How to Invest in Turbulent Times? ft. Graham Robertson

[00:00:02] 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.

[00:00:24] Niels

Welcome and welcome back to this week’s edition of the Systematic Investor series with Graham Robertson and I, Niels Kaastrup-Larsen, where each week we take the pulse of the global market through the lens of a rules-based investor.

Graham, it is wonderful to be back with you this week. How are you doing?

[00:00:39] Graham

Very well, Niels. Great to be back. Yeah, I had a couple of busy weeks traveling around, talking to lots of clients about trend and outlooks. Hopefully something we’ll be discussing in a bit more detail today.

[00:00:54] Niels

Yes, absolutely.

It seems like, because I’ve been on the road as well for quite a few weeks by now, it seems like we’re certainly in the busy travel season, which actually does lead to some interesting observation about what our prospects and clients are thinking about.

And speaking about thinking about, Graham, I’d love to start with this question, which has nothing to do with really the topics we’re going to talk about because I think we have a great lineup of topics that we’re going to be tackling. But I would love to hear, sort of from maybe your own personal point of view, what’s been on your radar the last few weeks?

[00:01:32] Graham

Well, I guess it’s hard to pass up what’s going on geopolitically, particularly what’s going on in, in Ukraine and Russia and the dynamics of the new president. And all that is happening, and I’m sure we’ll cover that and its implications for markets.

What I found particularly fascinating is just how engaged people have become, particularly, you know, my kids, for example. My kids are 20 or late teens, early 20s. And everybody’s engaged, everybody’s interested. And I think that’s a healthy thing. You know, it, it may not be… It’s controversial. What is happening in the world is interesting. Things are happening. The new president in the US is going about things in different ways and people are looking at it and discussing it and I think that’s a good thing.

[00:02:19] Niels

Yeah, I couldn’t agree more.

It was also the thing that I had put on my little radar was just the fact that the world is changing in front of our eyes and it’s changing a lot every single day. I also have kids in their early 20s, both studying in Copenhagen. And when you mentioned that, what it made me think about is kind of two things.

One is that I’m kind of curious to know if they’re old enough to know the difference, if you know what I mean, because they kind of grew up in a period where, I feel personally, a lot of the changes in the way things work, not necessarily relating to the new administration, but just things have changed is really in the last couple of decades. I mean, after the great financial crisis, both politically and so on, and so forth, we don’t need to go into all the details about that. So, I was kind of thinking, do they really know the difference? Do they understand the gravity of the change we’re seeing in front of our eyes?

And then the other thing I thought of and love to hear your view on this, and that is, are we scaring them, so to speak, are we making them…? I mean, because the youth has been through a tough time with COVID, in many respects. Certainly, in Denmark, where I follow the news flow probably a little bit closer still, there’s a lot of attention on sort of emotional health and so on and so forth, especially among the young people.

And I was just wondering whether this news flow coming out, and certainly Denmark is very. The whole discussion about Greenland and all those things, there are a lot of things going on where let’s say the noise is coming from the political scene is worrisome, let’s put it that way. So, I was just wondering, actually, how they may be affected by all of this. I don’t know if there’s an answer to it, but is that something you’re concerned about, your kids being worried about what’s going on?

[00:04:21] Graham

I think they should be worried about it. But the key thing to me is that they’re engaged, you know, it’s not just passing them by. And that to me is fundamentally important and good.

What else I’ve found interesting is the way that this information is now disseminated. It came up on a number of occasions recently where historically you might look at some interview of a politician where you’d get the message in whatever way was being portrayed according to the party line. But these days, it seems to me that the information is coming through the medium of podcast.

Look at the way, in the lead up to the elections, that it was the podcast, it was the bros that were the medium, and that really got across. And what’s interesting there is that the message is unfiltered, it’s less disguised, it’s less kind of roll your eyes at what the politician is saying over, and over, and over again. And I think that it’s probably a good thing too. We’re getting to hear what people really think.

[00:05:26] Niels

Yeah, that’s true, that’s true. Although, I will say also, even in the podcast space, I am seeing some worrying signs that it’s just being taken over by certain interest groups, let’s put it that way, and losing a little bit of that kind of raw independent voice which at least we try to keep up here on Top Traders Unplugged. But there we are anyways.

All right, so of course everybody knows we’re completely biased when it comes to trend following, but at least they know that before they sign up for the episodes.

Speaking of trend following, it’s been a little bit of a mixed start to the year, I would say. There were opportunities in some sectors for sure, like equities, but then kind of those opportunities have been somewhat canceled out in other sectors. Currency springs to mind, and maybe we see fixed income bonds being caught somewhere in the middle.

If I look at it from my vantage point. Love to hear yours afterwards. I would say that, of course, gold has been quite an interesting market, good for trend followers, to some lesser extent silver. And, of course, now there is a bit of interesting chatter around the shiny metal gold, including suggestions that the US administration could reprice the gold reserves.

I think they have like 8,000 tons of it and if they mark to market that instead of the $42 per ounce which I think is the official price, they are on the books for, of course, whoopty, you would have billions of dollars that you could lend against should you want to do that, like build a sovereign wealth fund or something else. So that’s kind of one thing that I find interesting, and I’m sure trend followers have enjoyed that.

