CTAs: Innovation Meets Legacy & the BlackRock Effect ft. Andrew Beer & Tom Wrobel

[00:00:01] 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 Tom Wrobel who is a director within the Capital Consulting and Capital Introductions team at Prime Services and Clearing at SocGen, as well as myself, of course, Niels Kaastrup-Larsen, where each week we take the pulse of the global market through the lens of a rules-based investor.

Andrew Tom, it’s great to have you both on the podcast this week. How are you keeping? How were your holidays? What about you, Andrew?

[00:00:51] Andrew

The holidays were wonderful, thank you. Except I’m struggling with the tail end of a of a cough. So, you’re going to hear a very raspy version of me today.

But again, it’s always a pleasure to be here.

[00:01:00] Niels

Absolutely. How about you, Tom? How are you doing?

[00:01:03] Tom

Very well. Thanks, Niels. Delighted to be on, I’m a longtime listener but a first-time contributor. So, thank you for having me on.

[00:01:09] Niels

It’s so weird. I mean, obviously we’ve crossed path for many, many years and we should have had you on a long time ago. So, we’re going to make up for that today and hopefully in the future as well.

I think this conversation we’re kicking off, kicking off a new year, I think we’re going to be touching on a lot of really important topics when it comes to the CTA industry, but also at a very important time, actually. And you both bring some unique insights that I’m very excited to share with our audience. So, I have been looking forward to this quite a lot.

Now, before we kick off with all the CTA focused stuff, I’m always curious as to what you have been keeping an eye on; anything that’s been on your radar. So, I’ll let you go first, Andrew, on this. Anything that you’ve been pondering over the holidays?

[00:02:01] Andrew

Well, to me, the thing that I’m watching probably most closely outside of the space is just what’s going on in the political sphere. And in the US, I find it absolutely fascinating how the Trump administration is bringing back a sense of animal spirits back into the US. Again, my mother’s side of family has been involved in this. They’re always businesspeople taking roles in the government, but it was always in this very austere, noblesse oblige kind of way. They’re very conservative people, this was their duty, they were serving, that kind of thing.

What you have now, with Trump, and it used to be a very, very reactionary movement, but it’s now been embraced by people who are economic glass breakers; you know, people who have done extraordinary wealth creation on their own. I mean, the people that he’s appointing are these brash billionaires who are untethered by what we normally think of as senses of propriety and decorum and things like that.

And I’m so utterly fascinated to see how this plays out in the US because there is a sense that the Trump movement has now been almost taken over by these people who are not reactionary, trying to take America back to what it was 30 years ago, but are thinking about where they can take America over the next 20 years. And it’s going to be entertaining, let’s say, to watch how all the skirmishes play out.

[00:03:45] Niels

Absolutely. Tom, I know UK politics is also quite colorful at the moment. I’m sure that’s not what’s been on your radar the last few weeks.

[00:03:54] Tom

I think Andrew’s right. I think we’ve just come out of one of the most interesting years in terms of elections and geopolitics. And I think how that plays out is going to be really, really interesting. Are we going to have a period of calm or are we going to have the continuation of a lot of interesting moves on interest rates, policy?

And potentially, from an investing side, we’re going to be in a scenario of one of the most interesting macro environments that we’ve ever seen with all sorts of things moving around after a period of continued calm. Where rates were all-time lows for an unbelievable period of time, the stage is set, ready to see what happens in 2025.

[00:04:35] Niels

Yeah, I mean, for my part, because I hadn’t had to record anything the last couple of weeks, I’ve had a little bit more time to think about other things. There are a few things that caught my eye that maybe are relevant for our conversation also, today.

The first, first of all, I do think it’s interesting to see how, after 100 basis points cut by the Fed, that long term rates have really moved up. And it hasn’t been a great year for fixed income, certainly not long maturity fixed income. I think the TLT is down like 8% or so in 2024. And so, in that light, again, you think about trend following or CTAs in a 60/40 portfolio context, and I think that’s certainly worth noticing because we know so many people like the bonds to be the protection of their portfolio.

The other thing that came across was something yesterday I just saw quickly. It’s an article, and I think it’s from a related to a demographer called Mark McCrindle who coined the phrase, I think Gen Z and there’s another generational term that he used, but he’s basically saying that all babies born now, from this year on, and then the next 15 years or so will be the ‘generation beta’. So maybe they will only be used to having these tracker products in their portfolio and so on and so forth. I don’t know. We’ll see.

It’s not a completely crazy thought when you think about what’s been happening in our investment world in terms of product launches. And then the other thing that came to mind was just, as the year was ending, the headlines that we’ve now had the best two year calendar year performance by the S&P since 1988. I mean clearly it has been a very easy period to be a long-only equity investor. And it also means it has been very difficult to be anything other than that, including a CTA, for example.

And then, finally, that coincides of course with the Cboe SKEW index heading A new, all-time high in December. Meaning that a lot of people out there might be worried, in terms of some kind of markets heading south in the coming year.

So those were my things. Feel free to comment. Yeah, Andrew.

[00:07:00] Andrew

Yeah, so actually the point about bonds is I’ve been waiting, since the end of 2022, for people to start to realize that. So, what happens is that when people have a favorite asset class, which bonds were for 20 years, and it starts to do badly, everybody’s first instinct is how do you defend it? How do you make an argument that it’s going to come back? Because wealth managers in particular, and lots of institutions really don’t have a playbook for if bonds aren’t working. So, in the absence of having a playbook, they kind of hope it’s going to recover.

And so, 2023, the beginning of 2023, it was the year of the bond, right? This is the year the bond’s going to come back. Then this year, 2024, was the year of the bond. It hasn’t happened now. And so, we’re now halfway through the 2020s, and we’ve had five years in the 2020s, and bonds have done nothing. Zero Sharpe ratio over that period of time.

So, to me, one of the triggering moments, just in the media, is some guy at the Wall Street Journal wrote an article basically saying bonds really aren’t working anymore. And so that’s a critical component for growing the buy in things like managed futures. Because the argument was always, why would I do that when I can do bonds? And it takes people a long time.

But I think, unless economic growth collapses and bonds do incredibly well over the next six months, you’re going to start to see this kind of wrenching, grinding change where people say maybe it’s not 60/40 moving to 50/30/20 because equities keep working. Maybe it’s 60/40 moving to 60/20/20. Maybe that’s where you take more of the money from. So, I completely agree. It’s absolutely fascinating.

And people don’t talk about it. They talk about equities going up, not the fact that bonds have been struggling the way they have.

[00:08:51] Tom

I think it’s something that we hear a lot in the discussions we have with allocators and investors and especially in the US where there’s a lot of forward thinking about what is the portfolio that’s going to be robust and protect us going to look like over the next 5, 10 years? And there’s big, big focus on building these robust portfolios.

We hosted an event last year where that was specifically the focus of a panel. And they are looking more and more to alternative strategies to fill maybe the void left by bonds, I don’t know, or as you say, adding it as an allocation to complement that bond portfolio.

But it’s specifically looking for things that are going to be diversifiers; non-correlated and adding a little bit of that performance when maybe the equity side does slow down. And I think that’s probably one of the biggest concerns that we hear from investors is that next year equities may not be growing at the same rate. So where are we going to be looking in our portfolios to get those levels of return?

[00:09:51] Niels

Actually, the average 12 month return, after a great 2 calendar year performance like we’ve just seen, is not very impressive. It’s pretty flat actually. So, who knows, maybe that will turn out to be true again.

Now, before we dive into all the details, let me mention first of all that my own trend barometer finished at 59 at the end of the year and it has been moving higher at the beginning of 2025. So maybe that’s a good sign for the year, who knows?

But of course, and especially in your presence, Tom, we need to go through the various indices which are dominated by the SocGen indices of course.

So, the BTOP50 finished the month of December up 1.22 and up 4.44 for the year. SocGen CTA up 1.16, up 2.24 for the year. SocGen trend up 1.4% in December, up 2.56% for the year, and 0.52% up for December in the SocGen Short Term Traders index and up 15 basis points for the year.

