Drawdowns Don’t Lie, But They May Mislead ft. Alan Dunne

[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 Alan Dunne and I, Niels Kaastrup-Larsen, where each week we take the pulse of the global market through the lens of a rules-based investor. Allan, how are you doing? It’s great to be back with you this week.

[00:00:37] Alan

Very good. Yeah, all good here. How are you doing?

[00:00:40] Niels

Doing well, except we might be completely frank about it, at the top of the hour, and that is we’re having a little bit of a technical problems. More specifically, I’m having technical problems today, so hopefully it all goes well. But, of course, it’s always stressful when that happens.

We got a solid lineup of topics. That’s why we really want to make sure we get this recorded today. But before we get into all of that, Alan, as usual, I’m always curious to hear what’s been hitting your radar the last few weeks.

[00:01:11] Alan

Yeah, it’s been action packed and plenty to talk about as usual. I suppose, with equities hitting all-time highs again this week, it’s worth talking about that. I saw a post which highlighted that it was the fastest recovery from a 20% drawdown for the S&P 500 in the last number of decades since the post war period. So, I think it was a 21% drawdown and a recovery back to new highs in 57 days. So, we’ve seen that kind of fast recovery before. Obviously, people will point to Covid as an example of that, but actually it was much faster this way. The recovery in Covid took 107 days.

There is a parallel, back in 1998, when equities fell around the time of the Russian debt default and LTCM and then rebounded in 61 days. So, we have seen something similar before in that period. Interesting when you look back at those two periods, they were both rebounds that coincided with significant Fed stimulus. There were three rate cuts in that September 1998 rebound.

Well, starting in September ‘98 and then obviously, during COVID, very aggressive Fed easing and asset purchases at that stage. So, it’s interesting. This time we’ve had to rebound very quickly, very fast. Even without that. You could say, I suppose, the reversal on tariffs might have been seen as some kind of stimulus. But I do think, to point to, the buy-the-dip mentality is very much alive and well and strong. Sentiment is very Bullish.

Now in those two cases, the rally went on to continue for about a year before we saw the reversal. So, who knows. But interesting to draw the parallels.

[00:02:59] Niels

Yeah, yeah, absolutely. The simple conclusion of course is the less the does, the quicker the rebound. So, that’s an interesting twist to comment or acknowledge, I would say. Absolutely, good stuff. I was not aware of that stat actually. So, that’s interesting for me.

What’s been on my radar is a few things, of course. One is that this week, I think it was, that my country of birth, Denmark. took the EU presidency for the next six months at obviously very interesting time, not just for European policies but for geopolitics as a whole. So, hopefully something good will come out of that. Maybe even it’ll give a boost to the Danish women’s football team as they start the European Championships here in Switzerland. You never know, it might help.

But of course, on the more usual scene, we just saw, in the last day or two, that Trump got his new Beautiful Bill through both houses. And so, it’ll be interesting. Obviously, a very, very narrow passing of such a big important set of legislations. So yeah, interesting how things are done nowadays with a few arm twists and threats in order to get things done. But maybe that’s just the way our democracy has started to work as well.

Other than that, I just thought it was interesting that Nvidia now is very close to being the first company at 4 trillion in valuation. That’s just astonishing.

Anyways, let’s run through some more June related trend following updates as we just started the month of July. In fact, we’re recording in the evening of the 4th of July, here in Europe. My trend barometer finished at 57 yesterday. That’s a rise over the last 10 days and that probably corresponds well with what’s happened in the industry in terms of performance the last couple of weeks as well. So that’s encouraging.

Obviously June was, from my perspective at least, I think it was a mixed month where perhaps how you dealt with the energy shock mid-month, I guess it was, when we had the surprise attack on Iran. That sent oil prices surging, catching, I think, a lot of trend followers on the wrong side, And of course, those who were quick enough to get out of those short positions, they didn’t get any benefit from the collapse in oil price only a few days later when the US got involved. Hopefully we’ve seen an end to that conflict. But other than that, I think the month, as a whole, was overall positive.

