenty of good choices to win. You didn’t have anything, it was a greenfield opportunity in the ETF space. We just passed a billion, we’re between one and two basis points of the ETF world. It hasn’t even begun. 

That was our thesis because, remember, we’re cheap. We need scale and we need people to stay invested with us for a long period of time. We want the guy who’s running the model portfolio to say, “Yeah, I can’t invest with you guys. I can’t invest with these guys and I can’t invest in mutual funds. I just want something where I can say, “Here’s my managed futures allocation, my managed futures beta, or beta plus (if we’re right about fees).” Then, in five years, if the space is up seven, my guy’s up 10, and he hasn’t gone through those big draws.

That’s what we’re trying to do. 

[00:34:26] Niels

Yeah okay, again, I’m going to go off because I still have so many questions but I want to pick your brain about some of the things you mentioned here. It’s super interesting to me. 

First of all, you could, of course, argue… I don’t know whether you pay 120 basis points to AQR or you pay 95 basis points to you, it’s not going to be a massive difference. But I do agree that the packaging I think you’ve got absolutely right – this thing about having sort of one line item that, ideally, you don’t have to spend too much time on. I was just curious because, again, in my own marketing material, I do compare ourselves to the two SocGen Indices.

When I look at them, and I am confronted with this, there is definitely a five year period from ‘15 to ‘20 where they were flat. But at least you could say, as a manager, you could give a story, you could talk about some new research, you could talk about new markets coming in, you could do something. I was just wondering if you had gone through that period. Let’s just say you had raised a billion dollars prior to 2015. Then you go through five years where the benchmark you’re trying to replicate, or ideally can replicate, is flat. Wouldn’t you end up in exactly the same situation as AQR where you see the money just disappear again? Because what’s the story? 

[00:36:00] Andrew

I’ve talked about that period in two ways. I think that period is not going to happen again. 

[00:36:08] Niels

No, no, I agree with that. 

[00:36:11] Andrew

I think that’s not the base case. But even during that period… The SocGen CTA Index is net of incentive fees. It’s 100, maybe 150 basis points of management fees plus incentive fees. You always have some guys who are up, some guys who are down. On average, going through that period, maybe you’ve got 300 basis points of all-in fees and expenses. Then also one of the things is (it’s impossible to get a precise figure on this), I talked to a lot of all allocators, and we spoke to guys who had run trading at a lot of different places, and when you trade 65 instruments, or now the hundreds of instruments you’re talking about, your trading costs are really high.

We are trading 10 of the deepest and most liquid futures contracts once a week. We’re 5 basis points. We’re 10 basis points. We are the least interesting prime brokerage client in this entire business. They’re like, “We’re not even paying for your taxi back to the office.”

[00:37:12] Niels

Okay, fair enough. What you’re saying is that essentially, even through flat periods, you expect that there’s going to be something for you that will show up as some kind of outperformance, essentially driven by the cost, et cetera.

Okay, that’s fair. 

[00:37:30] Andrew

When the space did zero, we did 4 a year. If you want to maintain an allocation to this space, earning 4 versus zero is a really, really big difference. 

[00:37:39] Niels

But this is interesting because I’ve heard you say that before and I remembered, back then, saying, “Well, I’ll have to ask Andrew about this.” When you say, “When the space is flat, you do 4,” but I’m thinking here that if the space is flat, there’s no performance fee, right? There’s going to be a management fee, right? There’s going to be some commissions, But I will share one fact with you and that is, at least the longer term trend followers, it’s not like we are paying massive amounts of commissions either. 

Frankly, we’re not the most interesting client of the prime broker either. So, I’m a little bit skeptical about how much (in a flat period) outperformance there could be other than whatever difference you’re going to have in management fees, et cetera, et cetera. There shouldn’t be any performance fee, frankly, unless you have one guy doing really well, or a few guys doing really well and others doing poorly, so they will obviously collect performance fees. The other ones won’t. And maybe it’s different for the CTA index because there are different types of strategies in there. But for a trend index, it’s unusual to see a couple of managers doing really well and everyone else doing flat.

Then they’re not doing trend following. 

[00:38:54] Andrew

People are pretty highly correlated. Again, we do trend and non-trend guys. So, part of the ethos is that it was a bit of a historical accident. In 2015, there was… When you said managed futures, you said SocGen CTA Index. And, by the way, people hated trend at that. Maybe not 2015, but it was in subsequent years it was, “Trend is dead. Trend is commoditized.” The cool stuff is machine learning, and counter trend, and whatever, whatever. So, we started with just the broad index because we’re just thinking, “What’s the benchmark people are most likely to use?”

You go ask a pension plan, “How did managed futures funds do last year?” They’ll cite the So Gen CTA Index. You’re right about the trend, they’re more highly correlated, but, back to your point, sometimes they could be highly correlated and they do really badly and you have no idea why.

The way that I talk about it is that the industry is definitely going to go through a lower return period at some point. I just think that was such a strange period. I don’t have math to back it up. I just remember at that time, and looking back at it, how terrified central banks were of deflation and that the hair trigger response. People talk about it in abstract terms, about the Fed put, but there was this very collective view that, if they let that go too far, their tools would be useless.

I think everybody lived in fear of becoming Japan. When people talk about it in simple terms, like the equity markets are going down, I didn’t really see it as that. I just saw it as they were terrified of a slowdown. Every time I looked at the space and I saw how we were doing, and I saw other people were doing, it was two steps forward here, one and a half steps back over there. We’re starting to make money here and then we reversed on it. It was so difficult. 

Look, I’m very optimistic that’s just not going to recur because the Fed has realized that’s a time bomb. 

[00:41:12] Niels

Yeah, I completely agree with you on that. I think it plays into, at least, my own thesis about the end of globalization and this carry regime.

Again, being incredibly selfish, and taking some of my own questions before everyone else, but I’m curious what’s the hardest part of what you do, would you say? 

[00:41:29] Andrew

Initially, the hardest part of what we did was convincing people to like the space. 

[00:41:38] Niels

Yeah, I mean mechanically. I know that part, but I think in terms of doing the thing, so to speak, in order to replicate…

[00:41:44] Andrew

We spend a lot of time worrying that we’re missing something. So, I was in London when Truss managed to blow up the pound. I was on my way back and what do we do at that point? We don’t have it in our models. That sets off a research project, which we’ve done (we’re doing this all the time), is to should we have the pound? Has something changed? We use twos, tens and thirties in treasuries? We don’t have JGBs, we don’t have gilts, we don’t have… 

[00:42:23] Niels

Don’t worry about JGBs. 