I’m going to include one more this time around, which I never do, and that’s the Bridge Alternatives index which is 5 flat-fee trend following funds. They were up 0.92% in December and it’s up 0.55% in 2024. And that will be relevant for one of the talking points later in our conversation today.

In the traditional world, MSCI world was down 2.69% in December but still finished up 17% for the year. The S&P US Aggregate Bond index was down 1.41% in December but up 1.82% for the year. And, and the S&P 500 Total Return down 2.38% in December, up 25.02% for the year 2024.

All right, so I thought we could start our conversation today maybe with you Tom, because we are going to talk a little bit about (maybe a lot actually) indices obviously from your perspective, from Andrew’s perspective. So, why don’t you spend a few minutes to talk a little bit about each of them; maybe the why they were conceived, the way they’re conceived or structured. And then also there is a new SGI CTA Managed Futures index but it sits in a different part of SocGen, so maybe we need to explain that a little bit. And so yeah, I’ll let you lead the way.

[00:12:26] Tom

Thanks. You know, so I think your trend barometer is probably in line with how we’ve seen performance play out recently as well. I think 2024 was an interesting period in Q1 and then a really difficult period through Q2 and Q3 coming back with stronger performance in Q4. So, we’re definitely seeing performance coming back in the trend following space and hopefully that’s going to persist through into 2025.

But you mentioned the various indices and maybe it’s worth setting the record straight on the sort of differences between them, exactly. So, we’ve been running the SGCTA index for 24 years. It’s coming into its 25th year now, and that is a live index, with daily data, which represents the largest CTAs in the industry. We go through an annual reselection process where we pick and rank the largest CTAs.

The two main restrictions we have are that the constituents have to be open to new investment, so they cannot be closed, and they also have to trade an appropriate strategy that is diversified, and in that strategy the main P&L driver has to be futures and FX trading. Because really, CTA is a bit of a misnomer. It’s a regulatory term that doesn’t necessarily mean that much. It’s obviously CTA, CPO are these historical terms for groups that run CTA portfolios.

But really, people have come to think of CTA with that instant association with trend following. But for us we run the SGCTA index as a sort of more open, broad-brush approach to futures trading. It includes trend following and non-trend following strategies. And approximately half the constituents of the top 20, half of those are non-trend.

So, we get this very interesting mixture of other strategies, for example, of quantitative macro, which is maybe a more fundamentally driven strategy, shorter term trading (and we define short term as anything less than about 10 days average hold, so a two week period), as well as maybe commodity only strategies or just sort of other technical strategies that don’t fit into the trend following subsets. I’m thinking of groups like FORT where they run really interesting strategies all based on technical price-based data but it’s not trend following explicitly.

And so, we’ve just announced and done the rebalance for the SG CTA index and the Trend and Short-Term indices. It’s going to be very interesting that we’re seeing very little turnover in constituents this year. We’re going to have no changes to the SG CTA index as well as no changes to the SG Trend index which is probably the first time we’ve had no turnover for quite a long time.

And we’re going to see, I think, two changes to the Short-Term Traders index where we have historically seen more changes but that is because that space is a more difficult space and you were saying the performance has come out pretty flat for the last year.

We tend to see a lot of performance dispersion in the short-term space and so often the groups struggle to persist for performance for many years in a row and it can make asset raising in that space a lot harder. I think it’s dominated by two or three groups that have been there for a long time and do very, very well at it.

And so that’s the sort of the SG Prime which sits on the agency side of the business. Those are indices which are the barometer for CTA performance. And then we’ve got the new product which is the SGI.

So, the SG index business, which is SGI CTA Managed Futures index. And this is run by the DBI strategy. And it’s really a product offered by our structuring team to provide access for investors to access DBI strategy. And for us it’s subtly different. It’s definitely different from the indices and I think it is an interesting product. But, for us, it’s kind of more of a single manager rather than an index. The index term is a nomenclature thing in the way our SGI, our SG index team operates.

And so, it’d be interesting to hear from Andrew about the engine that powers that and the replication that goes on because I think it is an interesting way for new investors to access the CTA space.

[00:17:06] Niels

Yeah, before, obviously, when you refer to DBI, that is of course Andrew’s firm, and we know it as DBMF, of course, the US ETF. And I was also, when you mentioned the word ‘index’, I was also (and we talked a little bit about this before we pressed record), I was also under the impression that you had to have more than one constituent to be an index. But Andrew corrected me that you don’t have to have that. So, that’s perfectly fine.

But yeah, I mean, what I’m curious about also is, when you create an index, maybe different from an ETF, do you have to make any disclosures, Andrew, about how it works, or can it still be completely proprietary in terms of that?

[00:17:52] Andrew

So again, let’s sort of differentiate between two different kinds of indices. One kind of index… So, every index is based upon a mechanical strategy where it’s supposed to be predictable. What I’m doing today is what I’m doing in 10 years, and what I’m doing in 20 years. And, by the way, when we first started looking at replicating the managed futures space, the obvious choice was the SocGen CTA index. That is the industry standard. It is head and shoulders, we think, above any other index out there.

But the whole idea of an index is you’re trying to create something around a mechanical strategy. The S&P 500 is an index, but it rebalances, and there is a methodology that they employ to rebalance it. Sometimes the methodology is purely mechanical, sometimes there’s an element of judgment involved in it.

In the case of, I Think what Tom is describing in this index, they have certain criteria, but there are also judgment calls that they’ll make in terms of whether a particular manager fits into their criteria or not as well. But the point is that the index, you’re supposed to be able to look at it and say, if I was looking at this space in 2015, how would I have thought about this space? Is this representative of the overall space, et cetera. So, every index has its own mandate.

When you move to the structured products world, or my argument is that a hedge fund index has limited applicability outside of that $300 billion of institutional investors and family offices that invest directly in hedge funds. Because in the wealth management space, most people cannot invest in hedge funds. So, to use an index of hedge funds to decide whether you find the space attractive or not, there’s a big gap between the data that you’re using and how they would think about… and implementing it in from a portfolio perspective.

So, the whole idea of replication was trying to create an approximation, clearly an imperfect approximation, of what the hedge funds are doing, but to do it in a way that was mechanical but also investable in that you don’t have to invest with another manager to do it. (In our case, we obviously have a few investment products that do it.) But rather to have a portfolio of instruments give you exposure to it so you can say, if I like that return stream, I can invest in it directly.

Now, when we launched the replication based strategies, back in 2015, 2016, they were, in essence, viewed as active strategies at the time because we had to decide how we wanted to build the models, how we wanted to implement it, et cetera. Eight and a half years later, nine years later, depending upon our two configurations of the strategy, we’ve essentially stayed with that same mechanical weekly approach that we’ve done, which looks and feels very index like.

And so, to us, the next evolution was for a wealth manager for whom a hedge fund index has limited applicability, let’s try to give them a tool where they can look at the space from what we would call… investable is a little bit of a loaded term because you’re not actually investing in hedge funds (we’re not even a CTA, right? I mean, we are a CTA technically, but we’re not building our own trend following models), but the idea is to give something that is actionable for them where they can say, what would my experience have been like if I had this in my portfolio over the past 20 years?

[00:21:30] Tom

Then are you not building trend following models?

[00:21:33] Andrew

We have trend following models that we run internally, but we don’t invest in them, we just use them as risk tools to understand what is working or what is working better or worse on the replication side. The way our approach to replication works is on Monday we’re looking at the very recent reported data of just the hedge fund index. The research conclusion that we drew in 2015, and then ultimately in 2016, was that over a one week interval, over a very, very short -term period, on Monday afternoon we can estimate the broad factor exposures (so, using only 10 deep liquid markets, S&P 500, 10-year treasury, et cetera) with enough accuracy that by the next week, on average, we’ll be pretty close to what the index is doing. With the added hook that, when I spoke to allocators back then, there was often a big difference between what some people would pay versus what other people would pay.