But I would say managers probably are going to come in plus/minus a couple of percent, for the most part, depending a little bit on speed, depending a little bit on positioning, as I said, in particular in the energy sector, most likely.

In terms of indices, the BTOP 50 index has started out July, up 30 basis points, still down 3.16% for the year. The SocGen CTA index down 21 basis points so far in July, down 7.8% of the year. SocGen Trend almost flat, down 11 basis points but down 10% for the year or so. And the Short-Term Traders Index, interestingly enough, it’s slightly up for the month of July, 16 basis points, but it is now down 5.15% for the year and, on a vol adjusted basis, that’s pretty much as bad as the SocGen Trend index.

So, despite the fact that, as you referred to in your segment, about a very, very fast recovery (meaning markets have changed direction very quickly), it doesn’t seem to have benefited short-term models as much as you might think in a range bound erratic market as we’ve seen because that certainly isn’t a market that you would expect longer-term managers to do well in, and in fact, of course, they haven’t.

On the traditional market side, MSCI World up 91 basis points, up 9.5% so far this year. And the S&P US Aggregate Bond index is down slightly in July, 43 basis points, up 3.44% so far this year. And the S&P 500 Total return up 1.2% and up 6.76% so far this year.

Of course there were some interesting moves. I don’t know how closely you follow this, Alan, but there were a couple of big swings, actually, in the month of June and not least the one that took all the headlines probably, platinum up almost 27% in June and I think, according to some long-term timeframes, breaking out to the upside. So, that’s interesting.

Of course to the downside, we also had significant downside moves, 12% in coffee for example and cocoa also got hit in the month of June. And of course all the equities did really well and oil, in the end, actually also at the end of the month had done pretty well. So interesting stuff.

What’s your kind of takeaway on trend at the moment?

[00:08:27] Alan

Yeah, obviously we’ll get into the overall performance a bit later in relation to a couple of papers, but June, I mean my perspective was I would say generally slightly positive overall looking at across the range of managers. Certainly, we saw the trend in the dollar was probably a dominant theme, particularly against European currencies. Euro up above 117 – capable trending higher, dollar/Swiss at multi year lows.

So certainly, the trend extending there and obviously in equities as well. But then elsewhere, you know, a whole range, as you say, depending on how oil went and lots of choppiness in some of the commodities.

So, the noticeable thing, I would say, is realized volatility has come down quite a bit where you can track daily return data. So, I’m guessing that’s probably not unusual in the aftermath of the spike and volatility that we saw in April, that positions have been scaled back and resized. So that’s sort of a feature that I would note at the moment.

[00:09:33] Niels

Well, before we jump into the papers you mentioned where we’re going to do much more of a deep dive. We certainly don’t want to leave out one of the exciting segments we have in our conversations. And that’s your global macro overview at the moment. I mean it just keeps giving, if you’re a global macro kind of watcher. So, what’s your current assessment?

[00:09:57] Alan

Yeah, well, I want to just… I mean I always have to kind of zero in on one aspect, and last time it was bonds. And I just wanted to continue on that theme. You know, it must have been a couple of months ago now, or maybe a month ago, I wrote a piece, All Roads Lead to Higher Yields. And obviously, as soon as you write something like that, you brace yourself for yields to fall precipitously. But I mean, they haven’t done that, but they have corrected a bit. And you mentioned the Beautiful Bill. It has been a little bit of a surprise that the bond market has been relatively calm about that, I would say. Obviously we had payrolls yesterday and yields went up on the back of that. Payrolls were stronger than expected, but generally, yields prior to that had come off highs by about 50 basis points.

Now, partly that was interest rate expectations. We’d had Waller out and Bowman, two Fed governors who seem to be more amenable to Trump’s persuasions around cutting rates. So, they had been kind of saying they were open to rate cuts in July. But that aside, even the rate expectation angle aside, term premia have come down and the curve has flattened a little bit as well.

