Honey, I Shrunk the Trend-Following ft. Andrew Beer

[00:00:00] Intro

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

[00:00:23] Niels

Welcome and welcome back to this week’s edition of the Systematic Investor series with Andrew Beer and I, Niels Kaastrup-Larsen where each week we take the pulse of the global market through the lens of a rules-based investor. Andrew, wonderful to have you on the podcast this week. How are you keeping? Where are you based today?

[00:00:23] Andrew

Oh, well, thank you. Thank you.

It’s great to be back here and I always appreciate you inviting me back for these. I’m back in Connecticut. I was actually on my way to Little Rock, Arkansas last night to see one of our clients and unfortunately, because of inclement weather, seven hours into my stay at the airport, my flight was cancelled.
So, I’m back at home with proper recording equipment.

[00:01:03] Niels

That’s our luck, I guess. In a sense, it’s two broken records talking today, right? We love talking about the same thing, but we can always try and talk about it in a different way, plus a few other things that come along.

But before we get into all of that stuff, I’m always curious from your side of the pond, from your vantage point, sort of what’s been keeping you, not necessarily busy, but what have you been focusing on? What’s been on your radar that doesn’t really reflect what we’re going to be talking about, just other things that you find interesting at the moment?

[00:01:38] Andrew

Well, other than hiding under my desk and trying to not read anything about the political situation in the US. Yeah, sitting in an airport for seven hours is awful, but it did give me an opportunity to read a book that came out recently about the development of social media and smartphones, the conversions of technology, and the incredibly damaging impact that it’s had on an entire generation of people. For those who know me, I’m remarried with a young son, and we have a running joke that my wife is trying to raise him in the 19th century, because she’s very, very worried about the long-term impact of this.

So I was reading it to try to be a little bit smarter about it. As I’m about to embark again on more active engagement on social media, I think my own mind and personality will revert to that of a crack-addled squirrel for the next few months. There’s some truth in it.

[00:02:34] Niels

Yeah. What was the name of the book? It sounds relevant.

[00:02:38] Andrew

I think it’s called The Anxious Generation.

[00:02:41] Niels

Oh, yeah. I saw that title somewhere. Yeah.

[00:02:46] Andrew

I saw, I think, it was a very good article in the Financial Times last week, and then I ordered the book and read it. I think it goes too far in certain ways, but I think we’re going to look back on this as cigarettes and things that just became accepted and convenient. It’s probably fine for adults, but not great for kids.

[00:03:09] Niels

No, no. Couldn’t agree more. Interesting.

Well, what’s been on my radar the last couple of days may have also been on your radar. If you’ve spent seven hours in an airport yesterday, you may have noticed, although I don’t think you trade this, but coffee, and specifically Robusta Futures, hit a new all-time high of $3,800 a ton, which actually is up 68% in the last 12 months yesterday. So, we may actually soon find our coffees to become even more expensive, along with our chocolate.

[00:03:44] Andrew

Well, that’s back to green tea, I guess.

[00:03:50] Niels

Fair enough. So that’s one thing I noticed.

Interesting. But also, the other thing that is actually, I think, somewhat interesting, and it goes to just why these markets are so wonderful and unpredictable. It’s just been quarter end, of course. And only three months ago, at the end of 2023, the Fed Fund Futures were pricing in more than 125 basis points cuts this year.

And now, we, three months later, only have a 75% chance of three 25 basis points cuts by December. I think that’s pretty interesting, frankly. And it shows how much things do change in the markets.

[00:04:33] Andrew

Well, I think this is something I was saying last year when people were talking about the pace of cuts. Spending is addictive and people get used to spending money. It’s much easier to plan a vacation, make it a little bit more elaborate than you expect it to be, then cut back.

And so, unfortunately, I think I’ve told this story before. My first job was working for Paul Volcker indirectly. I mean, he was the chairman of the firm that I went to work for, and I had the pleasure of working with him to some degree.

I mean, what he went through in the late 1970s, he was vilified for the steps that they took. Now, again, I mean, inflation was very, very different, and the country was very, very different. But it’s not easy for people to stop. Look at the government.

I mean, you have two parties right now who seem largely indifferent to what feels like running at top speed toward a propeller at some point. But for now, in the moment, it’s hard to get people to stop. So, we’ll keep buying our chocolate and Robusta coffee in the base of it for a while.

[00:05:35] Niels

Exactly. That’s right. Okay.

So, obviously, we’re going to be talking a little bit about trend following, as we normally do at this stage. I’m not going to spend too much time talking about April, because it’s only been three days since the month started. But of course, we just came out of a first quarter, which was quite strong, let’s put it that way.

But it was mainly driven by one market, as we all know, cocoa. And I think the audience might enjoy, and I don’t know if I’m stealing your thunder for later on. I think we will talk about cocoa, but maybe from a different perspective.

I’m just curious in the sense that, as far as I’m aware, you guys have kept up very well with the industry, but you don’t trade cocoa. So, maybe you could put a few words on that, because I think this is one of the arguments that I, and probably other people had, that those times will be interesting to monitor. Now, I do know that as the underlying managers go into paying performance fees again, it reduces their performance, and you will benefit from that.

But still, you’ve had to have some pretty good positions on to do what you’ve done. Can you elaborate a little bit?

[00:06:50] Andrew

So, cocoa has been a bonkers trade this year. I think it’s up 155% or something, and it was up a similar amount last year.

This is a once in a generation, one directional trade. We spent a lot of time looking at it. So, when you say that things were driven by cocoa, clearly there are certain funds who have had a huge tailwind from cocoa. Most have not.

The math around it, and I’m going to get this math wrong, because I’m not an expert in the minutiae of open interest and things like that. But a rough calculation is that even with cocoa going up 150% this year, a rough calculation is that something like $4 billion is made in cocoa futures. And by the way, if anybody has done actually really good work on this, please do share it, because I’d love to see exactly if you break down speculators versus hedgers.

But one of the things that I’ve always loved about the commodity markets, and again, I started a commodity business back in the early 2000s, was that you have these non-commercial players. So, presumably when cocoa is going up, there are certain people out there who are unhedged on their supply and start panicking, and they have to buy more. The argument can’t be, well, we’re just not going to sell more chocolate bars or whatever.

So, there is this negative gamma phenomenon that goes on in these spaces. But if you look at the overall space, when Powell spoke in November, at least from our perspective, it was clear, that was the definitive nail in the coffin that the constant rate hike period was over. The shock rate hike period was over.

And then the market in the unwind and the euphoria that followed in the last two months of the year, at least what we saw in our portfolios, was really jettisoning things that hadn’t worked, that were no longer working, and dialing back risk. And it felt like a period where the space overall was hunting for new opportunities. And that’s what I was writing about.

It’s sort of in this transitional period. And some of our investors agreed with it. Now, if you were more short-term focused, you tended to pivot around faster.

If you were kind of picking up longer-term stuff like we were, you tended to take a little longer to get out of things. But by the time you got to in the first quarter, what we saw was really a shifting from what had been crash protection mode across the space to risk-on in a number of different places. So, we saw exposure to gold and oil, not cocoa, but gold and oil go up.