So we said all right, instead of trying to go after the reported numbers, which you can answer this better than I can, tend to be headline fees, the idea was could we come up with some sort of an estimate of the pre-fee, pre-trading cost returns, aim for that, and then see how we do over the course of next week. So, what we’re doing is not at all based on our own trend following models. Rather it’s based on a factor decomposition of an index of hedge funds which you can invest in if you’re an institution but not a wealth manager.

[00:23:13] Niels

I don’t know, obviously, kind of the side-by-side evolution between the returns you’re generating, Andrew, and the index itself. But, from memory, when I’ve looked at it in the past, there certainly were calendar month where there were huge differences in the reported return. And so how do you think about replication?

Because maybe I kind of misunderstood the term in the sense that I thought, well, we want to have the same monthly returns as the index, but that’s probably not exactly what you’re getting, but you are over time. So how should people expect it to be different and how should they expect it to be alike, if you know what I mean?

[00:23:53] Andrew

Sure. So, what we’re doing is a vast simplification which is going to have a lot of noise, we would say. So, if the cocoa market is ripping, we’re not participating in the cocoa market. We’re participating in other things. We may pick up some of it indirectly. The question was what are your alternatives?

You mentioned the Bridge index. So, the Bridge index is interesting. It’s five managers. You look at the performance of that thing over time and it’s statistically incredibly close to the SocGen CTA index with 20 managers. And I believe all of the five managers are in the SocGen CTA index. That is the standard playbook for an institutional investor in the space.

They want exposure to the space. They love the SocGen CTA index, hedge fund index as a measure of… they love the statistical benefits of it. But when they look at each individual manager, there is far greater tracking error than what we would do. Sometimes you have, you know, a manager who underperforms by 20% over a period of time. So, they tend to combine managers and you get diversification very quickly. You don’t need 18 of the 20, you can get there often with two, three, or four managers.

So typical a portfolio is going to get diversification to reduce single manager risk, to raise your correlation to the index hopefully to somewhere in the 80s%. And if you pick the right guys, you’ll outperform by a few hundred basis points over time. That’s the standard institutional allocator playbook.

And by the way, if you’re a big allocator and you can compress people on fees, you’ll tend to structurally outperform as well. So, replication is philosophically similar to that. And we’re saying, well, you already have diversification built into the index of 20 managers, but the approximation is going to be much noisier. So over that one week period of time, because of the differences in fees and expenses, will tend to outperform 53% or 54% of the time. But it’s noisy.

We might be, on average, 60 basis points above or 60 basis points below. Over the course of a month the tracking error can be quite wide. But like anything where you have a… like the house in poker or anything where you have a repeated process, where you have a slight edge, it builds up over time.

So, the idea is that the tracking error is high relative to the hedge fund index, as you’d expect. But having the tailwind of consistent outperformance means that over the course of a year you might outperform 80% of the time, the index. Over the course of three years you get into the 90s%, so, what it was really meant. But unlike investing in hedge funds, you can do it in the ETF in the US and disclose all your positions every day.

So, it was really an investment tool that was saying that we love the space, we love the category, but within the constraints of we need liquidity, we need daily liquidity, we need position level transparency. We want to be able to do this as cheaply and efficiently as we can to try to expand the pie. What’s the best way we could get there? And this is what we came up with. Maybe someone will come up with a better idea tomorrow.

[00:27:22] Niels

Sure, so, let me stay on that and involve you a little bit here. And I’m jumping around a little bit in our planned agenda here, guys. I hope you appreciate that.

You mentioned fees and I remember distinctly that the Bridge Alternative index came up and saying oh, this is a great way to get exposure to trend following at low fees because it had to be flat-fee funds only. Can you remind us, Tom, what are the average fees in the indices that you have today? I’m just curious about that.

[00:27:57] Tom

Yeah, I worked this out for you in advance. So, with the new constituents that we’re going live with, although there’s obviously no change in the CTA index, we’re going to see an average fee in the SG CTA index of 1.3% management fee, and 13.9% performance fee, and then the corresponding levels in the SG Trend index is 1.1% management and 11% performance fee.

[00:28:24] Niels

Yeah, because. And this is what’s interesting to me just as a little anecdote and that is, so, I took a look, because now we have nine years of performance data I think from the Bridge Alternatives index, and of course we have a longer history from the SocGen Trend index, and it actually turns out that the promise of low flat-fees would produce better performance. It actually didn’t. The performance of the SG Trend index is marginally better over that nine year period and the Bridge Alternative has produced 50% higher drawdowns.

[00:28:59] Tom

Well, this is going to be one of the questions I was going to ask Andrew is, you mentioned the cocoa example. That was obviously a market which contributed a lot of positive P&L to the CTA space in 2024. But it’s something that, if I’m correct, you don’t trade. So how do you account for the missing of individual markets? And do you still think you create the performance characteristics that are so attractive to institutional investors when they build their portfolio, and they run it through their models with the data from the various kind of indices such as the Bridge or the SG Trend index?

Because it’s something that we’ve tried, and we had a research project 10 plus years ago where we created a similar kind of tracker, performance attribution called the Trend Indicator. And it’s something which is a very, very useful tool that allows us to see individual market positioning, likelihood of reversals in terms of changing from a long to a short position, how a trend is developing, and also the P&L that we’re deriving.

But although we’ve managed to create this long-term performance and correlation profile which looks very similar, as Niel says, the drawdown and often the risk that we are taking is very, very different from the real-life CTAs that we see in the SG trend or the SG CTA index. And it’s not something that I think people would be that interested in investing in and it’s not investable. Full disclosure.

[00:30:31] Andrew

Yeah. So, I think the answer to the last question first is what are people looking for when they’re investing in this space? Generally, they’re looking for low correlation to stocks and bonds, low beta to equities, alpha generation, performance during crises.

Somebody made sort of a pejorative comparison of replication to buying a cheap Louis Vuitton bag on fifth Avenue, and you really want the real Louis Vuitton bag. And I said, actually no, the right analogy is a Tesla. It’s that you have a 200 (I’m not a car guy), so, you’ve got 200 parts, let’s say in an ICE engine and you’ve got like 20 in an EV engine. And funny, is I’ve got a three year old who loves cars.

I’ll take them to car shows and they pop the trunks on all these cars and they’re showing cars in 1950s, 1980s, 2023, and everyone loves to look at the engines. Half the people show up in Teslas and it’s, what are you trying to achieve?

And so, to us we wouldn’t be replicating the way that we did if we didn’t think we were capturing those diversification benefits. And if you look at the correlation of replication over time, it’s not perfect, but the correlation ends up being about 0.9 when you do it with a full factor set. When you limit the factor set, you’re kind of in the 0.8-ish range and you tend to have the same beta, same correlation, and same crisis alpha.

The difference is that in a period like the long winter in the late 2010s when you have a convergence of three things that made the space a very difficult space. You had a market environment that was very anti-trend between the Fed put and everything else. You had cash earning zero. So, basically, your nominal driver of returns, your base case of returns was zero and you had a fairly high fee structure in that.

And so, you take the combination of those three overall and you end up with a, basically, a period of zero net returns over multiple years. Now, one of the benefits of replication is that it is just really efficient. You know, people call it a structural source of alpha.

If you can capture those same statistical benefits but with 10 or 20 basis points a year of trading costs, with a handful of instruments, and if we’re willing to charge lower fees to do that, then what ends up happening is that when you look at the long-term returns of the SocGen CTA index relative to cash, it outperforms cash about 60% of the time on a rolling one-year basis. But you start to eliminate costs and expenses on trading and then you quickly get up into the 80% or more on a one-year basis.

So, it’s all about just trying to create something that gets you to the same economic conclusion with clearly an intellectual leap of faith that we’re not doing what the underlying hedge funds are doing to get to that. Rather we are, I don’t know, piggybacking, replicating, whatever term you want to use, to try to understand what they’re seeing, what information they’re getting that’s causing them to change their portfolios.