So, I’m just wondering, is the curve steepner maybe widely held in the market? Maybe it’s a trade a lot of people have on, and that’s why we haven’t seen much reaction in the long end. Because certainly taking the bigger picture, the development with respect to fiscal policy and the Big Beautiful Bill, it’s kind of consistent with the trend that we’ve seen on a multiyear, multi decade basis, and that’s just of ever larger and larger deficits.

And in that piece I mentioned, I had a chart where if you basically look at the relationship on an annual basis between the fiscal deficit and the level of unemployment, it’s a pretty clear relationship historically.

Generally, as unemployment increases, you get a higher fiscal deficit, which makes sense because in times of recession you’ve got less revenues and you tend to pay out more in welfare. But what’s noticeable is that there’s been a structural shift.

So, the kind of deficits that we’re seeing now, 7%, 8%, used to be associated with kind of economic crises, whereas now we’re getting this kind of level of deficit with the unemployment rate close to full employment. So, the question is, what’s going to happen in the next downturn?

So curiously, if we do see weaker economic growth, that probably does take the heat out of the bond market in terms of fears of higher bond yields in the short-term, but it would probably push up the deficit even more.

So, when you get the subsequent recovery and you’d have to think that these pressures will come back. So, at some point, you would see the pressure for higher yields. It is something I spoke to Barry Eichengreen about. I definitely recommend that conversation I had with him on the Macro series, a few weeks ago, because he wrote a paper about this two years ago and presented it at Jackson Hole. So, I was very curious to get his perspective.

He’s literally in the room with Powell and all of these central bankers. His perspective was, at the time, central bankers expected governments to make more progress on addressing deficits. You were seeing deficits of maybe 5% to 6% back then, this is two years ago, which were seen as high, but the expectation was that that was going to be addressed. But actually, they’ve just got even bigger. So, he had got much more pessimistic. I thought it was quite noteworthy that he had got much more pessimistic on it.

And the other thing I’d point to, if you look at the experience of the UK this week, Labor, there was a highly anticipated welfare reform where they were going to really announce quite significant reforms and cutbacks on welfare. Basically, there was a huge U turn and now it’s kind of the can’s been kicked down the road again. The expectation now is that they’ll probably have to raise taxes in the autumn.

But it does highlight, again, the political backdrop to this is now is that there is zero appetite for austerity, there’s zero appetite for a political will, political consensus to address deficits. I think that stems from the 2010s when we had zero rates for so long. So, when Covid came along it was easy to spend freely. When the cost of living crisis came along, people expected more handouts and got them. So now, you kind of got a fiscal addiction that stemmed in the last decade, but it’s proven difficult to change.

So, I think all of those points still point to higher bond yields at some point. And obviously, since I was last on, we’ve had even more noise from Trump about a potential early announcement of the new Fed chairman. You know, there’s lots of speculation around who that might be. There’s a whole range of names, all kind of well known. But clearly, you’d have to think that it’s not going to be a positive outcome.

I mean you can make the point that, okay, the chair is only one vote and ultimately, it’s the whole FOMC committee votes on rates. But it is an influential seat and all it takes is just one influential chair to tilt the narrative, tilt the balance of the discussion towards a much more dovish Fed. So, I do think that’s another very negative aspect to it.

And one other thing that I thought was interesting, the FT had a report, a couple of weeks ago or last week, highlighting the outflows from the long end of the US bond market. So, I think it was about $11 billion in outflows of long-term bonds across government and corporate bonds. So, kind of curious that yields haven’t moved given that backdrop.

We have had the positive development of the liquidity ratio, the banking where banks will have to hold less capital against holding bonds. I mean that has progressed, it hasn’t come through yet. So that could be one positive development in the background.

But when I look across all the major drivers, the big picture, the fiscal situation, it is somewhat surprising we haven’t seen more of reaction this week. Maybe it’s a widely held position, but I do think the structural trend is still for higher yields over time.