We have a new ‘cocoa’, because last year it was all about cocoa. This year it’s all about coffee. So, we see some challenges with the crop coming out for next year. I think the estimates I saw were that it’s probably going to be lower by 4% or 5%, and that’s obviously sending prices somewhat higher as far as I can tell.

Then we have the widow trade which is interesting as far as I can tell. For those people who may not know what I mean by I say the widow trade. The widow trade is something that has been used to describe trying to go short Japanese government bonds for a long time, because every time you tried the BOJ would basically make you pay through its central bank policy. But there are some signs that things are changing.

Yields on the Japanese 10-year bonds have gone up from being negative 25 basis points to now positive 1.44%. And we’ve seen an interesting push higher, since around September of last year, in terms of yield, which means that being short JDPs, now, is actually something that has made a little bit of money for trend followers as far as I can tell. And, of course, depending on what kind of exposure the manager would have.

And then within equities, even within equities, it’s also been, I think, a little bit concentrated in just a few markets as far as I can tell. The DAX has done well, which may come as a surprise because people think of Germany struggling, which is true, but actually the DAX index is made up, as far as I know, of a lot of multinational companies that are making money at the moment.

And also, things like Hang Seng seem to have had an interesting move, a bit of noise in the last couple of months, but also a bit of movement that could be captured from a trend following perspective. So, those are some of the things that I’m seeing at the moment.

Graham, love to hear what your observations are on trend.

[00:09:21] Graham

The gold one is a fascinating one. The gold story is one side, but of course the other consequence is what happens to the treasury market as a result of an issuance in the treasury market. And again, that’s where trading all the different markets that we do globally is particularly interesting.

You look at the effect of one market and what should that do to another market and you can capture trends in lots of different ways. So, you mentioned a few. There’s a couple of other ones I would mention as well.

I mean, to me you covered equities, the fact that European equity markets are on fire this year is amazing given the noise that’s coming out of all the tariff talks and whatever. Again, breaking this link between economic news and market prices. It’s fascinating.

And then there’s the European energy markets. It’s very difficult for traders like us. Last year they were quite range bound but you’ve got very low inventories, you’ve got very cold weather. I mean, certainly, as I found out this week, traveling in the Nordics and Holland, you know that very, very cold weather coming through. Low inventories plus little wind means little supply from the German renewable networks.

And that just pushes up the price of European energy markets, whether it’s natural gas or power. There are hugely different dynamics going on, which is music to our ears in a sense. Lots of things going on is good for us, I would argue.

[00:10:54] Niels

Over at our firm, we don’t trade European energy other than Dutch nat gas. Tell me a little bit, if you could, just tell me a little bit about some of the opportunities that we now have today, as managers, to capture some of these moves in European energy markets. What kind of markets are you thinking of here and how do you even access them? Because I imagine they’re not really futures based just yet. Or maybe they are.

[00:11:21] Graham

Some of them are futures based. What I guess you find with some of the futures based markets is if you look at an exchange, the liquidity perhaps doesn’t look great, but there’s liquidity off exchange that you can potentially capture. Some of it is OTC, over the counter which, on first sight, people think OTC equals a liquid. That’s not necessarily the case. The way I like to think about it is you just have to work a little bit harder, roll up your sleeves in order to trade it. So, you might need a little bit of human intervention to execute it.

You might need to have some kind of ISDA arrangement perhaps in the background to trade it. So, it’s a little bit harder, but you can still trade it. But there are some big liquid markets out there that you can capture.

Historically you’ve seen some quite independent behavior from some of these markets. When we know the effects, someday a central banker stands up can affect big liquid macro markets, but you’ll have a situation with some European markets.

Nord Pool, I think I’ve mentioned, is one of my favorites there where the thing that drives the price of a Scandinavian hydroelectric market is weather patterns. It’s how much rain is falling. So, the trends you get in those markets are just completely diversifying to what you get elsewhere.

So again, if diversification is the name of the game, and I think it really is for a trend following strategy, the more diverse price sources, price drivers you can get, the better potentially it is for a trend following strategy.

[00:13:06] Niels

Now I know you guys have been, and when I say you guys, for those who don’t know, but I refer to AHL as one of the pioneers, not just in our industry, but also in the alternative market space, you have a very successful fund in that space. Can you, I know we didn’t prepare for this, but I’m just curious because I don’t have any firsthand experience with this, can you talk a little bit about maybe some of the other alternative markets that have been interesting as well? If so, because again, it’s not really something I follow to a great extent.

[00:13:47] Graham

I can give you a couple of examples there. So, the thing about the alternative markets, it’s a Very broad term. But essentially you could view it as not a classic futures and FX market, which are relatively straightforward to trade from a trend following point of view.

So, you might be talking an OTC market, an interest rate swap for example. One that maybe immediately springs to mind is something like Swiss interest rate swaps. So, there isn’t a Swiss fixed income futures market, it’s certainly not big enough. But last year, for example, the Swiss national bank opened up the prospects of going subzero rates again. And that’s something that of course would drive up the price of those instruments. And that’s something you could potentially capture if you’re able to trade, let’s say, interest rate swaps relative to the classic futures markets.

So really, it’s about just allocating or getting markets in there that you can’t particularly trade anywhere else. Opening up your price sources, opening up diversification, really was something I always find (I think I said this when we previously chatted) that the diversification or the spread in returns you can get from trend following managers, despite us all really trading trends. Right? Theoretically, it’s quite a simple thing to do. You buy something that’s going up and you sell something that’s going down.

