48 How to Understand a New Manager's Track Record with Bastian Bolesta of Deep Field Capital - 2of2

Bastian

… downside volatility in excess of 10% in a 1X version. If there’s something that is a highly profitable combination, but it does not meet this risk criteria it cannot be part of the portfolio. So the little guy can jump as high as he wants and say, “pick me, pick me,” if he… he might be highly profitable, but if he in combination with the others already being picked is causing a risk incident, he will not be picked. It’s a really sad thing for him because by himself he is really profitable, so he probably will not understand not being picked, but the allocation process is framed by these risk criteria and it cannot be guided by just profitability.

Niels

Sure, sure, I’m glad it’s all done from an electronic point of view otherwise there’d be a lot of disappointed fellows in your office every month.

Bastian

That’s correct, if they’re standing in line waiting to be picked, that would be a really sad picture because the majority of them are actually not picked, so they all have to go back home. One has to say they have a new chance next month. This goes for the strategy elements and this is, as I said earlier; it’s a two-step process, and in the first step markets are selected. I just the other day, I explained it to an investor how the market selection process actually works and I said, well, imagine all markets – we currently have 23 potentially tradable markets (and maybe a short detour here). We always first test everything with our own assets.

So we put principle assets at risk before actually putting client’s assets at risk. So the 23 markets, they are basically a result of us from time to time adding an additional market, testing if the market is generally tradable in terms of is liquidity sufficient; how is the market pattern; are there market makers which are behaving in a certain way, and so we can basically decide if the market is potentially tradable or not. Then it could theoretically be introduced to the process for the investors as well. Currently, we are trading 23, and you can look it up in our materials. They are only the big ones across all asset classes: the S&P 500, Euro stocks, the bond Indices, really highly liquid markets.

So when I explain the market selection process to the investor I said, basically, “think about all markets gathering at a bus stop, and the bus that they are all waiting for takes them to the portfolio selection process, where the little fellows are basically selected.” You can say every single market has a backpack with all his little strategy element fellows in there, and they’re all quite excited that now they have waited for one month and maybe this time it’s there chance to be picked. So the unfortunate thing for them is there are not enough seats on the bus for all these markets with all their backpacks and little fellows in there, They basically have to compete for a seat on the bus, and the number of seats is determined by the overall market environment we are currently in, and the characteristics of the individual markets in relation to each other. Unfortunate for the markets and the fellows, even when you have done much better in terms of our criteria in comparison to the months before, it might be that it’s just not enough because the others are probably also better, then you might not be picked again. So it’s also again a really disappointing perspective from these markets. So the bus is coming, and the idea is to de-select highly loss making markets. I can go into that in a second, so probably finish the bus story first.

So the bus is slowly filled and some of them are still standing there and they become aware that this time is not their time, and they put all their hope on the next months looking forward  that the months will be really profitable and really interesting for them, and that their characteristics are improving in relation… particularly in relation to the other markets. Then the bus is leaving. Very often we get the question, “well, does this process determine the waiting for the second process?” You can best explain this by, if you’re the first guy to enter the bus because you are just a hot shot, and you can pick the seat you like most, for example just behind the driver where you have the best view. I have to disappoint you as well because this does not mean that you actually get the most strategies elements selected in the second process. The bus only takes you to the process. It doesn’t really matter if you were number one, number five, number ten; it does not really matter. All markets are equal in the same process because the strategy elements and variations are selected based on this risk criteria. So even when you are the hot shot in the first process, it doesn’t help you in the second. You might end up being selected last the smallest number of strategy elements.

Niels

Sure, now I have a question about your bus story and that is, when they’re all lined up by the bus stop, and you have to determine which ones to pick and allow on the bus, is that done… it has to be done in some way, and the only way I can think of is that you would have to look at all the possible strategy elements for each market and see what’s the overall profitability, but it may not be done that way. How do you determine which markets are the best or the most profitable in broad speak? I’m not asking for any secrets here.

Bastian

You’re actually really close, you’re really close, and you pretty much described how it actually is. The profitability of every single strategy element back in the backpack of this market waiting for the bus is actually one major characteristic where this particular market has to be better in relation to the others. As I said earlier in the strategy element selection process, in the second part, the risk criteria come into play where a combination of strategies has to meet, for example, a downside volatility target, and the profitability is not the determining factor.

Niels

How do you determine how many seats are on the bus every month?

Bastian

That’s based on, as I said earlier, on different aspects: the overall market conditions in terms of volatility in these markets because generally speaking we like volatility, but it’s a dangerous statement. We can talk about that later because there are different kinds of volatility. That’s something we had to learn as we were in exchanges with our investors where people said, well, this volatility and this and that… yeah, but not really directional volatility but let’s go there later. Yeah, volatility, for example, profitability; and assets under management is one additional aspect. Generally if you have more assets you have potentially also more seats, but this is not a major driver.

Niels

OK, I want to… unless there’s more things you want to add about the actual trading program from an overall point of view, I have just one question on the trade implementation and then I want to move on to something I think, again which is very important. But just on, probably, more the selection process, and that is, how long do these small fellows have to wait by the bus stop for you to go through the whole process of selecting from this universe which is three-dimensional, thousands of combinations, how long does it actually take for you guys to do that every single month?

Bastian

Very good question. In the early days, so in 2010, the calculations in some cases took more than a week. Which is really a critical impasse, because if, for whatever reasons, your computers stopped calculating, because then we still hosted our own servers, you were… you could end up in big trouble because you just don’t have enough time for the allocations. This was still our own money. We hadn’t had any external assets.

So the next thing, once we started to accept external assets and actually were somehow limited to the month’s allocation because we had to be ready once new assets were coming in because we had this fund. In a managed account you can probably tell an investor, “let’s not do the allocation on Monday, we need two more days.” Fortunately, that hasn’t happened, but there you do have more flexibility. But if you have a fund you have to do the reallocation. So first thing we did is we took a lot of money and a lot of time and effort and bought additional servers – more, and more, and more. This was first a good idea, but secondly somebody has to take care of these servers. Once you’ve bought them a couple of weeks later you get more computing power much cheaper already. So we somehow already knew, while the experience of actually doing that is quite interesting, we had to go a different way.