[00:16:33] Niels

Yeah, well, I mean one thing that kind of supports that is, I guess with this new bill issuance and also, I think, issuance has been pretty low so far this year. I would imagine they would have to issue a lot more extra Treasuries, probably bills, in the autumn than relative to what they would otherwise have. And that should put pressure on rates to the upside and maybe that might even give some support to the dollar, which had a horrible start to this year, I think the worst out in 50 years, if, if I remember correctly.

[00:17:10] Alan

Yeah, that’s right. It has had… if you’re just measuring things on a calendar year basis, it is the worst start, I believe. Interestingly, just on that, obviously there’s a lot of talk in April and May around the weakness of the dollar at the same time of the bond market strains and the tariffs. The suggestion was foreigners were selling US assets and that was the source of the dollar weakness.

The BIS had a report out a couple of weeks ago and they’ve looked at this. They concluded that it was more hedging pressure than actual sales of dollar assets. So, if you look across the patterns, the timing of the dollar selling was more in the Asian time zone and also cross currency basis widened a bit. So that was indicative of more hedging demand.

So interestingly, there is this debate, are people selling US assets on the belief of the end of US exceptionalism? We’re probably only at the start of that trade. If it’s happened much at all, it would be the conclusion.

[00:18:12] Niels

Absolutely. Well, let’s move on to some of these wonderful papers that are coming fast and thick at the moment. The worse the performance gets in our industry, the better or the higher the number of papers being produced about drawdowns and skew and why trend following is still absolutely the best strategy to be in which, of course, we couldn’t agree more with.

But there is a very interesting paper, I thought, with a few things that hadn’t thought about for a little while, and it’s actually a paper from Man. They are, of course, always good in terms of delivering some research that we can dive into.

The paper came out very recently. It’s called Trend Following and Drawdowns, Is This Time Different? Russell, who’s the author, the CIO actually at Man AHL, he is a previous guest on the show. So, you can always go back and listen to much more from him in that episode.

I’d love to hear your thoughts about it. Maybe you would take us through the core messages from the paper. I’ve got a few observations as well, Alan, but very interesting, I thought.

[00:19:27] Alan

Yeah, sure, as you say, these papers do tend to come out in times of difficult performance for trend following. It’s a good kind of comprehensive rebuttal, I guess, of some of the typical kind of points made against trend following in times of drawdown.

I mean to start off with the premise that, for sure, there have been some systematic strategies that, over time, have seen a deterioration in performance and effectively stopped working. So, the question might be is that potentially happening to trend following at the moment?

So, they address that, and they also look at the explanation for the poor performance this time, etc. I mean, in terms of strategies, quant strategies that have worked in the past but then stopped working, they point to pairs trading as an idea.

You look at two stocks, similar characteristics and you adjust for factors. That was something that was a successful trading strategy back in the ‘60s, ‘70s, ‘80s, stopped in the 2000s, basically. Fast trend following is the second one that they point to as something that used to work quite well back in the ‘70s, ‘80s, but then over time stopped working. But equally other kind of traditional quant strategies have gone through periods of tough drawdown and they point to equity long/short strategies based on standard equity factors and also trend following.

So both of these they would put in the camp of yes, have had tough periods and kind of prolonged drawdowns at times in the last number of years, but, overall, still look fine in the bigger picture. And I mean in terms of the trend following, the look at the drawdown for the SocGen Trend index down 18% over one year. Interestingly only twice has the SocGen Trend index been down more than 15% over 12 months. The last one was down 16% in January 2019 and after that had a big rebound.

I mean, they do point to the fact that, for all the concerns about trend following performance, those losses are not very large. I mean, if you were to compare it to the kind of volatility the drawdowns you see in equities, the risk reward profile is better or at least the downside is better managed in risk in trend following.

Yeah, and as I said, they do show what happens after a drawdown. There was obviously the very strong run up after the last drawdown that ended in January 2019. So, from January 2019 to May 2024 that was a particularly strong rebound, but normally up kind of around 10% after being down in a 10% drawdown for the stock SocGen Trend index.