[00:42:32] Andrew

I remember in (I think it was) September of 2021, where natural gas went up 34%, and we didn’t have natural gas. So, we see the guys are doing much better than we’re doing. We then sit and say, “Should we have natural gas?” We spent a lot of time thinking about that. People, at one point a year ago, were saying, “Bitcoin is going to be 20% of everybody’s portfolios. Shouldn’t you get in front of Bitcoin? Why don’t you have VIX futures? Why don’t you have this?” The way that we do it is part math. But if you call me up one day and say, “Boy, the trade of the 2020s is Ethereum, we’re trend following Ethereum.” It’s understanding how the business is changing. I think what’s going to happen is the business is going to grow a lot from here, for reasons we can talk about, in ways that people will look back and say, “Wow, that’s a lot more than I expected.”

I think we’re all anchored to what feels like, generally, a big industry. In the context of that though, I think it also means that these big trades are going to matter more. That one, of a bunch of guys, may make a killing on carbon futures or something, but I don’t think that Man AHL can dial up their book or would take the risk of dialing up their book in something where they could be the guys paraded in front of the LME as getting caught on the wrong side of a trade at the wrong time. The markets just seem really fragile right now. 

We’ll see. That’s the bet that we’re making. 

[00:44:21] Niels

Exactly, I think that’s completely fair.

All right, so let me be unselfish now and give you a question that has come in. One question that came in is from Brian. And Brian asked about the fact that you are an ETF. You pay year end capital gains, which in the US has a lower tax rate than income and distribution. He says, “I’m not an expert in taxation of these products. Maybe you could quickly explain the relevance of this compared to other products.” 

Maybe that goes to one of your topics where you wrote why an ETF and not a mutual fund, I imagine. 

[00:45:04] Andrew

Sure, there’s no tax advantage to doing what we do in an ETF versus a mutual fund. So, here’s a massive disclaimer that I’m not a tax expert, right? But, directly trading futures contracts tends to be more tax efficient than getting normal income distributions. Some mutual funds trade all of their contracts in a way where it all comes back at the highest effective tax rate – ordinary income.

We try to trade as many of the contracts as we can in a way to have a lower effective tax rate. If anybody has questions on this, what I would suggest is you reach out to me over LinkedIn or social media and I will put you in contact with the guys who can answer it. Brian, I will put you in contact with the guys who can answer it in greater detail and more intelligently than I did.

[00:46:01] Niels

That’s fair. 

Then there’s another question coming in here. Obviously, for people who don’t follow it, I would be surprised if [most people weren’t aware of] the incredible success that you’ve had, and congratulations on this.

But now that you’re at a billion dollars, what does the investor base look like and how much concentration do you have in terms of largest investors in a product like yours, at this stage? 

[00:46:30] Andrew

So, have an army of smaller RIAs that bought into this product. We’ve gone from $60 million to, we’re closing in on $1.1 billion as of yesterday. We are not on Morgan Stanley, Merrill Lynch, UBS, no institutional consultants have approved us. We are not in any Vanguard models, iShares models. It has been an army of independent entrepreneurial RIAs who love the space and either have portfolios that only invest in ETFs, so they can’t select from it, or they want to make it part of their asset allocation models. They want index-like. For them, boring is good. They want to build the model, fill a bucket, and not talk about it for the next five years unless it’s doing well. 

It’s been an incredible opportunity for me to get to know these guys and to understand how they think. That’s how I’ve tried to talk them through, not as much the bells and whistles of what we do, but rather like the impact on a portfolio. How to talk about it with clients, how to weather those low return periods. How to weather the period where our skis are pointing in the same direction as equities and, and there’s a flurry of criticism because, weren’t you supposed to go up when equities went down on Wednesday?

They’ve been our adopters, and there’s no concentration risk. What I think is going to happen now that we’re big enough, you start to see we actually have a very narrow segment of the market we’ve been focusing on. We start to expand, I hope. 

[00:48:25] Niels

Yeah. Getting to know all these people, that has been the groundwork you’ve been doing in order to get that adoption. 

[00:48:33] Andrew

Yeah, exactly. That’s all I do. I spend my days on the phone with these guys and basically I’m not selling them. I’m telling them that this is how we came at this space. This is why we love this space. This is why we built it this way. If it works for you… If you love the American Beacon product with Man AHL, they’re great. If you’re investing with you guys, you guys are great. You are destroying it this year. All that’s good. 

[00:49:00] Niels

Yeah. In the ETF space, as far as I could quickly work out myself, there’s four or five ETFs. Some of them (and you correct me if I’m wrong here), but I think Wisdom Tree and maybe even KFA (the Mount Lucas one) have been around for quite a while, actually. But today you’ve got 55% or more of the whole ETF and managed futures space. I’m sure they would’ve talked to advisors as well. What do you think has caught the advisors’ attention in what you do compared to what they do? (And I actually don’t know what they do, but I do know that they’re managed futures type products.)

[00:49:55] Andrew

So, Wisdom Tree has been around for a long time. They launched it in 2010. My apologies for saying this to Wisdom Tree, it is an awful product. It actually almost managed to lose money. It’s down this year.

So in ETF land, people want an index. Why do people love the S&P 500 Index products? They’re not just cheap, they’re never wrong. If you build a model portfolio, and you have an allocation that goes wrong on you, you get fired, you lose your job, it tortures you for long periods of time.

The Wisdom Tree product was basically… So, there have been various products that have been said, “We’re tracking an index,” but it’s a different index. If you and I built a trend following index tomorrow, back to your point, it could be wildly different. Look at the SocGen Trend Indicator versus their Trend Sub Index.

First Trust has a product out there. KFA seems to have a great firm. They entered the ETF market last year, but they have an index that’s been around forever. What they’re doing, from a marketing perspective, is saying, “Look at the index, which is basically our live, out of sample performance, but we’re calling it an index because we have simple rules. You can look at our hypothetical numbers for a long period of time.” They’ve had a great year. They’re up in 300 or something.

[00:51:16] Niels

But their index (just for me to understand the difference for someone like that) is that also a trend following index? Because it can’t be an index of many managers.

[00:51:29] Andrew

No, it’s a trend following index. It’s basically their index there. It’s their own model in Microsoft Word with Greek letters.

[00:51:39] Niels

Okay, okay. 

[00:51:40] Andrew

It’s no different. The reason people do that, it’s like in smart beta, people say, “Oh, here’s my selection methodology and if I’ve been doing it for the past 30 years, this is how I’ve been doing it.”

What I understand from them is they actually have been doing it for 30 years. It’s real. By the way, I want them to succeed. I think that their mandate is a little bit different, but I want everybody in this space… So, we’re 1 to 2 basis points of the ETF world. You add in everybody else and we’re 2 to 3 basis points of the ETF world. Should we be 100 basis points? Should we be 500 basis points of the ETF world? This is a strategy that hit the trifecta of .com, GFC, and now the unwind of the bubble maximus. Every model should have it.

They’re a single manager product wrapped as an index, but that has a closer correlation to the index than maybe the guy who’s doing carbon futures. There’s another fund out there called CTA that Simplified launched.

[00:52:47] Niels

Oh yeah, Mike Green’s, yeah. That’s a specific manager doing the strategy right. 