So now-a-days, we are basically using cloud computing. We heavily rely on cloud computing of one of the largest service providers there. For the allocation process… not the allocation process it is actually quite fast now already, but if we do long terms of calculations where we test all kinds of different angles, we build up the universe and do all kinds of testing in a different part of the universe, we sometimes have 40 servers,  with 50 cores, or 60 cores. I’m not really a computer guy, but it sounds like a lot of computers and a lot of cores and a lot of calculations and it only takes a couple of hours now a days. It is much cheaper as well, so that’s a big learning as well. I refer to it earlier, do not necessarily try to do everything in house. If you’re good in developing trading ideas and you need computers in order to verify what you’re doing there and test everything from different angles do not think that you have to have a server park as well. This is not just not your business. Your business is to develop these ideas and test them and let the server park be taken care of by people that actually know how to run servers. This is what we do now-a-days and it only takes a couple of hours to build up the portfolio.

Niels

Is there a minimum number of markets that you have to have every month and a maximum number of markets that you have to have?

Bastian

The minimum is six markets. Theoretically there is no maximum, but the trading universe has up to twenty-three. You generally see six to twelve, six to fourteen markets because they have to compete based on these different criteria. Even when all of them are profitable, and all of them are really good, naturally the first ten, they are better than the other half. You can, for diversification, in terms of cross-market diversification, you can add additional markets, but you’re always taking away potential trading capacity on the other markets. It’s a thin line in order not to curve fit into a really small number of trading opportunities and a small number of markets, but at the same time why should you go for third best choice, fourth best choice, fifth best choice. That’s something which is driving the process.

Niels

So it’s not like in football where there’s only room for eleven players, and you could have a few more, if so. Let’s jump to something that I think is really important, and I think is a great topic to talk about, and that’s risk management. I think risk management when it comes to a product like yours, is probably even more fascinating with everything that goes on inside. First of all I wanted to ask you how you view risk and what you mean by risk when you talk about it, but I also, so I don’t forget, also wanted to ask you… let me put it this way. I assume that each market that does get a selection obviously doesn’t have the same risk exposure because the risk exposure comes from the number of strategy elements, or the number of fellows that are allowed to play for the month within that market, is that correctly understood?

Bastian

Yeah, that’s correct. They’re two drivers. It’s the number of strategy elements, but there’s actually one before that as well. If you take a strategy element in silver for example, and exactly the same the same strategy element in Euro stocks in terms of what kind of trend following strategy am I using, what kind of trading parameters am I using, second, level and third level, what kind of risk parameters – the same strategy elements from two different markets. The silver strategy element naturally has higher risk because one silver contract has a larger nominal value in comparison to the Euro stocks, and silver is more volatile as well. So if you take these two guys and they compete against each other, actually silver has more risk right from the beginning, so if you build up your portfolio, because you cannot just say, “let’s take one silver, one Euro Stocks and we’re all even and equal.” These aspects have to be incorporated in your portfolio location process.

Niels

Absolutely, anyway, back to my first question. What is risk to you? How do you view risk in your program?

Bastian

I already hinted at it when talking about the allocation process. One dominant risk framework, a part of the risk framework is downside volatility. So the allocation process is a certain optimization, one could argue, because of course we would not select in the portfolio and trade in the portfolio that which is just not making any money at all, so the profitability is certainly part of it, but it’s dominated by the risk aspect. Here in that particular case it’s not just volatility but it’s downside volatility. Because the way Singularity works, and actually a lot of managed futures work in terms of risk-return profile, you have a larger number of small losses throughout the trading months and you have a smaller but more attractive number of days where you have high, high profit.

So if you actually just go down the volatility risk perspective, that actually means you punish yourself for the upside risk because it’s somehow influences the allocation process and the way you perceive risk. But we are actually focusing on the downside volatility because we love to see the upside volatility. That’s perfectly fine, but we focus all of our efforts on the downside volatility in order to limit drawdowns. This is probably the major, major aspect of how we look at risk. It’s also reflected in our marketing material or our fact sheets or our presentation. You generally always have the question, “what is your sector allocation, what percentage do you invest in fixed income, or in equities?” We approached it from the perspective that it does not make sense to add up all the nominal values of our strategy elements in a particular market and say, “add this up and divide it by the total.” Let’s say fixed income currently has 24% or current equity is 24% that’s not how it works.

We look at it as risk contribution. Going back to the allocation process, when you take one strategy element and you take an additional strategy element you test if there has been a risk incident and if they’re profitable and when they’re confirmed you take the next one. You always look at how much do these two guys, three guys, four little fellow, five little fellows actually contribute to your overall risk budget? Every single asset in a portfolio have a certain risk budget when you look from the risk perspective. When all of the risk budget is basically used by the allocation process, then it stops and the allocation is ready, and you have the one thousand five hundred whatever selected strategy elements. That actually means that every single strategy element has a contribution towards your downside volatility budget, so to say. Our pie charts, where we say that we currently have 24% in equity and 28% fixed income and so on, this actually refers to the risk contribution of all these fixed income strategy elements which are equity elements to the risk objective of downside volatility 10%/risk budget available.

Niels

A quick question for you here Bastian, and maybe this is sort of a very naive question, but if there is, just to say, 10 markets, 150 fellows in each market trading for the month of November, could they all go long in their respective markets, or is there some kind of limit where…?

Bastian

And we all have a very sleepless night? (laugh)

Niels

Or a very good night, you know.

Bastian

Yeah, a very good night. It’s a very theoretical question. Theoretically you could have such a situation. That would be absolutely the worst, worst, worst case in terms of if all these positions were actually wrong in terms of what is actually happening on the next day in terms of overnight gap and something like that.

