260 Systematic Investor Series ft. Andrew Beer – September 9th, 2023

00:00:00 Intro

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.

00:00:23 Niels

Welcome and Welcome back to this week’s edition of The Systematic Investor Series with Andrew Beer and I, Niels Kaastrup-Larsen, where each week we take the pulse of the global markets through the lens of a rules based investor.

Andrew, great to be back with you this week. How are you keeping? Where do I find you today?

00:00:40 Andrew

I’m back in the New York area, and thank you. So, it’s great to be back here. I really appreciate the invitation to return.

00:00:47 Niels

So, you’re watching, following the US Open I imagine or not?

00:00:52 Andrew

I am not. I was a huge tennis fan. I played tennis my whole youth and, for some reason, I just stopped having any interest in sports about five years ago. So, I’m in this embarrassing state now where when people talk about the stuff I’ve absolutely no idea what they’re talking about anymore. I’m unbelievably good with baseball in the US up until about 1985 and then then I kind of go dark.

00:01:16 Niels

Fair enough. Anyways, we’ve got a great conversation lined up today. But before we do that, before we dive into all the topics, we, or I like to just ask sort of what are you keeping an eye on at the moment? What’s been on your radar? Are there any particular things you see happening around the world that you think might be interesting?

00:01:37 Andrew

Well, I think the most interesting thing is the fact that it looks like rates are not going down soon. I think the whole dynamic of rising rates, you had vast portions of the asset management industry that were desperately hoping. As rules based investor, you know how bad it is to hope that a trade that is going against you is is not going to continue to go against you; that it’s going to reverse. It’s the worst heuristic bias that people have when it comes to investing.

I think Warren Buffett said it’s like watering your weeds and cutting your flowers, or something to that effect. The thing is that the entire asset management industry; every pension plan, every family office, every RAA, every wealth management firm has built their businesses around an inverse correlation between stocks and bonds, and it looks like that’s over. And people will have been… it’s not clear exactly what they do. So. to me, what I’m really interested in is this dawning realization. But people aren’t really thinking through the implications of it. We can talk about it more because I think it’s the single greatest selling point for managed futures over the next decades. You will certainly hear me, once or twice, talking about it.

00:02:54 Niels

Okay, well, we’ll definitely talk about that.

Before I forget, because I’ve reached that age that if I don’t say things as soon as I remember them, then I might forget them. But I will say you mentioned this word that the correlation had changed (or I can’t remember exactly the words you use), But the funny part, of course, Andrew is that it hasn’t changed. Meaning we’ve just gone back to the way it normally is, but hasn’t been for the last 20 years. I think that’s the key thing, which actually goes to your point about well, it might actually stick around like this for a while. So, anyway, we’ll come to that.

I think your point about the bonds, I spoke to Katie Kaminski; last week she was on. I think that’s also something really worth paying attention to, that people really hope that bond prices will start going up. But we’ve had another week where they’ve gone down again. And that’s going to be putting pressure on certain things.

I also find, personally, that the same could be said about the dollar. People have been talking so long about how the dollar will demise and it’ll fall off a cliff. Yet we’re sitting at a six months high right now; interesting dynamics. And finally, I don’t follow this closely but I hear people talk about the GDP now numbers, looking incredibly strong at the moment. I know some of it is taking July, I think, and then sort of putting that out into the future, so it may change. But still, there’s a lot of narrative that doesn’t add up to the to the facts, which is really interesting.

00:04:25 Andrew

In what way do you mean?

00:04:26 Niels

Well, because I think people are saying, well, the economy is struggling at the moment, and yet the numbers that are coming in are suggesting that this may or may not be the case. So that’s what I thought.

00:04:40 Andrew

I think that for a lot of people it’s hope, right? You really hope that there’s going to be this decline in economic activity, inflation is going come down another couple of points. Nobody knows. But you look at kind of the bigger things: you look at deglobalization, you look at that real interest rates have gone positive. They’re kind of supposed to be positive. You’re not supposed to have negative real interest rates for long periods of time. You’re not supposed to have $18 trillion of negative yielding bonds. So, I think your point is that people grew up in an abnormal world. It’s returning to normal and they’re having a really hard time making sense of it, because a lot of people’s businesses and livelihoods and success was built on a very, very, very, very strange artificial situation.

00:05:25 Niels

Yeah. true, yes, which reminds me about a podcast I was listening to the other day, I can’t remember which one. But again, where you just hear the narrative, well, let’s just wait until bond yields go back to normal around 2% or 3%. And I’m thinking, well, that’s not normal. I mean, I’ve been around long enough to know that that definitely isn’t normal. So anyways.

00:05:46 Andrew

Old guys unite!

00:05:50 Niels

Yeah old guys unite, exactly.

Now, from a trend following perspective, just before we dive into the topics, I completely forgot to look up where the performance is coming from, but September is looking pretty good, actually. Maybe you know where your performance may be coming from. But actually, September, so far, looks pretty good. Although my own trend barometer is not sort of firing on all cylinders, but it has increased in the last week or so.

But anyways, for the industry, and we don’t even have Thursday numbers in here, but up 1.46% for the BTOP 50 for September, up 36 basis points so far for the year. The SG CTA Index (which will be very relevant to you, of course) up 1.77% for September, up a fraction – 17 basis points for the year. SocGen Trend up about 2% for the month, and now it’s only down about 40 basis points for the year. And the Short Term Traders index up just shy of 1%, but still down two and a half percent for the year. Equity, so far this month, down 2.59% For MSCI World but up 14.6% for the year. World Government Bonds down another 75 basis points this month and the S&P 500 was down, as of yesterday, 1.25% but still up just shy of 16% so far this year.

All right, Andrew, you sent over to me some really great talking points but I want to begin with an article that you just published in the prestigious, I will say, publication called institutional investors. So first of all, congratulations for getting that published. It’s titled Why Managed Futures Funds are Ripe for Replication. That’s how it starts. Then it goes on to say, “Research shows that replication, rather than investment in single manager hedge funds, may make sense for most allocators.” (writes Andrew Beer)

Okay, of course when I see a headline like that I’m curious to learn what research you may have found, or maybe conducted yourself, of course, to make such a bold claim that most investors would be better off investing in a product like yours. Of course, I’m a little bit cheeky when I say that. So let’s dive into this for a little bit, and then we’ve got a lot of sub points we want to discuss.

00:08:13 Andrew

Sure. So, first of all, I didn’t actually choose the title. So, what happens is that when you submit these things… I can write, in a somewhat punchy way, when I want to, but it was actually a little calmer. It was more about the nature of replication of managed futures funds. The reason I wrote it was because earlier this year we had a bad first quarter. We had a great, generally, very good 2022.

When you look at what we’ve done since 2016, when we started doing it, we’ve outperformed in every year. We kind of matched in one year, but every other year, we outperformed the index, and we did it with a correlation of around .9. In the first quarter of this year, after this great year if success, we underperformed. What it did was it opened up these attacks on whether there was something structurally wrong with replication that hadn’t shown up in the first year.