And I’ll pause for a second then I want to answer the question about the idiosyncratic positions because I think that’s an interesting one as well.

The stocks and CTA index are large CTAs and usually what you have is, you know, we trade 10 markets, they’ll trade the same 10 markets and then they’ll trade another anywhere between 40, 50, 100, 200, whatever, markets outside of that. As your portfolio expands and as the liquidity of those positions goes down, it is natural for firms to limit the sizes of those positions.

And so, if you take a market like cocoa, earlier this year when cocoa was ripping (and this is rudimentary Andrew calculations again, Tom, you’re going to have a much more sophisticated way of looking at this), but it looked to me like there was about five or six billion dollars that was being made in cocoa over about a two or three month period earlier in the year.

And if I take that and I say, all right, let’s say half of that is CTAs, and there’s $300 billion in CTA hedge fund assets that we can see, plus synthetic process products on top of that, plus internally run programs, et cetera. You’re not talking about AQR, and Man AHL, and all these other firms saying, our year was made by cocoa. It’s going to clearly incrementally add. Now there are periods where replication will underperform, but it’s because there are multiple things that are working at the same time.

January and February of 2023, we’re running our own trend following models and we’re like, yeah, we’re missing the Mexican peso, front end of the Canadian interest rate curve. Look at Neil having a field day in softs and commodities and other things that we’re not getting direct exposure to.

So, statistically there will be times when all these other things that are trading, a whole bunch of them are going up for them. I think there are periods this year where a whole bunch of them were going against people and we weren’t getting hit in the same way. But most of the time some will be doing well, some will not be doing well, and they tend to cancel each other out.

[00:35:57] Tom

Right. It’s just, you know, if we look at the main performance drivers for performance over the year, it’s probably commodities that is that standout sector which was contributing, I would say for most of the trend followers, a large part of their P&L. So, the top 1, 2, 3, 4, 5, 6 commodity markets in our trend indicator contributed a significant amount of P&L to the theoretical portfolio. And it’s just interesting, if there’s an omitted, is the client getting the similar profile that they’re hopefully expecting is the question.

[00:36:31] Andrew

The paradigm that you’re saying is that if we admit it, we get zero. Right? So, if we ran a trend following…

[00:36:36] Tom

Zero is on the positive side, yeah.

[00:36:37] Andrew

Well, if we ran a trend following model, and so if we did bottom-up replication, and we did it like some of the firms we talked about, and we said we’re going to mechanically decide to invest these markets but let’s get rid of all the commodities, we’re going to have a much, much, much bigger impact in that case. When you’re doing a one-week factor replication, one of the statistical conclusions it’s almost like the metaphor is almost like planets and moves, if oil is moving (so in our standard model we invest in oil and gold), if oil’s moving it may not matter to the cocoa markets. But if oil is moving in a big way, it’s probably pulling other markets along with it. So, it’s not that we’re going to get zero exposure to commodities, we’ll get some exposure to it.

Now, again, there are these idiosyncratic positions that will do well, but often over short periods of time. There’s something bigger going on in the market. There’s a bigger wave out there. And these are very, very important crests on that wave.

Now, if I were trying to maximize my own P&L in terms of building one of these strategies, again, I built a commodity business in the early 2000s and that was based upon these highly, highly asymmetrical payoff profiles. But as an allocator, you can concentrate on those bets. You can make that bet, but you tend to take a lot more risk, you tend to have much higher drawdowns. It’s very difficult to model how you would have felt about those bets 15 years ago.

So, I think people often think about replication as sort of one or the other. We just think it’s an incremental tool that people can look at as they’re thinking about how to build a portfolio in this space.

And I would say that most allocators that I know well, who invest with us, combine us with other funds precisely because they recognize that we’re very open about the things we’re not doing. Like in the US people often combine us with Man AHL’s mutual fund. They’re much better at short-term inflection points than we’ll ever be. If you look at even their ETF in December, their ETF ripped in December, is great in December, again, because they’re going to get direct exposure to some of the things that are moving in December that we didn’t. So, we’ve always tried to view this as something where we can incrementally add tools to investors. Given that people are looking to accomplish different things.

[00:39:05] Tom

It just seems counterintuitive to your earlier talking about how you’re trying to replicate a portfolio, and you aren’t a single manager strategy, but then to say that a lot of your clients blend you with other single manager strategies in the way of kind of creating a portfolio or an index similar to sort of the way we run the SG CTA index. It seems quite counterintuitive to sort of one of the big areas where we’ve seen kind of innovation and developments in the CTA industries, over the last five, 10 years, which is really that focus on execution being very efficient and big focus on trading costs which, then, allows them to access more and more markets. Because one of the sort of main phrases in the industry is, diversification is the only free lunch.

Standalone, a market maybe has a trend following Sharpe ratio of 0.2, 0.3 but if you add more and more assets together you can increase that Sharpe ratio. And I’m not going to pretend that I don’t think many CTAs would say they’re achieving a Sharpe north of maybe 0.9. So, the only way you’re going to get to that point is if you are adding more and more individual idiosyncratic bets, shall we say, as in individual markets.

[00:40:19] Andrew

So, the point about the investors, so the investors, I don’t think it’s an economic decision on their part. I think it’s a client communication issue that they know that the day that SVB hits, at that point to be able to say we’ve got guys who are replicating and they’re going to be slow at an inflection point is not the only conversation they want to have. They’d rather say we’re blending that with somebody who’s going to respond better.

[00:40:45] Tom

So, are you slower in an inflection point?

[00:40:48] Andrew

Sure. Oh yeah.

[00:40:49] Tom

Okay.

[00:40:49] Andrew

Now, half the time, right we like in SVB when you have an inflection point that then goes on. It’s like SVB hits, and then, oh my God, the regional banks are going, and then, oh my God, credit squeeze is going. When it happens like that, at a very sharp inflection point, we’re going to underperform by a few, maybe several hundred basis points after the inflection point. The reason we don’t try to model around it is because half the time, the guys with short-term models, it’s actually a head fake.

We remember the SVB. We don’t spend time talking about the seven other head fakes that happen during the course of the year that are wrong-footed short-term models, or vol controls, et cetera. So, if you look at like SVB, we were slow but then, particularly the shorter-term stuff got wrong footed about a month later when the markets came back and recovered after they realized that Credit Suisse was going to be absorbed by UBS. And so, by the end of say September, or something, the replication had basically caught back up to where it was.

So, back to the point. Investors make decisions on… The whole point of doing these indices and these other products is that every investor has their own very, very specific preference function. And the reality is that there is no one-size-fits-all solution. So, I think the more I get to know investors in the space (and I know them much more in the wealth management space than I do elsewhere), is really trying to understand how do we bring a product to them that solves whatever issues they have.

I say this very, very openly. I will sit in front of clients who are hedge fund investors, and I’ll start the conversation by saying, I highly doubt you’re going to be interested in what I’m talking about at the end of an hour. And most of the time I’m right. They do want that relationship with a hedge fund manager to hear about all of the instruments that they’re trading, et cetera, et cetera.

The guy who’s running an ETF based model portfolio in the US, whether the wheat market is ripping or the cocoa market is ripping, that doesn’t really matter in his day-to-day job. What matters is finding a great diversifier that he can put into a portfolio that he doesn’t otherwise have access to in a reasonable, predictable way.

[00:43:11] Niels

I want to pivot our conversation a little bit, but I have a question before I do so. But Tom, maybe you can think a little bit about a brief description of sort of the CTA AUM evolution we’ve seen, and maybe some of the other points in terms of performance bias, etc. etc. And then of course we also have some really good topics that Andrew had brought along that we’re going to be talking about.

But I had one question that I was thinking about while you were talking about the new index. And I think you said that one of the important things are, when you do an index like what you’ve done with SG, is that your model has been consistent now for a long time, many years. Just out of curiosity, if you decide to change your model next year, two years from now, what happens to the index?