[00:52:53] Andrew

Exactly, yeah. There really hasn’t been something that I think you could reliably say is ‘index like’, and that’s just my drumbeat. We’re less exciting, but we’re very unlikely to have a hangover.

So, simple and boring, for a certain segment of the community is very good. Those are my guys. 

[00:53:18] Niels

Yeah, that’s great. 

I just want to acknowledge someone called Jerry (not the Jerry, you and I know, but another Jerry) wrote in saying exactly that about the fact that (I think it says that he must have read your perspective), he says that there’s now a sentence saying, the fund will not invest in cryptocurrencies and digital assets. So, good on you, Jerry, for reading all of that stuff. But maybe, just for my benefit, is that just liquidity driven, that you don’t want to touch it? 

[00:53:55] Andrew

Honestly, it was a very, very, very important allocator. I don’t think we’re going to be trading cryptocurrencies. If five years from now cryptocurrencies have cleaned up their act and everybody’s trading it. If we had to, we would presumably go back and change the prospectus, because everyone will be doing it, and it will be institutionalized. We had a very, very significant allocator basically saying, “We don’t want ambiguity around this.” 

I don’t think it’s something that would impact us. We obviously are completely open and transparent about it. Maybe you have a different view. Maybe you think crypto is around the corner. I think it’s going to go through a particularly dark winter. 

[00:54:40] Niels

No, we don’t trade crypto on our side either. But of course I know some of our good colleagues do.

People have different opinions about it. I guess you could say that if it is a liquid futures based market that exhibits different characteristics, you could argue that okay, then maybe it should be on the radar of CTAs. Then I think it becomes more of a question of whether you truly believe in the liquidity of it, and also whether it’s just something you want. I think there’s also a little bit of a kind of personal preference type of thing. Do I want to be in this or not? 

I see the same with China. There are some people adopting China as a space. For example, at our firm, we’re not adopting it as a place we want to be. Yeah, perfectly fine. This is what makes us different. 

[00:55:34] Andrew

Yeah. I would be surprised if a large, established, managed futures fund bet the farm on it.

[00:55:39] Niels

Oh yeah, sure. 

[00:55:40] Andrew

I can see them dabbling in it, and trying to understand the market. Soros used to say, “Ready, Fire Aim,” and basically get into a market and figure it out. The four big established managed futures funds to meaningfully trade in these markets… It sounds like it should be a trend following dream. It is literally a greater full magnet. It plays off people’s emotions. It should be phenomenal in that way, but I think it is in its infancy. I think when you’ve seen people really get excited about the space, they want to own the infrastructure because they think this is a decade of egregious spreads, information, asymmetries, and they’re not doing it because they think they’re going to capture the next 20% move in Bitcoin. They’re doing it because they can squeeze money out of retail traders.

[00:56:43] Niels

Yeah, I think that there are definitely managers, as you say, dabbling with it. Of course some of my good cohosts on the podcast definitely are involved in it, and have talked about it. Success is very hard to measure.

It’s about what kind of profitability are you going to get over the next 10 years? It’s not about the next year. Who knows what one single market or even a sector is going to do. Currencies where as dead as a dog for 10, 15 years, and then suddenly it comes to life this year. These things go in cycles.

Let’s see what else we have. There’s another question that could be from the same guy, Jerry, who writes in about, “How is the price of the ETF made up during the day? How does that work? Because people can trade intra-today.” 

[00:57:31] Andrew

ETFs always have two prices. There’s NAV, and in every moment of the day we know what our NAV is. If we’re making money on these contracts our NAV is going up. Any risk management tool has that. You can’t buy the NAV. You buy the market price. The way ETFs work is that there is, yes, unlike a mutual fund where you can buy it at the end of the day, you can buy it at 11:17 PM if you want.

It requires at least more art and knowledge. When somebody’s buying Tesla stock, they want to trade close to the markets, but they don’t really think about the NAV of Tesla as this. I didn’t execute it very well, and I paid 50 basis points more than the NAV of Tesla, and therefore, that’s a horrible outcome. But in ETF land, people are very focused on trading close to NAV, which is reasonable. The analog there is, I know at 4:00 PM I can invest in that mutual fund exactly at NAV.

In the earlier years it was very, very hard for us because we had a small ETF, and I talked to an advisor who wanted to put $5 million into it, but there wasn’t $5 million of trading activity. Fortunately, now as you grow, what happens with ETFs is you just get a lot more trading volume, a lot more activity, and that issue goes to the side.

When I think of the ETF, and I think about it from a returns perspective, I just think in price terms. People who look at it sometimes want to also view NAV performance over time. To me, the experience of an investor is that I bought it at 11:17 PM here, and then I sold it three years later at the following price. That’s how much money I made. 

[00:59:23] Niels

Cool, all right. Then there’s a few questions from Mike who writes in. Some of the questions are probably also sourced from other people. It’s quite a long list, but I think some of it we’ve already covered. There’s a question about whether you trade on US exchanges, but I think, I guess you do.

[00:59:45] Andrew

We do. It’s a New York Stock Exchange listed ETF and you can pretty much buy it there. 

[00:59:39] Niels

But all the markets you trade are also US exchanges, more or less, I would imagine? 

[00:59:49] Andrew

Yeah. It’s all US exchange traded futures contracts.

[00:59:52] Niels

Yeah, absolutely. We talked about how you select the markets. We talked about what happens if there is a big commodity market trend. We talked about the pros and cons in terms of that. 

Okay. Here’s a question that might be interesting. Will capacity become an issue at a certain level of AUM just like it does for traditional CTA strategies? 

[01:00:14] Andrew

We don’t think so for the foreseeable future. Let’s say this space is $400 billion and very quickly getting very close to $500 billion after this year. We’re trading mostly the deepest, most liquid contracts that everybody else trades and we don’t trade it that often.

[01:00:36] Niels

So you trade once a week, you said you adjust your position. I forgot to ask you before, and just sorry to interrupt you. I think this is public, so I don’t want to ask any secrets, of course, but how far back do you need to look at the performance of the index in order to get your linear regression or whatever you’re doing to line up?

[01:00:57] Andrew

Yeah, so the principle window that we’re looking at is about 20 trading days, and it’s short. The reason we do it once a week… We could do it every day. We could do it three times a day. It’s just a decision in terms of when you look at the quality of the information that we get on Monday, when we rebalance, it doesn’t deteriorate that much over the next week. If we were to wait three weeks to rebalance again, by weeks two and three, it starts to get a bit iffy. It’s really just an efficiency.

Obviously, if we get a lot of inflows on Tuesday, we’re going to add positions incrementally to rebalance. But in terms of trying to guess as to where people are. We’re trying to look at very, very recent history. We do look at somewhat longer window lengths in conjunction with it, primarily because we don’t want to be fooled by market correlations in just the past 20 days.