One of the attacks was around this idea of diversification. The sort of inference was (and, by the way, I’ve written a lot and we’ve done all these videos and I talked about what happened) it was a period where basically managed futures hedge funds were finding better trades than we were in the simpler portfolio that we were running. What we concluded and now it’s been shown in, like in the second quarter we were matched again, and then in the third quarter we’ve been outperforming so far.

We viewed the first quarter as just a very just very unusual period, when we looked at it; not unprecedented but very unusual. Things like the Mexican peso were contributing more than they would have, the short end of the Canadian dollar curve. We run our own trend models as kind of a sanity check on what we’re seeing out there. But what came out of it is I started getting questions and criticisms as well was, is 10 core futures contracts too few.

When we first started looking at the space back in 2015, we didn’t have 10. We said, Let’s do it in the simplest way that we can, and we’d actually started looking at it with 4 contracts. And we’ve actually looked at a bunch of other things. Most hedge fund strategies that you can replicate, you can do with surprisingly few contracts. But when we looked at it, we actually found that, when you’re picking for contracts, if you pick the S&P versus Euro stocks, you can end up with quite different results. So, you expand that a little bit.

What I want to do is write something that basically showed a very simple study, which is that if you took just the 4 biggest, deepest, most liquid contracts (or close to it) in each asset class: the S&P 500, the 10 year Treasury, the Euro and crude oil, and you ran the same kind of replication model, where you said, let’s look at recent data of the index of hedge funds, SocGen CTA index. Let’s try to figure out and estimate what they’ve been doing before fees, and the model basically says, what portfolio, long and short of these, would have most closely matched in this recent period.

The whole idea of replication is, is that likely to be a good representation over the next four or five days? It turns out that actually, it works really, really well. So, what I was trying to do is basically, I was trying to do two things. One is to say, the debate isn’t between 10 and 70 because 4 works well. We obviously didn’t do 4 because we actually see some risks in it, in that the factors that we tend we felt more comfortable with.

So I wanted to make a point that this dichotomy between 10 and 70 was not right, it was actually between 4 and 70, and then where we were 10 was not on one end of it. The second was actually just to write a framework as to why why we think it works. A lot of the language in the space is about idiosyncratic factor contributions to returns. Again, not as a managed futures guy originally, but just in general, when I look at the markets, I see stuff moving in packs, all of these.

I look at a value investor. If value stocks are doing well, that’s a bigger driver of what he’s doing, than whether he’s picking the 10 best value stocks. I haven’t found that guy yet. But I could find the guy who is sort of religiously dividend value stocks. So, our whole philosophy has always been that this idea that stocks, bonds, everything else; every everything is just either going up or down, or not moving.

You know, people talk about these orthogonal risks, that somehow you’ve got things going up or down. But then something else is flying off to the right, something else flying off somewhere else. That is not the way the financial markets work. So, part of it was also to introduce this just kind of basic idea of that we’re not trying to do what you guys are doing. We’re just trying to identify what we call clusters. When rates start going up, that’s going to ripple through every different fixed income instrument. And the argument you guys would make is that, yeah, but it’s going to ripple through some in a much more pronounced way, in a much more meaningful way than others. And we’re gonna hop on that, and we’re going to find those in advance. And our view is, well, we’re okay, just getting broad representation of the pool.

So the instrument that we pick, let’s say, 10 year Treasury, is not designed to be a we think everybody has, on average, you know, a 19.3% short position in the 10 year treasury, whatever it is, rather, it’s that happens to be a deep and liquid way of expressing what’s happening with these clusters. So, in a period, like the first few months of this year, having the two year Treasury did not work nearly as well as having the short end of the Canadian curve – like we missed something. So anyway, that’s why I ended up writing it.

00:13:55 Niels

Okay. I mean, this is great, because it allows me to pick your brain about a few things that you just said. First of all, I’m curious, what risks did you identify with just using 4 markets? Why not use 4 if it works so well?

00:14:10 Andrew

Well, so we are huge skeptics about backtesting anything. So we like simplicity. So, we’re very different. The ideal model for us is one that is robust, and we don’t change it, and it works, and we don’t change it for 20 years. It’s a very unquantified approach to things. Friends of mine who’ve been quants at investment banks, if they’re not constantly creating new products, then they’re not doing their job. If they’re not taking the models that they have and making them better.

As an investor, and as somebody who has allocated to hedge funds over a long time, those things sound great, but I always ask basic questions like the only reason you’re telling me about this enhancement is because something didn’t work. So, your best guess as to how to make this work five years ago didn’t work. And now you’re telling me to take a bet on you that the new thing that you’ve done is going to work better than what happened previous.

You don’t, generally, have people saying, “I’ve been knocking the cover off the ball. And now I know how to knock two covers off the ball.” Usually, it’s that very American expression, you started talking to me about about sports, so I’ve gone back to my 1970s analogies. So, I don’t know for certain that if I had been standing there 15 years ago, that my partner and I, looking around the world, would have said those factors make the most sense.

I might have said, “Well, the S&P had done really not much very well.” I might have said, “Yeah, we want the MSCI World, the MXWO, we want something else, we want some broader representation.” Also, these guys are what we call wave detectors, because we think you guys are out kind of looking across the market sea and trying to find these waves, how you focus on what you do may change over time.

So, there is a nonzero chance that the next 10 years will be a lot more about markets outside the US. We have a quite US centric portfolio, not totally US centric, but the portfolio that I’ve described to you was more US centric than what we would have today. So, modeling is judgment calls. And, for us, we were trying to find the right balance between, when you’re doing replication with a short data set, you statistically shouldn’t have 70 instruments, and you can’t look at 20 daily data points and try to map 70 futures contracts on it. It doesn’t work statistically unless you then reduce all of your dimensions and and get it down, but then you’re just using a smaller set of factors to begin with.

So, it was a it was a judgment call that we made. In retrospect, it looks like the right one. Sometimes we look at things that were simpler than what we did. This was the something we wrote about earlier this year, when we were looking at the performance of replication based strategies in the first quarter. We were too complicated in the first quarter. We should have had a one factor model in the first quarter, which was just the two year Treasury contract that worked at a 90 something percent correlation. Instead, by taking but what a model does and saying, “Well, I’m not going to take some risk, and I’m going to find the S&P or something that is moving with it.” Those broke down, they didn’t work as well. So, all of this is a judgment call, you know.

00:17:23 Niels

Okay, so another thing you mentioned, was that, yeah, I mean, if you look at global interest rates, a couple of contracts will probably be fine. And maybe you’re seeing this across all the sectors. Interestingly enough, what I’m seeing, and I was also talking to Katie about this last week is, when I look at our positions, I would say (and this is just from sort of eyeballing it), I would say I’m actually starting to see more divergence among markets, just in currencies. I mean, they’re not all short or long against the dollar and stuff like that. So I’m seeing a little bit of divergence.