But when you start to figure out, okay, how long does it have to go up, how long does it have to go down, which markets are you talking about, how are you measuring it? These things introduce huge variations in trend following strategies and you can get some up and some down over the same kind of timescale.

And that’s been quite evident, I would say, this year in particular, if I look at… We’re fortunate at AHL, we trade a range. We trade anything from, you know, tens of markets all the way to kind of hundreds of markets and all have different characteristics.

But what was very evident, particularly post the US election, let’s say December last year and January this year, the very biggest liquid markets really nicely trended, particularly in a relatively slow point of view. So, they’ve been doing relatively well.

More recently, and I’m going back over the last couple of years, diversification hasn’t necessarily played out. That was certainly the case, I would say, in 2022 when we had some big moves in markets. But year to date that diversification has a little bit…

We’ve talked about the European energy markets and those three factors coming together, the low inventories, the cold weather, and the lack of wind to power the renewables has really driven those markets higher. So again, it’s been fascinating to see what differences those different effects can play.

Now, we know in the long term, when we run a simulation, diversification tends to play out in the short term kind of anything goes, which can present a few problems to those of us who are explaining the strategy to investors, but it keeps us on our toes.

[00:17:13] Niels

Just staying at this theme just for a second more, some of our good friends in the industry, and I think I’m referring mainly to Florin Court here because we had them on the podcast a few years ago. They obviously came from AHL and were kind of one of the pioneers to go and say we exclusively focus on alternative markets. And so that was very interesting.

Now I remember, well, I think I remember from the conversation that there was some suggestion that maybe, at least back then, alternative markets in their view were trending better. And I’ve always had a little bit of a struggle with that concept because I was thinking, why would they necessarily trend better? And when I looked at the data, it didn’t look to me like performance was better in the long run, but it was different.

And then I know some of our other friends, who I probably can’t name right now because I haven’t had their permission and they haven’t been on the podcast, so, I can’t use the source, but what I can say is that they did a presentation a while back, because they also trade alternative markets, and they concluded that actually they don’t trend better, they just trend at different times.

I’m curious as to how you think about alternative markets from your side. Do you think that they have some inherent benefit or advantage to developed markets or whether it’s kind of more, what I believe, that they just tend to do things differently at different times and therefore they can add some diversification?

[00:19:01] Graham

Great question. So let me answer it in a slightly different way. To me, performance of a trend following strategy is a lot to do with the diversification that you can get out of the individual markets.

The maths basically says all things being equal, if everything is completely uncorrelated, your Sharpe ratio increases with something like the square root of the number of markets. You can get a 0.1 Sharpe up to 1 Sharpe by trading 100 completely independent markets.

On the face of it, if you can access a broader range of price drivers from alternative markets, you should be able to get a higher Sharpe ratio in the long term. And then if you look at the futures and forward side of things, you do tend to see a bit higher correlation, particularly with macroeconomic events. It seems to be the case that the big liquid futures markets were more susceptible to, let’s say, what a central banker might say. These two observations kind of come out, I think, when you look at the properties of them.

So, I guess where your question comes from, if you look at the Sharpe ratio of alternative markets, it tends to look better in the long term, I would argue, because the diversification is better. And that’s me kind of dodging your question about do they trend better, but the performance tends to be better in the long term.

But the classic futures markets seem to have a lower long-term Sharpe ratio. But that crisis alpha property for which people really look to are strategies that tend to come out stronger.

And if you look at the big sell-offs in risk assets in 2008, and even more recently in 2022 when we had the big inflation spike, you know, it was evident to us that that was really coming through in traditional markets. And what we think is relatively appropriate here is asking investors the question, what are you trying to do?

Are you looking for something that has perhaps a long-term Sharpe ratio, a steady performance independent of markets, or are you looking to trend crisis alpha properties?

And specifically, with regard to the latter, you could make the case of well, if I want to insulate my risky asset portfolio to a crisis, you probably won’t be trading the kind of instruments that you’d have in that risky asset like S&P is a classic example. Treasuries is an example.

Going back to my case of Nord Pool, you’re not intuitively going to be insuring yourself or protecting yourself from a sell-off and risk assets by investing in something like a Scandinavian hydroelectric power contract. I think the intuition is there. So, it kind of depends what you do.

And I think it might be a case of greater diversification with alternative markets as opposed to they intuitively innately trend better. I’ve heard it both sides, but that’s probably the way I would look at it.

[00:22:21] Niels

Okay, very good actually.

So, my follow-up curiosity about that would be given the fact that there are these benefits that you mentioned, and obviously not just you, but other people as well, alternative markets in the CTA world have been around now for a few years, right? It’s not ‘new new’ anymore. You were the pioneers as far as I remember, but others have joined since.

So, my question is, do you see any signs of an area which, I assume, liquidity is obviously not going to be the same as on the developed markets. Do you see signs of some level of crowding?

Crowding is not exactly the word I’m looking for, but let’s go with crowding, that there are simply maybe a few too many people trying to extract that benefit now using more or less same techniques, and in a world where liquidity could be a challenge from time to time, not in all alternative markets. I’m fully aware of that but it may also have a little bit more cost associated with it now than compared to when you guys were doing it more or less on your own.