We saw long equity exposure go up. We had some spread trades. We saw some spread trades, US versus EM at one point last year, but it really went into long, particularly long EFA.

We kind of mixed, I think, given the whipsaws last year, fixed income is still a little bit of a kind of hesitant positioning, not quite sure which way it’s going to go. And then, obviously, in the currency side, you’ve had the yen, which has just been not the shocking 100% moves every now and then, but just in sheer dollar amounts, the end trade. So, we saw the industry really hitting on three or four cylinders.

Now, cocoa to me is so fascinating because it’s one of those things that appears to validate the whole idea of the space. Who but a trend follower is buying cocoa up 100% and then buying it up another 100% after that? And we have this graphic that we put on our website that shows the cross correlations between assets. And it shows that most of the things that we trade pick up probably 90% of the instruments that a typical managed futures fund would trade.

And guess one of the ones that doesn’t get picked up is cocoa. So, hats off to everyone who has cocoa in their portfolio in a meaningful way, because that’s exactly the source of alpha and idiosyncratic returns that you’d want an individual manager to deliver. But when you look across a multi-hundred billion dollar space, and you say, here’s something that’s generated $4 billion of gains this year, and that currently has a 50%, 60% volatility, most of the people in the space who run funds are going to have exposure to it, but it’s going to be of such a small size that maybe they got another 100 basis points of returns from it.

So, to us, the phenomenon of the first quarter was, it’s exactly what the whole space needed after last year, which was really an embarrassment. Because this was the year where cash was earning a lot. We were all supposed to do better than cash last year, and then we had terrible returns across the space relative to cash.

And now you have a first quarter. I mean, how many people in December of last year would have said the SOCGEN CTA index is going to match the S&P in the first quarter in a great year for equities? So, I think it really just shows the dynamism of the strategy. Yeah.

[00:11:50] Niels

I’ll push back on a couple of things, not in a great way, but I want to make sure that everyone understands that trend followers are not the ones who pushed cocoa prices up by keeping buying it. In fact, we probably stopped buying it a long, long time ago. And as you and I talked about, Andrew, before we pressed record, trend followers, classic trend followers or traditional trend followers have been selling, or anyone who used dynamic position sizing, let me stress that, has been selling or have been selling cocoa certainly strongly this year to a fraction of the notional size than it was.

So, very important because they will come out, the headlines. They have already been there to some extent about how trend strategies are pushing up the price of cocoa. And there was one a few weeks ago suggesting that trend strategies were piling into cocoa at the end of last year, which is completely wrong.

Completely wrong.

[00:11:50] Andrew

Well, here’s some statistics you can throw at them. At the end of last year, the open interest was 140,000 contracts. By the end of the first quarter is 54. So, somebody’s closing out their positions. And I think that’s always the great disconnect. And you see this in every category.

You’ve got some guy wants to talk about one position. They bought a stock that tripled. And if that stock is a meaningful part of their portfolio, they’re going to have crazy returns relative to everybody else for a period of time. But more often than not, people prudently size things in an intelligent way. Having been a guy who picks stocks and when it goes up 50%, it’s really hard not to take money off the table because you imagine that guy who saw it go up 50% didn’t sell a penny and then watch it drop 80%.

And so, there is this natural desire to take profits in the space.

[00:13:55] Niels

And there are exceptions, of course. We know there’s probably a handful of managers out there who have just basically made an extraordinary amount of performance in cocoa alone. And that’s fine. That’s great for them. And so, that’s just something to be aware of.

The other thing I want to push back on a little bit is just your choice of word when you say 2023 was an embarrassment. I don’t think it was at all. If you think about the transitions that some of the markets went through, in particular fixed income and equities, I actually think it was a fantastic year for our space.

Imagine to give back 20% maybe of the 2022 returns in a year like that and then come out strong in 2024. I think personally, it was a great effort. And by the way, wonderful for people to have made money in stocks and bonds last year. And maybe they were flat in their managed futures. And that’s not a bad result, in my opinion.

[00:14:53] Andrew

Oh, no, completely. I mean, look, I make all those arguments. Look, I’ve called it the year of the whipsaw. If on Jan. 1, you’d said, we’re going to have rates going up. One of our best trades is rates going up. There’s going to be an insane 13 sigma or some ridiculous unwind that’s going to happen in March. People are going to redial up those positions again. It’s going to happen again later in the year.

I think the managed future space, for a lot of reasons you and I have discussed, there are a lot of people who, whether it’s wanting to blame it for the rise in cocoa, which is absurd, but there are a lot of people who are very negative about the space and they like to dump on the space. And all I’m saying is that by the end of 2022, when I was talking to investors and trying to explain the long winter and what zero interest rates does for a strategy, unless you’re going to swing hard with your fixed income portion of your portfolio, you are basically generating zero returns on a huge portion of your portfolio versus what you hope you’d earn in a normal market environment.

And then once we finally have that, it would have been a much better story to tell people that, look, it was a terrible year, cash earned four and we earned four. Instead, it was a terrible year because we got whipsawed back and forth in this brutally violent way. And that’s not going to be a normal market condition.

But that also is why the first quarter was so important, right? Because people want to look at 2022 and say it was a flash in the pan. And there’s a certain constituent who wants to say, no, no, no, actually 2023 proves that we were right to view 2022 as a flash in the pan. And then my point in 2022 was nobody in 2021 realized we could have had a 2022.

But the space can be frustratingly unpredictable. But the first quarter basically showed that no, this strategy is not a one trick pony. It’s not only going to make money if the Fed is hiking, it’s going to find other ways to make money.

[00:16:57] Niels

Yeah. No, absolutely. All right.

Just finishing the little trend update before we get into things. My own trend barometer finished at 45 last night. I should say we’re recording on Thursday today because I am going to spend 13 hours in a plane tomorrow. So, we’re a little bit early here. But it did hit 64 only a couple of days ago, which kind of confirms the strong period we’ve been in. BTOP50, as of Tuesday, I guess it would be up 77 basis points in April, up 9.45% for the year.

SocGen CTA index up 86 basis points, up 10.6% for the year. Soc Gen Trend up 68 basis points, up 12.99% for the year. And the Short-Term Traders index up 53 basis points, up 1.76% for the year.

And to the traditional markets, MSCI World down 82 basis points in April so far. That is actually as of Wednesday, up 7.6% for the year. World Government bonds down 66 basis points. And the S&P 500 total return is down 81 basis points to 9.66%.

All right, before we get to the topics, there was one question that came in from Peter. And I’m going to just summarize it for you, Andrew. Essentially what Peter is saying is that as part of his career, what he’s come across is that people look at a few different things when they evaluate managers, like performance, people, process, product, and philosophy.

But there’s one thing that he finds to be absent, something that actually Nassim Taleb has written about, and that’s skin in the game. So he’s asking you a personal question, which I respect that you probably don’t want to answer specifically, but you want to probably address it, I’m sure. And that is just sort of what’s your exposure of your liquid net worth to DBMF.