[00:44:02] Andrew

So, in every index you have the ability to change it over time, but there’s a process you go through. There’s a review committee, or something to that effect, and you publish the changes and tell everyone who uses the index what those changes were and why you made those changes.

[00:44:20] Niels

But do you change the historical performance of the day, of the index, or not? Or do you just…

[00:44:26] Andrew

No. And I think this is, again, where you get into a gray area, right? If you say, we’re launching an index today but every six months we’re going to change what we do, again, index, as we’ve described, is this very squishy semantic term that means different things to different people. The general idea is it’s supposed to be predictable and predictable means consistent.

And we are odd, from an investment manager perspective, is that our goal, the best outcome for us, is we start to do something on day one and don’t change it over 10 years. That’s very… When you talk to most people in the space, they’re talking about what’s my edge next year and how am I going to change it, and what new things am I going to find? That’s why we’ve always had very much of an index like ethos in what we do. And that, again, lines up with the wealth management world.

There’s a reason index products have taken over a lot of the wealth management world is because people say, how do I decide whether I want to invest in the space; whether I want to invest in hedge funds, whether I want to invest in private equity? Okay, well, I need 20 years of data. Or in the case of the SocGen CTA index, I need 25 years of data. And I can see, would this have made my life better over the past 25 years? And in the case of managed futures, yes, it is. Okay, that’s the first question. The next question is now, how do we get exposure to it?

Well, if you, you do that Bridge index, as you described. And by the way, when you’re talking about performance, I suspect, without knowing that’s before somebody else’s fees on that. In other words, there may be implementation fees that we don’t see when you’re looking at those numbers. And, by the way, I think it’s just a managed account platform. So, it’s not actually a funded product you can invest in, it’s rather that you have to have a certain minimum and simply go through leverage and whatever, all sorts of other things.

But the challenge is, then how do you actually get exposure to it in a way… And the reason people like indices is that you’re never wrong. If the S&P 500 goes down, it’s an issue with the S&P 500. And so, the reason we’ve gone down this path of wanting to have an index out there is because a wealth manager… You’ve brought up this issue about tracking error. Okay, we have tracking error relative to the hedge fund index, as to be expected. We have virtually no tracking error to the replication based index.

[00:47:00] Tom

Because it’s your same…

[00:47:04] Andrew

Because it’s circular, right? But that’s the same way an S&P 500 ETF product is a circular product. There’s the S&P 500 that is calculated on a certain way. It is not actually all US large cap stocks. It is a representation of US large cap stocks based upon a very specific weighting methodology. And the ETF is designed to give you delta 1 exposure to it. So, as a wealth manager, what I’m seeing is people increasingly saying, well, maybe I should just start on day one with a replication based index because, if I like it, I can actually do something with that. It could be an ETF or potentially through structured products with SocGen.

[00:47:48] Niels

Yeah, I mean, I get that and I don’t mean to always sound (when we speak) like or to be the devil’s advocate here. It’s almost like, to me, well, what if I created an index called the Dunn Capital index and then everybody could say, well, I’m investing with Dunn. And that’s great because they track the index. Well, it’s. Dunn.

[00:48:08] Andrew

You can but would you be willing to not change what you do?

[00:48:11] Niels

Well, this is the thing that actually is an interesting point. Obviously, you’re not giving a guarantee that you won’t change it, I imagine. But the other thing is, I imagine, and Tom might know something about this. I wonder how much the large managers have actually made huge changes in the last 10 years. Because I think a lot of our experience has come in the 20, 30, 40 years prior to that.

So, I don’t see managers making huge changes, frankly, on a year-by-year basis, just small tweaks because I guess also there is not too much or too many ways you can do trend following. I think where we, as managers, are consistently or constantly learning things is probably a little bit on the risk management side.

I think we are becoming better risk managers even though we are probably risk managers as a starting point. So, obviously we make small tweaks – completely open about that. I don’t think we’re making huge differences. So that’s one thing.

The other thing, because I asked Tom about this because I think this is also an important part when we compare these products, because this was my suspicion. I think I mentioned this to you, Andrew, a while back. I was thinking, well, maybe indices are a little bit disadvantaged if some of the managers in the index don’t report interest income in their return stream because clearly, you’re comparing it with a product that has interest income like any other fund. And it did turn out, actually, that 25% of the managers in the SGCTA index do not include interest income. So. there is a little bit of something, at least, people should be aware of.

But Tom, when you look at managers trend followers. Before we move on to the point I wanted to move on to about the evolution of AUM, which I think has not really moved much in the last many, many years. But I could be wrong here, But do you think trend followers that you meet with make big changes to models as such or…?

[00:50:21] Tom

Well, I was going to say it ranges of interesting questions when you talk about an index having a consistent methodology. But if your methodology is to track trend followers, of course you can be making changes under the surface. And I’m sure Andrew, your principal component analysis is changing the composition of the portfolio similarly to how a CTA would maybe be changing their allocation of risk and portfolio construction. But also, you’re tracking an evolving portfolio. You’re not tracking a portfolio which is a static portfolio. Every year we change the constituents and those individual constituents are updating their models as well.

So, I would argue that your top level objective hasn’t changed, but the way you implement it is slowly evolving in a similar way to how a research process might be happening at an individual CTA. And it’s really something we see a lot of. You think, going back again to the areas of innovation, trading and execution is one of them but the other one is risk management. And Niels, I think you make an interesting point. I don’t think CTAs are developing new trend following models.

Trends are pretty easy to recognize. It’s the implementation of the model, the allocation of risk, the recognition of trends overextending or pulling back that is very, very important. And I’m sure you would have maybe more concern if someone had access to your investment committee and how you were managing risk than maybe if someone saw, okay, you’re using a moving average crossover model because that’s pretty much standard off the shelf kind of stuff.

And so, that kind of focus on risk is the important side. And I think that’s where maybe you touched on the depth of drawdowns that certain low-fee products have maybe got different characteristics to the SG CTA index.

There’s a big, big focus on the management of risk and trying to create a profile that investors are going to be interested in, and which is going to be delivering the best product for an allocator.

[00:52:30] Niels

I wanted just to maybe you can give us a little brief thought on sort of the AUM landscape and how that’s evolved from, as I said, from my experience. I know it’s, I think it’s Barclay Hedge that I normally look at when I look at AUM. You may have better data than that, but I always see it stuck between sort of $400 billion.

[00:52:51] Tom

I think that’s right. I think we had to be a big period of growth in the late 2000s. So, like in the 2009, 2010 when it got up to $350 billion, and that was sort of correspondingly shown in the assets represented by the SG CTA index. I think there’s that kind of corresponding growth. It’s been fairly stable since then. I think it’s bounced as you say, between $300 and $350.

Post 2014 there was a small uptick on a record year, but the big growth has really been on the back of a knockout performance in 2022, where the performance was very strong. And so, assets have kind of organically, through that performance, but also on the back of increasing investor interest in the strategy, there has been that corresponding uptick.

I think now, when we do the annual rebalance, we get very clean asset data because asset data can obviously be very self-reported and hard to interpret. But we’ve seen the cutoff. So, that’s the number 20, so, how large do you have to be to get into the CTA index has grown quite rapidly and that’s really quite interesting. Back in 2010, to be in the index, you had to be approximately $800 million. That then grew to one billion in 2016 and then accelerated quite rapidly to north of one and a half billion in 2019 and has now reached (what is it going to be for this year?) was 1.82 billion.

So, it’s kind of continuing to grow and that’s where I think we’re seeing the growth is in that medium sized group, especially in the trend following space. I kind of mentioned earlier that trend is 80% of the CTA space and there’s that automatic association of trend following with the CTA world.