[00:23:38] Graham

Great question. So, let’s see if I can remember them all so I can unpack them.

So first of all, I think we need to be careful in terms of liquidity and the connotations of that. So, the alternative markets, if you look at them on a market-by-market basis, they’re not necessarily smaller than futures markets. They’re harder to access, but not necessarily smaller. So, I think that’s an important point.

And certainly, we view the trading or the size that we would have in any one market for an alternative market in exactly the same way that we would do a futures market. So, I think that would be the first point to make. It’s not necessarily giving up liquidity.

I mean, even outside of alternative markets, a smaller futures market will probably get a smaller size within your portfolio, all things being equal. So, that’d be one thing.

The size of the industry. I think you were right with your question. If that was becoming an issue, you might pick it up in terms of transaction costs increasing, but you don’t necessarily see that and you get independent…

We obviously measure internally the size of a market in which we gauge our position. But there’s also independent surveys that you have on credit derivatives and interest rate swaps, and they showed that these markets are actually growing as well. So, you can kind of glean from those whether or not perhaps the space is getting too big. And we certainly don’t think that’s the case.

And maybe the final point, and again, your question alluded to it. Does liquidity necessarily dry up in times of stress? I mean, CDS is almost the poster child for that not being the case. A credit derivative, when times get stressy, what you often see is the demand for insurance. And credit derivative, to some extent, is insurance from your credit risk.

That doesn’t dry up. If anything, the size of that market tends to grow at that point. All good questions, and it’s something we actively monitor, but we don’t think these are significant causes at the moment.

[00:25:54] Niels

Final question on this, and I really appreciate you sharing your insights here because we didn’t specifically plan for this, but in the alternative space, at least in my view, you would include crypto. And I get a lot of questions personally from people who ask whether we are considering crypto. And, of course, you could say from a return stream point of view it’s an interesting non-correlated market, and so on, and so forth.

But I did notice that even at this stage, where some of the cryptocurrencies have become very well established, you have even got ETFs on those markets, we had a little bit of a crypto crash earlier this month where Ether dropped like 20% or more over the weekend in one day.

So, to me, the exit liquidity risks that, what if you had to trade on that day? I know you couldn’t even trade futures on that day, but some people may trade it in other ways. Is this something you just simply…

And I don’t know if you can answer this question, of course it’s more of a research question, but I’m sure you could. Is this something that you just simply have to kind of take into your analysis saying yeah, this could happen. So, we take that into consideration when we price positions or calculate positions. Or is this something that may even surprise, a little bit, your research team when they see that in a relatively established crypto market like Ether, that suddenly you have a 20% drop in a day.

[00:27:28] Graham

Great question. I guess as always you just have to weigh up the risks with the opportunities as well.

We’ve got fairly well established futures markets on I guess Ether and Bitcoin 2017, off the top of my head, something like that. So, fairly big and fairly liquid. What’s certainly apparent to us as traders, and this is not us expressing any fundamental opinion either way, which I’m sure Rob Carver would be very happy to hear about. But you know, you just have this complete missing idea of value within there. It’s been, you know, over the years. You know, obviously we’re, we’re bounded at zero on one side, but where’s the other end of that spectrum? Is it, it used to be 100, and I hear people talking about 200, who knows where it is.

But that is, to a trader, particularly a trend following trader, that is just a wonderful thing to hear. Trend following strategies love bubbles. And anything where there is just very little idea of fundamental value has this propensity to form bubbles.

And that’s something that we absolutely love. So yes, there’s definitely opportunity there and risk there as well. So, I guess your classic way to look at the risk side is well, how do we diversify?

And of course you diversify across as many future strategies, futures markets as you can, I mean broadly too their investor appetite comes into it as well. Even though we can say we think it’s potentially a great opportunity set, some people just don’t want to trade it and that’s fine. We have to accept that.

But you know there are other options too. You can, you know, there’s decent liquidity in a lot of the coins now, as well. And that’s something that we can, we can look at and try and diversify some of this idiosyncratic risk that you mentioned. But I think to us the opportunity set is fabulous there, but very cognizant of the fact that some people just don’t want to be exposed to that, and that really limits where you can put these things into.

[00:29:38] Niels

Yeah, no, absolutely, great stuff. Thank you so much for playing ball on these questions. It’s very, very helpful and I’m sure very interesting for our listeners.

Now let’s get back to the normal programming and that is talk a little bit about what trend following is doing at the moment and then we’re going to get into a question which actually I think will be quite interesting for people to hear and then we’ll get into some topics that you brought along.

From a performance point of view, first of all, my own trend barometer finished at 30 yesterday which is weak, on the weak side. But I think also, people should always remember that it is using somewhat shorter term timeframes so it’s more in line sometimes with the Short Term Traders Index which is pretty week so far this year. But still, anyways, it can be tracked every day on the website. But it’s at 30 right now.

Performance wise, and this is as of Tuesday since we’re recording Thursday so we don’t have the Wednesday numbers yet, but I think yesterday was a little bit of a down day for the industry. But as of Tuesday BTOP50 was up 56 basis points for the month, up 1.78% for the year. SocGen CTA index pretty much flat, up 11 basis points for the month, up 73 basis points for the year. Trend index making 41 basis points in February, up 56 basis points for the year. And the Short Term Traders Index, as I mentioned, struggling a bit, down 30 basis points and down a quarter percent so far this year.