Niels

What I was getting at here was more to understand whether if your system sees that if all fifteen hundred guys go long, that you have some other mechanism that comes in and says, well actually once the first seven hundred and fifty have gone long you have a cap saying well, then we have to wait for some of them to get out again before we allow a new one in. But I did understand it as they’re operating independently, so I guess your answer is theoretically they could all go long, but it doesn’t happen.

Bastian

Based on the strategy element, there is no panic button, basically where it’s put in sleep mode. This little guy gets seduced and doesn’t know what’s happening, wakes up with a headache and just missed his trading opportunity. What you’re referring to is taking place during the allocation process. Because if there are developments in the market environment across all the ten markets currently allocated, which actually would force a currently selected strategy elements to all go along. Generally there should have been something like that in the past. Of course, the future is always slightly different to what’s actually happened in the past, but there are connections. Let’s say, in your case now it actually all goes long, then we probably should have seen something like 90% or 80% all go long in the past. Maybe not as extreme as now, but some kind of indication. The allocation process would have picked that up and actually defined that as something probably quite risky, particularly if you have movements on the next day which are not beneficial for larger parts of your positions. That would have caused a risk incident.

So it is unlikely, if not to say impossible that you actually have selected all these strategy elements which actually would result in an allocation that all of these are long. What you generally see… there’s one characteristic of a strategy element, if you go back to level number two, of the strategy elements: timeframes for example (e.g.trading parameters). That actually means that you have strategy elements which are highly reactive on the short term side, and you have some which are really slowly reacting to new market environments to add some numbers here. Highly reactive means just holding a position for an hour, in our case, and really slow means up to, currently we have two and half years. We have some strategy elements in the S&P, which have this two and a half year horizon. This actually means there’s a diversification in terms of reactivity as well.

Naturally, of course, when you have one hundred fifty strategy elements in the Euro stocks, you will see some of them being long the entire time. If you take October, for example, October has been a really good month for us – the perfect market scenario. I think one of the other managers wrote in their newsletter, “it was a perfect storm,” and in that case it was leading to a really high drawdown, and I said yeah, it was a perfect storm and we had a sailboat and we reversed there faster than ever. It was actually the best month in the history of the fund, but not in the history of the program, but we were up 7.5% or 7.75% or something like that. How did that happen?

If you look at the equity strategy elements for example, in the S&P 500 there’s a larger portion of them that are in the long-term space, so to speak, and they were long the entire months, that actually meant that when the equity markets dived, I think it was October 15th when they had the deepest point, they lost pretty much 10% from mid September to mid October, these little fellows were quite sad because they actually had a loss and they could not do anything about it because nothing was triggered because they’re so slow and so long term, while this was actually a substantial loss for people looking at the chart when following the S&P, for them it was a loss they could not do anything about because no counter signal was triggered based on their setting. If you look at the midterm and the short term strategy elements they were actually quite active at that time. The short terms actually were able to make money in the downwards movement and in the upwards movement. The same goes for parts of the midterm strategy elements as well.

If you look at the positioning that can be quite interesting because you have some elements actually going short, and some of them also taking profit, for example. So if you look at the end of the day and say well, the S&P just dived X%, why do we still have an over or long position? Because the long-term strategy elements are still long position and the midterm strategy elements are still long positions, though maybe slightly reduced, and the counterbalancing short term ones, which might have reduced the overall net position a couple of days earlier, when you looked at the overnight positions, some of them have taken profit or something like that, or they are not part of the overnight allocation and so the resulting net position might be reduced, but still be long despite the equity market diving. That’s a really important aspect that basically the net position in every single market, of course, is the net position of these individual behaviors of these little fellows. Your question is consequently highly theoretical.

Niels

No, absolutely, just out of curiosity are there any of these markets in your portfolio, and I’m sure there is? Are there any of these markets the fellows prefer to play in, or actually do better in over time?

Bastian

You mean in terms of these top markets?

Niels

I mean that trend followers in general we know, for example that interest rates have been a particular good market sector for these kinds of strategies over time, but since you’re putting a new team out every month, I was just wondering whether you’d found that there are certain markets that are more consistent and better performing in general in the long run?

Bastian

Interest rates are certainly an interesting market spectrum, and they are among the top, top performers throughout the entire time. Precious metals are quite interesting as well. Naturally, in the last eighteen months equities have become more interesting, but lost parts of it, if you for example go and look at the NASDAQ for example, or the Russel, this has lost attractiveness certainly, but the S&P still has a valid position there. This is a very dangerous occurrence when describing Singularity because very often in the early days when investors said where to you make market? You probably make market in fixed income, right? And we said yeah; the bond is a very profitable market for us here. Well, I don’t need something like that. I already have that in the portfolio because all the trend followers make money there. Then I said, well, but let’s look at May 2013, he said yeah; that was a devastating month. It was actually the worst month in terms of fixed income. All my trend followers in my portfolio lost heavily on the fixed income side and dominated the entire P&L for the entire year. Then I could say, yeah, and we actually made unbelievable amounts of money in fixed income in May and it actually made fixed income the most profitable sector for that particular year, and was driven by May. When I’m referring to fixed income being a very attractive market, one probably has to be very careful why this is an attractive market. In general, you would most likely see that Singularity makes his profits and his losses at different times compared to the classical trend followers.

Niels

Let’s jump to something which is related to risk management which is drawdowns. I wanted to ask you, given all these computations that you do, given all your research, what kinds of drawdowns do you in your own mind expect a strategy like yourself to exhibit from time to time? I know whatever number you say now or range, obviously it may be completely different if we come back and talk about this ten years from now, but I’m just trying to get a feel for how this works and how maybe your drawdown/risk profile might look different to a more classical product where you don’t see this bus coming by every month to pick up markets and fellows.