Now, this is not a call of whether it’s right or wrong, I’m just saying that. And I wondered, maybe, your perspective on this. And that is (and I don’t know how far back you go when you do your backtest) one of the things that I could imagine is that in the last couple of decades (and we kind of talked about this just before about how abnormal those decades have been) there has also been a period where central banks have been very, very good at keeping things quiet. There have been a couple of crises, they’ve kind of done what they needed to do, but generally speaking, no big booms, no big busts, etc., etc.

In an environment like this, I can imagine that things are perhaps more clustered, that they will move more in tandem. When I started in this industry, many moons ago, economies were actually quite divergent. Japan could have a great period, and the US would be in recession and Europe would be somewhere in between, etc., etc. What happened then was, it all got very synchronized. All the economies more or less moved in tandem, and I think that that may be changing again.

So, I wonder if you’ve ever thought about whether the data set that you’ve been looking at to create these replication models and to kind of pick your universe, where you say, “Well, actually 10 markets is enough,” whether you think that could be just because we’ve been in a pretty unusual, quite stable environment?

00:19:37 Andrew

Sure, so, on our side, we can run the data reliably back to the early 2000s. So, the SocGen CTA started in 2000. The SocGen data gets worse the closer you get to 2000. SocGen didn’t start on Jan 1st, 2000 and didn’t say that we’re going to create a pure hedge fund index and find the 20 guys at the time. I mean, this was before institutionalization of the business. It was kind of the Wild West. So, since SocGen was created, you get more selection bias and more data issues. And also, from an intellectual purity perspective, of those 10 major contracts that we trade, before 2002 some of them sort of drop off.

Again, looking back (I’m a history major, I’m not a quant, almost became a quant but I dodged that bullet, or maybe I’m a quant now making up for it now) of course the world changes. In fact, the whole lunacy of the whole factor investing business is the starting assumption that what has worked over the past 70 years will work over the next 70 years.

That is like literally an insane assumption, because you would think then that if somebody decided on a factor in 1992, like when Fama and French published their paper, you’d think they’d still be using it today, because if it’s permanent, you don’t have to keep changing it. And yet, every couple of years, they keep changing the value factor to try to come up with something that would have worked over the past period. So there’s no question.

Replication is surprisingly robust for the following reason, and the core idea is that things either go up or down. So, let’s say I wanted to replicate (I’m just gonna use a silly example), let’s say I wanted to replicate Bitcoin. The Bitcoin guys will say, Oh, no, we do it (and for a period of time, right when it went from like, $1, to $70,000, or something, of course, but then it kind of becomes bigger and becomes institutionalized.) Now, I haven’t tried it, but I’m sure you could probably replicate Bitcoin with NASDAQ and it wouldn’t look terrible or crazy, because Bitcoin is only going up or down, and something is causing it to go up or down, and something’s causing NASDAQ to go up or down.

So, the really simple thing about replication is it’s just a bet on some stability in the correlation structure of the market. Let’s say you have 70 instruments, 69 of them haven’t moved over the past 20 days with the exception of the S&P 500 has gone up 2% and wheat has gone up 10% and nothing else. Sixty-eight positions haven’t moved over that period of time. A replication model would say, well, I need five S&P 500 contracts to get to the same exposure. Now, that sounds insane unless, over the next five years, that’s a reasonable representation of what wheat is doing.

The thing is (and that’s an incredibly extreme example), in a sense, the whole managed futures business is a bet on stability of what’s happened over some recent period of time and is going to continue. Replication is philosophically identical, but it’s not a bet on single instruments going up or down. It’s a bet on the correlation of the structure of the markets is relatively stable, and it’s not always.

Let’s say US and European interest rates diverge for the next 10 years. Well, something’s gotta be correlating with either side of that. We could have direct exposure to the US interest rates, indirect exposure to something else to non US interest rates (it’s moving in the other direction), and you could still actually get an accurate replication.

On the equity long/short side, we don’t invest in single stocks. You can do it with futures contracts, because if hedge funds are moving from growth to value stocks, and you can see that in their numbers, if you have more Russell 2000, which overlaps like a Venn diagram with with value stocks or more European stocks, you’re picking up on something fundamental. Now, if they are only finding the stocks that do well, then it may not be. So, in the case that I described, if you guys really find the one position that goes up and nothing else goes up, we’re not going to be able to figure it out. We know this, because there are a lot of things you cannot replicate, and you should not try to replicate.

So, the great investment strategy du jour or multi strategy hedge funds. These guys are magicians in what they do. They’re taking $1 If your capital, they’re leveraging it at 5 to 10. They’re hiring teams of people to deliver several 100 basis points of of excess returns per dollar of capital. They take half, you end up with 10 to 15. They make 30 on your dollar. They take half, you end up with 15, and they do it without blowing up, and they do it with zero correlation. So, you cannot replicate that because there is nothing there they, themselves, are hedging out the underlying risks.

Managed futures as a strategy, or equity long/short as a strategy, in general, are not hedging out their underlying risks, they’re betting on the risks. Replication is basically saying that there will be some short term persistence of returns in the correlation structure.

That was not nearly as clear as I expected it to be. I apologize.

00:25:02 Niels

No, I mean, it is it is fascinating. I actually think that once I heard someone, and it could have been a previous guest on the podcast, saying that that, also, for a long period of time, there had been a 95% correlation between, I think he said something like Indonesian potato prices and the S&P 500, something like that. I mean, so you do get some crazy stuff going on from time to time.

00:25:25 Andrew

The way that we tested it is that we’re very skeptical of cherry picking anything. So, back when we first looked at this, we said alright, 4 seems a little… Obviously it just felt like it was it was it was too aggressive or too concentrated. So we realized, pretty quickly, is that if you want to do it, well, you do do need exposure to 4 markets.

You should not try to replicate the SocGen CTA index with just the S&P 500. You can do 10 different equities contracts but it doesn’t get you to where you want to be. So, you need diversification across the four asset classes. So, we said, “Let’s take the three or four most liquid contracts per asset class, and just do random combinations of it over the preceding 10 years.” Every single combination we looked at, aiming for the previous returns of the SocGen CTA index, and adding in because replications is really efficient from a trading perspective (that’s another thing that we like about it), so, basically adding in what we thought were the additional trading costs, every single combination did better than the index.

So for us as for an investor, people often think hedge funds want to do complicated things. We want to do the simplest things. We want to do the simplest and most straightforward things we want to get it. We want it to be like this guy that Seth Klarman that I worked for, who published his book called Margin of Safety, you don’t want to have to be right to two decimal places to make it right. It’s exactly what Warren Buffett and Charlie Munger say.

So this, to us, was our statistical margin of safety. We can pick the wrong factors and we’ll still be okay. We can be in a world where this factor set, we would have picked this factor set and we didn’t. So, our view, obviously, is that 10 is sufficiently robust. It’s designed to be able to accommodate things. In three years, we’ll have the discussion, we’ll see if the world is shaped and now we’re doing it.

00:27:21 Niels

Yeah, I mean, it’s fascinating, and of course, for someone like myself, having been on on this side of the table for so long, it’s kind of very hard to accept that you can do what we do with 4, even 10 markets. But as you say, I mean, we’ll have to just wait and see.