To be in the SG Trend index, which is only the top 10 CTAs, the smallest size is $4.8 billion assets under management, and I think that space is the one that’s become really, really commoditized. It’s a space where we rarely see new entrants unless they have a very unique feature to what they’re doing. Now, that might be, as Andrew’s sort of was saying, an access vehicle, an access route which is really interesting. But typically, it’s more around maybe a focus on alternative markets or it’s looking at something different. So maybe the employing of machine learning techniques.

I think almost 90% of new start quant, what we would call a CTA, is not necessarily going to be in the trend following space. And it’s maybe a slight evolution of the newer groups that we’re seeing emerging, are operating not as a CTA but becoming more and more multi-asset quant – almost like a quant multi-strat group. They’re targeting high Sharpe returns and incorporating models across a whole different variety of approaches and deploying those not in a pod structure how a multi-strat would do it, but more as a collegiate research team.

And these are groups often that come from a variety of different backgrounds, and they maybe, explicitly, don’t want to be part of a pod shop like a multi-strat, but they’re quite happy to run 1.5, 2 billion in assets. And it’s a really interesting space. I think more and more of the CTAs are maybe pivoting into that multi-strat space as well. They want to be able to deploy risk in equities as well as futures. In FX they want to go more and more short-term to extract more interesting returns from markets. And it’s something where we, as a prime broker and a clearing group, are seeing more and more interest with our cross-asset capabilities, especially as we can cross margin everything in a very, very efficient way.

[00:57:06] Niels

Could you replicate a Pod shop, Andrew.

[00:57:10] Andrew

Like a Millennium? Like those guys? No, absolutely not. Those guys are incredible. Their Sharpe ratio is at 2.2, or whatever. No, look, the thing about replication is that you have to know what you can replicate. And I think part of the thesis of this discussion… I mean, Niels, you said look, the industry hasn’t changed that much in 10 years, right? And Tom has said that like ‘core trend’ hasn’t changed very much. We’re picking up on mostly (I mean I again it depends on how you define it), we think we’re mostly on medium-term trend, maybe longer-term trend.

And the thing is, the reason we went this route (because we could have built our own medium-ish term trend models like other people have done, Corey Hoffstein and Katy Kaminski have – they incorporate their own various models), the reason we did was actually because of a belief in evolution. And if you go back to 2015, 2016, when we first started looking at the SocGen CTA index, it’s a very, very, very different group of guys back then. And I mean there are some guys who’ve got currencies in their names or something.

And so, our expectation actually was that the industry would change more over time. And instead, what had happens is it seems to have settled into there’s this kind of core trend which is going to be a little bit cheaper, it’s going to be a little bit more commoditized, there’s going to be sort of more focus on risk controls and other things to avoid the crazy drawdowns, and then there’s going to be a lot of focus on other things. And the whole point of doing it, with just these kind of one week, very, very short-term model, sort of like the paradox is you’re trying to just…

I’m much more comfortable making a one week bet in an industry that I think will change over time than I am locking myself into a particular way of doing trend or a particular way of approaching the space today and expecting it to be right in 10 years. So, to me it’s absolutely fascinating and I think when we talk about the AUMs of the space, what I see is a very, very, very loyal and stable constituent of investors who are sophisticated, who view this as something that brings great value to their portfolio from a broad diversification perspective.

But even though the overall allocation is tiny relative to their portfolios, the typical US pension plan has 8% of their portfolio in hedge funds, of which 6% is managed futures or trend. So, one of the most valuable things they can put in their portfolio is locked at a 50 basis point allocation.

Because the people who oversee the hedge fund allocations won’t say let’s get rid of equity long/short, let’s get rid of this, let’s get rid of these things that haven’t added value in a very, very long time and are very expensive and very difficult to implement. It should be half the hedge fund allocation just statistically. But the people who make that decision are very wed to the existing portfolios they have; their particular way of looking at things. And that’s part of why what we’re trying to do outside of that $300 billion is get people to say, this doesn’t need to be in a hedge fund strategy.

Back in the 1990s this wasn’t in the hedge fund bucket back in the 1980s. It wasn’t in the hedge fund bucket, it was put into the hedge fund bucket and that’s actually limiting growth of the space. Because this is one of the few hedge funds you can say that, on a standalone basis, this deserves a place alongside REITs, infrastructure, or whatever, whatever, whatever. Just because the fiscal benefits are that strong.

[01:00:49] Tom

Yeah, I think you’re very right. It’s definitely a lot of investor pushback on how they view it and can they make a large enough allocation to it? I don’t know where it necessarily comes to, whether it’s quant aversion or just the periods that are often seen where it’s been difficult to pick a CTA which has delivered consistent returns.

I think we do see two interesting developments. One is a more definite uptick in interest in importable alpha solutions. So, moving from a model portfolio of sort of 60/40, or 60/20/20, or I don’t know what, the small 5% allocation to CTAs, where they can actually overlay the CTA or the alternatives allocation on top of their equity portfolio and achieve a 60/40/20. That definitely seems to have been an uptick in interest and something which is very, very well suited to the CTA industry operating on margin. These strategies are relatively easy and cheap to implement.

And the second one is really aligning the expectations of the investor of how they allocate. How do they put the CTA’s objective in their portfolio? And I think it goes back to what you were saying. There’s this misalignment of expectations.

The CTA is meant to be this non-correlated diversifier but paid on an absolute return. But they still, fundamentally, in their mind, if equities are up 25% (as we saw this year), CTAs were only up 2%. That isn’t objective achieved, that is objective missed because the CTA has underperformed. But that goes against the original objective of why they added the CTA to the portfolio.

So, CTAs are constantly criticized for doing one or other of the things wrong. Either they have too much correlation to equities because they are participating in equity trends, or they’ve underperformed but been very non-correlated because they weren’t allowed to participate in equity trends. And it’s a really difficult question to get the result.

[01:03:02] Niels

Now let’s pivot to Andrews as we start to slowly wrap up because that is some interesting things you brought along; some American pop culture reference as well. So, let’s dive into it.

[01:03:17] Andrew

Well, so, back to Tom’s point. I think one of the problems that I run into with allocators all the time is they see the statistical benefits of the space, but it doesn’t fit into their view of the world. And I really think it’s a narrative issue.

I think part of the problem is, when you go back to who were the original trend following guys? I had this great discussion yesterday with a guy who was one of the original hedge fund allocators to the space.

I think he may have seeded Winton. I think he may have been an early investor in Aspect. I mean, he was there in the very beginning, and he said, even from the very beginning, hedge fund guys, the people who were making allocation decisions, they wanted to sit across the table and hear Alan Howard talk about his view of the world, or Julian Robertson talk about this stock or that stock. It was very different.

And, and the ethos of trend following was well, we look at prices and we extrapolate from it. And that doesn’t fit into their model of we want somebody who’s going to show us how they have an information advantage. Why this is valuable in my portfolio.

And so one of the things that actually, I was listening to, Niels, your podcast with Graham Robertson at Man AHL, and when I was in London I asked to see him because I said, you said something in it that I found really, really interesting, which was, you know, basically that CTA basically got the market – got it right. CTA’s got the market right.

We ended up having this conversation where I said, look, I know that people focus on trend following, but that doesn’t land with most investors because (and Nick Baltas and I talked about this, he brought this up on the year end thing), basically, it’s not that people can’t see the benefits, it’s they feel it shouldn’t work because past prices are not supposed to be indicative of future performance. It’s not supposed to work in the same way.

What I think is that I think the focus on following prices misses the point for most investors, which is, what is it that the prices are telling you? The prices are telling you that information is changing. The market’s view on things is changing.

And so, when we talk about why the CTAs are positioned the way they are, think about what the experience is of a typical allocator. You make the very best decision you can today across your portfolio based upon all the information you have. Six months from now, everything’s going to look wrong. Whatever you thought Apple stock was worth six months ago, it’s going to be 20% above, 20% below. It’s going to be all over the place.