If two things look like A and minus A, or A and B look exactly alike in the past 20 days, but they look nothing alike in the previous 20 days, our models really want to know that. As I’m sure you guys do. Basically we’re trying to look at the shortest window length we can look at where we can get enough information.

[01:02:21] Niels

Yeah, absolutely. Next question was about the volume, which you talked about. It’s obviously improved significantly. If there are big inflows or outflows of your CTA, your product intra-day, how often do you take that into account? If someone came in and said, “I want to buy a hundred million of that today.” Do you have to adjust your position sizes straight away, or how do you react to that? 

[01:02:52] Andrew

So, the money doesn’t come into the fund. That’s the difference with an ETF. What happens is you’ve got these market makers. The plumbing of the ETF world is completely different.

You have market makers. You come in and say, “We want to buy a hundred million dollars of it.” There’s a market maker who will take the other side. There are these guys called authorized participants, and what they’ll do is they’ll basically go short by selling a hundred million and there’s a negotiation as to how close you are.

Going back to the NAV question, we have family offices who will come in and out with 5 million at a time, and we always intervene a little bit to make sure they’re executing close to NAV because we want them to be happy. Then what they would do is basically short and then they would hedge themselves with the underlying contracts, because they can see exactly what our positions are.

Then they have a flat book, and then at 2:05 PM every day, these guys will tell us, “All right, we’re converting that short position into an actual investment.” That’s where we see the inflows.

[01:04:01] Niels

Ah, okay. So, once a day you have to adjust your position. 

[01:04:04] Andrew

Once a day we see the inflows. It doesn’t hit until midnight. We add for the following morning. Mechanically for us it’s no different than a mutual fund. 

[01:04:14] Niels

Okay, fair enough. 

Alright, here’s a good one. Recently I’ve seen Andrew quoted as saying, “CTAs were once an optimal allocation for any diversified portfolio, but now CTAs are an essential allocation for a diversified portfolio.” I could not agree more. How has this message been received by the financial professionals Andrew communicates with? 

[01:04:36] Andrew

That’s a new tagline that I’m using. Managed futures from optional to essential. My argument is a couple fold. One is, so you’re an allocator at the beginning of 2023. In the beginning of 2021, you had a 60/40 portfolio. It really didn’t work this year. This is something Dan Loeb said about this regime change. We need a new playbook. The world has changed, as you say. They’re going to then go look for, how do I diversify what I have?

Do I do REITs? Well, REITs are down a lot this year. It used to be private equity and venture capital. We’re going to start seeing markdowns on that. What do you have out there that adds more diversification bang for the buck for any dollar that you take out of your beloved 60/40 portfolio?

I’m sorry, it’s managed futures. Two years ago, talking to people about it I would say, “Look at.com, look at GFC.” They’re like, “Yeah, what have you done for me lately? That’s ancient history. The world’s changed. It’s commoditized.”

There’s a million reasons not to do it. I think every allocator is going to be confronted with the question of, why don’t I have managed futures pretty soon? If it doesn’t happen immediately, it’ll happen over the course of several years.

You’ll see certain people adopt it. They’ll highlight it because it’s now the coolest thing in their portfolio. The other 95% looks like everybody else, when you get this kind of amplification effect. 

The other thing is, and this is really important on the wealth management side, is that there are a lot of great products out there. If you are a wealth manager who invests in mutual funds, you have multi-billion dollar products. You’ve got 25 great products you can pick from with sophisticated guys, and you can decide how you want to put that together in your portfolio. The last time we went through this in 2008, there weren’t.

You had Equinox and LoCorr products that were, “Oh, we’re 95 basis points,” but ignore the 300 basis points we’re paying to the guys underneath in this swap contract with Deutsche Bank. Morningstar said this is the worst practice in mutual funds. Big platforms wouldn’t approve them. There wasn’t a viable option. 

What we believe is between us (on the ETF side), and the mutual funds (on the other), is you’re going to see… ETFs are $1.7 billion, two to three basis points of the overall space. The mutual fund side is $25 billion. Why isn’t the mutual fund side a $100 billion, $200 billion, $300 billion? 

What I am trying to do, and I hope people will look back on this, is I am trying to find a way to get more people into the tent. I am much more interested in seeing the pies expand 2, 3, 4, 5, tenfold. I think that’s the message I’ve been delivering to some of my peers in the ETF space is that we should get this to a reasonable allocation, which means let’s get our messaging together. 

I think what I’m trying to do, based upon my experience with these guys, is that a lot of the language around managed futures is imposing. It’s intimidating. Talking about trends and why they work. What I hope to do is wrap it more in stories. I did this LinkedIn post about the yen.

The yen to me is an incredible example of how hard it was for a human being to get that right. This is where the machines win. Anyway, so that’s why I think they become essential, and I think it’s going to be great for the whole space.

[01:08:23] Niels

Yeah. I saw another, and maybe they misquoted you, or maybe you also said it like that. There was another variation of your new tagline, where you said something with 2023, and then you said CTAs will be essential for the next two years or something like that. Is that right? You’ve said that? 

[01:08:42] Andrew

Don’t think I’ve ever said that. 

[01:08:43] Niels

Okay. The only reason why I noticed it was I said, “Hang on, I need to tell Andrew. It’s not just for the next two years that’s essential.” But your tagline now is perfect. 

[01:08:53] Andrew

My other one is, managed futures goes mainstream. That’s the other one. Can I add one thing to that? The criticism of this thesis is investors are hot handed; the equity markets are going to come soaring back 20%; they’re going to dump managed futures, because managed futures are getting whipsawed or on the wrong side of it. 

There’s a reason I focus on the model guys. This should be a strategic allocation in a portfolio for the next five or 10 years. When you have guys who build model portfolios, they’re thinking 10 year horizons, 20 year horizons. What’s the right mix today? What are the right tools to get there?

I don’t think that will happen this time. I think because in 2008, or 2009, or 2010, there was still much more of a fun selection, gun-slinger mentality in the retail world. I’m going to find the best guy. Look at this guy. He’s up 20%. I’m going to add him to my portfolio.

Since then, the world has become dominated by model portfolios. Model portfolios mean a collection of asset classes, capital markets assumptions for the next 120 years. How do I maximize my efficient frontier? How do I improve my risk adjusted returns? How do I deliver that integrated message to clients as opposed to having them focusing on the line items?

I think the money is sticky this time. There will be plenty of hot money, but I think, particularly after this year, it’s going to be obvious. 

[01:10:32] Niels

There’s one thing that I will say, that I hope you’re right, but I also am a little bit cautious when hoping that you’re right. It is interesting to me, having watched this space for a long time, I think that there is definitely something about capacity. You mentioned people like AQR going to $14 billion in a trend following strategy. We’ve seen other managers go to many, many billions in a strategy, and suddenly returns start to come off, and so on, and so forth. Maybe they would say, it’s nothing to do with our capacity, blah, blah, blah. 