00:27:43 Andrew

Now we’re hearing about all these alternative markets funds that people are focusing on. So, that’s based on the idea that it’s less liquid and it’s harder to access, and we can show evidence of trends, and that’s where the real Alpha generation is. So, are there funds out there where people say, “Well, of course you can get a trend in the yen like last year,” but we’re not going to do that. We’re going to give you not contracts 1 through 10, as a matter, we’re only going to give you contracts 31 through 112, and we’re only going to trade in those markets.

I think the reason people don’t do it is because one, my guess is, when you really dive into the numbers over a long period of time it actually isn’t meaningfully better than when you include these other larger markets as well, where there are clearly underlying trends. I think it can be very inefficient and difficult to trade, but you would think that there would be, let’s say, a fund out there that only trades in those markets and has a Sharpe ratio of 1.8. But we don’t see it.

00:29:01 Niels

Well, there is one fund that, I think for the most part, trades all of these alternative markets, which is Florin Court, and they do say that they believe they can create a better Sharpe.

00:29:14 Andrew

It is totally replicable. This is as replicable. So, are you going to pick up on the carbon markets moving when they go through some astronomical outlier? No, usually there’s some underlying force that’s driving it. The analogy they use is if you think there’s going to be a commodity supercycle, is natural gas is going to go down? Probably not. Most of it is going to go up more than oil, I suspect probably, because it tends to be a leveraged exposure to oil. But, if your view is natural gas is going to go up over the next five years and you buy oil in some sort of a leverage basis. You’re going to be pointing in the same direction.

So look, I think part of the reason people are going into these alternative markets is because this industry has been on a 30 year path toward dissemination to sort of proliferation of the the strategies. The people who were doing this 30 years ago, like your firm, 50 years ago, 49 years ago for you guys, how many people out there knew how to do it? How many people knew futures roles?

When I first started looking at the commodity markets (an interesting sort of historical point), I started one of the first of fundamentally driven commodity fund of funds back in 2003. It was actually based on an industry structured question, which was that commodities, I thought, would come back into the portfolio. So around 2001, I made my first investment in a hedge fund, where the guys were basically tracking barges. They’d have a guy sitting in Brazil, counting the number of pallets of sugar that were going off on barges. That was a totally unique skill set. The Alpha generation of these guys was insane, because they had information advantages, and they knew how to do things that nobody else in the world knew how to do.

A business school classmate of mine made $4 billion trading natural gas and coal for a power producer. He knew who was buying the coal and natural gas. It was the stuff that a discretionary trader dreams of. I know, something nobody else knows about. But it was also the futures markets. I would talk to unbelievably sophisticated family offices, who didn’t know what a futures contract was, and didn’t know how to trade it. “How do you roll that? What do you mean they expire?”

A lot of areas in the investment business are really these areas that were totally unique. Then some really smart guy leaves DUNN Capital, and he starts his own firm, and then somebody – a turtle trader like Jerry goes off and he starts his own firm. So, you get more and more people who know how to do it. And now on Twitter, or X, I guess (whatever you call it), you’ve got people out there who are publishing their own trend following models. So, of course, then people go in the same way that Winton was not trend when GSA was out there sweeping up assets, and they sort of come back into admitting that their managed futures fund at heart. In the same way you’ll get people who will push into these other markets because what they were doing in the broader market is becoming challenged or commoditized.

00:32:39 Niels

Yeah, well, you know, if they were really smart, they wouldn’t leave DUNN Capital, but that’s another story.

00:32:44 Andrew

Maybe nobody’s left. It’s a bad example. It’s like the tiger cubs, the tiger cubs, the DUNN cubs, you need the DUNN cubs out there.

00:32:58 Niels

Now, you kind of touched on something, and I don’t know how to kind of formulate it on on my feet here. Because on one hand, our audience will have heard me say many times that I don’t see a material difference in performance between those who trade 400 markets and those who trade 50, 60, 70 markets. It’s different, but in the long run, it’s not hugely different. At least not what I think is just driven by the markets themselves. I think there could be something with the models and how good your models are. So, because you’ve probably studied managers, to some extent, to get to where you are, what is your sense? I mean, with all the technology we have, with all the sophistication we now have, you know, do you think… Are managers… You also talk about, in your article, I think it says, “However, replication of single managed mutual funds, demonstrates conclusively that complexity can detract from returns over time.” La, la, la, la, la.

Do you think that managers have become more different or more similar in the last decade, given all of these things, or has that changed at all? This leads me to the next question, which is something you brought up, I think, and that is, how can a single manager differentiate themselves?

The reason why this is an interesting question, also, for me, personally, is that, I would say that probably 98% of the time, when you go out and you meet someone for the first time, they’re going to ask you, “So, how do you differentiate yourself at DUNN?” So I’m curious.

00:34:49 Andrew

So, my guess is there’s probably been a narrowing of performance over time, because people realize that certain things work better than others. When people ask what window lengths we think we’re picking up on longer term trend, medium-ish to longer term trend. If a guy is day trading or trading in five day cycles, you’re obviously not replicating that guy. But when you look at the overall space, particularly the trend subindex, it seems to be pretty slow moving. It’s not slow moving like equity long/short, but it’s slow moving enough that I’m not worried that we’re missing something big.

So, when you look at the trend side, actually, the correlations are pretty high. I think from an industry structure perspective, I think trend was not cool until March of 2020, because trend was what the banks were trying to commoditize aggressively in 2014, 2015. So David Harding, if you interview him, can answer this better than I can. What I heard from people about Winton, when Winton sort of famously said that they were not a trend follower anymore, what I was told was that they had gone from, like, 65% trend to 30% trend, whatever that means. But it was really more of a semantic shift, and they went out and hired other people.

People do things like that, in part to defend, to create a moat around their business model. It was a full fee hedge fund, profit generator extraordinaire. So, I think sometimes when people talk about the changes that they’re doing in their models, it’s designed to try to differentiate themselves from the pack. If the trend guys, in general, have correlations to the SocGen CTA index between .75% and .8%, or .85% over time, that starts to look and feel a little more commoditized. Up until March of 2020, when we would talk to people about the space, they loved the other stuff – machine learning, you know, machine learning is going to tell us what trends are working right now; we want to be counter trend; we want to be all these different things, because trend, itself, hadn’t been working terribly well.

Then in March 2020, we saw a big shift and trend did better. And then guess what, last year trend did better. And so I think there’s been a huge shift back where people, instead of saying managed futures, now it’s more about trend following. And my guess is usually in an industry, and, generally, in any population over time, you start with a very, very wide dispersion of outcomes. And then over time, people kind of realize, and they narrow in on what tends to work.

I think medium and long-term trend is the single best diversifier you can put next to a portfolio of stocks and bonds bar none. Whether they get exposure to that through you, or one of your competitors, or through us. The other stuff, though, will be differentiated.