So I’ll allow you to answer it however way you want.

[00:19:06] Andrew

Okay. So, first of all, as a guy who has been in the hedge fund industry for 30 years, this was the big differentiator of hedge funds. I mean, if you’re going to invest with Seth Bowman in 1994, the first guy I went to work for, there was no doubt Seth had all of his money in his fund. And so why? Why would people care about that? Well, it was pitched in contrast to the mutual fund industry, where you’d have guys who were talking about this stock or that stock, but there was just this sense that there was this misalignment of incentives.

[00:19:41] Niels

Because they were employed, right? They were not the owners of the firm.

[00:19:43] Andrew

And they would get bonuses, and they’d get bonuses on asset growth. And if the S&P went down 50, and they went down 48, they’d get a bigger bonus.

I mean, it was kind of designed to address that. So, I think if you’re going to invest with a guy who is a stock picker, and particularly a guy who has become very, very wealthy and is off buying sports teams and other things, it’s a legitimate question to ask, you know, are you on my side? In my case, you know, my circumstances are very different. I took a meaningful portion of my liquid net worth and poured it into this business for 10 years to prove that what we could do worked.

You know, my partner and I have been doing this for 15 years. The questions that I would ask, and it gets a little murky when you get into Quant Land. So, first of all, I’m more than fully invested in everything that we do. But when you get into Quant Land, it gets a little murkier. So would you go to Cliff Asness and say, hey, you’ve got 72 different products out there. What percentage of your net worth is in product number 69? That’s not really the way the Quant world works.

You know, do you think that Cliff Asness, who is an absolute genius and a star of this industry, is going to work harder to build a better model today because he has more of his net worth invested in product number 69? So, it’s an absolutely very, very good question. It’s just, it’s, I don’t think it applies in quite the same way in the circumstance because of what we do. We also, we don’t know charge incentive fees.

So what we’ve tried to do is actually come up with a way of providing access to a space where that’s a great question to ask every one of the 20 managed futures funds that we’re seeking to replicate. It doesn’t apply to us in quite the same mathematical way because we’re trying to come up with a way of replicating what these guys do. But the day-to-day motivation of trying to get our correlation from 0.9 to 0.91 is not going to be closely tied to whether I have 89% or 53% or 25% of my net worth in an ETF that we manage.

So, I like the question. I think it’s a little hard to apply it given our particular business model.

[00:22:05] Niels

Now you had written down, you know, the thing about cocoa.

I think we’ve talked about cocoa. If not, feel free to always bring it up. But you do talk about, or you do want to talk about something. You know, what does Q1 2024, what does that mean for CTAs? I’m very curious, because you’ve got some great analogies. You speak to a lot of people or types of investors that I don’t speak to. So, you may have a different narrative, a different perspective, even though I completely agree with its importance.

But I’d love to hear your thoughts about this.

[00:22:46] Andrew

Well, so again, you’re talking to a guy here who is in a greenfield area for the managed future space. And so, we manage an ETF that has negative correlations to equities since we launched.

It’s hitting its five-year track record and is basically designed to be a diversifier for people who already have 60/40 portfolios in the ETF world. We are around 0.01% of the addressable market. So my challenge is, who are going to be the people over the next five years who are going to say, A, we want this strategy in our portfolios.
And then hopefully my argument would be, well, please pick us.

So, I spent a long time talking to people who build asset allocation models over time. It’s its strange own little world.

So these guys, in order to build a multi-asset model for, let’s say you’re working in an institutional consulting firm, they come up with what are called capital markets assumptions. And capital markets assumptions are their expectations of the return, volatility, and also correlation of asset A versus another 20 or 30 or 40 other assets. And over a very, very long period of time.

So when they sit down, they say, we think the S&P 500 is going to do 87 basis points less than European equities with a slightly lower NA correlation of 0.92 over the next 20 years, over the next 10 years. And so the allocations across these models are then geared off of this underlying data. Which is, if you went back and said, I’ve sat on boards where we’re using stuff. And I said, I’d really like to see your numbers 5 years ago, 10 years ago, and 15 years ago to see if those correlations actually held up. And they hold up no better than anybody else’s. But these people are just trying to make the best educated guess they can make today as to what the world is going to look like. But then it gets wrapped up in all these statistics.

So my point is that, a couple of years ago I was talking to these guys and I was saying, I was actually talking to a consulting firm and they’ve got 45 different asset classes they do this for. And I said, but you don’t have managed futures as an asset class. And they said, well, we don’t know how to model managed futures. And I was like, well, okay, you’re telling me that with a very, very clear view on emerging market equities versus every other equity category, but somehow modeling managed futures, your head’s going to explode. And I learned over time, talking to these guys, that a lot of it’s based on fundamental things. So the PE of European equities is historically low. And when we look at seven years of history, we find that low PE periods result in higher performance, et cetera.

So, there’s a process that they go through. It’s often based upon fundamental things. And then you throw in the strategy that has, sometimes it’s long, sometimes it’s short. It doesn’t fit. You’ve got these huge, concentrated periods of alpha. It doesn’t fit very neatly into how they think about the world.

So if you’d asked me this a year ago, I would say my challenge over the next five years, because these guys control staggering amounts of money. ETF based model portfolios, UCITS based model portfolios are trillions and trillions of dollars. I’ve got to convince them to make a new asset allocation bucket for managed futures.

I don’t think that’s true anymore. As I’ve gone back and talked to these guys recently, what I’m seeing is that actually the guys who build those models are convinced about managed futures as its own category. Now they’re not going to do a 20% allocation to managed futures, but that it should be part of their portfolios is something I don’t have to convince them of anymore. Their challenge is convincing the people who use their portfolios to use it.

So if you look at now managed futures as an asset class and, you know, take this SOCGEN CTA index or the Barclay BTOP50 as you use, and you can look at it over the past 24, 25 years and you run it through any asset allocation model. It has a place. Maybe we’ll talk about some people will throw out huge numbers, right? Because it has these such unusually valuable properties, but then on the implementation side, people often don’t use it.

So, the other side of it is how would you use it as opposed to something else? And I just threw something up on LinkedIn, which shows that part of what made it different is that CTAs, as a diversifier in the 2010s, was basically try to outpunch Superman – who were bonds. Bonds from 2000 through 2020, this was a quiet bubble of staggering proportions. If you map bonds versus the S&P 500, on a cumulative basis, bonds outperformed the S&P 500 for 18 of those 20 years, because it never went down. It did 300 basis points more than cash, which is a lot higher than you would think.

It had a max drawdown of below 4% over that period of time. So managed futures was competing with Superman from a diversity perspective. And now the other chart that I throw up is you roll it four years forward. And now the Sharpe ratio has dropped 60%. Sharpe ratio is 0.9, right? I mean, that’s a world-class hedge fund to have a long-term Sharpe ratio of 0.9.