I think it’s hard to argue that there isn’t an impact. You could say that if you were right, and the industry grew (say doubled), does it mean that these managers could actually double in AUM and the returns will be the same? I question that. I would question that. 

Now, it doesn’t mean that they’re not going to try. Frankly, of course the management fee income alone is very interesting. I come up from a firm where we only make money when our clients make money. We’re performance fee only. We’re in the opposite camp here. We are very attuned to this thing about capacity. We’re very cautious about it. But, of course, people with different business models may see it differently. Are you not concerned a little? 

Just look at your success, how quickly it’s gone. Let’s just say, as you rightly put it, when people start to look at their allocations for 2023, and they say, “Hang on. The only thing that worked was trend following and managed futures. We need some of that.” What I also hear, from my friends in the industry, is that there are a few big pension funds that have allocated to trend following in recent years, and they’ve done really well.

Their share of the AUM, with some of these firms, has become so big that the firms have started to give the money back again. That to me is also a sign of, hang on, maybe we are hitting capacity with some of these firms that I, and the indices, and that you also look at. As much as I hope for the success, and I have cheered for it for the last 30 plus years of this strategy, I do believe it needs to be in every single portfolio. I also feel that cannot happen. We just don’t have enough capacity for that to happen. 

Maybe we can transition into where you see this is going and all of that. How do we marry both of our optimism about the adoption of this strategy, but with maybe a little bit of a concern in terms of how big it can be?

[01:13:43] Andrew

So capacity is always an issue. Back to your point about at what capacity do returns get diminished? I don’t know how to do that analysis. 

[01:13:59] Niels

I don’t think many people know, frankly. 

[01:14:01] Andrew

Yeah, I’ve been hearing about this for years for risk parity. Risk parity was always the de-leveraging bug-a-boo that the markets are going down because the risk parity is de-leveraging. People talk about, “Oh, CTAs are flipping from a hundred percent short to a hundred percent long.” It’s like, what are you talking about?

Look at the private equity world. All of the opportunities that made the private equity world incredible, from a risk returns perspective at the right time, went away with institutionalization. You can make that argument with hedge funds.

Clearly there’s a capacity issue to any strategy. I feel better about the capacity issue with this strategy, because when I look at the instruments that we trade, that I think are the big drivers… It may make it harder to trade those if Man AHL is $50 billion and whatever incremental value they’re getting from a lot of these positions is probably going to go away.

In terms of the big positions, if the space is up 35 this year, how many people would’ve said, with a $400 billion industry, would’ve been making $130, $140 billion dollars this year in profits? In a year where markets are kind of fragile and illiquid.

Definitely long-term returns will come down. I don’t think we’re going to know the answer for 10 years. It’s going to depend on how much money comes in. It’s going to depend on what happens to the overall liquidity of the markets. From our perspective, if returns come down marginally, it’s still valuable for people’s portfolios.

Did you think we’d have this year? As good as it is this year?

[01:15:52] Niels

No, so, from my perspective a single year doesn’t really mean that much to me. If I look at our returns and we do this analysis where we divide… We have a 38 year track record in our flagship right now, though we’ve been around for 48 years. 

[01:16:13] Andrew

Wow! Congratulations.

[01:16:14] Niels

Dunne was started in 1974. We really are one of the pioneers. The most important thing is that when I look at our returns in three different buckets where I look at the full track record, I look at the period from when we started to make some improvements to the model, and then we made some further improvements a few years later, but that’s about 10 years ago now. I have three different periods of return. You could argue that they’re very different in terms of environment. The full track has many different environments, and you could argue that from 2006 until now, and from 2013 until now, have been in this little bit different type of environment.

The good thing is, what I see is that our returns are completely consistent. They are more or less within 1% on an average return. They’re the same. My point is, did I expect it to be this year that’s going to be the outperformer? Not necessarily, but do I expect us to continue to find opportunities to deliver whatever we’ve delivered? (Obviously I’m being careful not to talk about performance on the public podcast.) Am I optimistic and confident that we’ll continue to deliver what we’ve delivered now for almost 50 years? Absolutely. I’m even more convinced, with what you and I talked about earlier about how the world is changing, et cetera, et cetera., I actually think maybe we are going to have a period, now, of above average performance, because we had a period of below average performance, frankly. 

Yeah, but year by year, I think it’s impossible to say. Even month by month it’s impossible to say what kind of performance to expect.

[01:17:54] Andrew

This business is so surprising. You mentioned the point about currencies, and people were asking for attribution from us last year, and they were saying dump currency. Do it all without currencies, it’s not helping you. We said that’s not how this game works. First of all, it’s not our decision. It’s these smart guys. 

I think everyone adapts over time. You have a very different business model than the asset gatherers. If the business grows three X in the next five years, you guys may say, “You know what? We’re not going to spend as much time on treasury futures. Look at what’s happening with this market where we can still trade in a way.”

In fact, there’ll be people who will come in and say… When I started a commodity business in 2001, and the flows started to come into the business, there were significant businesses trying to anticipate those capital flows in getting in front of it. That’s what I mean about the dynamism of the industry.

We don’t know, again, how all that really plays out. I think that’s where our mandate is different. If somebody said, maximize the dollars you can make running one of these firms. It’s like an equity long/short guy is going to do better with $200 million. 

When I started Baupost, at $600 million, 15 years later they had $32 billion. You can’t do the same stuff. That may change the industry. I think what we’ve tried to do is again, say I still think that these big trades… In fact, if the industry grows it’s good for us in terms of the reliability of what we do. We’re supposed to be the beta, the S&P. If we don’t outperform through fees, and we just match what everybody else is doing, and you guys are all doing incredibly well over the next five years, that’s a heroic outcome given the fact that it’s in an ETF.

Within that, people will make each of their own decisions in terms of where they think the best opportunity set is and how to capitalize on it. I’m not terribly worried about it in terms of what we do, or the overall industry does. It’s more of just an observation of what’s going to happen, and I’m going to try to make it happen.

[01:20:09] Niels

Yeah, I also believe that, of course, I’ve heard the thing about capacity as a potential issue for the industry as a whole for a very long time. When I started in the CTA space, I think we were between $5 and $10 billion. It always came up.

Then once the institutional adoption happened, around the year 2000, people were saying for the longest time, “Oh, but clearly it’s getting too big now.” You’re right. I’m not worried about it but I’m aware of it. 

Final few questions. I’m curious, do you have to register with the CFTC and NFA when you trade? Because you’re not a CTA, or you are CTA or you are?

[01:20:50] Andrew

Yeah, I am. We’re registered with the CFTC and the SCC. 

[01:20:52] Niels

I’m sure you saw this on Twitter a little while ago. Someone said we can just replicate the replicator. 

[01:21:01] Andrew

I love that. 

[01:21:02] Niels

Yeah, and charge 10 basis points. Let’s not hope that happens, because we shouldn’t drive for the lowest number, for sure.