Comparing that to the traditional world, MSCI World up 1.83%, very strong despite everything that’s going on in the world, up 5.37% so far this year. Even 20-year bonds, the S&P US Treasury bond index for 20-year plus is up 68 basis points so far this month. That surprises me a little bit actually. It’s up 1.15% so far this year. And the S&P 500 Total Return up 1.8% in February, up 4.64% this year.

All right, let’s move on to a question that came in from Rick and it goes I think a little bit into sort of the structure of how the trend following managers look to extract the trends, so to speak. How do we do it? And I’ll read the question in a second. But also, I think it allows us to talk maybe a little bit about the history of how some of this may have evolved.

And I will say to you, Rick, appreciate the question, but of course I don’t think Graham and I can claim that we know enough about what our competitors are doing to give you any reliable data in terms of the breakdown. But let’s deal with it one by one.

You write, “The SG trend index (and I think it’s the trend indicator that you’re referring to), utilizes the 20 and 120 day crossover as a trigger and has some nuance sizing. Here are my high level questions.

Is a crossover system typically the primary tool for trend?” (And when I read this as moving average crossover, that’s how I read the question.) So, I’d love to hear your thoughts about this because from my memory, I think actually that AHL in terms of the CTA, (here, I’m going back to the original, so to speak, AHL with David, Marty and Mike) they were maybe some of the first people to use moving average crossover.

I don’t know if you know this or not, Graham, but that’s just how I remember my conversation with them many years ago. What would you answer, whether it’s the typical primary tool for trend following?

[00:33:29] Graham

So, I guess back in the very early days, I think the original signals were kind of binary. It’s on if it’s going up, or it’s off, or it’s minus one if it’s going down. And I think the natural progression from that kind of binary signal is something that’s a little bit smooth, something that moves gradually into positions. And I think a classic moving average crossover will give you that kind of response.

You said it in your introduction. We don’t necessarily know what everybody’s doing, but I’d be surprised if that wasn’t happening in a lot of trend vol managers analysis. And the indicators, as far as I can remember, uses one crossover, the 20/120 day to represent the index or it best fits the index over a number of years. So, I think that’s where that comes from.

In terms of what I said earlier, we need to be a little bit careful there in terms of the huge dispersion we get in trend following managers who are using all these different techniques for looking at trends in all these different markets. Even with a consistent approach, trend following approach, that dispersion is absolutely huge. So, we need to be a little bit careful if we’re boiling it down to one tool this 20/120 day. But more broadly I’d say moving average crossovers or something similar. They’re one of many tools that we use to look for trends.

Others include, you know, breakout models where you effectively form a channel around a better price and then if the price moves upside, on the upside you go long, if it moves in the downside you go short. People also look at back returns. There’s lots and lots of different ways to do it.

Even within moving average crossovers, for example, there’s lots of design choices you can use. Do you use a fixed window, you know, that 20/120 day that the trend indicator uses, you know, is that just a constant window constant, 20 day constant, 120 day average? Or is it some kind of weighting towards more recent observations which might make more sense to make you a little bit more reactive.

Whatever the case though, the beauty of a system like that is that they’re smooth, they’re incremental and any kind of positions that you put on through moving average crossover type models they don’t hit the markets hard and they incur relatively small transaction costs. So, they have lots of advantages.

[00:36:08] Niels

Yeah, no, definitely, because actually Rick goes on to ask whether the breakout models are also used and what’s the typical split of crossover versus breakout models, so on, and so forth. So, of course, you and I don’t know the split. We can certainly confirm that they’re both used.

I mean I can say from my point, at Dunn, we actually started using volatility breakout. That’s back in the early ‘70s. We never used moving averages. But then later on we added, as you say, more continuous systems like a lot of people would call time series momentum, which by the way AHL has a wonderful YouTube video called AHL Explains.

And it’s very well explained, actually, by one of Graham’s, I think maybe former colleagues now, about how time series momentum and other of these signal generation methods are used. So, Rick, maybe you want to go and check that out as well.

But then I dug a little bit into sort of the archives and I found, from books, and I don’t necessarily agree with the timing of this, but it was interesting. So, some people would say that breakout systems can be dated back all the way to the 1800s with David Ricardo and his kind of rules. There are some quotes that we’ve used in the trend following industry for many years about, ‘let your winners run and cut your losses short’, dating back to that era. I think it was like 1789 or something like that.

So, some people claim that breakouts have been around for a very long time. It may be true, I don’t know. Then there were people talking about sort of Dow theory as also a kind of a breakout dating back to the 1900s, which may be true.

There is this article, I think actually it’s something I came across on Michael Covel’s podcast many, many years ago. I think he had an article of this show dancer called Darvas, I forget his first name, who made a lot of money, not from dancing, but actually from using what became known as the Darvas box. So, when prices broke out of this box or range, I guess, he would follow them and apparently made a lot of money there.

That’s back from the 1950s, this article. So, that’s been around for a while. Then you have these channel breakouts that you refer to Donchian Four-Week rule as a concept. I found some references back to 1960 about that. Something called the Dreyfus 52 Week Rule, also 1960.

And then of course the Turtle Traders, which most people listening to us will probably be aware of, which started out, I think in 1984 and lasted for a few years. Later on, according to the sources I could find, you had Bollinger Bands, which is more volatility breakout and average true range.