Bastian

(laugh) Drawdown is a very good thing. Of course, we’ve had our largest drawdown already… no, of course not, the biggest drawdown is always ahead of you. Rule number one for sure. The fortunate thing about the risk-return profile of Singularity, but also a painful aspect of it, that we see that our drawdowns buildup over time. We learned from some US investors who refer to it as “you bleed out”, so you bleed out over time. If you look at the drawdown, for example of Autumn last year, until recently. We are currently in the recovery there. What were the driving factors for that particular drawdown? We were quite lucky that we could communicate quite straightforward already in Autumn what was actually happening and that the driving factors for this drawdown actually remains the same throughout the entire period.

If you think about the highly reactive profile of the program that actually naturally means that Singularity doesn’t like choppiness; that sideways moving markets are a difficult environment, but sideways moving does not necessarily mean sideward moving. So if you have larger strings, even in sideways moving markets, a larger part of the strategy elements can still make profits there. It becomes really tricky when the narrow ranges get narrower and narrower. If you, for example, take, let’s take oil. Oil has been trading in a sideways movement since 2011 more or less. You still had big swings in 2011, and in particular 2012 where you had a big downside movement to the middle of 2012 and then an big upward movement as well. There, your long and midterms can still make some money.

If you look at the more recent past, since mid 2013 until more recently, mid 2014, the movements became smaller and smaller and narrower, and this narrow range is really difficult for Singularity because it starts making more and more losses and we refer to that as there are a lot of “fake outs” where the system and these good little fellows believe something is happening and there’s a directionality they can actually take advantage of. They jump on that directionality and then they just realize, “oh no! It’s changing direction!” Then they get off this directionality and maybe it’s coming back again, particularly when you look at it on an intraday basis. So this choppiness, and on top of it the interventional aspect where we saw a lot of uncertainty around the government shutdown in Autumn last year in the US, and comments from Drahgi which shortly pushed some movement into the market, but which turned out to disappear quite fast again. This is a really difficult environment, and that’s where we start to build up a drawdown over time. You have an increasing number of losses which build up the drawdown, so you bleed out over time.

This can be a really difficult period. Historically we know that something like that ends at a certain point. Why it has been quite difficult for us in that particular drawdown because it was quite long, in historic terms. In our live trading as well as in our data, we haven’t seen something like that in terms of length and particularly markets involved because you saw more and more markets actually falling into sideways pattern, with the exception of the ever-rising equity markets. But you cannot just trade equities, or you could but that’s not how we do it. It got narrower and narrower, and this has never been the case for our way of trading in our set of data as well. I said earlier that we are looking at a certain minimum liquidity in markets, so we go back to the early 2000s. Something like that hasn’t happened before.

Deep in our understanding of how the program works, and when testing during the drawdown is the program doing what it’s supposed to do, is the drawdown coming from somewhere else? We could always confirm it’s actually doing what it’s supposed to do, and it’s losing money in an environment which is not good for it. But at the same time we did not know how much longer this would actually last. That’s a question we could not answer as well when the investors said, “well, how much longer will this take?” We don’t know the future, guys. We can tell you if this continues we are not a good place to be. If you have a certain understanding about market timing and you think that it will continue for a certain period of time, we would recommend not to be invested with us for a certain period of time.

That’s where I can refer back to what we discussed earlier about different types of investors. Investor number one, chasing performance, these investors they will come to a point where they will actually redeem during that drawdown because the driver for them to invest was performance, you’re not performing anymore. They’re scared that this will continue, so they basically leave. Then you have a second type of investor. We here, internally we refer to them as silverbacks, like the gorillas – silverbacks they have seen so much. They have developed an understanding of how the program works and we actually had one of these silverbacks as a very interesting investor – it’s a family office and he actually invested in Autumn during a period where it became more difficult.

He exited in January, which was a first disappointing for us, because we said, why doesn’t he stay longer with us, but he actually said straight forward. I like you guys, and it’s really interesting what you’re doing, but I strongly believe it’s not your time. You’re currently in a certain part of the business cycle of your business in terms of how you’re looking at markets and what markets have to offer you, where I believe, based on my experience (that’s where the silverback aspect comes into play) that this will continue for additional X amount of months. I most likely will come back if this changes because I still like what you’re doing and you can play an interesting part in my portfolio, but I don’t have to go down in this drawdown if I have my own experience and believe how the markets most likely will turn out over the next couple of months. If I’m wrong at this point, it’s not so bad. I will miss part of your first evolvement, but I strongly believe in you guys in the long term, so don’t worry about that.

This was helpful to understand that certain investors will try to time you and if they have the skill set and have done well over all these years, that’s why they are silverbacks, it is a perfectly fair point to make. The third type of investor, which we love probably the most, is the guys who take the time to really understand what you’re doing. They incorporate an understanding of how your drawdowns look, bleeding out over time. They make assumptions how long these periods could be. They add an additional margin of safety and say well, that’s how you do, but don’t worry. You have a certain risk-return profile, and you’re a building block in our portfolio. We want you to act exactly in that way. Even in your drawdown we have different managers who actually will perform in such an environment, so that’s why you have to live through that particular drawdown. This is a very interesting type of investor because he will generally stick with you in a drawdown, and you learn a lot. You particularly get a lot of support dealing with a drawdown and the emotional aspects when investors are disappointed that you’re currently not performing.

Niels

It’s interesting. I appreciate the way you describe these kinds of investors, and I think you’ve got some great points about it. To me at least, investor number two who knows your picking fifteen hundred different market model combinations on a monthly basis across twenty-three different markets, I have to wonder how they know exactly that you’re going to go through a good time or bad time. It doesn’t really matter whether they’re right or wrong, but the fact that someone actually believes that they can foresee what’s going to happen in a strategy like that, to me it’s a little bit incredible that they would go with that kind of notion, but anyway, that’s a different discussion. We all have drawdowns. We know that. Is there anything that you’ve learned from the drawdown you went through, is there anything that you’ve said, “yeah, that’s something that we need to take into account, because it’s going to happen again and we want to be approaching it differently,” is there anything?