And then they also take the perspective of what’s the probability. Say, you take a strategy with 0.5 Sharpe, 10 vol, 0 correlation to equities over a 25 year period, the probability of a 20% drawdown is nearly 80%. So, that’s kind of consistent with what we’ve seen.

So, I guess just making the point that for this kind of a strategy, at this level of Sharpe ratio, what we’re seeing is not outside of statistical expectations. It’s very much part of the normal distribution of returns.

They do look at some of the other kind of common concerns about trend following. Crowdedness is one. You always get this comment, is there too much money in trend following now? I mean, they looked at that as a percentage of futures volume. It’s been going down, like CTA volume, as a percentage of the overall volume.

I mean, the tricky part here is people will say there’s more money in trend following now, in QIS and in-house trend following, not necessarily captured in the CTA industry. So, you could debate that a little bit.

They also look at if you were to maybe actively manage your exposure to trend following or the kind of quant strategies in general, you know, if you were to cut it in drawdown and then wait for it to come back up, you know, obviously what they find, that doesn’t prove to be a good strategy historically. You end up losing quite a lot of the return.

And another part of this analysis that they did was, you know, if you take a 0.6 Sharpe strategy at 15 vol, over 30 years, you know, over the full 30 years your money would have grown about eight-fold. But within that there was a 32% drawdown and you were underwater for nine years.

So, it’s all about, you know, I guess, one, refuting the narrative a little bit, and two, just saying just because we’re in a drawdown of this nature, it feels comfortable from a statistical perspective, you know, nothing unusual, I guess, nothing to see here, in a sense. I mean, my own perspective is

I absolutely agree with everything to say. I think it’s a good paper. The challenge is, obviously, that people like stories better than statistics. So, narratives tend to resonate more. And the narrative, maybe at the moment, is we’ve got choppy markets, we’ve got erratic policy making, tariff on/tariff off. That’s not a conducive environment for trend following.

And that’s an easy kind of observation to make. So, you make that observation, you point to negative performance and you say QED, but it’s hard to refute that. But I think it depends on your perspective. If you go back in time, we had kind of risk-on/risk-off in around the time of the European debt crisis.

That was around 2011, 2012. Yes, it was tough for trend following, but eventually it did come out of that period. Equally, if you went back to the 2016-2019 period, we had choppy markets. The narrative at that time was central bankers control the markets. You’re not going to see big trends in markets because the volatility is dampened.

So I think it’s always dangerous to make an observation like this and then assign a narrative when in reality, you know, it’s just random. I think what has probably been very frustrating is, you know, as we did speak, back in 2022, we were all quite optimistic on the outlook for trend following because 2022 had been a great year. But not only that, you know, we were seeing much more macro volatility, higher inflation, plus higher rates. So, it is a good lesson in trying to link the expected performance to a macro scenario. It’s just hard to do that. The trends will emerge when they do.

And if you look at it, since 2022, bond markets have been up and down in a range. The 10-year yield has been fluctuating around maybe 4.25% up to 5%, down to 3.5%. It’s priced in a recession maybe four times. So, I think all of that, that kind of gives a bit more color on it.

I think it’s the kind of thing that if you’re kind of already predisposed to believing in trend following, the paper is a good. It sums up why it still makes sense.

If you’re already suspicious, skeptical, you’re probably not going to change your mind on the back of it because you’re probably going to be seduced by the narrative. So, I think it’s one of those tricky situations. You have to really be a believer that is a strategy that works over time.

[00:27:26] Niels

Yeah, I agree with that. There are a couple of things that I thought was quite useful to be reminded of. You mentioned that (and this is as of end of April, so the number could be three instead of two now) at the end of April there had only been two times, in the prior 25 years, where the rolling 12 month returns of the SocGen Trend index was down more than 15%. So, we see that number. Then I was just glancing at the chart while you were speaking and I’m thinking okay, well, how many times has the SocGen Trend index been delivering more than plus 15% on a rolling 12 month basis in that 25 year period?