Think about what this must have been like 30 years ago, if you had gotten five guys who were doing this. You’ve got some guy who doesn’t know anything about the space, who’s backtested a model where he’s got a15 day window that I’m looking at, and he doesn’t even know that he’s trading on the morning of the day that he’s getting the data. So he’s kind of front running his own analytics. That guy’s going to launch. He’s going to be down 70%. In the first year he’s gone, he disappears. And if people know about him, they’re not going to do that again. And that’s where people study and papers get published.

So, I think in general, you do have this compression over time, and also because people don’t want to be the guy who’s down 30 or 40, when everybody else is up 20. So, just from an economic perspective, particularly for bigger firms, usually the incentive is, you want to stay relatively, the bigger you get, the closer you want to stay to the rest of the pack, the more enhancements you want to talk about. But if you’re young and hungry, you want to do something different. And you’re hoping that the pack gets hit, and you look like a star, and then you have a business.

00:38:56 Niels

I want to just clarify one thing, because, actually, I did sit down with David Harding back around 2017, with his two co founders of AHL and, you know, this was kind of around the time where he decided to make some changes. I will say that, I think (and whether this was during the recording or just after I don’t know) he did acknowledge that it was certainly something that was significant. But I also know, from a more recent conversation with one of the heads of research over at Winton that, of course, from their point of view (and I want to make that clear) that they never left trend following, but they certainly de -emphasized a bit.

00:39:39 Andrew

People were saying trend was dead, and they were using Winton’s de-emphasis of trend. If David Harding is reducing his exposure to trend and doing equities or whatever else that they were doing, you know, people look at that and they assume that he knows something about the future and trend. Again, my observation is from somebody who doesn’t know a whit about what they do and could not hold a candle to that guy in terms of his understanding of this business and the incredible success of what he’s had and what he’s delivered to his clients over time.

What was happening in the mid 2010s, with banks coming out, look, GSA had a 50 basis point product. They flipped heads a few years in a row, and they had $10 billion of assets after a few years. When you’ve got somebody who’s out there offering something at a much lower price, who’s knocked the cover off the returns, people have to respond competitively to it.

I think back to your point, I think just just the general dynamics of the space, in the mutual fund space in the US (which I know better) is that there’s a lot of pressure for people to explain what it is that’s going to differentiate from the pack over the next five years. I’m just skeptical that these things do what people are hoping they’re going to.

00:41:02 Niels

This may sound like a really cheeky question, and it’s not meant to be, but I am curious, because you bring up a really good point. That is (and I don’t necessarily know that we need to pick on that particular firm starting with a G and an S and an A) they definitely came out and disrupted the industry by lowering the fees to that extent, and people thought they were going to get the same as they would going to get from a firm. Aren’t you doing exactly the same Andrew, though, because you’re also disrupting our industry by saying, I can give you what all these other guys are doing, but I can do it for 85 basis points. I mean, I’m just really intellectually curious, where’s the difference?

00:41:48 Andrew

Well, as you know from last time when I got to ambushed, the expression that fee reductions appears more as a form of alpha. The best investors and hedge funds that I know, they start with, do I like the strategy, and then how do I want to get exposure to that? The thing is, in the hedge fund industry, 98% of people who invest in the hedge fund industry are price takers. They show up after a fund has been really successful. They show up and there’s already a line of people around the block, and they don’t have a lot of money to invest.

Even consulting firms, consulting firms walk in and say, “Well, we’re not going to approve you unless you give us a fee discount.” They’ll take like a 15 basis point fee discount on a 2 and 20 structure and call it victory. So to me, we think just that if you want to consistently outperform. GSA was different in that GSA was a single Manager product. There’s always a single Manager product, who’s going to do well.
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GSA wouldn’t have taken market share, with a low fee product, if they had not been doing well. It was the combination of flipping heads multiple times in a row, plus a low fee product and timing, converging at the right time, and they get this geometric asset growth.

We’re trying to do something different. We’re not trying to take more radical risks. We’re just basically saying that what we think these guys are doing, collectively, is amazing and valuable, but we are going to try to find the most straightforward, most efficient way of getting exposure to it. We’re not always going to be right. But just purely from an asset allocator perspective, we think we’re going to be right. We’re going to have a tailwind from fees.

I learned a little bit about this from guys who run hedge fund portfolios at some of the sovereign wealth funds. They always do better than the SocGen CTA index. If they came to you and said, “We’ll give you a billion dollars in title for five years, because this is a space that is not massively capacity constrained, They’re not going to pay what the private bank who’s on-boarded the fund is paying. They’re going to get a special deal. So, their experience from 2015 to 2020, In this space, was better. It wasn’t 1000 basis points better, but they do that with four or five different guys, and they do better.

So DUNN, to me, was a a fund that had done well, but had done well (I don’t know exactly what it was in their modeling) because luck was a huge component of it. Luck, or leverage, or something was a huge component of it. We’re not trying to do that. We’re trying to eliminate that side of it.

We’re not trying to be the one guy who does well three years in a row and then underperforms. We’re trying to just grind out, through efficiency, a little bit of outperformance over time. It’s very boring compared to it. It’s not exciting. We don’t have lots of good stories to tell about it. But for the asset allocators that we want, that I talked to (and on this webinar I did yesterday), we want guys who want no noise in the allocation. They don’t want to have to worry who’s the best. They like the space. they look at this SocGen CTA index and say, “I wish I could have that. I don’t want to try to find which of the guys I like, I don’t want to pick a guy like you who’s done a lot better, but who’s not in it.” They just don’t want that risk. They want to put they want an easy way to get exposure today.

The irony of the ideal diversifier, for these guys, is they want to talk about it in 2022, when it’s doing well. They don’t want to talk about it for the next seven years, and then they want to talk about it again. The way you avoid talking about it during that period of time, is your benchmark plus where you’re in line with the benchmark. Then, if the space goes through another long winter, it’s not that your guy was down 20 when the space was flat.

Again, we came in from their side. I think it’s different because I would bet more on the disintermediation, trading efficiency, and things like that over time, unless there are demonstrable sources of excess returns that we’re not capturing, in which case, we’ll do okay, but we won’t do as well.

00:46:18 Niels

I’m not going to go into today. But I did pick up, because you mentioned Transtrend, and I think you said you’ve sort of followed them, or you have a pretty good idea. I just wanted to maybe, because I was going to pick up this next week with with Nick Baltas, or at least if you want to talk about it, because Transtrend actually put out a paper a couple of days ago, talking about what they thought was really the edge in them and other trend follows. From memory, I kind of briefly skimmed it. Harold was talking about that, actually, the fact that they trade around their positions, that that’s really where they think the alpha… and not so much the fact that they’re in, you know, short dollar or long dollar, whatever, the fact that they are dynamically managing their positions. Not everything that he wrote, I agreed with. I thought some of it, I couldn’t quite reconcile. Anyways, people should go and read that article so they were ready for next week when I talked to Nick about it.

Anyways, we’ve got a couple of other topics we need to cover, I think. Okay, let’s just focus on two more topics, Andrew. We’ll finish with the with the story about the train wreck. But before that, I want to talk about something positive, because you also wrote to me about why CTA assets will be much higher in 10 years. That gets me excited, and I’d love to know how I can help and benefit from it.

