Sharing the Trend Following Pie 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 be back with you this week on the podcast. How are you keeping? How are you doing?

[00:00:39] Andrew

I’m great. Thank you so much. It’s great to be back as always.

[00:00:41] Niels

It’s always fun to have you on. Now, we’re obviously going to have our usual lineup of different topics somewhat related of course to your world of ETFs and replication. We’re going to have a few other things that are not necessarily related to that. But before we jump into any of these topics, I always love to hear what you’ve been keeping your eye out for or what’s caught your attention since we last spoke.

[00:01:14] Andrew

There have been two things that are totally not work related, but my God, the political situation in the US is depressing. It’s a little bit hard to do anything else. For both sides, come on, guys. Can’t we do a little bit better than this?

I don’t know how you feel about it from the European side, but my God, it just is people just talking past each other and the venom and everything people do sometimes plays into the arguments on the other side. I am just at a loss, but I can’t stop reading about it because it just feels very important for this country.

The other thing which is, again totally unrelated, is Spring is finally here. The weather has warmed up. We had this long, wet, couldn’t quite catch on. So one is putting me in a terrible mood every day, the other is putting me in a great mood.

[00:02:09] Niels

I can kind of relate to both of them, not because the US election is something that’s top of mind, but of course, we do hear about it quite a lot over here as well. But we are having our own European Parliament elections this weekend in Europe. So of course, there’s a lot of politics going on. Of course, there’s a lot of divided opinions in Europe, about how much influence we should send down to Brussels and how much we should keep for ourselves.

Now, luckily, I live in Switzerland, so we’re outside the EU. But I am Danish by background, so I do follow what goes on with the EU. So I can certainly relate to that. Weather-wise, I actually can relate to that as well because in Switzerland, we’ve had so much rain. It’s literally been raining almost every day for weeks on. We haven’t quite turned the corner just yet, but I am hopeful that we’ll get a little bit of that.

So you obviously brought two topics along for what’s been on your radar that has nothing really to do with finance and so on and so forth, except of course politics is related. There are a couple of things that caught my attention this week. First of all, I couldn’t help just notice we’re talking Friday afternoon. I couldn’t just help to see the latest US unemployment numbers which are somewhat surprising for those who keep saying that interest rates are going to drop like a stone and inflation is going to be 2% anytime soon.

So again, I’m personally cautious about that view. I think we’ve got another little bit of sign of evidence. But what I wanted to bring up is something I listened to. I came across Jim Bianco, who has been a guest on the podcast a while back, but he was on another podcast this week or last week. What he brought to my attention is something I actually haven’t thought about, maybe you have, because everybody talks about, so what should the interest rates be and how does that relate to inflation and so on and so forth.

What I didn’t know was actually that before 2009, so before really the GFC, real yields in the US were about 2% above inflation. But since 2009, real yields have been significantly lower, like a quarter percent above inflation, or less during certain periods of time. So the question I took away from that is that, well, maybe with so many other things where the last 10, 15 years has been the abnormal period, maybe this means that we have to go back to what is ‘normal’, and 2% plus inflation does certainly not suggest that interest rates are going to drop from here in the long end for sure. Why is that important?

Well, it’s important because I think a lot of people still hope for some kind of return to what they remember with low interest rates and all the good but also all the bad that came with that. I also still think that many portfolios are not really positioned for that environment as well. Finally, you could argue that with the debt we’ve managed to build up in terms of government debt, real yields of 2%, so somewhere between 4.5%, 5.5% in terms of 10-year and 30-year bonds, it’s not going to be very helpful for governments who have now borrowed so much money that they have to service in terms of the debt.

Could that mean that we, also in other countries other than the UK, would get one of these Liz Truss moments where you come out with a budget, it’s a little bit too much stimulus, and then the bond vigilantes will come out and basically vote with their feet and the bond markets collapse, essentially, until the government steps in. That’s actually something that when I hear Cem talk about it, giving me that information that I hadn’t thought about and wasn’t aware of in terms of where real yields used to be, I thought it was very eye-opening.

[00:06:22] Andrew

Bianco produces probably my favorite single chart of the past several years, which is they show I think it’s the two-year Treasury yield or something over a very, very long period of time. It’s like this sick black line showing it going almost down to zero and then it spikes up and it starts to come back down. Attached to that line are a million little filaments. What they’ve done is gone every month and basically said, what was the market’s expectation going out for the next year, or the next year or two? Always wrong.

I think that’s the fascinating thing about how much airtime gets taken up with these near-term macro predictions that are really no better than a coin toss. In a sense, when you look that at that evidence, I’m friends with a lot of journalists who write about things like this. What’s fascinating about it is after today, they have go-to people who believe that this was the right thing. They’re going to give them a lot of coverage and a lot of airtime.

The next time an inflation print comes in lower expectation, you’re going to have a different set of people… Journalists are always talking their own books in some way, shape, or form. It’s just this constant, it feels like this sort of merry-go-round around it. I started talking a number of years ago, I think there is an existential crisis in a lot of macroeconomic modeling.