But all I can say is that at least at Dunn, and I think also maybe people like Campbell and others, who date back to the early ‘70s, this was volatility breakout. So, that certainly came before what these sources had found.

And I also think that there are fractal, Bill Driess who also had been on the podcast and who’s unfortunately retired now, good for him. He was using some fractal analysis, I’m not entirely sure how to describe that. But he also dates back to the mid to late ‘70s.

So that’s kind of what I found in terms of the history of these things. Feel free to add anything, Graham.

[00:39:59] Graham

The only thing I’d say is one, I’m incredibly impressed about your expansive knowledge about the history there.

[00:40:06] Niels

Well, I’ve been around for a long time, unfortunately. I date myself, Graham.

[00:40:10] Graham

Well, I was going to say, I mean, I remember reading, I think it was Reminiscences of A Stock Operator, which I’ve just been looking up Lefevre. I mean, that to me was one of the earliest instances I saw of people talking to me. It didn’t say trend, I recall, but it was clearly what it was. And that was absolutely spot on. It’s just really interesting to see how people got it from very early days.

[00:40:36] Niels

Reading the tape, I think is how they described it.

[00:40:39] Graham

Great book, well worth the read. And also, Anthony Ledford, who is the author of our little videos that you mentioned. He’s still around, actually. Still around, still going strong, and still very able to get across relatively complex ideas in a nice easy manner.

[00:41:02] Niels

Yeah, they’re wonderful. They’re absolutely wonderful. I think I had them in my resource section for a while on the website, linking to you guys, because I thought there was no point in trying to replicate that because they were done so well.

Anyways, now we’re already 42 minutes into our conversation, and only now we’re going to get to the best part, which is your topics, of course, Graham. So, I’m going to let you lead the way. I know you’ve got a few sort of big ones. And feel free to dive as deep as you want and then I’ll try to keep up with you.

[00:41:38] Graham

Right, okay. So, I think there were two predominantly on my agenda.

The first one, which I’m calling ‘the taxi driver problem’, and then the second one, which we’ll touch on later, talks about the recent events around DeepSeek and implications on defensive equity strategies. But let’s talk about ‘the taxi driver problem’.

As you’re probably aware, when you travel a fair bit, you get to hear, you get to talk to a lot of people, and it’s a really good way of finding out what’s on people’s agendas. And clients, at the moment, it’s very difficult to beat a dominant performer in an index.

So, the Mag 7 being the classic case in the US driving everything. So, you might hop into a cab in the US and they’ll tell you how well they’ve done being long the Mag 7. And of course, they were in there before they took off.

And if you were in Copenhagen, you might have the same issue with your cab driver talking about Novo Nordisk and how they’ve been in there since they’ve exploded, and done really well. So, you know, you’ve got these classic problems where very well-known entities do basically make the average man in the street do very well. And it presents problems for investors who try and diversify across lots of different assets to try and protect themselves in the long term.

It’s very hard to get it right in the very short term.

So, I guess the most often question, the most popular question we’re getting from clients at the moment is kind of, I’m underperforming the Mag 7, for example, what can we do about it? I mean, to be clear, it’s a very tough problem.

Here is a very large component in a very large index, already overweight, that’s performing ridiculously well. And it’s very hard for a stock picker to beat that. You know, the largest components are the ones that are performing best. It’s very hard to figure out how you beat that.

And one thing that people are gravitating towards is a portable alpha solution. I know lots of people call it different things, but essentially what we’re doing here is saying, okay, well let’s separate our stock pickers problem into a kind of beta part. You’re just trying to perform in line with the index; with an alpha part, which is a kind of long short stock pickers problem.

And the stock picking aspect of that is very hard because the largest components are doing well. So, I guess the portable alpha framework would say, well, let’s separate the two. Let’s accept that you want your equity beta in there, but can we port that alpha problem somewhere else? Can we take it potentially out of that pure equities domain, and can we put it somewhere else?

I guess the obvious area, particularly with this podcast and the subject matter is, can you put it in quant strategies? Can you put it in multi strategy funds? Can you put it in trend following just to diversify away from that pure equities framework and diversify your alpha sources?

So, we see portable alpha strategies coming back on people’s radars. It’s something that you have to think about very carefully. Margin management can be very tricky. You’ve got to make sure that your alpha strategy isn’t drawing down at the same time as your beta strategy, clearly, which I guess from a trend following context at least should be beneficial. Typically, when your beta portfolio is drawing down your alpha, if it’s trend following, tends to do quite well via this crisis alpha property.

So anyway, it’s an avenue that we’re seeing increasing interest from clients and it really is started quite often from a Mag 7 type problem.

[00:45:39] Niels

And do you offer standardized solutions for that or is it always a customized solution if people come and say, yeah, I need you to help me solve that problem, or do you have products today where people can just simply buy from, you know, an equity index plus some kind of trend on top?

[00:45:56] Graham

We’ve certainly found it to be fairly bespoke problems from some larger clients. As it stands, that’s the kind of problems that we’re solving. But clearly there are potentially opportunities there to look for commonality across other investors to see what might be more broadly acceptable.

[00:46:17] Niels

So, when I think about that, because obviously it’s also something that I come across, and this portable alpha, although it has found itself getting a lot of publicity in the last couple of years, it’s certainly not a new concept. I remember working on this back in the ‘90s. So, it just comes and goes.