And, I mean, you should never do math live but I’m pretty sure the number is 59. That, I think, should surprise people in a very positive way to say wow, okay, only twice have we had to endure this pain. But look at this, almost 60 times we’ve had rolling 12 month returns of more than 15% and of course some of those returns are more than 30%. So, definitely skewed in the right direction.

The other thing I thought that was kind of interesting when you have someone like that go through the math and that is this thing about the probability of a 2 standard deviation drawdown where they talk about, well yes, if you have a 25 year history there’s an 80% chance (or 79%, to be precise) that you’re going to experience that.

What was interesting about the table they put, I thought, was, well, if you’ve only been in business for five years, you’ve actually only got a 21% chance of having experienced this. And I think it puts into context the value of long-term track records where you really have been tried and tested.

I mean, at Dunn we have a 50 year track record and we haven’t quite been actually at a two standard deviation drawdown at any point in time because we have had large drawdowns but, at that time, we traded at much higher vol than today.

But it’s a good reminder that the longer you are in business the higher the probability is that you’re going to experience something. And sometimes when you see someone coming up with, oh, this is a brand new, great new strategy, it’s look at the last five years, it’s not really been in the same trouble as some other strategies. And you think. Well. give it another 20 years, or 30 years, and the story, the conversation might be a little bit different.

You know what this paper reminded me of, Alan, a paper that you co-authored a number of years ago.

[00:30:11] Alan

That’s right, yeah.

[00:30:13] Niels

Yes, because some of the things… For example, they mentioned this thing about crowding and they look at the percentage of AUM of the total hedge fund industry that is occupied by CTAs back in the ‘90s. They they show it as high as something like 27% of the AUM today. And you’re right to say that there are other strategies than the official CTAs that do trend following, for sure, but it’s down to around 6%. I mean, I think you showed something similarly, maybe with some different numbers.

But I’ve also seen numbers or comparisons about the volume of futures and the AUM of CTAs which officially has been pretty stagnant for the last 20 years, really, and where of course the volume has gone up dramatically. So yeah, I don’t buy into those arguments either that the space has become too crowded.

This is a period where trend following should not work, when you look at what markets are doing, especially when it happens in the three main financial sectors at the same time. So, I’m not surprised, not concerned either.

But I think the question they also ask, or maybe it’s one of the other papers that we’re going to be looking at, and that is does it feel different this time? I mean, one thing is that it’s not different from a statistical point of view. But does it feel different, Alan, do you think?

[00:31:42] Alan

The shift in sentiment is very noteworthy. As I say, only 2022 is very positive. And that was still… I think people, there was a sense that trend following went mainstream. I was hearing people talking about allocating to trend following who had never said that before. So, I was hearing that more and more.

So, I think that’s maybe a surprise. It’s kind of come into the mainstream and now people will look at it and say, oh, I’m not sure about that. So that’s one thing. I know we’ve debated this before whether the index includes interest or not. And my understanding is it ??? but I know you’ve said before, just that we might have to disagree on this.

[00:32:23] Niels

Well, 75% of the managers include interest income.

[00:32:28] Alan

Ok, I mean, I looked at it and I took out the interest, you know, that drawdown does look… Well, it’s a bigger drawdown than we’ve seen historically.

I guess it’s hard to compare because I think SocGen just take how the managers report them. As you say, some do, some don’t include it. And of course, that might have shifted over time as well, you know, depending on which manager is reporting.

But if you take out all of the interest and assume that it had been in, it looks like, what, about a 27%, 28% drawdown ex interest because it didn’t get out of the drawdown in the kind of the 2024 period. So yeah, I mean, I think it’s this year’s performance much as the drawdown. But then, I mean, we’re talking about the index as well.

I think for individual managers, they’ve probably had even more negative experiences. So, that will influence the perception of certain investors who’ve just been kind of unlucky enough to maybe be one or two managers who are doing even worse than the index.