00:47:48 Andrew

Well look, so we started talking about it, which is that today there are $5 trillion in model portfolios. And Blackrock thinks it’s going to 10 trillion in five years. The entire wealth management world, every pension plan, etc. they live and breathe through model portfolios. The entire basis of a model portfolio is the core of it is that stocks and bonds are not going to move together, they hedge each other, and almost all diversifiers that they have.

So we have this kind of pithy analogy, which is that basically (and by the way, I will credit Eric McArdle at Simplify, in the US, for coming up with this), basically that stocks and bonds had been this two legged stool, and two legged stools are not stable. On the other hand, for the past 20 years the Fed has been a wall; it’s been up against the Fed not letting that thing fall down. It’s not quite perfect, because they actually were inversely correlated.

Thirty years ago, that was very risky. That was a scary roller coaster up and down. But then, because of the strength of recent history in that the 2000s, if you look at the .com crisis, equities went down 50% but bonds soared because we started with high interest rates and then bonds came down. In 2008 equities got crushed again, and bonds don’t go down but they don’t soar because, again, they don’t have as far to go down anymore. Then you get down to 2022. They both go down. Then in January they both go up and then February they both go down and then last month they both go down etc.

This is an existential threat because what has happened is you now have a two legged stool with the walls been taken away and it just fell over. So you need a third leg. Most diversifiers are designed to bolster one of those two legs. Private equity is equity with a different wrapper. Private credit is credit with a different wrapper, and real estate and things like that, everything has a high correlation to one of the two. The only thing in the liquid hedge fund world where you can say it as a correlation to neither one of them is managed futures.

So, imagine an allocator in 2030. Okay, the guy just got out of business school, he’s got his CFA Level Three or something and he’s been hired to build an asset allocation model. He’s going to think about efficient frontier and how do I increase it? That portfolio of stocks and bonds is not really helping each other very much. What can I add that would have given me a smoother ride?

So the asset allocator of 2030 is going to look at the 2020s, I think, because I think the correlations will stay positive, I think it’s normal, and think that I really wish I’d had this managed futures strategy, this trend strategy back in 2022, 2023 because you know, it didn’t just work in 2022, it worked again in 2025. It worked again here, and statistically, it raises efficient frontier.

So, the messaging then, is that managed futures anchors the third leg of the stool. Now you have stability, and again, that you don’t have without it. I know it’s a very simple, pithy metaphor. But that’s the way we get the 99.9% of people who are not invested in the space to be able to visualize the experience of owning the strategy without having to revert to Sharpe ratios, drawdown stats and other things like that. We have to help them give what their clients want, which is they want to retire with as much money as possible, with as little noise between here and there. And if stocks and bonds start moving in tandem, or continue to move in tandem, those people are wrapped or stuck on a scary rollercoaster, and we can try to get them something better.

So going back to people, it’s just dawning on people that it’s probably not going to change. What do you do if you’re that asset allocator? You like how you’ve been building your portfolios, and it’s very hard to say we think the world has changed. So that’s where, when I talk to people about it, they’re like, “poof!” And make all the way up to a 5% allocation in manage futures, “I’m really going to load up. Back up the truck and go to 5% allocation.”

You’ll see standard allocations could go to 10%, 15%. But what we need, as a space, is a better narrative. With managed futures, I waste so much time and try to explain to people what managed futures means, and futures contracts sound scary. They sound like they’re going to blow up on you. The SocGen CTA index has a max drawdown of 14% since 2000, using using monthly data. That’s not risky. But people think it’s risky.

Going back to the point about how people try to establish a competitive advantage in the space by differentiating themselves from the next guy, those are very, very technical distinctions. Again, a guy at a wealth manager who buys your fund is not going to take comfort in the fact that, don’t worry, those intraday trading things that were introduced here, or this thing that was introduced there, or these these things that were introduced there, they’re not working now, but don’t worry, Bob (as you’re sitting on the golf course with them), they’re going to come back.

We went from CTAs, which was weird and arcane, to manage futures to trend following and trend following gets us closer, the problem is trend following can be really bad. In trend following we are not only identifying the good trends, 52% of the time we’re identifying other trends. So, every asset class that becomes institutionalized, has a term associated with it. That’s so compelling. We don’t say, Oh, what are you buying?” “I’m investing in high yield and high default bonds,” or “Oh, I’m buying quality stocks that are actually overpriced right now,” “I’m buying value stocks that are the worst companies in the world that I’m pretty sure I’m buying too cheaply.” We don’t do, say, leveraged buyouts, we do private equity. So, I haven’t come up with it yet but we’ve got to convince asset allocators that they need this in their portfolio in the next 10 years, and that’s going to be, what most people in this industry would consider to be, a mind numbing process.

00:54:31 Niels

As long as your narrative doesn’t say, well, we buy stuff that has already gone up in price, or that we sell stuff that has already fallen, I think we should be okay but that’s actually what we do. That’s another story for another day.

One point of clarification, actually, before we go to the last point, which I’m very interested in hearing. You said earlier in the conversation, you said in Q1 you struggled and you looked at things, but actually I didn’t pick up on that, did you find anything? Did you make any changes to the way you do replication?

00:55:06 Andrew

No, and it’s really hard not to. I’ve got to tell you, when you’re in the middle of it, God, you want to add factors. God, you want to change things. It is so hard. We haven’t changed the model since we started in 2016, in this particular strategy, and in 2015 with the other one. That is just based on an idea that, we’re not going to anticipate some change that’s going to take place.

We’re going to have to really see it play out for some period of time, and then we’re going to have to verify it in two ways. We’re going to have to really believe, in a way that we can prove because of the past. We’re going to have to really believe that the world has changed in some fashion, and then we’re going to have to see you guys doing it.

So if, let’s say, crypto becomes… Two years ago, everyone was saying, “Why aren’t you using crypto, Bitcoin in your model? What we were saying is, “Because they’re not.” People might dabble in it here and there to see, but nobody is loading up – backing up the truck to trade crypto. Then, as the correlations with crypto got very positive, we said, “Alright, then then you’re kind of back into this clusters idea.”

What we would have to see, if we’re going to do something like that, we’d have to meet the criteria that what it is really different from the stuff that we can get liquid, because I’m guessing that Bitcoin future will not be nearly as liquid as the stuff that we’re currently trading. Then, we’d have to see that you guys have decided; you and Katie, and Harold, and all these other people have said, “We’re going to bet the farm that this is where we’re going to be generating,” and then we’ll do it. So, we could miss a period of time. If you guys see it, and you guys get into it, and it’s a great trade for six months, but it won’t be five years. There’ll be some period of time then we’ll do it.

00:56:53 Niels

Yeah. Cool.

All right. The final point that you wrote, well, actually you wrote some more, but I think one point I wanted to get in before we close up today is your thoughts on where the next train wreck as you so bluntly, put it, in hedge fund land will appear. And I’m curious about this myself, frankly. So, talk a little bit about that.