So now the Sharpe ratio has dropped by 60%. The max drawdown is 17%. So, it’s four to five times higher than it was. The returns over cash with just those four years changed are now down to 150 basis points. So, there’s this existential crisis that’s going on across the model world where people have built huge businesses around 60/40.

And so, the allocators are now saying, we’re going to do this grinding, uncomfortable pivot from 60/40 to 50/30/20. But most of the people who use my models were also sold on 60/40 and it worked so well for such long periods of time that there’s a huge education process that requires getting people to put managed futures as part of that 20. Because they’re not going to want it at first. They’re going to want private equity. It sounds better. Private credit, infrastructure, REITs, maybe the more bold ones will pick straight up commodity exposure and talk about commodity super cycles and they’ll read about cocoa and think we definitely need that in there.

So, I think it’s really on two sides. It’s one, that 2022 showed that even as managed futures has become this big space with lots of mutual funds, and lots of hedge funds, and people who’ve been doing this for a long time, that the alpha in the space was greater in 2022 than any period that we’ve seen. And then 2023 was sort of a frustrating flip side to that.

And then 2024, so far this is where we’re early in the year, is basically a validation. So, imagine you’re one of these guys at the end of this year, or in 2025 or 2026. And now you’re looking at all of these different asset classes and what they’ve done. You can’t escape the bad periods when you’re looking at historical data. You can’t pretend that bonds go up every year anymore. You can’t pretend that you get a free 300 basis points over cash because the fed… As they wrestle with that, then the obvious question as a diversifier is what has a low correlation to both stocks and bonds? And so that’s the catalyst for the change. It won’t be 10% of people’s portfolios, but it’ll be part of that 20%.

[00:32:50] Niels

Yeah.

It kind of reminds me of the paper that John Lindner wrote back in 1983 where he basically said exactly what you have just laid out that, you know, an allocation to, I think it was just called managed futures. I can’t remember what, what the term was he used in the paper. Yeah, would increase the returns of the 60, 40 portfolio or stock and bond portfolio, as he wrote it, and reduce the drawdowns.

So, in many ways, nothing’s changed and yet people are now starting to come to these conclusion, except for, as you rightly point out, we’ve been reminded that maybe the bull market in bonds is over. But for people to think that it was going to continue, when you looked at where rates were, is obviously then you have to kind of question their sanity and say, how could you have thought that you’re going to continue to benefit from that negative correlation and protective properties?

But I think for people in that space, they’re not trying to maximize the Sharpe ratio portfolios. They’re trying to generally build models that have a very, very high correlation of that, which is their benchmark, which is 60/40. So as long as there is a 40 in the 60/40, they’re going to have exposure to bonds in good times and bad. Now, the argument they would make is that there will of course be periods when it’s a bad idea to have it, and in periods of like we saw, for 20 years, it was a great idea to have it over time.

But look, this is also where hedge funds had a big advantage. The reason hedge funds had a, I mean… I remember Paul Singer from Elliott basically saying that bonds run investable. If you’re giving one and a half percent with de minimis protections to tie your money out for 10 years with some AA rated corporate borrower. It was economically insane for people who didn’t have to do it. But then what do you do instead? Cash was earning zero. So, there was this whole idea. We’ll look back on the 2010s and think it was crazy. Negative yield, $18 trillion of negative yielding bonds.

[00:33:03] Niels

Absolutely.

[00:33:03] Andrew

Yeah, 10 years of money printing left and right. Governments became these crazy pinatas, and central banks just beat the crap out of them until money flew out everywhere and there was no inflation for 10 years. A lot of the standard playbooks that we had just simply didn’t work the way people expected in the 2010s.

And so, I think we’ve gone into some sort of a period of normalcy. That’s why I think somebody rashly today would say, great bonds are yielding a lot more. But in January of last year, people thought bonds were a no brainer trade and it was a bad investment for 10 of the 12 months.

Then it came roaring back in the past two months. It was supposed to be a no brainer this year and they’re down again this year. It’s not Superman anymore. They’re just going to be another asset class that you have to look at as critically as people do something like managed futures.

You know, on the episodes, we’ve kind of touched a little bit on a paper that Alan and I will dig into a little bit more with the authors of, well, not the author, but the guy who runs the firm, namely Aspect Capital, who put out a paper a couple of weeks ago. And I think we’re going to release our conversation with Anthony Todd, this coming week or the next week. And it changes the narrative a little bit about trend following managed futures away from the crisis alpha to the unpredictable alpha.

I don’t know if you read that paper, but I know you’re good with these terms and analogies and so on and so forth. So have you read the paper?

[00:34:50] Andrew

I haven’t. No, no. I’ll take a look though.

[00:34:53] Niels

I think it’s interesting because it doesn’t take anything away from the crisis part, but it is true, as you rightly said, if someone asked us three months ago, are CTAs going to match or outperform the S&P in Q1, Q1 being the best Q1 for S&P in the last five years, we probably wouldn’t have necessarily said, yeah, of course.

[00:35:19] Andrew

You got zero out of a hundred.

[00:35:21] Niels

So, the unpredictable part. And in a sense, when I saw the paper, and the words ‘unpredictable alpha’, what I like about it is I think it pinpoints also why people don’t like the strategy because it is unpredictable in many ways.

And that’s what people don’t like. They want certainty. They want someone to tell them that, yes, Apple is going to go back to $200 and you just need to buy it or whatever it might be.

So, there is something there, I think. Whether it’s going to be the new term we’re going to be using, I don’t know, because it’s not necessarily a positive term if you go and say, well, what I’m going to deliver for you is completely unpredictable, but just trust me, that doesn’t work either.

[00:36:04] Andrew

It’ll be a surprise and I hope it’s a good one.

I would add a little bit more context on it. When you talk about the paper for 1983, there is an institutional memory about just how client abusive this space was for a very, very long period of time. Everybody who’s doing anything in this space should go back and read a 2013 article that was in Bloomberg that was titled How Investors Lose 89% of Gains from Managed Futures Funds.

[00:36:39] Niels

Well, they just need to replace Managed Futures Fund with Multi-Strat Funds and then they can change the date to now.

[00:36:44] Andrew

Except those guys are generating incredible…

[00:36:52] Niels

Obviously, this plays into your game book here, right?

So, I’m going to defend trend followers a little bit because actually it wasn’t the trend followers or the CTAs necessarily charging all the fees. It was the layer above, packaging the wire houses, packaging the funds.

[00:37:09] Andrew

Of course.

[00:37:10] Niels

Into, into that. So, I just want to defend our industry.

[00:37:11] Andrew

No, no, no, of course. Look, one of the funds that they, cited. so basically, I mean, you know, they throw out some statistics. Now Bloomberg, I don’t know whether their numbers are right. I’ve looked at some of the underlying funds back then, just because I was curious. A lot of these things you could actually get SEC filings on them, unlike a normal hedge fund product. They looked at 63 managed futures funds, as they defined it. Over the decade, to the end of December 20, 2012, they generated $11.5 billion in gains before fees of which 10.2 was paid out in fees and commissions. In one fund that I looked at, they had a contractual, so the bank would take money. They would put it with underlying managers like you and other people, and they would pay a normal 1 in 20, or whatever they would pay to the underlying hedge funds.