So yeah, it is a bit surprising. I mean it’s certainly surprising given the macro backdrop. Obviously, when you look back you can explain it easily, as you say, with the choppiness in bonds, the choppiness in the dollar, etc. and the reversals that we’ve seen. So yeah, I mean it wouldn’t change… You know, I agree with everything in the paper and that was the conclusion.

I mean the conclusion is we haven’t seen enough sustained trends in aggregate. Of course, we have seen trends in some markets. And I think the other thing was, 2022 was an exceptionally positive year. I mean, the setup in interest rates was so good. You know, you went from a really low environment, rates were close to zero. So, managers get in on that trade early on with large positions. Okay, you might have volatility size and reduced it over time, but it was kind of a once in a career kind of rate adjustment. So, that was exceptionally good.

But these opportunities come along from time to time. It’s just we don’t know when they’re going to come, you know.

[00:34:28] Niels

Exactly, exactly. Should we spend a few minutes on the next paper which is from a company that I’ve actually never read one of their papers before.

But, of course, in a time like this you shouldn’t waste a good crisis. So, Capstone, which is not known for trend following but they have released a paper titled From Hero to Villain, Is There a Problem with Trend Following? I remember them as volatility managers. So, that was a little bit surprised to see a paper on trend following from them.

But it’s not just about trend following. So, maybe you can enlighten us a little bit in terms of what they’re writing that might be a little bit different from all the other papers we’ve seen.

[00:35:16] Alan

Yeah, I do think they do have trend following programs. I mean, they’re better known in the volatility space, but they certainly do trend following and offer kind of solutions that combine. I mean, as you say, their focus is more on volatility trading. And I guess there’s two kinds of points to the paper. One is kind of similar to the Man paper. Is there a problem with trend following? The answer is no, for similar reasons given by the Man paper.

The highlight is that we’ve been here before. It’s not unusual for trend following to do badly in periods when equities have done badly for a while and then subsequently do well as the equity market decline continues. So, it’s kind of like highlighting this idea of first responders and second responders, with being a potential role in the portfolio for long volatility strategies as a first responder solution and then trend following as a second responder. And they look at the different types of equity drawdowns that we’ve seen in the last while and how the two different strategies have played out.

Obviously, 2022 was much better for trend following than long vol, but long vol did better in, in the March 2020 drawdown. So, you go back in time and a blend of them can be a more robust solution. So, I mean, that’s certainly not a new idea.

We’ve had that in terms of risk mitigating portfolios and there are a lot of believers in that. Yeah, I mean, I think what they’re saying in their paper makes sense, but in terms of kind of the explanation for the trend following drawdown, yeah, kind of very much on the same lines as the Man paper.

[00:37:05] Niels

Yeah, it’s kind of the same thing. I mean, after 2020, or after the spring of 2020, I mean, long vol strategies were really the flavor of the month and lots of people wanted to get into them. And then, you know, nothing happened except for continued losses in that space for a very long time.

And then 2022 comes along, equities go down, but hey, there’s no protection from vol because that happened at a very low vol. So yeah, it’s never easy. So maybe combining them makes sense. I don’t know. I still like the pure trend approach, of course.

Let’s do one more. Let’s do a slightly different thing because we’ve talked a little bit about the challenges we’re facing, but it’s also interesting to talk about what are investors actually looking at? What are they interested in? And luckily, we got a hold of UBS Global Family Office report from 2025. Here they capture the views of 317 UBS family office clients. The average net worth of the families was $2.7 billion.

And the survey they did was really conducted from late January of this year until the early part of April of this year. So, I’m curious what your takeaways were from that. I know we’re not going to spend too much time on it, but just the highlights.

[00:38:37] Alan

I mean, the one thing that stood out, they have an asset allocation chart within it, and let me just pull it up, you know, I wrote a piece there recently on my Substack called Looks Diversified Acts Like Beta. And it’s not a criticism of these portfolios per se, but the kind of asset allocation that’s represented here is kind of indicative of what you see in a lot of portfolios in that there might be an allocation to lots of different categories, but you have to question how diversified the portfolio really is. So, in this instance they talk about the kind of average allocation of these family offices.