Bastian

Yeah, certainly there’s a really important aspect which is probably quite interesting for other younger managers as well, or people who are actually thinking about setting up their own asset management business. Looking at our development, basically being traders ourselves, and actually trading the Singularity  program – the first starting point was trading it for ourselves and enabling investors, based on institutional setup, to trade alongside us. It’s probably fair to say there’s a business side of things – these are basically the investors. In dealing with them in good times and bad times, and actually building up a sustainable business as well. If you do something like that you want to have positive development there as well, more assets, stable investor base, and stuff like that, and make some money as well, otherwise you would not just do it for the fun of it. There is a trading side of things.

Whereas we feel very comfortable with the trading side of things, how Singularity is developing throughout the different market environments, even in a drawdown. You can tell this basically when looking at our leverage. We are trading Singularity on a leverage basis throughout most of the time since going live. We trade FOREX and program when we run into deeper drawdowns in particular areas. The lowest we have been trading was 2.5X, but you can tell that there’s quite some conviction… The partners’ capital is traded, we put our own money at risk between 2.5X and 4X and investor’s capital generally has a 1X, not generally, it actually has a 1X in comparison to principle assets. We just recently introduced a 2X in the fund, but I can talk about that later.

So basically the trading side of things has been quite straightforward. We were also surprised about the length and the magnitude in terms of how many markets are at exactly the same sideways pattern, but we were also convinced that this would not last forever. You could also talk to investors. There’s hardly anybody out there who said, as well, the way it currently is it will stay forever. So it’s more a question of how much longer this will last and do we still have money left in the end? You can refer to a roulette table, in gaming you need a chip. If you don’t have any chips that you can put on whatever color or number, you’re out of the game.

So even in trading if you think about chips as money you need some chips left on the table in order to grow your business again. As you can tell even in the deepest drawdown of 2.5X we were very convinced that this will not last forever and we were ready to sit that through and not touch the program and change anything, but actually let it trade the way it is. This does not really work on the same emotional level when actually looking at the business side of things, because when you’re dealing with investors, particularly with these different types of investors we were talking about earlier, there is a lot of pressure, basically, from investors: actively from investors, but also perceived by an asset manager that you feel under pressure, but probably nobody has said something, or they just commented in a certain way. It adds additional aspects when people invested in you because they like you and they don’t even know how the program works because they were not interested or all kinds of different aspects, family money, stuff like that. So if you go through a drawdown, actually before, once you start trading external assets, you have to prepare yourself that there will be a point in time where you go through a drawdown and where you have to manage these emotional aspects as well.

If you look at our development in early 2014, March was a difficult month, and April was a difficult month, so we were in a drawdown where we had a lot of choppiness in the markets. We could always explain what was happening, and we were quite consistent in the narrative and a lot of our investors understood what was happening, but you still feel pressure. When we reached early May, I think it was the second of May, a Friday, non-farming employment data, this was a day with high intra-day volatility. We got chopped out again, particularly on the midterm strategy elements, and this added additional weight on the already accumulated drawdown. If you look at the performance of the program, the program performed 3% in May. Why? May was actually the beginning of the recovery. So if you look at the fund or the beginning of the recovery which continued in August this year and now in October. In the fund, the fund is actually down 2.6% so how could that happen? Actually, in communication with investors in the fund and all the pressure we felt on the business side of things, not on the trading side. We reduced the trading level to 20% in the fund.

It was our own decision. We are the asset managers. We are responsible for it, of course, but in the end it was more an interactive communication between investors and what we felt pressure to do in the particular circumstances and at the same time, if you look at principle assets and we communicated this to investors. We continued to trade these assets at a 2.5X at that particular time. So the reduction took place on May 5 and on Tuesday the recovery started. It was a beautiful recovery and it’s really good in terms of development of the program but it was really unfortunate in terms of timing for fund investors and of course we sat down afterwards and discussed it heavily and if you trade a fund you’re not as flexible because you have all kinds of different investors and you can actually put certain investors at disadvantage if you do things like that. You have to do whatever you think is the right thing to do.

If you have a managed account with investors that’s perfectly fine. They can decide every single day what they want to do. That’s all good. So we decided that this has been a very important learning and lessons for us – how to deal with pressure on the business side of things and that we will not touch the program again in circumstances like that. Particularly not if we ourselves are convinced that you can ride this situation through. We did not know how much longer that would take, but we knew historically that our recoveries are high. All of us were disappointed about the length of the sideways markets, but it naturally makes sense when you look at the overall macroeconomic environment. We all somehow knew as well that this will end at a certain point in time. Every single day you stick in there longer, is one day closer to a potential day where things are changing. In terms of wrong timing, this has been the worst wrong timing ever, but I think I can remember one of your earlier guests also talked about drawdowns and I had to smile because a lot of managers have made exactly the same experience and it made them much stronger because they have made this experience and they have a different skill set now to deal with drawdowns when dealing with investors.

Niels

This is the natural evolution of building a business. Every day is a learning process, and I think its… I appreciate the openness and the honesty about an experience like that, but this is something that we all can learn from. I completely agree that probably most of the billion dollar managers that we see today, they have, of course, been in a similar situation in their early part of their career, and you learn from it. This is what it’s all about. Our conversations today are about sharing both the ups and the downs because we want to pass on these experiences to people, so I appreciate that.

I wanted to jump, because we’ve already spoken for more than two hours, I want to make sure that I cover the last couple of sections and so in terms of research. It’s not that I have many questions, but I have one question at least and that is when I look at your strategy I see massive amounts of different market model combinations being deployed every single month, some live and some need to wait until the next month begins. So in one sense I would say it’s hard to imagine you coming up with a lot of new trend following strategies that could be deployed and therefore I’m thinking, well, maybe the future development is, in terms of research, is more related to are there any more markets we can trade? But I may not be right on this. What’s the research discussion inside your business right now when you sit and talk about where to look next, what are you looking at?