But the managers had to trade with them, and they set a commission schedule of between 4.6% and 6% a year. And the first generation of mutual funds, again, I’m dealing with people who remember that stuff, but honestly, some people remember it favorably. There were products in there that had four points per annum loads and you’re talking tens and tens of thousands of people.

So, as a friend of mine described it, it was the fee and commissions equivalent of a debaucherous Roman orgy, right? Everybody was making money on this, and it was set off to sell. So, when you hear about people who are inclined to be suspicious of this space overall, there is that institutional legacy. It is fading over time, right? And there have been various milestones.

So, the first generation of mutual funds were basically fees on top of fees and you’ve had three or 400 basis white products, right? Those steadily went away. AQR and Alpha Simplex did a great service to the space in the early 2010s, to investors, I should say it’s in 2010s by launching institutional quality products on their own that had 1% plus expense ratios. Yeah, you look at the constituents of the SOCGEN CTA index, they’re 1 in 20 funds in general. You know, these are not multi-strat hedge funds, but they’re also not generating job ratios of due. So, that’s part of the challenge in the space.

Now, as it relates to Aspect’s thing, I think anything that tries to address, to really try to get in the head of the allocator, because it’s not just talking to the allocator about why this strategy should be in there and how you can think about it in your portfolio, but you’ve got also put on… Imagine yourself sitting in their shoes, trying to explain it to their clients.

And when they’re trying to explain to their clients, they’re not talking about it in terms of sharp ratios and efficient frontier. They’re talking about, this is part of an integrated strategy to help you grow your money so you have enough or more money than you need when you retire, and you can sleep at night between now and then, and you can trust me.

What I’ve actually found when I talk to people about what we do, I really try to understand what matters to them in their business. I’ve been on calls with people and I’ve said, honestly, I think the best fund out there for you guys, to invest in the mutual funds wise, is the American Beacon Man, AHL fund. I’m telling you honestly, if I’m sitting in your shoes, That’s the one I’m putting into my portfolio and they’ve done an incredible job in that fund.

There are times that I’ll start off by saying like, I’m not sure what we do, what we do is elective, given how you’ve set up your business. So, I think there’s a huge gap between the space that was viewed as something where it was sold.

And we, and we deal with wealth management platforms today where there is still this institutional legacy of why I would do this if I’m not getting paid a ton of money. So, I think that has to be addressed.

The other thing was just on the narrative side, when I talk to people who build model portfolios and those are the guys that I care about – the guys who build the model portfolios, my argument to them is forget about what’s underneath the hood. Forget about what it does, forget about managed futures and what it is that we’re actually doing on a day-to-day basis. The key is that you’re going to buy stocks and bonds. That’s going to be the principal driver of risk in your portfolio. But you and I both know there are other trades out there that can make sense. There are other opportunities.

Sometimes, you weren’t really in a position to be able to short bonds, and that was a great 18 month trade for certain people. So, the simplest way to describe it is that it’s macro. That there are macro developments, or things that happen in the world, that these guys can take advantage of.

And the reason it works in the context of your portfolio, going back to the capital markets assumptions, is that your business is to be the steady hand at the wheel. Even if I told you with 98% certainty that inflation was coming back, until the flotilla of other models starts to point in that direction, you cannot break from the pack as part of your business. Your clients don’t want you to, you’ve told your clients that you’re not going to do things like that.

So, in that context, there are these speedboats. They’re not going to be a big part of what you do. They’re not going to be 20% of your portfolio, but they are something where you can say to clients, look, we have found a way to efficiently capitalize on things that otherwise wouldn’t be up to what we’re doing.

And no, we’re not radically transforming our business overnight. It’s going to be a small piece of what we do. And we think it’s going to help you at the margin, but don’t worry. You can still sleep at night.

I think if we can solve that, then you start to open up this vast, vast, vast world of people and get them from zero to 1%, or zero to 2%.

[00:42:55] Niels

You mentioned to me that you were more convinced that we were kind of on the cusp of a broader adoption.

You laid out a case. Are you seeing signs of it?

[00:43:08] Andrew

Yeah. So, having done stuff like this for a long time, I’ll take user replication as an example. I started talking about replication and I went zero for a hundred talking to fund of hedge funds about it because I didn’t really understand them.

I’d actually started, it was sort of a quasi fund of hedge funds in the commodity space. But our view is we always approached it as investors and pouncing on opportunities when they were available, and these kinds of structural asymmetries in the market and how we’re going to capitalize on it. But, in the broader fund of funds business, people were deathly afraid of cannibalization. So, I would talk to people about replication for a long time and fund of funds hated it.

Then some academics for hire came out and hated it. Then consultants hated it. And now, a couple of weeks ago, I gave a talk in this hedge fund class at London business school, and I got outreach and people at other universities saying, you know, we learned about it in Kaya which includes it in their curricular material on a hedge funds now.

So like replication, isn’t a radical concept anymore, but nobody announces to you the day that they agree. The same people that I spoke to seven or eight years ago about it, who never would have touched it, now simply view it as a potential tool in in their arsenal. So, that’s what I’m attuned to in the managed future space, the resistance to it that I felt in 2020 and ’21. The potty language and the bias was that there’s a trick in here. Every time I didn’t do this I was rewarded for not diversifying into the strategy. And my friend over there bought X, Y, Z fund right at the peak. And, you know, it had almost ruined his business. Everybody was just full of these stories.

So, I was talking to one of our investors last year about last year. And I had this chart that I’d basically showed people where manage futures were down and we were down more. So, it was a tough year for the space, a tougher year for us.

I basically showed them what we had was this chart, where basically everything else they had was up. And he told me, he said, look, he said last year was fine for us. When we got into this, we knew we were going to be long-term investors. But the narrative that I’ve told to my clients is it’s a problem if everything is up. Just like it’s a problem when everything’s down. Part of our job is to find a mix of things that go up and down in time. So, the advisors, the allocators out there are making their conversations with their clients more sophisticated in terms of what they’re really trying to achieve.

10 years ago, that wasn’t the case. It was the same guy who jumped, you know, I found a fund that was up 30% last year, and I’m going to make it a 5% allocation. And, you know, I found a guy who could do no wrong.

And then a year later, something bad has happened. And he’s spending all of his time talking about a 5% or 10% allocation. So, the overall sophistication of the buyer base keeps improving. And the narrative keeps getting refined in a way that it reflects more about what it is these people actually care about to include something like that in their portfolio.

[00:46:21] Niels

Yeah. Good stuff.

All right, moving along. We still have a paper from Mann that just came out that we want to maybe talk a little bit about. But before that, one other thing that kind of has come back in vogue with the emergence of actual earning interest again, in the last 18-24 months is, of course, a new way of talking about a very old concept. And that’s sort of stacking returns. And you posed the question, is that a good idea or a bad idea? Why don’t you talk a little bit about that?