Asset classes don’t move in lockstep the way asset allocators would like where you take a little bit more volatility, you get a little bit more return, et cetera. It’s very, very unpredictable. And the unpredictability is based upon changes in information because the world will be different in six months.

We start off talking about, you know, the guys who are coming into the US, and this whole political and geopolitical backdrop. Things are going to be very different and unexpected in six months, and that’s going to flow through markets.

So, to me, the value and the semantic shift around it, which is not original but I think it’s something I’ve come back around to, which is, basically, the way we can get an allocator to think about this in their portfolio is that the reason you analyze prices is to essentially extract information in the markets as the information is changing. There are certain unconstrained investors.

A Stan Druckenmiller, in early 2021, who makes an inflation call. He’s more flexible and he can see things coming. And so, when you start to see things move, like interest rates move, CTAs will pick up, but it’s the information they’re picking up on. And that information is very, very valuable, particularly at inflection points. Because the great weakness of every institutional allocator is they are slow by design. Even when the house is on fire, they’re not going to leave until it is absolutely certain that the house is going to burn down.

So, there is something in this, and I will continue talking to everybody in this space about it, but I think there’s something jarring about it. So, I think the more we can get people comfortable with the idea that the alpha here makes sense, and it’s based upon information advantages and taking contrarian trades. The more the language lines up with what a typical multi-asset or hedge fund allocator is looking for, the easier it is for them to get comfortable holding this through periods.

I look at 2024, and I look at this space as having gotten the information change right early, and dialed into equities early in the year. We hadn’t been long equities in a long time. The first quarter we were dialing into long equities, we were dialing into basically for most of the year, had rates that would remain higher than people expected. This wasn’t going to be the year of the bond, as people thought.

So, though the changes in information were correct, what hurt the space, I think, was the whipsaws in sentiment. Yes, the world was changing and the CTA’s got it correctly, but people really believed it for a few months, and then went completely in the opposite direction for a few months, and then kind of went… So, the sentiment was very unstable, but the underlying change in information they got right.

So, I think if we can just pivot the narrative a little bit into language that people are more comfortable with, it’ll be easier to get people to view this as a strategic allocation, something that should be in their portfolio today, 5 years to 10 years, irrespective of those short-term moves in performance.

[01:09:21] Niels

Yeah, I mean, I know you’re good at narrative, so I wouldn’t doubt that you’re right. And of course, it’s part of what has been a constant theme in the last 10 years of the podcast, and actually throughout my career, is the fact that, how can we better explain this industry? And it’s not because we haven’t tried a few different things, but the information part is new. So, that’s an interesting thing.

[01:09:52] Andrew

I’m glad you think it’s new. I wasn’t sure if it was new or not.

I had dinner with Rob Carver in London as well, and I was bouncing it off him and he talked about a lot of academic references to information, and slow adoption of information. I think maybe the twist is, you know, frame it in the context of the alpha in the space, it’s not Man AHL against AQR, against Aspect, against Linked. Alpha in the space is not zero sum. This space is trading against every slow moving investor out there. And every slow mover investor, if they look at themselves in the mirror, they say, you know what, as human beings we really shouldn’t try to be tactical with our portfolios.

And so, what managed futures then becomes is a completion strategy for a broad multi-asset portfolio. That then allows you to pull it out of the hedge fund bucket into a standalone allocation. And then you can make the argument that, hey, out of your hundred dollars that you have invested maybe 3% should be in this, not 20% because of the issue that Tom raises that at some point everyone’s going to hate you because the S&P is going up and this is not. But enough so that in a year like 2022, when the upper 97% of your portfolio is going down at the same time, you have this beacon of green you can point to; something you can point to. Because the diversification argument that managed futures funds use about more and more instruments also applies to asset classes; 20, 30, 40 individual asset classes – this should be one of them.

[01:11:30] Niels

You’re very quiet, Tom, but nodding along the way. Any thoughts on this before we…

[01:11:36] Tom

No complaints from me. I think Andrew raises a lot of very good points for the industry. And it’s just getting that understanding and the interest in the industry and in the strategy, which is going to be, it’s going to be the thing that helps the growth, you know, from $350 billion to the $400 mark.

[01:11:56] Niels

Sure.

[01:11:56] Andrew

Trillion.

[01:11:57] Niels

Well, there might be one other factor that’s going to get to the $400 billion. It starts with a B, and it has a color black. And then there’s a rock at the end of it. Andrew, you brought this up. What’s going on with BlackRock?

[01:12:12] Andrew

Okay, so BlackRock filed a prospectus to launch an actively managed managers ETF in the US. As happens when people launch prospectuses or prospecti (I’m not sure what the plural is), there’s a lot of missing elements of it and there’s a lot of boilerplate language. But I think in my email to you I said, the death Star cometh, right?

So, BlackRock is different from almost anybody else who could come into this space in that they are not just asset managers, but they are also opinion leaders as it relates to the structure and configuration of model portfolios, particularly in the wealth management space, but also in the institutional space as well. And so, a lot of what BlackRock understands is that if something becomes a strategic allocation, private credit, private equity, et cetera, it doesn’t go from 0 to 5, it goes from 0 to 100, to 500, because you get trillions and trillions of dollars of pools of capital start to move in that direction. In the US ETF world, there’s $12 trillion of capital right now, of which the entire managed future space is maybe two and a half billion.

So, this is either incredibly good for the Managed Futures ETF world in that if BlackRock comes in, it adds value, it validates the space, and BlackRock controls not only zillions of dollars of their own models. So, if they start putting in this fund in their own models, the AUMs are going to spike. It’s going to make our growth look like child’s play.

They also control the software, called Aladdin, that many wealth managers use to determine their own asset allocation models. And people rely on BlackRock to tell them what a diversified portfolio should look like. So, if BlackRock, if this signals that BlackRock has made a decision that when they do that analysis that managed futures, as a category, should be a 2% or 3% allocation, you start to see true, what I’d call institutional type adoption across the wealth management space.

Now the wild cards that we don’t know are how they’re going to price it, whether they’re going to be any good at it, whether this is just kind of putting their toe into the water to make sure that… We don’t know. There are a lot of things that we don’t know at this point. What’s interesting is that the PMs of this are not managed futures people.

One PM is, I think they’re head of quantitative Fixed Income Strategies and other is head of their Quantitative Equity Strategies. And they both come, it looks like, from the old BGI Barclays Global Investors business. And I think they’re based in San Francisco.

So how this all plays out I don’t know but it’s either phenomenally good news for growing the pie. Whether they then also make a push into to try to take assets from hedge fund investors for the hedge fund, again, I don’t know. But it’s big news one way or the other.

[01:15:29] Niels

You had some big news yourself, actually, just to round things off about another index, or maybe not another index.

[01:15:37] Andrew

Oh yeah. So, when we first started to replicate the managed future space back in November 2015, we did it for a mandate that we had for a UCITS fund. And so, the strange thing about replication is that because you’re only making these short, one-week bets, it’s actually not that sensitive to what instruments you use because you’re essentially making a short-term correlation bet on the market. So, when we first did it in the context of a UCITS fund, it was very, very difficult to get exposure to commodities.

So, we basically said, all right, let’s see if we can replicate the managed future space but without commodities. Where this has become interesting is, so we now have a nine-year track record of having done that but it’s in the context of this fund. It’s not a standalone product. What I’ve seen in my travels is that you get very, very, very different preference functions among investors.

And there are certain investors, more so in Europe than here, who just don’t like investing in commodities but really want more ways of getting diversification, so within the context of their own constraints. So, in one of my trips to Europe I met with some investors who it’s very difficult for them to invest in commodities. And I basically said, well, maybe we have an answer for you.

If you like the space, and you want to get similar kinds of returns over time, but without exposure to commodities we have a way of doing that. And so, we’ve been working with Tom and his colleagues, at SocGen, basically to bring out a non-commodity replication-based index.

And so, the idea is, and I think Tom in like an investor survey for this pub that came out a couple of months ago, around a quarter of European investors are looking for things that are ESG sensitive. So, can you build a product that allows an ESG sensitive investor, or somebody who’s restricted on commodities, to get exposure to space?