Bastian

All kinds of different things on our research list for quite some time. I said earlier you can always explore into different markets and check whether additional markets might be beneficial for the way we are trading, but this is more a regular thing we do. It’s not as exciting. If you think about the allocation process, the adaptive allocation process, what is this actually doing? It’s actually trying to build the optimum portfolio based on the information available for the next month. The next month it’s doing that again, and again, and again and of course the allocation process learns about things which went right and went wrong, so it adapts itself to changing market environments and learns as well about its own experience of allocating in particular situations. Currently, as we said earlier, Singularity only trades trend following signals, so it basically takes trend following signals and these variations for these little fellows.

You can think about the perfect system, theoretically, would not just only take trend following signals but all kinds of different strategies available and try ways to build up the portfolio basically based on the different types of strategies as well. We actually have explored in that direction with our principle assets and are currently trading on separate accounts different kinds of strategies as well as mean reverting strategies and things like that. Potentially in the future you could actually create a system which goes beyond this more trend following focus approach, but actually incorporates all kinds of different trading, and types of trading strategies and builds up a portfolio on a more regular basis trying to react to changes in market environment by allocating capital toward these different strategies. But this is probably something we would do in a separate product in order to keep Singularity as it is. But it’s certainly something that we do on the research side, and we are quite excited to explore opportunities on that side.

Niels

Absolutely, that does sound exciting – another dimension to the program. I want to jump to the next section which is just a little bit about, I call it the business side, but it isn’t necessarily the right description but, when you look at your business right now, what do you see as the… what’s the biggest challenge today do you think?

Bastian

We discussed parts of it in terms of regulatory aspects. So you have to keep updated in terms of the regulatory aspects of the business, and I would say that’s probably one of the major drivers and then how investors react to it as well. We cannot fully escape the overall situation, the space – when I refer to space I mean the managed futures space or CTA space is currently in. While it was quite fortunate for us to actually navigate the last couple of years in a different fashion to where it’s a classical program. We haven’t had any negative years so far, and currently we are quite close maybe to even be successful in not being negative this year. Let’s keep our fingers crossed, but this shows that we were somehow able to navigate these waters differently but at the same time we cannot escape the suffering of the space so to say. If the space is not hip and in, it’s certainly much more difficult even for a successful manager in terms of what they’re delivering in an environment to attract additional capital because the decision makers on the investor side, they might not be aware of what you are doing.

In our case we’re quite lucky. We have a lot of investors actually following us quite closely because we quite regularly go to these larger conferences where you have one on one meetings with investors and this is a very perfect setting for us to get to know new people and to stay in touch and on top of it to exchange yourself with the industry and we basically go twice a year on all of the larger conferences. They might be aware of you but politically internally they might not be able to invest. We actually have seen, in our case as well as with other managers here in Switzerland, other managed futures managers who are actually quite successful as well, even being larger than us, some are trading 500 million or something like that or even more, they saw redemptions because their investors had to redeem because their investors, if they are fund the fund or something like that, saw outflows.

You cannot escape the overall condition, the space you are living and working in is developing. You can try to stick out, you can try to stay away from the major troubles, but you have to somehow keep fingers crossed that the space itself is doing better and gets more attractive for investors again. If you think about when CTAs actually perform best, and why they actually got all these assets in the post 2008, 2009 environment, I don’t want to be here and use my glass ball to tell you how the markets will look in the future, but one could probably argue that we are closer to an environment where you can see larger swings and more volatility than two years ago. That might be a rebirth of the space, so to speak. We would definitely also benefit from that despite having a different profile.

Niels

I have one question, just before we finish off this. But then I thought of another one and I just want to jump in here and ask you. When you talk to potential investors, what are they telling you is the main reason they can’t invest? If they were to give you a reason at that moment. You know, if I look at your returns, that’s not a reason for not investing, because your returns have been very attractive. So, what is the reason they would typically give for not investing?

Bastian

In the beginning, the reason was size, but then we got more and more assets. Then the size part disappeared in terms of an argument. Timing is also something that you probably hear very often when you’re a young manager that you need a minimum number of years of a track record. But, in our case we have four plus years, so that’s not a reason as well. It’s actually something I just said a couple of minutes ago that they not necessarily have capital at the moment. They are already invested with managers. Definitely different in comparison to our profile. In many cases, they are still in drawdowns with these investors, and they fear to pull money from them and invest in us, and lock in their losses. What we experienced, in some cases, where investors were interested in what we were doing, so the recovery of the already existing bonds, they pulled the money, and we got an allocation. Unfortunately for them, this happened in autumn last year and early this year, so what happened in their particular case, which I will re-emphasize what you said earlier about the skill set of timing managers. They actually locked in the losses of the classical trend following programs that they had in their portfolio, and now they’re in a drawdown with us. Fortunately for them, they’re now back in a recovery.

Of course, classical trend following programs haven’t done relatively well this year. They would have made a better decision if they would have considered redeeming now from them, maybe, to invest in us. I will always prefer for them to invest in us of course. But in that particular case I was actually quite sad for their decision making and timing. Because being locked into a loss or drawdown, and joining us in a drawdown, I’m quite happy that we are currently seeing light at the end of the tunnel, and have quite a good development at the moment. The market environment is moving towards a direction which is offering us much more opportunities over the last couple of months. Not only in just one part of the universe, but actually across all markets. October has been a perfect example of that. Where all asset classes were basically positive contributors, and the majority of markets were all positive as well. So, we already discussed equities in the beginning. If you think about precious metals, they left the ranges as well at the end of the month. So it was a perfect storm in terms of a beautiful market environment, where Singularity can catch a lot of opportunities. And it seems to be that an environment like that is more likely to reoccur, and the overall market isn’t developing in that direction, when we thought about that a year ago.