Funnily enough, it always comes back when equities are doing really well. And we have to come up with a solution as to why we’re… How can you participate in trend and not feel you’re underperforming all the time?

But seriously, it also obviously has a very important function because it is a way for giving people the solution they need in a package that they want, essentially. And so, I do think it’s very valid. And often, I’ll come to my question, because often we think about this as, oh, trend should be combined with equities. That we can help you diversify away from equities.

What about bonds? What about trend as a, I wouldn’t call it a bond replacement because in Europe… So, you and I deal with, well, I don’t know about you, but I deal with mostly European and non US investors.

And so, for them it’s not necessarily the S&P they’re worried about or the DAX as such, but it’s the 80% or the 60% bonds they have in their portfolio. And of course, we don’t know what’s going to happen in the future, but it sounds like what’s happening in this new world order, that it’s not going to be cheaper for countries to defend themselves. So, you would think that there’s a lot of bond issuance coming one way or the other.

So, maybe the real risk is not being invested in private companies, but it could be being invested in government bonds, to some extent, from a yield perspective. I’m not talking necessarily about a default perspective, but just from a yield perspective.

So, is that something that comes up in your conversations of saying, well, Graham, could you help me find a solution where I could maybe replace some of my fixed income exposure with something that could work well regularly?

[00:48:29] Graham

Yes. So, the crisis alpha framework is typically referred to in terms of equities. And I think the reason for that is you’ve had some very well-known equity market falls in the last 25 years. I mean equities, you look at MSCI World has lost about half their value, twice since 2000. You know, the tech bubble bursting, 2000, GFC 2008 and then, of course, you’ve got Covid. MSCI World I think was down about 30% in that period.

So, you’ve had a few instances where trend following has been able to shore those credentials in fairly recent memory. Certainly, as long as I think Dunn has one of the longest track records around, we’ve been around for a few decades as well. We can see that in the track record.

The problem with bonds has always been, at least until recent memory, you’ve had to go back an even further time period to see it. You need to go back to the ‘70s to see inflation really taking off. Bond crises have been relatively few and far between, with one exception, the recent one, 2022.

And I think that really has been, from talking to clients, that’s been the kind of wake-up period where people have thought of bonds as, oh yeah, as soon as equities go down, bonds will go up.

Well, 2022 showed that that wasn’t the case, and it’s definitely rekindled interest in a dynamic strategy like trend following where you can be short bonds, you can be short equities. And if you’re looking to bonds as defensive, or as you quite rightly said, if you’re slightly worried about the US repricing its gold and all of a sudden not needing to issue any Treasuries and what happens to treasury markets? I think it’s quite possible that people might be looking for alternatives to that and I think trends and other strategies with defensive capabilities could step in and fill that hole.

[00:50:29] Niels

So, I have another related question to that. Obviously, we know that interest rates came down for about 40 years from ‘81 through 2020, thereabouts there. Of course, bond yields have picked up after Covid. Now they’ve come off again to some extent, but they’re a little bit higher than they normally were.

Now, my recollection is that after the financial crisis and when rates were really low and short-term interest rates were about, you know, zero or negative in Europe at least, investors weren’t really looking for double digit, mid double digit returns or volatility for that matter. Now that it’s changed, do you think, I mean from trend followers, that they were quite happy for lower volume type strategies?

And so, I think there was a general deleveraging in our industry compared to say the ‘90s and the ‘80s leverage and volatility came down. And if you look at, say, the UCITS space, there is a little bit of a range in terms of volatility. But I’m just curious whether you think, now that we have a little bit more volatility in say fixed income markets, we have higher rates, do you think that investors are actually now looking to their trend followers to also deliver a bit more. They want a little bit more juice from what we do and they’re not really looking at these low vol alternative products, so to speak?

[00:52:02] Graham

I think that question really depends an awful lot on individual investors. I hear some people will be dyed in the wool. Something that’s low volatility is all that we’re looking for.

I met an investor yesterday who had completely the opposite view to that, actually. You know, given what you said, given what’s happening in the world now, we want a little more juice out of this. And I guess, from my point of view, the beauty of a trend, but quant strategies in general, is their flexibility. You can do a 5 vol strategy, you can do a 10 vol strategy, you can do a 20 vol strategy. It’s just the turn of a dial. It doesn’t really change anything.

The volatility of markets doesn’t scare us. I’ll go back to Bitcoin as an example again. You’ve got an asset class that trades on or around about 100 vol. It doesn’t bother us at all. It just means that we need a smaller amount of it to generate a certain level of risk.

And that’s just the way that we look at markets in a day-to-day basis anyway.

[00:53:11] Niels

Yeah, absolutely.

Now, in the interest of time, of course, I know you’re a busy man, you had one other sort of main topic you wanted to discuss and maybe we’ll have time to. I’ll throw in a couple of thoughts at the very end but I certainly don’t want to miss your last topic for this conversation so, feel free to take over again.

[00:53:35] Graham

Great, thank you, Niels.

Yes, so the second topic was about defensive equities and explicitly about the news that we had on DeepSeek that came out on the 27th of January. So, just to recap, this was a Chinese company coming up with a new large language model which could be done much cheaper than previously thought.

Donald Trump called it a wakeup call for US companies. Marc Andreessen, who was the co-founder of Netscape, referred to it as a Sputnik moment.