This is one of my questions. There’s one thing that I want to ask you actually here, and I don’t know if you thought about this, a lot of people buy managed futures, or CTAs, or trend followers, because of the “crisis alpha,” which of course Katy Kaminski coined.

As I’ve said so many times on this podcast, I love the term initially. I’ve come to learn that it’s a little bit tricky because then you have to debate what is a crisis, et cetera, et cetera. But still the concept is easy to understand and it works. However, when you look at when people would buy your product, or they would buy a manager, and they’re hoping (maybe some people would expect) to get some kind of positive return when the crisis hits, like they did this year. But we also know that doesn’t always happen, because what (not just we have found) many managers have found is that when you go through an equity crisis, what drives the returns are actually often commodities.

It’s the most consistent sector within that. Is that something you have thought about a way to overcome somehow? I would imagine that many of your advisors are actually also including managed futures for that particular reason. 

[01:22:43] Andrew

Sure. I tell people flat out, the most annoying thing about the strategy is when you’re long equities.

In January, 2018, I’m in London talking about this multi-strategy fund that we have that has a 40% allocation of managed futures. The market had gone up every single day. S&P had gone up every single day in the back half of 2000, then had this melt up.

I’m standing in the middle of the melt up and guys are saying, “Oh, thank God you’ve got managed futures, you’re hedged.” I’m like, “No, we’re not. We have both skis pointing completely in the same direction.” We’ve looked at taking out equity risk. It’s always a bad idea.

The crisis alpha term, I think, is a brilliant term. It’s very catchy, and very clean, and very simple. I talk about it in a little bit of a different way because I’m trying to set the right expectations. If you talk about crisis alpha, you assume that if there’s a flash crash on Wednesday, you’re going to go up.

I talk about it in two different ways. I say one, this is a strategy built for regime shifts. What made 2000, 2008, and 2022… the common thread between them is that the world changed and people fought it like hell, and very smart people. Why did they fight it?

They fought it because they’d benefited from the prior regime. They’d made bets. In early 2021, I was talking to RAs about what Stan Druckenmiller basically called Inflation. I’m talking to advisors and they’re like, “We don’t believe it.”

I’m like, “Guys, that’s investment suicide.” Don’t trade against Stan Druckenmiller if you want to be in business next year. Then we got a little bit more into it, and what I realized was that they had made bets in their own business. They had a huge S&P 500 bet, which was FANG stocks, which were dependent upon low interest rates.

They had bonds that were earning 2%, they had private credit, they had all these different things. Everything in their portfolio had a low rates bet. What we’ve seen over the past 21 months is fighting adjustment. They can’t go back to their clients and say, “Guys, new playbook, game’s over, I know you thought I was the sober steward of your capital. Sorry, I just read this interview with this guy named Stan Druckenmiller, we’re changing everything. It’s value stocks, we’re dumping our, etc.” 

I’ve described it in terms of like where the emotional opportunities are in what we’re seeing now. You said two years at four and a half percent. That is wild. Find a strategist in the beginning of 2021, let alone even the beginning of 2022, who got even near that. 

I think some people will put very good language about the unexpected keeps happening, the impossible keeps happening. The other way that I describe it to people, to temper their expectations (and maybe this will prove to be wrong at some point), but I said, whether we make or lose money in the first month of a crisis is hit or miss. It depends on what happened in months minus one, minus two, minus three.

Months two through six, two through ten, two through twelve, that’s when the strategies have had time to pivot. At least what we saw in our portfolios was that 2020 was really damaging to the strategy because it was, “Guys, you’ve been telling us this was the moment you’ve been waiting for.”

People have their one ski pointing in equities and the other ski, thankfully, is pointing long bonds, but they’re tripping over themselves and they’re trying to change their positions. They’re kicking off their boots, they’re putting their boots back on. 

Then the Fed comes in at the moment, everybody is ready for this. On March 23rd, the Fed comes in and ruins the party. That was really hard because that was supposed to be the shining moment. That’s when I realized that I had to change talking about the crisis alpha implied that the strategy had failed. I didn’t think it had, seeing what I had in the portfolio. Instead, let’s just have very clear expectations if the market rallies, comes back tomorrow, there are a few scenarios where you’re going to be unhappy with a strategy. 

If the Fed comes in tomorrow and says, “Never mind, just kidding.” And Putin says, “Never mind. Just kidding,” we’re going to lose money. We’re not positioned for that. A rapid shift, like the Omicron weekend. Omicron weekend was hell, because you had all these underlying influences. We’ll lose money then. Okay? But guess what? You’re making money everywhere else. You’re thrilled. Point to the other 95% of your portfolio. 

The other one is we repeatedly drunkenly walk into propellers. But again, those are more a series of paper cuts. But what the strategy doesn’t do is hold on with a white knuckle grip. Cathie Wood cannot buy value stocks. Chase Coleman is not going to buy railroad companies, even if it’s the right trade today. The dispassionate nature of, “Oh, I loved being long oil at the right time,” and then it starts bouncing around in awkward ways. “Ah, never mind, let’s find something else.” That is a huge, huge advantage.

Then, as you get into a period like this, it’s the unexpected. It’s the things like six months ago when you said, “The yen is at $150? Are you kidding me? How do we still have the electricity on? How is the world not falling apart?” 

What I’m trying to do is describe it in a way… I realize that the goal with these guys is not to have them get to the end of a call where I felt like they understood what I did. The goal is to have them be able to get off the call, turn to everything else, not talk about this for a month, but then have some memorable anecdotes, stories, examples, a month from now, when they’re sitting down with a client or they get asked a question about it and they feel like they understand it now.

That’s my sort of mission, over the next several years, because that’s me. I’m the guy who has to… I look at our portfolio and I understand why you guys are doing what you’re doing. I understand, then, why we have those positions. It’s not usually a surprise. It’s not, “Oh wait, we flipped a short yen, even though it continues to go down.” I’ve never seen that. Anyway, crisis alpha is very useful, but I think there’s a better story around it.

[01:29:29] Niels

Yeah, and it’s great to have people like yourself out there talking about this. It is actually quite interesting that every time there’s a good spell of performance, that we have all these investment banks so interested in front running our signals and talking about what we are doing.

I think I mentioned a few weeks ago on the podcast that I’m surprised because we’re actually, for the most part, clients of these investment banks. You don’t really want your positions being front run by the people you do business with. Anyway, that’s a different story. I think we’ve covered a lot. We’ll have to get you back later and just continue this conversation. It’s super exciting. 

My final question to you would be something along the lines of, are you going to send a large Christmas basket to the 19 CTAs that make it possible for you to replicate their performance each day? 

[01:30:26] Andrew

I don’t think they need a Christmas basket this year. We’ll cross that bridge. People have always talked about what we do in terms of how worried are the big guys. Who cares? They have as much money as they want. Institutions are lining up around the block to give them money at five times the fees, 10 times the fees that we earn. They bring something incredibly valuable to the table.