[00:47:00] Andrew

Sure. So, I’m a huge fan of Corey Hofstein, who came up with this. I’ve been on his podcast. I think he does great work. I think his education stuff is phenomenal.

And, you know, this is my description of it, which is that back in ‘20 and ‘21, he was trying to solve a really vexing problem for managed future strategies, which is that a typical portfolio didn’t have a lot sitting in cash earning zero at that time. Bonds became the cash equivalent. They never went down, as I described, and you were earning 300 basis points more than cash. So why would you ever own it? So, it looked like it was free money, basically.

The question that a lot of these guys face is, if I’m going to put into managed futures, where do I take it from? And we were at the tail end of the long winter in managed futures. And the whole idea of return stacking is basically, you can do it with futures contracts to try to get to amplify your returns, essentially, and make it more capital efficient. So instead of putting a dollar, 60 cents into the S&P, 60 cents into bonds, you can use futures to give 120 and 80 if you wanted to, or whatever ratio.

The idea is that if you believe these things are going to generate higher returns over time, you’re adding this implicit leverage. So, your returns are going to be higher over time if you can weather the volatility. The problem with managed futures, and it really started with managed futures, so managed futures, because it’s futures contracts, you’re taking money from equities, which are earning 10% and 15% a year for a decade, or you’re taking from bonds, which are earning 4% or 5%, putting it into something that’s earning zero.

So, the futures portfolio has to do 500 basis points, 600 basis points a year, just to look even reasonable relative to any of the things you’re taking money from. And so, when it came out in 2021, it was picked up by a really, really great journalists, Robin Wigglesworth at the Financial Times, Jason Zweig at the Wall Street Journal picked up on it and wrote about it. Then something happened. So, then rates go to 5%, short-term rates go to 5%.

And what is managed futures at its core? It’s stacked returns on top of cash, and now cash is one of everybody’s favorite investments. I’ve been trying to raise money for UCITS funds in Europe and in the UK in particular, and people are like, all the money was just going to short-term gilts. It just is. People are so relieved to have a positive coupon coming out of their fixed income portfolios and not take duration risk.

So, to me, managed futures today, a straight managed futures allocation is just stacked on top of cash, and cash is one of your favorite investments and likely to continue to be a very attractive investment for the next 10 years. So, the idea of taking it and stacking it onto managed futures on top of bonds, there’s some logic to it, but to me it’s a niche product.

The guys that I talked to on the advisory side, if you think about kind of who the advisors are, there are guys out there who have smaller businesses who need to really do something special to grow. You know, when you’re young, you’re hungry, you’ve got to show that if there’s another crisis next year or over the next three years, you can do much better than the other guys and that’s how you’re going to attract the next group of clients and grow your money. For them, the leverage inherent in stacking makes a lot of sense.

For somebody who’s got a big established business, would you take money from equities, put it into a stacked equities plus managed futures combination that right now you have both skis pointing in the same direction. You are flying downhill, on both sides of your portfolio. And so, God forbid there’s a flash crash tomorrow and you’re down 20%.

So, I love financial innovation. I love when people come up with different kinds of products. I don’t think this is something that’ll take over the asset allocation world.

I think it’ll be something that the more sophisticated, hungry end of advisors will use. So, on our side, we haven’t done it. Now there’s a quasi-stacking version that I do love, which is, have you had Eric Crittenden on the show?

[00:51:22] Niels

Yeah, yeah, Eric has been on. It’s a while back.

[00:51:26] Andrew

Yeah, so look, I think what Eric has done, with adding some long equity exposure to a managed futures allocation, solves one of the great vexing issues of the space, which is the irritating line-item risk. I think that’ll largely be solved by growing sophisticated advisors and how they communicate what the portfolio is supposed to do and having people focus on the overall portfolio, as opposed to obsessing about individual line items.

I think it’ll be perfect. He’s also doing a great job of solving it the way he solves it. Now, the disadvantage of that product is you can get incredibly tax efficient exposure to something to a long equity allocation in the U S through ETFs because of this weird quirk where you basically don’t pay capital gains on it ever.

But when you take it and you put it to a mutual fund, you lose some of that. So, it’s not quite 1 plus 1 equals 2. It’s 1 plus 1 equals 2 minus something, some cost of that. But that side of it, I like. But I don’t think people would consider that to be truly stacked.

[00:52:35] Niels

Good stuff. Very good stuff.
Let’s round off with a paper that literally just hit my inbox this morning. It’s a paper from Mann. It’s called Honey, I Shrunk the Trend Following.

[00:52:51] Andrew

I’m still trying to grow it.

[00:51:26] Niels

Exactly, exactly.
Now, I’m going to let you talk about it. I have glimpsed over it, but I have been in meetings all morning, so I didn’t have much time to spend on it. But the concept is not new. But I know you had some thoughts and some views on this. So, why don’t you roll along, and I’ll try and keep up.

[00:51:26] Andrew

Well, you sprung it on me just before we’re getting on here. So, I want a massive disclaimer that I’ve spent maybe 7 or 8 minutes reading it and trying to understand the footnotes. But here’s basically what I understand the thrust of the paper to say, which is basically, if you were to have added the Barclays BTOP50 Managed Futures Index to a 60/40 portfolio of global stocks and bonds, going back as early as 1995 and said, what’s the right allocation that I would have had to maximize the Sharpe Ratio of my portfolio? The answer on average comes in around 40%. So, the argument is, instead of having 60/40, I’m having 40% of 60/40 and 60% of 36% and then do my math, 24% and then 40%.

So, I don’t like the paper. I don’t know who the audience is of the paper. And by the way, first of all, I’m totally in favor of the conclusion, which is that people should have managed users in their portfolios.

And I think the world of Mann as an organization. I think I just said before, is that literally, I think they run and are the absolute standard bearers in this space. The structure of the argument is that if you, at any point in time (the way they do the analysis), any point in time from 1995 to December 2023, and you looked back and you said, all right, if I started in June of 2007, what would have been the right allocation? If I started in 2015, et cetera? By doing that, you’re always starting 12 months after the best year in history of this space relative to 60/40 portfolios. And the worst year that 60/40 portfolios have had.

So, I’ll just give you some analogies where I’ve seen stuff like this before. End of 2007, if you were running a fund of funds and you were trying to convince people to put hedge funds in their portfolio, you would do a similar analysis and you would say, we’re going to look at all these asset classes from 1987, let’s say through 2007. This is right after these guys hit the lottery on subprime.

And a number of years before that, during the dot-com crisis, according to hedge fund data, which gets really bad when you go back before the early to mid-2000s, they’d also not lost any money during the dot-com crisis. And so, the asset allocation analysis, you run it in an unconstrained mean variance optimizer and your allocation is 80% hedge funds and 20% cash. And then the next year, literally hedge funds do terribly.

If you looked at ARK, Cathie Wood’s ARK, and you ran the analysis. So, 2020 ARK is up 150%. It was up 35% the year before that. And you said in early 2021, in all the periods where I could have possibly owned this fund, how much would I have wanted in this fund versus the S&P or versus anything else during the entire life of it? The answer is always going to be 100%. So, I don’t think it’s reflective. I don’t think the analysis is structured in a way to reflect the actual experience that people have had in this space.