I’m going to go off on a tangent given that you’ve displayed your knowledge on history there. So, I looked that up. It was a lovely analogy. So, the Sputnik moment goes back to 1957 when the USSR launched Sputnik 1 and showed the US just how far ahead they were. And it turns out that NASA was founded the following year. So, things happen on the back of that. So, I thought that was quite a cool link there.

But certainly, judging by subsequent price moves, I think a lot of the Mag 7 components there just bounced back. That Sputnik moment doesn’t seem to be playing out too much at the moment, but the context that was particularly interesting for us was regarding defensive equities. By that, I specifically mean long/short quality or QMJ as our friends at AQR first talked about it in 2013.

I think in previous chats that we’ve had, Niels, I’ve mentioned that that worked particularly well in recent years when trend has struggled in typical flights to quality like the Silicon Valley Bank Crisis 2023, and we had Yenmageddon when that big carry unwind happened in Q3 last year. Long/short quality a cash equity strategy, where you go long high quality stocks and short low quality stocks, that did remarkably well.

So, we’ve seen it as a really nice partner for trend following strategies. Trend, I always think about lines of defense. Trend requires sustained sell-offs, typically, to work, to exhibit these crisis alpha periods, typically, I guess, of the order of weeks to months. I think long/short quality stocks tends to be a bit more immediate and sits in the middle of something like let’s say a long volatility strategy.

So, it’s something we’ve been looking at quite closely to sit alongside trend following strategies. But I guess why it’s relevant is that a few people have said, well, if you look at quality stocks at the moment, you tend to find that they’re often dominated by technology stocks, software and services, semiconductors and equipment. What would happen in an environment where the tech sector sells off? Is a long/short quality stock strategy going to struggle as well?

And I guess this links into the DeepSeek episode the 27th of January. That’s clear that was linked to a fairly big sell-off in tech stocks, but we didn’t necessarily see a sell-off in that factor. So, that was reassuring. I think that was on our radar in the last couple of months. But it kind of makes sense as well.

Even when the tech bubble burst, 2003, you saw long/short quality strategies, at least in simulation, do okay. So, it’s kind of nice to see, more recently, in a very sudden market move, like we saw on the 27 January, that this, at least for now, doesn’t seem to have been an issue. So, I think that was the main point I wanted to raise with that one.

[00:57:26] Niels

Yeah, it’s funny, the whole DeepSeek event obviously happened, as you said, the first Monday of the week of the big alternative investment conference in Miami that I was attending, actually. And there were a few nervous faces in the morning of that day when you looked around, but it all turned out not to be too big of an issue.

This was great.

There’s one thing I maybe wanted to sort of leave people with as a thought because you mentioned it already when you talked about this thing about value. Now, I forget the exact wording you were using earlier, but the way I think about it is that we do live in a time right now where there is, in my view and others, there is a disconnect between the price and what we define as value or what we used to think about as value.

And you talked about it in terms of Bitcoin, where value is very subjective. What is it worth? Some people say it’s going to be worth millions and some people say it’s going to be worth zero. So, value has become very subjective in many ways. And I completely agree with that, I think we live in a world where we see some crazy price moves and crazy assets, as well, being priced.

And I was thinking about this, and I think, well, if we’re in a world where there is less of a connection between value and price, wouldn’t it be a good idea to just focus on price? Because that’s the one thing we do know, because we have it in front of us on our screens every second.

And so, in an odd way, because of what’s happening, even though it’s not good news necessarily, what’s happening around us, but in an odd way I think it might present more opportunities for strategies that are just focusing on price, like trend following. But there may be others as well.

So, it’s not always nice to be optimistic at a time where the world seems to be falling down around you but I do feel that there are some opportunities for these type of strategies. And maybe more so, that there is a bigger understanding, and recognition, and acceptance, by investors that maybe they need some of this in their portfolios if they haven’t got anything. And maybe they need a little bit more than what they have right now.

Not that I think that there is a lot of massive changes in inflows to our industry right now, but I certainly feel, from my travels, that there is a bigger openness to have these conversations compared with a few years ago. Don’t know what your thoughts are because you travel as much as I do.

[01:00:26] Graham

I would agree. I think maybe, to quote a friend of the pod, Andrew, who says about trend following, Mr. Market is your portfolio manager. You know, let’s see what’s happening in the price, not necessarily what’s in the value. And there’s just as, at least, if nothing else, a different way to look at things. And I think that’s really quite relevant right now.

[01:00:49] Niels

Yeah, it is indeed.

All right, well, great stuff. Thank you so much, Graham, for preparing, and coming on, and sharing your knowledge. We’ll, obviously, have you back in a few months when the weather is a little bit warmer. And so, I already look forward to that.

Of course, for those of you listening and you want to show a sign of appreciation to all the prep work that Graham did, go to one of your favorite podcast platforms, leave a rating, a review of this episode, and give him some nice feedback.

We talked about crisis alpha a fair bit. I’m glad to say that next week I’m joined by the queen of crisis alpha, namely Katy, who’ll be here to talk about maybe even a new paper she’s been working on. So that’s very exciting news, I think, for all of us.

And if you have some questions that you want to ask Katy, you can email them to info@toptradersunplugged.com and I’ll do my very best to, one, remember them and also make sure I put them in front of her as best as I can.

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

[01:02:06] 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.

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