Fund selection is not going away. I don’t think a Man AHL wants an ETF where somebody can look at their positions every day. There are trillions of dollars of capital who will never go to their door because they cannot. We are incredibly grateful for these guys, and we root for them.

We root for you, we root for them. We want you guys to destroy it and make your models better and do that. If we can come along for the ride and benefit from that then we’ll bring real value to the millions of investors in the ETF world who wouldn’t otherwise have access to it. I think that’s really my focus. 

[01:31:44] Niels

Yeah, exactly. I’d said that as well, on several occasions, that even though I can have my own question marks, let’s put it that way, but I think what you guys do and I think this is why it is so useful and that is that it helps many more people get exposure to a strategy that we should all have exposure to. So that is really important. 

Now, you just mentioned something that makes me come up with yet another question. That is, I’ve spoken with a Jerry you do know about this. There are two questions we’ve talked about.

One is, is it easier to replicate a manager or a group of managers that are “dynamically adjusting their position” (so, vol targeting), compared to managers that just keep their position size constant and where they could have big outliers, so to speak, because the one market or two market just goes and they have a big size position on?

Then also whether you could, in theory (I don’t want to put words in your mouth), but could you replicate a single manager as well do you think? Are you that good at it now that you can say, “Give me whatever daily data from a manager and we can get there.” Who may trade, obviously many more markets than you do? 

[01:33:14] Andrew

Let me answer the last one first. We would never try to replicate a single manager. I don’t think it’s right. If somebody comes in and does the DBMF, one day later ETF, okay, it’s cute, I get it.

I would hope the investor base would say, I’m not going to do this. The whole thesis is big pools. Within that, you’re going to have guys who are easier to replicate and guys who are harder to replicate. It’s really dependent upon different guys doing different things. It’s very much of a portfolio approach and the bigger the better.

It all comes back to if everybody decided that the SocGen CTA Index isn’t the right index, we’re going to use the Credit Suisse Index, which  I think is essentially just their own model, which is designed to look like it. That would change how we would think about it a little bit. We really start with the outcome. 

The good outcome is three years from now I matched or outperformed my benchmark and never went through a period of significant underperformance. Part of the reason that some people say it’s disruptive is because you really haven’t had a good way to invest broadly in the space. You can hire fund the funds, but they’re expensive. 

This is where you get into non-economic considerations. It’s a tough pill to swallow to buy a 200 basis point fund in the US mutual fund world. Even if they’re incredible, because somebody is going to look at the expense ratio of your overall portfolio and it shouldn’t matter, but a 5% allocation adds another five basis points to your expense ratio. You will lose mandates on that in certain segments of the market. It’s a non-economic consideration. 

I think what we’re known for in the replication space, we’ve been doing this for 15 years, we’ve only done three products. We’ve rejected dozens. “No guys, we’re not going to try to replicate Bridgewater Pure Alpha.”

Recently it’s been, “No, I know, it’s Millennium. Yes, we’re still not going to try to replicate Millennium.”

[01:35:30] Niels

What about Medallion? If you could do Medallion for me, I think I might be surprised. 

[01:35:34] Andrew

I think I’d be in a different business. I would be the single stop. I would be the single fund guy.

We call it Medal-lion or something. 

One of the things I’m known for, as I try to study the industry, is 19 out of 20 things that people have tried to do, of taking hedge strategies and putting them into mutual funds, ETFs, UCITS funds, have worked terribly, terribly.

The entire space has done one and a half or 2% per annum over 10 years after 200 basis points in fees. You were talking about incredibly well known managers who have entered the space. It’s an embarrassment. It’s the one space though, where you have a combination of diversification bang for the buck, products that can work in these vehicles.

When did you launch the mutual fund in the US? 

[01:36:28] Niels

So, we took over (we’re just a sub advisor) in late ‘15 for that one. Yeah.

[01:36:37] Andrew

You’ll hit leverage and some other constraints, in terms of what you’re doing, but it’s not going to be night and day. You’re not a distressed debt investor who’s then just buying liquid bonds like everybody else and charging a lot of money for it. There’s a history, and a long history of products, and it’s a strategy that works. In these big industry shifts, it’s always a combination of factors that converge, in a way. Then it’s also, on the allocator side, these guys have their own competitive pressures. 

The most sophisticated allocators out there that I talk to are guys like Corey Hoffstein, Meb Faber and Wes Gray. These guys are all over Fintwit and Resolve. The Resolve guys are great and they’ve all been huge buyers and believers in this as part of an asset allocation model, but they’re also the disruptors. They’re saying the Vanguard 60/40 model portfolio, for free, worked great, but it’s a single bet.

It was a single bet for 10 years that worked. They’re going to try to take share from all these guys who are down 20% in their diversified portfolios this year because they’re flat, or they’re up. It’s those competitive dynamics that causes people to then change what they do and adapt.

[01:38:08] Niels

It is interesting. All the names you mentioned there, they’re all great guys. Some of them have been on the podcast and so on and so forth. But all I want to say is that, that message obviously is not new. It’s pretty much the same message we’ve been going out with for 30 years.

It is interesting that it always gets more attraction after a bear market in equities, for sure. We had big inflows in 2009 following 2008, et cetera, et cetera. After the tech bubble, we also saw big inflows and the whole institutional adoption started around the year 2000 in the CTA space.

So without a doubt, and maybe these new ways of having people who are real influencers on social media, maybe that’s also touching another audience, for sure. 

[01:38:53] Andrew

I think the buyer base has changed. This development of model portfolios happened gradually, but constantly.

I’m talking more about the wealth management space. So look, do I think a hedge fund group at a consulting firm is going to buy us? No, we’re not a fund. Maybe they’ll have a $25 million client over here and they’ll use it. They’re going to pick four of you guys. They’re going to write long research reports. They’re going to talk to you every month about it. It’s what they do, it’s what they like to do. It’s good for them and their business. That’s what their clients want to see them do. I think we can solve the problem for them if they have a bunch of small clients, I think we’re probably a better answer for them.

They don’t invest in ETFs. ETF is a weird animal for them. Ethos wise, it sounds passive and it’s very scary. This growth of model portfolios really happened after the GFC. What wealth management firms found was it’s always the one lunatic who throws off the business.

You’d hear guys at these huge wealth management firms saying, “Wait, we’ve got a guy in Iowa who put all of his clients into three stocks and they’re down 80% and we’re getting sued by everybody.” What it caused in the wealth management space was to say, look, we don’t want our wealth managers focused on picking stocks.

Don’t do that. We’re going to centralize it. We’re going to create model portfolios, run by teams of people who know how to do this in New York. Your job is to go and pick the guy and talk to the guy, figure out his risk profile, and basically convince him that our Navy SEAL Team 6 of asset allocators here, is going to build the right model for him, and put him in the right products.