It’s very hard to do that in traditional trend following because, as we talked about when you start kicking out asset classes in a traditional trend following model, you really do lose something. But if you can do it with replication, then start with an index, talk to people at the index, and then maybe SocGen can provide exposure to this index in that fashion. So anyway, it’s all about just trying to understand different investors and whether we can build things for them that meet different criteria.

[01:18:07] Tom

And Andrew, will you be substituting the commodity exposure for something else which you think has maybe a high correlation or similar performance characteristics or will you just simply be excluding? Because it’s something we see a lot of in the European investor base, this inability to touch commodities for various kinds of constraints.

And it’s really divisive when it comes to the hedge fund or the alternative UCITS space about because there are various structuring solutions, and SG is like a leading Europe bank, and we continue to push that innovation with ways of structuring exposure to these kind of asset classes via structured notes where there is demand for it, working with US and European groups. But on the investor side, it’s definitely splitting the consensus of the UCITS kind of ESMA guidelines and the way the deregulatory is interpreted is that there shouldn’t be any exposure to commodities.

And then some of them fall down the line of, well, I really want to have the best product that has as many asset classes in it and has those diversification benefits that commodities bring. And therefore, they’re happy to have the structuring solution which allows them to have the commodities added to the portfolio via a different source. And so, are you going to be, essentially, are you going to be hopefully replicating it in a different form or are you simply going to be excluding it?

[01:19:34] Andrew

So, what we do is we add the Australian dollar and Canadian dollar, so we’re in currency land. But as proxies, it’s imperfect. It doesn’t work quite as well. So, if the replication model, over long periods of time, outperforms the hedge fund index by 350 basis points, this will outperform by 250 or 300. If the standard replication model with Golden Oil has a correlation of 0.9, the slave has of a correlation of 0.8. But again, as you say, product structuring is alive and well. You know, it is entirely possible we’ll show it to people and they’ll say, oh, we already solved it because, you know, somebody came up with some incredibly clever solution. This is just pretty straightforward and, I think again, a relatively simple and elegant way to get to it.

It may, it may not be the only solution, but what it does, for instance, is it creates the possibility that if you manage the collateral, in an ESG compliant way, or you do a portable alpha overlay, it opens up a lot of things because if you’re doing it with 10 futures contracts that are easy to trade, it’s structurally extremely efficient and extremely flexible. So, we’ll see. We’ve seen some indications of demand from a limited pool of investors. We’re going to work really hard to come back to them with ideas that they think are attractive. We’ll see how they respond and we’ll adapt.

[01:21:05] Tom

Yeah, I don’t want to… I’m going to open up a whole new topic here which we could talk about for hours. Niels, but on the ESG side, I think it’s really interesting that there’s no CTA that really exists at the moment that has that “kind of ESG stamp”, and that is an SFDR, Article 8, Article 9, certified fund. And I think that’s the interesting challenge for the industry in Europe. Can someone think of a way, legitimately, that fulfills those requirements? Because at the moment it’s really something which is hard to do.

That sort of first, kind of, ESG Version one, per se, was to have that exclusion of bad stocks if you’re thinking about a simple equity portfolio. But it’s very hard to translate that to futures. Futures being a zero-sum game; for every long there is a short that offsets it. So, can you be short commodities if you have a negative view on them, but then there’s still going to be the open interest on the long side? And is your objective to price the use of, let’s say, carbon emitting things out of the market or to reduce them so that no one wants to produce them?

And so, the big challenge has been the way derivatives are viewed from an ESG kind of metric, or lens, is very unclear, and everyone seems to have different opinions on that.

[01:22:29] Niels

I’m sure we’re going to come back to this topic. It’s an interesting idea, replicating commodities without trading commodities, I find it an interesting challenge. But for time constraint purposes, we will wrap it up today for this.

I will say one interesting little anecdote in this commodity discussion. I was actually looking at historical contributions, by market, for each sector that we trade, and looking at it over, say, rolling 18 years, 10 years, 5 years, 3 years, 1 year data. And there were two sectors where the average performance for each market was positive throughout all the different rolling time periods.

[01:23:22] Andrew

Right.

[01:23:22] Niels

One was grains, the other one was softs. So, just to throw it in and say commodities can be quite useful and very important in a CTA portfolio.

[01:23:36] Andrew

And that’s sort of my point. It is very, very hard to solve. What Tom is saying is that there is… We have no idea the demand.

[01:23:44Niels

Well, I think the demand is there if you can deliver it.

[01:23:47] Tom

It’s the unification of the demand into alignment of what everyone can then have.

[01:23:52] Niels

And I think you only need to go to one country. Andrew, this is a secret marketing tip, just go to Germany.

[01:23:58] Andrew

So, Germany is weird though, right? Because I have talked to people in Germany, and you can’t do it with agricultural commodities because they don’t want you betting on foodstuffs. But they’re fine with gold, oil and everything else.

So, the reason I’m saying, we think that there is huge untapped potential, but you don’t really know. If you go to an average investor and say, if I could give you Man AHL’s Evolution Fund but in an Article 9 wrapper, right, everyone’s going to say, yes, of course, right, of course, I’ll take that. It’s not practical and realistic. You’re not going to find out what they really think until you’re standing in front of them and saying, okay, here we are with something you can actually invest in today and would you like it?

So that’s the fun of this, though, right?

I mean, the fun of it is sitting in front of investors and finding out, like when I talk to people about our ETF in the US and they start off the conversation and say, well, what are you looking for? Something with low correlation to stocks and bonds. It’ll do well in a crisis. It generates a lot of alpha. It’s in an ETF and has reasonably low fees. My conversation is, well, why would you not invest? That’s to me, a more interesting question. And what is it?

And that’s when it comes down to the narrative. It comes down to how do I explain it to my client sitting across the kitchen table. And so, we’ll find out over the next, however long period of time, as we get more specific, and hopefully we’ll be able to refine it in a way where a lot of investors will breathe a sigh of relief when they hear about it. And again, for me, I’d rather focus on areas where we can strategically expand the pie by bringing a product that you can’t deliver under normal circumstances.

That’s a much better use of my time than trying to shake some guy who’s been invested in hedge funds for 20 years and have him give a quarter of his allocation to us. Why would they spend time doing that?

[01:25:58] Niels

Absolutely. Super interesting conversation. I really appreciate both of you for coming on, and I think it’s a great way to kick off another year with such a deep dive, but also quite broad conversation and analysis, really, of the CTA space and where we are. And as I said in the beginning, I think it is also at a very critical time, actually, for our industry. So, I really appreciate that.

Hopefully we can do this again later in the year with both of you on. It’s a great dynamic. And if anyone out there listening feels the same way as I do about these conversations, and certainly the inputs from Andrew and Tom today, why don’t you head over to your favorite podcast platform, leave a rating and review to show your appreciation for all the information that they provided today.

Next week I’ll be joined by Cem. He will be back with, I’m sure, some interesting predictions maybe for the coming year. He was very right about 2024, so that’ll be interesting. And if you have any questions for him, you can email them to me info@toptradersunplugged.com and I’ll do my best to bring them up next week.

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

[01:27:18] Ending

Thanks for listening to the Systematic Investor podcast series. If you enjoy this series, go on over to iTunes and leave an honest rating and review. And be sure to listen to all the other episodes from Top Traders Unplugged. If you have questions about systematic investing, send us an email with the word question in the subject line to info@toptradersunplugged.com and we’ll try to get it on the show.

And remember, all the discussion that we have about investment performance is about the past, and past performance does not guarantee or even infer anything about future performance. Also, understand that there’s a significant risk of financial loss with all investment strategies, and you need to request and understand the specific risks from the investment manager about their products before you make investment decisions. Thanks for spending some of your valuable time with us and we’ll see you on the next episode of the Systematic Investor.