00:57:20 Andrew

So my definition, trainwreck is a bit of an exaggeration, but I thought it would get your attention which it did. I think that I’ve always been fascinated with this industry. I love when I see everyone rushing to one side of the boat, and then they go rushing to the other side of the boat. Even recently, the funds in the 2010s, that could do no wrong with the tiger cubs, they got slaughtered. Some of them are down 50% last year, and they’re “Oh, it’s a big recovery,” and they’re up 20%. I’m sorry, you’re still down 40% year over year. What happens is when a strategy that everybody thinks is a ‘can’t lose strategy’ starts to do badly, they just stop talking about it. It gets really quiet because the only people who want to talk to it are journalists, but allocators don’t want to talk about it. The fund managers don’t want to talk about it. So that was kind of last year’s news.

Everyone is obsessed with multi strategy hedge funds today. And they have been magicians. Who would have thought, in early 2020, that you would have a series of multi DECA billion funds out there leveraged 5 times, 10 times, or something, that would skate through COVID, the recovery, inflation, etc. and bang out returns. They’re like 12% CDs. I mean, they’re like hippopotamuses doing pirouettes in ice skates on the bow of a ship in a hurricane. You can’t believe they’re pulling this off.

So a lot of people have been expecting them to blow up. I don’t expect them to blow up for the following reason. We are in the 25th anniversary of long term capital. If you or Ken Griffin, or Izzy Englander, or any of the guys who run these firms, you have hired the very, very best risk managers in the world to try to understand everything that could possibly go wrong. And so I doubt they’ll blow up in the way that people are kind if expecting.

On the other hand, they could be dead money. Every other strategy that we look at that was highly leveraged, it was terrible for CTAs when interest rates were zero, but if you were a massive borrower; if CTAs were just we’re just using futures contracts to go long everything, and therefore the interest rate was kind of implicit and it would have been great, but unfortunately we go long and short. So, our long position is cash which wasn’t doing it.

Now, think about it, you’ve been leverage 5 to 1, and your borrowing costs have gone up 400 basis points. Your real borrowing costs have gone from negative 200 basis points, 150 basis points, to positive. That’s going to be a problem for private equity, leverage companies, real estate. If you were leveraged and long in the 2010s (even in indirect ways, like disruptive tech stocks and things where they were pushing money into it), you would look like a genius. So what makes these guys different?

Now, at the same time, there are the two other industry dynamics that have been happening. So one is that they managed double the assets they’ve managed four or five years ago. The way that they manage more assets is that they have a lot of strategies that are somewhat capacity constrained. So you need lots and lots of teams to do it. But the insanity is that they don’t pay their guys, you do, as the investor. They cycled a pass through.

So they say, “This is a great team. We want to bring them in,” and they can offer $100 million signing bonus that they don’t pay a penny of, their clients do. They just add it to the list of all the other expenses. They’re offices, they’re this or that, they’re planes, everything else. All of that goes into their expenses, and they just pass it along. So, when have we ever seen something where people do not bear the costs of things that they are going out and buying where people have been overpaid?

So there’s increase in asset growth, a rapid increase in the expense side of it, and then your funding costs just went up a lot. And, by the way, just from a comparative perspective, they used to be compared to zero, and anything looks great relative to zero. Instead, they’re now being compared to 5%.

So, what I think is going to happen (most likely). Oh, and by the way, when you invest with a hedge fund, you want them to be a rapacious capitalist. You don’t want to invest in altruistic hedge funds, you want them to wake up thinking about how do they grab more money out of that guy’s chest. So, as these guys were lined up around the block, they basically said, “I’m sorry, we’re closing the doors unless you tie up your money for five years.” So hundreds of billions of dollars of capital cannot go anywhere for the next five years.

I think, when we look back in five years, there will be some guys who will knock the lights out, there’ll be some guys who will disappoint. But I think, on average, you could see a situation where the guys who were the best and brightest of 2023 underperform cash, or come close to it. The reason I think it matters to us is that it’s the one strategy out there where you can say, definitively, if you’re an institutional investor at zero correlation, and yet it’s this alpha generation machine; it’s this 2 Sharpe ratio kind of monster that you have.

If I’m an institutional allocator in 2021, and I can do that, or I can do CTAs, CTAs are a headache for me. It’s too volatile, it’s too transparent. It’s liquid, and if it’s liquid, it means somebody’s wondering whether I’m making the right decision on when we get out or not.

But, five years from now, if we’re earning 5%, on the cash and making something on top of it, and maybe the liquidity starts to look good, maybe the 3% that you’ve been in that in that multi-strat hedge fund, when they’re getting paid 10% in fees, and your board has asked you why you tied up money in 2023, and (going back to the point you made earlier) your stocks and bonds are correlated, which means your private equity and your private credit and everything else is correlated, what’s the obvious solution? That’s where I think you’ll get a lot of people who, historically, have not bothered in this space because of the difficulty of explaining it. That’s when I think you get the kind of the real expansion of AUMs.

Now, if f we have terrible two years, that’s all lost. Anyway, I just think it’s interesting. These things come in waves that I think we’re very well positioned for it.

01:04:03 Niels

I think it’s interesting, I think you bring up some very interesting points, I have no inside view on how they do with their expenses. But I did read a Bloomberg article this week saying that some of these firms will pay their interns $19,000 a month, fly them business class, and I can’t remember what else they mentioned, but it sounded pretty good to me. So if you’re about that age, where you’re looking for internships, I would look up the list of multi-strategy funds before we do anything else,

01:04:38 Andrew

You know, people suspend disbelief when they want to believe it. The great lesson of Madoff, and this is nothing like Madoff. These are some of the greatest money makers who’ve ever lived. But thing about Madoff is that the people who bought Madoff, it was obvious there was something wrong with Madoff, but the people who ended up buying into it, they didn’t want to ask the question because you kind of know what the answer is going to be. The answer is going to be that you’re not going to get a really satisfying response.

But it was hard. It was hard to say no to him because if you’ve been skeptical of Madoff in 2004, you saw firms growing up around it, and enabling it and kept it going on. They kept making money, and they looked better, and their returns were better. What happens with these bubbles is that the early cynics, who will be right five years later, they get run over and they get marginalized, and the people who buy into it – it’s not just the fund selling themselves, it’s the allocators taking credit for what the fund is doing.

I wrote something recently on this whole phenomenon of these global hubs of return funds, where there’s this thing called Standard Life GARs, which is promising, basically, cash plus five with with a low standard deviation. I call it the Voldemort of the asset management business because, when I first started coming to Europe, for this USITS fund, a USITS fund I ran called SCI, everyone talked about this. It’s was like, “Well, this is a no brainer, it’s a no brainer, it’s a no brainer.” At the time, it’s abundantly outside $90 billion in assets. It was bigger than Bridgewater. This global, multi-asset fund was bigger than any hedge fund in the world at the time, but it was liquid at a low fee, and people were selling it.