Niels

Last question in this topic, before we go to the final section Bastian. And that is, clearly, growing your business, it means you meet with lots of potential investors. And you have answered, I’m sure, many different due diligence questionnaires along the way and so on and so forth. What I’m interested in finding out from you is, what is the question that investors really should be asking you, which they’re not? That you don’t see in their due diligence questionnaires or in the meetings, you participate in?

Bastian

I would probably think less about a particular question and more about an emphasis on what they should spend time on. It links to the aspect of your question about a track record. So to really sit down and not just be interested in performance, but actually developing a good understanding of what actually happened in all the different market environments, and linking it back to performance in that particular environment. So that the manager can explain to you why you actually make money in that particular environment, why he’s expecting to make money in such an environment again, and why a drawdown will most likely be a drawdown again in a similar environment.

So, spending time on that helps the investor much better to help define the role that a manager or Singularity can take in his portfolio. It saves him from disappointment; it saves an investor in case it’s not his own money, but he’s working for a larger institution and investing money on half of the institution. He has a lot more information available to defend his position and decision making and makes life easier for everybody. And we have made the experience that the majority of investors just don’t have the time or don’t take the time to develop an understanding there. A lot of due diligence takes place on the operational side. And this is a very important thing, and it was good for us as well, because it helped us to improve our operational side at a really high level on that aspect.

We see less interest and less time spent on understanding what are good times and what are bad times in the case of a program, which would be more beneficial for everybody. The investor type number three, they know you best. They do that. Not necessarily right at the beginning, they might start with a smaller allocation, and increase the allocation over time, but they are interested in a continuous dialog. They want to hear from you what is going on, they ask you what’s going on, and this is very beneficial for all sides because for you as a manager learn a lot as well. But investor type number one isn’t interested in that at all, and he might actually benefit from that as well. As a silver back which we already discussed as well.

Niels

The last section, Bastian, you probably know already that I try to finish off with some sort of general and fun questions to shake things up a little bit and for people to get to know you even a bit more. Is there any book, for example that you would recommend that people read? It could be a book that has had a big impact on you in general. But it could also be a book that is more trading related, even though I know you sit mainly on the business side of things. But you know, we’re all influenced by these books, so is there anything that you would recommend for people to dive into to learn a bit more generally?

Bastian

We as a team read a lot of books actually, in order to get a better understanding of what’s out there, in terms of other managers and thoughts about the space. But in terms of the development of the program and the research process, I would say that we are most influenced by the sorts…Nassim Taleb’s about the Theory of the Complex Plane, particularly Antifragile as well, because it somehow refers to an aspect of the strengths of Singularity as well, in that you actually deliver something when the rest starts to fall apart. And this Antifragile aspect can be directly linked to when we actually make performance and when we don’t make performance as well, and how these little fellows react to sudden events.

Of course, an overnight gap is difficult for us. So, discontinuity risk is a difficult thing for Singularity as well. Volatility, as an intraday volatility bird, where nothing happens, non directional volatility, nothing happens on a day to day basis, but you saw all these movements up and down in a particular day, that’s not good for us either. But, for example, if you have a large incident, a natural disaster, something which infuses a lot of chaos into the markets. Singularity might be hit as well, first, but as long as the markets continue to trade, the worst case for us is that future markets close, and you sit on your losses. If markets continue to trade and there’s still some way to continue trading, it’s very likely that this newly infused volatility leads to new directionality which can be really quickly captured by a trading programs which is highly reactive. So in those terms basically, the Antifragile contribution to an investor’s allocation, something Nassim Taleb talks a lot about, somehow links to one of our strengths in our portfolio. We probably have developed in that direction as well, because we read his books, and particularly Ralph is very deep into this mindset as well. Spending a lot of time looking at things from that particular angle. That’s probably as well why he has theis risk manager role so to say.

Niels

I certainly..and the interesting thing is of course, is that these black swans, they tend to happen more and more often, so that’s probably a good starting point. I wanted to ask you, partly as an entrepreneur, partly as an alternative investment manager, if you put that thinking cap on, and that is, based on everything you’ve learned from starting your business, and so on and so forth..If you were starting today, is there anything that you would have done differently?

Bastian

That’s a very interesting question. I would say two different things, as to how I would approach that. Of course, there’re certain things we would do differently, but second, the market environment now is different as well, which would even enforce certain aspects of doing things differently. Let’s probably start with the second. It refers a little bit to the regulation part. If you are a young manager, and you have a trading idea and in the best case you’re trading with your own assets or small assets. And you think about starting a business. Even when it’s difficult to develop an understanding who your potential investors could be, and where they are geographically, you should spend a significant time on that question. Go out and talk to other managers. Try to find managers who do similar stuff as you – not necessarily the same, but similar. Look at them and how they’ve positioned themselves in the market, and where investors are.

I’m saying that in terms of the question of regulatory aspects because the environment as I said earlier in Europe has become much more difficult. For example, if you are a CTA managed futures type of manager, to be in the US might be a much better starting point than actually staying in, for example, in Germany, which is really strict on the forefront of regulating pretty much everything on this particular alternative investment industry. It can be really difficult for you to start your business properly because you might spend a lot of time on the regulatory aspects, without really knowing if you have an interesting business idea there.

So, the geographical question is certainly a thing, of course, not everyone has the flexibility to move immediately to the US and start a business, but imagine you failed, you’d probably be in more trouble. But think about where you can develop and grow your business best in terms of framework. Think about where your investors are and develop for yourself a very good understanding of what you’re doing. A good narrative in why you are different, and be careful about vocabulary. You might find some literature to read first because it might mean something different, and you might use it in a different way than someone else is, and an investor might misunderstand it as well.