There are allocations to 12 different categories from, you know, infrastructure to art.net, antiques and gold, commodities, precious metals, etc. I mean, when you dig into it though, I mean you’ve got equities, different types of equities. You’ve got developed markets, emerging markets. Then you’ve got private equity. You know, it’s all equity risk equally. You’ve got, you know, real estate in there, which tends to have a, you know, high equity beta as well. It’s very much growth sensitive. And then you’ve got a decent chunk of allocation to fixed income.

Now the issue with that is if your fixed income is tilted to things like high yield or investment grade, in times of stress, they can also get challenged, or emerging market debt as well, because credit worthiness come under scrutiny, spreads widen, and credit instruments start behaving more like equities just when you want them to behave less like equities. So, the point is a portfolio like this, they have a 4% allocation to hedge funds. There’s not a whole lot of pure diversifiers in it.

And then we don’t even know what the hedge fund strategies are. Are they long/short equity or are they divergent or convergent strategies? And then the other question would be, what level of vol are they running at? If you have a 4% allocation to hedge funds, and they’re all low vol market neutral funds, you’re not going to get much convexity there in times of stress. So, it’s a classic example of a portfolio that is by design more growth centric.

Whether that’s the intention or not, ultimately it’s a play on favorable growth and stable inflation, that macro regime continuing because there’s a less than 1% exposure to commodities and very little exposure to other strategies that might benefit.

Okay, you have real estate that would hold value in an inflationary environment, but you know, in a stagflationary environment, should that reemerge, this kind of portfolio is going to struggle.

[00:41:25] Niels

I look through sort of very briefly at some of their tables and charts that they show, obviously in terms of what people plan to invest in, there’s a small increase, about 20% planning to increase hedge funds applications, 59% saying they want to stay at the same level, with 7% looking to decrease their exposure. Gold got a little bit more attention as well, almost also about a 20% or 21% actually, looking to increase their allocation to gold commodities, 9% looking to increase, but a lot of them not making too many changes.

Then they talked about active and passive Investing strategies, and 64% invested in, that’s how I remember it, 64% in actively managed strategies, and 36% passively managed strategies. And then they looked at also, what are the biggest risks that people focus on over the next 12 months and 5 years?

And over the next 12 months the biggest risk they see is global trade war. But over the next 5 years it’s a major geopolitical conflict that they worry about mostly. There are also some people, about 53%, who mentioned that they do worry about a global recession in the next 5 years. And then a debt crisis, 50% worries about a debt crisis in the next 5 years as well, not so much in the next 12 months. So yeah, I mean there’s obviously lots of things to be concerned about.

And then maybe the final thing I want to mention that I took away and that is what are the main things, the key challenges in terms of what they’re trying to find to manage their portfolios? And 38% responded that they’re trying to find the right risk offsetting asset or strategy is their biggest challenge, which of course is where we think trend following comes in. But there we are. Look no further, I guess. So, that’s interesting. And also 29% says the predictability of safety assets is something that they worry about, cost and fees. 26%. So yeah, very interesting.

You know Alan, because we’ve had these technical challenges, I’m kind of tempted to cut our conversation a little bit short today just because I don’t actually know, at this stage, what quality we’re going to be getting when we listen back to this. And I want to keep some of the, the things that we have planned maybe for another time when we’ve ironed out these issues.

So if it’s okay with you, we’ll leave it there. This is pretty jam packed anyways, and I really appreciate your flexibility working around these challenges today. Next week I’ll be back with Katy. No doubt there’ll be another paper to discuss. I know she’s been writing ferociously about what’s going on in the CTA space, so looking forward to that.

If you have any questions for Katy, please email them to info@toptradersunplugged.com and I’ll do my very best to bring them up with her.

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

[00:45:03] Ending

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