So, the way that we would have constructed the analysis, if we were going to do it, is we would say, okay, you pick a window, a naive window, let’s say every 10-year period. If you felt that sharp ratio was the right measure, let’s do rolling 10-year periods to come up with that analysis. And I think what you’ll find is that you’ll get in a period like the 2010s or overlapping periods where you have bad periods and a lot of periods where you would want the allocation to be very, very low, probably never zero.

So, my answer would be, I think you’re going to come up with an allocation that’s not going to be 40%.

[00:57:10] Niels

I’m not a math wizard by any stretch of the imagination, but on the chart, on their charts in the paper, if you started in 2008 or whatever, the allocation to trend is pretty low, because we didn’t have a great 2010 period for that index. So, obviously, they’re not saying that people should put in 40%.

They’re just saying people should take it more seriously. That’s the point of the paper.

[00:57:44] Andrew

No, no, but you’re saying windows down to 20%, right?

[00:57:46] Niels

I guess I’m trying to understand here.

Yeah, you can do rolling 10-year periods, and you’re going to have periods where it’s going to be high, and periods where it’s going to be low, but that’s also what they do on their chart, right? They get low allocations. And what I mean by low is 20%.

So, I mean, I guess their data, it’s a different way of showing it, but it doesn’t show, oh, yeah, 40% all the time. For sure not.

[00:58:12] Andrew

No, no.

But what they’re saying is the worst allocation you would have wanted is 20%. I don’t think that’s remotely realistic.

[00:58:20] Niels

Fair enough.

[00:58:21] Andrew

I don’t know if the answer is zero. So, the question is, who’s the audience for this document? And Mann has a huge business where they go in, and they have great people who go in and work with institutional investors and basically say, we’re going to try to help you improve the returns of your portfolio.

These are all the different arrows that we have can bring into it. And so, they’re essentially almost merging consulting, investment consulting with the investment side of it. And so now what I suspect is that, and I’m sure they have huge fans on the institutional investor, in the investor world who love these guys, right? And they have great products, and they will do a lot of work for these guys, right? So, one of the questions is, is this document designed to be able to say, well, look, according to this paper, 40% would be the right allocation, but we’re only going to make it 10%. And therefore, that’s conservative relative to 40%. And that plays off kind of the old marketing thing of, there’s a famous story about steaks in New York restaurants.

So, give me three minutes for this, for this diversions. Some steak restaurants in New York, I think it was the 1980s. I’ll say it’s the, maybe the 1970s realized that if they had steaks between, you know, $20 and $40, no one bought the $40 steak.

They always bought the $35 steak or the $30 steak. They generally didn’t buy the $20 steak either, unless there were, you know, whatever, it shouldn’t have been there in the first place. And then one guy realized let’s put a hundred dollars steak on it, right? So, he throws the hundred dollars steak on it and everybody starts buying the $40 steak.

So, there’s this long history of that it simplifies this in the U S as well. You know, 40% allocation to managed futures is the optimal weight, therefore if you put in 10, it’s a no brainer, or five, it’s a no brainer.

I think it’s a little tone deaf. Now again, for the people that I deal with, it can be very valuable. If I’m a guy working at an institutional consulting firm that’s working with Mann on this, or I’m at a sovereign wealth fund or something, and I’m looking for things with six point fonts and graphs where I can slide it across the desk to an investing committee and basically say, you see, this is quasi academic work that is supporting my underlying thesis. And it helps them to basically make the pitch internally.

By the way, I think AQR and others pioneered this in the risk previa space. They took things that were leveraged long, short derivative-based black boxes that periodically would blow up and then called them risk previa, and showed them these papers that showed 70 years of back-tested returns. And therefore, if you do terribly for three years, well, it’s just a blip in the context of it.

It was absolutely the world’s greatest Jedi mind trick from an institutional perspective. But the reason it worked was because they had a receptive audience on the allocator side who wanted to invest in these kinds of products to begin with, and they needed the ammunition to go sell their investing committees on it. And so, if it’s in that context, I think it’ll be very effective.

So if it’s in the context though, of convincing somebody who’s not been in this space before, that they should have this in their portfolio and that therefore a 5% or 10% allocation is conservative relative to what it could be, then I think it’s counterproductive. It’s tone deaf relative to the realities that outside of this cloistered institutional world is what people deal with.

Here’s sort of a funny story. I was talking to a multifamily office in Europe about what we do, and they’re very quantitative. And they said, basically, how do we think about sizing this in the portfolio? I said, well, here’s the analysis that I suspect you’re going to do.

So, take this SOCGEN CTA index from 2000 forward and look at your current suite of investments, run it through whatever portfolio allocation tools, and you’re going to come up with a 20% allocation. That’s my guess when you come through all of that. I said, I will physically fly over there and stop you from making it a 20% allocation because you’re a multifamily office in Europe. You are talking to people, like my mother’s family, whose grandfather made money in something like a manufacturing business and are worried about preservation of their wealth.

This is not something that should be a 20% allocation. My guess is at the end of the day, the right allocation for you guys is going to be 3% and we can talk about why that is and how to frame it and how to pitch it.

So, I think when people put out these things like 40% and you know, it’s, it just, I’ve done this in the past, by the way. I learned by doing it. The reason I like talking to potential investors is that I can see how they react. And I used to say, yeah, look, it should just be 10% of every portfolio. Again, in the back of my mind I’m thinking, well, even if they don’t do 10%, maybe they’ll do 5% and we’d be thrilled. It’s just not the way I operate these days.

[00:51:26] Niels

It’s kind of funny, Andrew.

I had no idea how our conversation would go in which direction, but when I hear you talk about it.

[01:03:46] Andrew

That’s why you invite me back.

[01:03:46] Niels

I know this is the fun part, right? Because we can respectfully kind of disagree with each other.

When I hear you talk about something saying, no, 20% is too much, should be 3%, maybe 5%, I completely disagree. It makes no difference to a portfolio if you have 3% in two managed futures, you might as well not do it. Frankly, honestly, you shouldn’t do it.

If people think we can have any meaningful impact on their performance, if they go through a drawdown and they have 60% of their portfolio in equities, and they have 3% in a crisis alpha strategy, they’re going to be disappointed by that, I think. I would much rather they have had 20% in a diversified trend following portfolio. But let me pivot a little bit here and just give you two anecdotes, actually.

One is, a number of years ago, in the early days of the podcast, I did a roundtable interview with three consultants, three big consulting firms. And I’m pretty sure it was part of the recording. But they were basically saying, yeah, when they run their sophisticated models, the allocation to managed futures was way, way higher.

I mean, literally mentioning numbers like 30, 40%. But of course, they could never pitch that, they would never mention that to the clients. So, in a sense, even their models would come up with a number quite high. So, I did something on my side just to take a completely different, non-scientific approach.