It has been dead money since then. It has actually gone down, I forget the numbers, down since 2015, 2016. The thing is nobody talks about it anymore. Because who wants to talk about that they bet the farm on this thing that didn’t do well? At first, they’ll defend it, because that’s what we do. At first it’s, “It’s just a weird market environment, it’s going to come back, it’s going come back,” because it’s much harder to admit the decision was delusional in the first place. Cash plus five, is really hard to do. Cash plus five, overtime, is equity like returns, but when you’re saying I can do that with ⅕ the risk of the equity markets, the beta of the equity markets, that’s the Holy Grail, and you’re offering it in a liquid form.

So, when people want to believe it, they’ll believe. What I would like to do, at some point, is be at the point with managed futures where we’re demonstrating the benefits, where people want to believe it, and they accept it. The problem, I think, with the language of the space, is that it’s so embedded with with technical stuff, and futures contract.

I was talking to one of our competitors in the US, and they were saying “How do you tell people why managed futures should make money?” They went into this long story about price taking, and commercial hedging and other things like that. I said, “I’m the guy who comes up with a stool, or talks about a stool analogy.” Once you started to talk to the average allocator about a futures contract and what you’re buying and selling, it’s very hard to get yourself out of that hole.

So, we get the narrative, right, the markets cooperate, stocks, and bonds… And by the way, all those allocators who are looking at substitutes for their multi-strategy allocations in five years, they’re buying you not us. They are, they are, they are buying you, Man, AHL Pimco, you know, Transtrend, it is going to be a bonanza for you guys because they are set up to buy a bunch of single funds to get exposure. It’s what they want.

01:08:25 Niels

Now, if you’re right about that, then I think the real challenge will be on us as an industry, because then it’s up to us to make sure that we don’t overstep our capacity. I think that’s a real risk. Of course, I don’t have any idea if, suddenly, what we do will be so popular that we were going to see, you know, hundreds of billions of dollars moving into the space. But in any event, I think that is a challenge for our industry.

I think some of the strategies that we’ve seen both on the trend following side, which is a bigger amount you need to get to before you get to capacity. Certainly, in the shorter term space, I think some of the funds out there, that have maybe seen their performance come down, I think a lot of it has to do with capacity, not so much that the strategy has kind of stopped working. But anyways…

01:09:26 Andrew

But we’re going have what we always have. You mentioned, “Has it gotten more different?” It will always be different. There will be the esoteric product funds out there, that’ll be launched. There will be the core trend followers who are doing what they’re doing. There will be people who come up with a new thing. If short term trend, in three years, still isn’t working there won’t be short term trend funds, they’ll have they’ll have become something else; they will have found something new.

I mean, the business is built around product creation, based upon the changes in the world and then also marketing around what those changes are. I think the core trend following driver of returns, I don’t think it’s capacity issues for a long time. Do you think we couldn’t have made 20% last year with twice the assets?

01:10:13 Niels

No, first of all, I think there’s a lot more assets, in trend following, than what we see. So, I agree that there is definitely a lot of capacity out there. But on the other hand, I will also say that I think that they, when I look at managers that have come and gone over the years, I think some of that has to do with them just being becoming too big. What I don’t really understand is, you know, let’s say you’re fortunate enough to get to $5, $6, $7 billion, as a trend follower, even if you think you can get to $15, why not just make sure that you what you do at $5 or $6 billion, works really well, because then you shouldn’t really have to worry about much more in life.

01:10:56 Andrew

That’s rare. I mean, most people let it ride.

01:10:58 Niels

Well, this is the thing, just as we say that trend following works because of human behavior, and emotions, and fear, and greed ,and all that, I mean, I kind of see the same thing within the industry, so to speak. There’s definitely some greed here and there. I don’t want to pick on any specific firm. but you did talk about, earlier today, one particular firm that kind of had meteoric asset raising, you know, capabilities in a very short space of time. I don’t think that’s healthy for any firm to experience that kind of asset growth. So I’m kind of glad to be working for a 49 year old overnight success story.

01:11:45 Andrew

I think there are these people trying to come up with these big broad generalizations. “Oh, there’s replication, therefore, people aren’t going to invest in actual funds.” I’m sorry, it’s more fun to invest in actual funds. People who go into the fund selection business like to select funds. They are not going away. People who are consulting firms who are telling their clients that they’re going to find actual hedge funds are still going to invest in actual hedge funds.

ETFs have been around for years, index products have been around for 30 years, and they’re a fraction of the active management space and the mutual fund space. Because people are human, and there are advisors out there who, this isn’t a cold exercise for them. They want to tell their clients something that excites their clients that they’re excited about. Look, we have a competitor in the US. It’s totally rational, I think they’ve marketed their success around flipping heads a couple of times.

01:12:41 Niels

When you say flipping heads what do you mean by that?

01:12:43 Andrew

Luck going in your direction. So, their model was configured to be up a bit more than everybody else in March 2020, they had a very good 2021, and then they had a bad 2022 and everything went bad this year, but they but they had meteoric asset growth. That asset growth was not a cold, rational decision. It’s an incredible firm, with a huge presence, with many, many great products.

So if I’m an allocator, and you come to me with that fund, that’s done well, and I can see that as a complement to other things that I have. It’s totally rational and reasonable for me to do it with you. You’re the sales guy, you’re a human being, I’ve known you for 10 years, I love you when you come because I’m invested in your other products, and they’re great. The business is built around that.

So, diversity of products is very much about finding the products that fit for the right audience. The people who buy what we do, in general, I think in five years will have very little overlap with the people who are buying it. I think we’re going to find people who are coming into the space, who are investing with us, who’ve never invested with a space before, because they look at me and see somebody who kind of is like them except I’m asking questions and I work with quants who a run an analysis.

01:14:05 Niels

Well, we should never forget that people do business with people. So that’s a whole other can of worms we can talk about which would be fun one day to talk about those kinds of things as well. The softer side of what we do.

Andrew, this has been wonderful. I always enjoy our conversations we don’t always see eye to eye on things and I love the fact that you allow me to probe into your views and thoughts and actually think there’s so much good stuff there. At the end of the day, there’s room for everyone and I think both of us, we try to promote the good stuff that these strategies have.

01:14:19 Andrew

Grow the pie.

01:14:05 Niels

Exactly. We want to grow the pie.

Andrew, thank you so much for today. If you, the listener, enjoy these conversation, head over to iTunes, Spotify, Amazon Podcast, wherever you listen to podcasts, please leave a rating and review, it does help the podcast and more people to discover it. Next week as I mentioned, I’m joined by Nick Baltas, from Goldman Sachs. So, that’s always going to be an academic expedition into the world of systematic strategies. If you have any questions for Nick, you can email them to info@toptradersunplugged.com and I’ll do my best to make sure we get an answer for you.

From Andrew and me, thanks ever so much for listening. We look forward to being back with you next week. And in the meantime, as usual, take care of yourself and take care of each other.

01:15:39 Ending

Thanks for listening to the Systematic Investor podcast series. If you enjoyed 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.

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.