That was a control thing, and it was designed to make the manager more efficient. We want him acquiring new clients. We want him to be servicing those clients, cross-selling, maybe we get them to buy a mortgage, do all this stuff that from management’s perspective, made it less risky and more effective with fewer regulatory compliance issues.

Now, when you walk in, they do this financial planning exercise and they put you in a model portfolio. What they want you to do is focus on the model. That worked great during the 2010s because the model always worked. That’s where they could come in and say if you want to be different from Vanguard here we’ve got private credit.

Vanguard doesn’t have private credit. Just take a step back, Vanguard is the most peculiar business that I’ve seen in a long time of doing this. It’s a nonprofit. Imagine if Man AHL decided tomorrow that they were going to be a nonprofit, and every time you invested with them, they would just reduce everybody else’s fees until they basically went down to zero.

It creates such competitive distortions across the business. Everybody is trying to figure out how do we justify ourselves relative to Vanguard. Vanguard is the standard bearer of simple and dirt cheap. They’ve gotta add things in to differentiate from Vanguard, more sophisticated products.

Sometimes they get paid more on those products. Basically everyone’s trying to build these more and more complicated model portfolios to match what institutions have. Institutions didn’t used to have 40 different asset classes and 300 underlying investments.

It’s a race. It’s a battle toward complexity. The problem is a lot of the moves toward complexity hurt people. With DBMF there was almost a sigh of relief when I would talk to people. If you’re looking at the mutual fund space and then say, “I’ve got to pick one of these guys. I want to pick it, I want to be in this space, but I’ve got to pick one of these guys.” The second or third time you’ve had a guy who hits the windshield. Again, I’m not saying you’d like they’re down 80% cause that’s not the way the strategy works but if you’re sitting with a benchmark that’s flattish, as you say, and your guy is down 10% or 20% over some short period of time it, your diversification plays against you and your business. It’s why low cost ETFs have taken off, why index products have taken off. It’s all tied into getting people to think more holistically. Now you’ve got guys like Brian Portnoy who talk about the behavioral side of it and conditioning people.

I think that is very different than it was post GFC. A lot of how we’ve positioned our business and how we think it changes from here is driven by that. On the pension plan side, have fun. I think they’re going to be knocking your door down to give you money and they’re going to think you and three other guys, and you will have as much money as you want in your products on whatever terms. Everyone’s going to probably raise fees because, like what D. E. Shaw and everybody else has done. 

[01:44:15] Niels

Oh yeah. I think, hats off to people like D. E. Shaw who just since, I don’t know what it was, 50% of their money back plus raising their fees dramatically.

This is actually one thing that could be interesting, and now we are really speculating here, Andrew, and that is maybe that does come a point where CTAs say, “Well, hang on, we are close to our capacity. Why should we continue to bend over for lower fees? In fact, we think it’s so valuable, what we offer, that we’re going to increase our fees.”

Now, I know this is again, a little bit of a stretch. People probably wouldn’t think about that, but it’s like talking about inflation two years ago. Who knows? Hats off to those who would do that and say, “Actually, why would I want to give this valuable product away for free?”

[01:45:07] Andrew

At some point I’d love to have a conversation with you about that. I wrote a paper on the bank trend products and they were supposedly cheap, but they weren’t as good. When we looked at actual hedge funds versus the trend products, to us it seemed like yes, you pay a lot more for those for the hedge funds, but you end up on a net of fee basis, roughly where these guys were coming in. 

The implication was they’re not as good on a pre fee basis. There’s not as much excess returns, there’s not much alpha, however you define it, but they’re charging you less for it. Sometimes going down the low fee route can be a peer victory. The way I’ve always viewed fee reduction in hedge funds, and I have this kind of pithy expression that, “In hedge funds fee reduction is often the purest form of alpha.” If somebody dropped me into a sovereign wealth fund and said, here’s $25 billion to go invest in hedge funds, I would take that money and I would try to get the best deals that I could with credible firms, and I’d be making choices.

This guy’s GSA. I get GSA for 50 basis points, but do I really think they’re better – they’re worth it relative to Man AHL or whomever else? It’s a hugely powerful thing. The buyer base in hedge funds is incredibly fragmented. In other words, a consulting firm approves XYZ manager without writing a dollar for them.

A sovereign wealth fund approves a manager and gives them $2 billion on that day. Or a private equity firm goes to market and in a sense, they’re talking to all their investors at the same time. Cliff Asness, one of his great tirades at one point when people were talking about fee reduction, how hedge fund fees were going to come down and they were going to be commoditized. He had this great thing about how there’s going to be so much demand for hedge funds that fees are going to come down.

This is the first time in history that massive demand results in commoditization and lower fees. He was right. The guys who could command it… If you think about a hedge fund that was long only tech stocks that had a 2 and 20; you’re getting paid 20% of profits over zero and getting paid it annually. It’s like just torching money and people did it voluntarily with hundreds of billions of dollars. 

I think you’re right. Look, I think there’s going to, maybe, be a point here if you do see capacity, you do see meaningful performance, people would say, “Look, we dropped our fees at the right time. It’s a new world. We’re closing, we’re shutting down this fund for our existing clients. We’re launching a parallel vehicle. You can come into that, but it’s doubled the fees.” 

[01:48:08] Niels

Yeah, let’s hope that one day that will come, Andrew. 

[01:48:14] Andrew

I suspect our fees will go down over time because that’s the nature of ETFs. But hopefully we’ll be big enough. 

[01:48:21] Niels

We’ll see about that. Anyways, we’ll have to continue the conversation of course, and we will do that. This was fun. This was long. We appreciate everyone still with us after an hour and 50 minutes. But there was so much to cover and something that I’ve really been looking forward to.

Definitely this conversation has been a great joy. If you do like this conversation in general, please head over to iTunes, leave a rating and review, Spotify, Amazon, wherever you listen to these conversations. Next week I’m joined by Cem Karsan and we’re going to discuss another strategy that is often used as part of a diversifying and portfolio protection allocation, namely volatility.

So, this is your chance to send some questions for me to tackle next week with Cem. If you can send them early, because we’re recording on a Friday, I believe. 

Anyways, with all of that said, Andrew, thank you for taking time out of your weekend to do this. From Andrew and me, thanks so much for listening. We look forward to being back with you next week, and in the meantime, take care of yourself, and take care of each other. 

[01:49:26] Ending

Thanks for listening to the Systematic Investor podcast series. If you enjoy this series, go on over to iTunes and leave an honest rating and review, and be sure to listen to all the other episodes from Top Traders Unplugged.

If you have questions about systematic investing, send us an email with the word question in the subject line to info@toptradersunplugged.com, and we’ll try to get it on the show. And remember, all the discussion that we have about investment performance is about the past and past performance does not guarantee or even infer anything about future performance. Also understand that there’s a significant risk of financial loss with all investment strategies. And you need to request and understand the specific risks from the investment manager about their products before you make investment decisions. Thanks for spending some of your valuable time with us, and we’ll see you on the next episode of the Systematic Investor.