We have to take volatility as an example. We did that as well in the beginning; you build up your narrative, you try to develop a story that everyone including your investors can understand. Keep in mind as well how your profile looks like and what you’re planning to deliver. For example, if you were to say that volatility is good for us, that’s a statement. But, there are different types of volatilities, and you might not be aware of that in the beginning because there might also be volatility in a certain variation which might not be good for us. But if you actually have investors who tick the box…okay, the volatility is up, singularity is up, or your program is up, they will be disappointed. So you have to be careful about the narrative and take your time to develop that properly. You can only do that by going out and reaching out to other managers.

I personally haven’t had the experience of people pushing you away because they perceive you as competitors. I would say that the space is generally quite friendly and open as long as you don’t talk about secret sources and stuff like that, and you don’t want to do that anyway. So if you just talk about the general stuff it’s more supportive, which might be the case because the space is suffering or has been suffering for a long time, so everybody is suffering and everybody sticks together, I don’t know. But we felt welcomed quite frankly by peers and by potential competitors. They were quite friendly and exchanged all kinds of different sources, and that’s something

I would recommend. In terms of aspect number one, do something different, yeah, I’d reflect on what I just said earlier. I think it’s really important that you’re passionate about what you’re doing. I’m so grateful that I have the opportunity to start the business with friends and continue doing business with friends. And as I said earlier, life is way too short to spend a lot of time working with people you don’t like. So if you can somehow influence that aspect, you will be much more successful. That doesn’t mean that things are always going straight forward. I think the benefits of a friendship are that you can discuss things quite openly. Things are probably much more hotly debated and can be very disturbing for outside people to look at a discussion when it’s at its hottest point. But the friendship helps you as well to find solutions much faster because everything is sad, and the friendship holds you together, and you can actually start working on solutions. And whatever aspect you discussed about, has been looked at from all kinds of different angles, further fueled by emotions. And that’s probably something that is really beneficial. And that’s something I would recommend to strive for if that’s somehow possible.

Niels

We’re almost at the end Bastian. A question that I try to remember and ask all my guests, and that is, can you share with me a fun fact about yourself? Something that even people that might know you, might not know about you? It could be a hidden talent!

Bastian

Oh, I don’t know! Hidden talents..I don’t know, probably…I spend so much time talking with the team, so I would probably argue that the team knows pretty much every aspect of my life. Particularly as we spend so much time, not just discussing business, but also other aspects of life. But for the outside world, there are probably all these different aspects, so there’s probably something that could add a funny aspect. When an investor looks at us… this is a story about risk management and why Ralph is now-a-days our risk manager. Prior to taking money, external assets, accepting external assets as prior to 2011, we were actually just trading our own assets as I said. And we used to go together on adventure trips once a year. Our last adventure trip took us to Papua, New Guinea, which is probably still one of the fewest traveled places on earth. And it’s very difficult to get around there because there are many islands and there’s hardly any infrastructure and they have hardly any roads, and only a couple of really worn down ships that work as ferries between the islands. And foreigners are actually not allowed on these ships, which are large ships. So nobody could report on the poor conditions.

So we were traveling there in early 2011, and Ralph argued that we would be safer on what I think was called a dingy boat or something like that? It’s a small piece of wood with a big, big engine. So it looks quite impressive, but you also know that these engines might run or not, then you’re actually in big trouble. And he was actually considering crossing from island to island through open water on these tiny boats. And the rest of us said no, no, no, that’s way too dangerous! We insisted on taking one of these larger ships, and we actually finally bribed our way onto one of these ships called the Rebel Queen… considering us on the safe side. Only to hear that one year later that the ship sank! Exactly on the same route! Without any warnings. And we said okay, okay, thank you Ralph.

On the same trip, Ralph also argued that he would not recommend climbing the Tavurvur, which is an impressive volcano on New Britain, one of these islands, actually being active. And the rest of us said that we wanted to go anyway and why? Look at it, it’s all calm, there’s no problem, it’s just a little bit steamy. Ralph was again right about that. Just that those particular circumstances, timing wise, needed some improvement on his side. But all in all he got the concept of risk. Because this was confirmed when Tavurvur suddenly exploded a couple of months ago, I think in early September of this year. It was a huge eruption. I saw a video on it, and if we had been there, at that particular time, which could theoretically be possible, that would be it. And that’s probably why Ralph is our risk manager today, and why we actually stopped traveling since managing other people’s money as well. This adds a twist from the investor’s perspective.

Niels

Absolutely, now we’ve been obviously talking about what investors should emphasize more when they talk to you and ask you questions, so I always finish off by also asking you about our conversation today. Is there anything that we’ve missed? Have I done you and your company justice, or is there anything that we should have brought up in our conversation today?

Bastian

I think you did perfectly well. I think you actually did a great job on hitting all these interesting aspects. Not only about Singularity in our development but also referencing it to a certain condition that the industry might be in at the moment. I think we got it all; it was very interesting, and I highly appreciate all your questions.

Niels

Great stuff. And now, before we finish completely, what’s the best place for people to reach out and learn more about Deep Field Capital?

Bastian

We certainly have our website, which is www.deepfieldcapital.com, and there you can find the contact details, and you can certainly reach out to us. Probably also ask us about our presence at the conferences that I referred to earlier. That’s a good starting point where one can learn about each other. Send us an email, give us a call. That’s probably the first thing that one can actually do.

Niels

Sure and we, of course, also will put all the details on the show notes page for this episode of our conversation on the Top Traders Unplugged.com website. So that leaves me, Bastian, really as to say, thanks so much for a great conversation. I really appreciate it. I thought it was fun to learn about your small fellows. We are based in the same city so I imagine when I come and visit you for a coffee at some point, I will meet all of these small fellows, I certainly look forward to that.

Bastian

That’s for sure that’s quite witty!

Niels

Absolutely, and I hope we can connect at a later date and see how you’re getting on in all the great work that you’re doing. So thank you so much Bastian, it’s been a pleasure.

Bastian

Sure, excellent. Thank you very much Niels, have a good day!

Niels

You’re welcome, take care, bye bye.

Bastian

Bye.

Ending

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