I said to myself, because we do get asked, so how much should I invest in trend following? Of course, it’s a natural question. So, I give them a different perspective by saying, well, why don’t we take some extreme starting points? (I’m sure you’re not going to like this either, actually.) But why don’t we take some extreme starting points instead? And so, I look at what if you had only stocks, bonds, and in our case, I use the DUNN’s performance, the track record, and just say, what if you only had those three, and you started before the tech bubble, and after the tech bubble? That’s very extreme starting points for stocks and bonds.

And you did the same with the great financial crisis. And then, of course, we run it until the end of whatever the last month was, and we just do simple optimization on sharpe. And what’s interesting about it is, you don’t get to 40% at any point in time.

But in one of the two cases, and I forget which one, I think it’s the since the great financial crisis, you get pretty close when it comes to how much you should have allocated to trend. But the before and after starting point, the difference of allocation to trend is actually much less different than the difference between stocks and bonds. So, my point is that the biggest question mark, what’s more difficult for them to determine is actually what should your bond/stock allocation be, not how much your allocation to trend should be, because that is a much more consistent number.

It doesn’t change so much, which is obviously my argument for why it should be a core allocation all the time. I’m not saying it should be 40%. I’m just saying it should be a core allocation. I don’t mean 3%, I don’t mean 5%. I think that’s ridiculous.

Even though I understand the constraints some managers have, but it’s not going to change something in their portfolio if that’s what they’re seeking. But that’s just a different view.

[01:07:13] Andrew

Oh, no, look, first of all, I totally agree with that.

So, you know the space. You do podcasts on the space. So, there are people who I think should have a lot more than that. I guess what I’ve learned over time, I was giving a talk on managed futures about 18 months ago in London at the end of 2022. And managed futures looked like heroes or whatever. And I was going through this. It was a whole bunch of wealth managers out in London at an event.

And I showed them all this data, exactly the kind of data you’re talking about. Invested in the good times, bad times, blah, blah, blah. You are always better off. Your Sharpe ratio is always higher. And I stopped, paused in a second. I said, and not a single one of your clients will care what their Sharpe ratio is.

No one gives their advisor a hug for their Sharpe ratio. The advisory business, when you’re dealing with a pension plan, when you’re dealing with a single-family office, it’s different. When your business is the wealth management business, and most of our clients are going to be wealth management clients, it’s a different thing.

So, when I mentioned that consulting firm that has 45 different asset allocation buckets, think about that. Do any of them matter? Do you really need 17 different equity buckets in a 1% allocation? Pension plans will often have, it’s this fragmentation of portfolios in most circumstances. So again, it depends.

If you have just stocks and bonds, your clients don’t have any experience in alts, you need to be very, very close to zero for this allocation. Because the question is not how much would I have been happy to own in 2022? What’s the most I could have owned in 2023? And for it to be a small enough allocation that it’s just washed out by the fact that everything else is doing well. Because clients aren’t fair, right? It’s not like they come to you and say, I’m sure you made a great decision five years ago when you took money out of the S&P 500 and threw it into bonds earning 1% that just went down. No, it’s their money, it really matters to them.

On the other hand, I talk to guys who, their clients only look at the overall portfolio return. They don’t obsess on a line item by line basis. They’re 10%.

But again, remember it’s 10%. It’s not like they only have three arrows in their quiver, stocks, bonds, and managed futures. They’re going to have hedge fund strategies, REITs, infrastructure, et cetera.

So often when I talk to wealth managers in the UK, and a lot of them will say that they’ve kind of already moved to a 50/30/20 model. Then I say, look, we should be % of the 20%. Managed futures should be 5% of the 20%.

And that’s the point they’re saying about bonds. It doesn’t just apply to bonds. Another thing that people, again, compare it to, not on the hedge fund side, is the liquid alts world. And the overall liquid alts world has been, I mean, that truly has been an embarrassment. It’s done between 1% and 2% per annum over a decade after 200 basis points and fees. It has actually made democratization a bad word.

And in a sense, because it was people taking products, it’s a business where things get sold. And you have 30 funds in a space and two of them are doing well. They have armies of guys behind them. And that’s all you can hear about. They raise tons of assets. They do badly, whatever. They go try to find new clients for the next one.

So, when you look at managed futures in the context relative to that, again, it looks heroic. If you look at a recent pistor and look at a relative bonds, it looks heroic.

So, it’s all of these complicated dynamics that I’m talking about.

[01:11:01] Niels

I’ve worked it out, Andrew. I now know why you’re only saying 5%. It’s because you’re saying 5% for you. I’m saying 20% for trend following as a whole.

[01:11:12] Andrew

No, no. When I say 5%, because the other 15% and the 20% will be a relative value UCITS fund, this fund and that fund.

[01:11:21] Niels

I’m teasing you a little bit here, Andrew.

[00:51:26] Andrew

Look, honestly, I hope you guys are right. I hope in five years… I’m all in favor of a massively rising tide lifting all boats. But usually, the issue that I’m dealing with is, honestly, it comes down to one of trust. And the advice that I give people is, I was with a consulting firm when I was in London. And I started off by saying, look, what we do is not going to be for you guys in 19 out of 20 circumstances. I wouldn’t do it.

If I’m representing an institutional client and I want to go into the managed futures space, I am walking over to Mann, I’m walking over, I’m talking to you guys, I’m putting together four or five of single managers to do it.

On the other hand, if somebody walks in and says, I have these particular constraints and I can’t do this, and I can only invest in a UCITS fund, whatever the constraints that come in, you should just know what we do. But I am too old and tired to spend my time trying to convince people to do things that I want them to do today but may not work for them over time. I’d much rather have people who, where we have an honest upfront conversation about what it is that we do, why we do it the way that we do it, how it may or may not be able to help them in what they’re doing really day to day in their business, because I’d really like them to be around for 10 years.

I don’t want to be cycling through clients who have unrealistic expectations about what we do.

[01:12:53] Niels

Absolutely. Well said.

This is a good point to wrap up because I think that’s actually what our industry generally, not everyone, but generally where I think we spend a lot of time on education and it is critical for sure. Yeah, let’s wrap up the conversation. This has been fun, Andrew.

I really do enjoy it. And I really do enjoy also that we don’t necessarily always see eye to eye on things, although we both…

[01:13:18] Andrew

I’m waiting for the moment when we disagree sufficiently where you disinvite me from all future podcasts.

[01:13:24] Niels

No, I’m not worried about that. I’m not worried about that.

In any event, if you, the people listening to us today, enjoyed this conversation, I certainly invite you, I’m sure Andrew would as well, to go and rate, review the episodes, the podcast on iTunes or Apple podcaster as it’s called, Amazon, Spotify, wherever you listen to it, we would so appreciate that.

Next week, while I am in Asia, I will be joined by Rich. So, I’ll be much closer to him, although not quite out there. So, make sure you send in your questions for our upcoming episode and you can email them as usual, info@ toptradersunplugged.com. And I will do my best to bring it up with him.

From Andrew and me, thanks ever 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.

[01:14:19] 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.