If you just take a step back and you say, how many economists predicted the 2010s would look like they did, if there’s a number lower than zero, you should pick it. If you’ve given them a whole series of facts, we’re going to have $40 trillion of spending, there’s going to be no fiscal restraint anymore, the stock market is going to do this, all these other things, and they plugged it into their models, we would have had inflation in 2014 or 2015, and it didn’t come forever.

I think we have these models that people rely on that just don’t seem to be working well. I don’t know what people are going to do to replace it. So, we have people who can make predictions with somewhat more accuracy. Look, if the Fed doesn’t know, they’ve recently got pretty good information and they don’t seem to be getting it right.

So my totally non-quantitative thing is it just doesn’t feel like the economy is slowing down that much. Yes, there are pockets it. Of course, there are pockets of it. It doesn’t feel recessionary, let’s say. But two months from now, I could be wrong.

[00:07:14] Niels

Of course, we could all beat that.

[00:09:04] Andrew

By the way, for the overall managed futures space, not to be a little schadenreude about this, I’m kind of happy the number came in strong today. A lot of us have been positioned for a healthier inflationary environment than we’ve seen over the past few weeks.

[00:09:20] Niels

That’s true. By the way, of course, between you and I, Andrew, there’s nothing wrong with talking your own book, of course, which we do every week.

The other thing, and that kind of relates to speaking our own book here, the other thing that I came across was a Bloomberg podcast. There’s so many of them, I don’t really remember the name of it. But in that one, they had been out speaking. I think they had been invited to some kind of, I wouldn’t call it a conference, some kind of like a gathering of short sellers.

They were basically reporting the fact that many of these famous short sellers, like Jim Chanos and other well-known names, they’ve kind of closed down shop, because after how many years of a relentless bull market with very few breaks, it just hasn’t been profitable to be a short seller. I got the feeling, well, I wonder if this is happening right before you’re going to need short selling the most. With so many things, like every time trend following is pronounced dead, people redeem, and then, hey ho, six months later, they have a great run.

So I was just wondering about that. But the way I was wondering about it was the fact that maybe that leaves trend followers as more or less the only group left that are true short sellers, meaning we don’t have any biases. Most of us at least, we don’t have any biases in our model, so we can truly go short when markets point in that direction. We saw that with the bond market in 2022, 2023, as you just alluded to, still short in 2024, and so many other things.

When I’ve come across global macro managers and people talking at events, even during the last couple of years, and they talk about how are you positioning, a lot of them were quite bearish on say bonds. But when you drill down and you ask them, so how are you positioned, they weren’t really short bonds. They just had some other stuff on that felt would do well if yields would go higher.

So yeah, I think as I said, trend following might be the only true short sellers left, if I’m being a little bit cheeky here. So that was another thing I thought was interesting. I don’t know whether you ever think about that.

[00:11:43] Andrew

I have a lot to say on this topic. Short selling generally sucks. It sucks because you’re starting with a horrendously asymmetrical nonpayoff profile. First of all, you short something, if you get it unbelievably perfect time you get everything else, you make 50%. If you get the timing wrong or other things, you lose 200%. So the odds are stacked against you.

Now, my first job in the hedge fund industry was working for this guy, Seth Klarman. He knew Chanos well. Chanos was one of that generation of hedge fund guys. There was this great story about Chanos that that Seth would say as we would go up and say, boy, the stock seems really overvalued and we should short it. He’d tell this story about Chanos. Back then, you actually had shareholder meetings and hedge funds would show up and yell at managers in person. They weren’t yet at the point of sending poison letters and things like that.

So Chanos apparently had shorted some stock, and he goes to the annual meeting and all the shareholders there, and he grabs the mic and he starts yelling at management about all these things that are wrong. And then apparently, the management CEO said, are you done? And he said, yeah, I’m done, or something. I want to hear an answer. He said, well, the answer is, we just got a takeover offer. That added a 70% premium to the stock. So, you can know everything backwards and forwards about this, but these things can go on for a very, very long time.

I actually wrote a paper in the 2010s about the demise of short selling. It really had to do with the fact that if you think a hedge fund is capacity constrained on the long side, but then you’ve got a guy who’s made a lot of money shorting stocks but he’s got a $200 million fund. So in general, if there are 20 or 30 stocks that you love on the long side, nobody’s foolish enough to short 10 or 20 or 30 stocks on the short side. You do these kind of much more diversified books. The hope is that the one guy you get wrong that triples on you isn’t going to…

Look at Tesla. Tesla put a generation of short sellers out of business. That stock has to be sufficiently diversified. But the problem is, as you get bigger, the short constraints or the capacity constraints on the short side become much, much more difficult. So once you get past a certain point, there’s really very, very little point of trying to do shorts on individual socks and generate alpha that way. Long before Melvin Capital getting blown up on GameStop and these other positions, I think what was confusing to people in the hedge fund industry was that just seemed really reckless.

It seemed reckless 10 years before, but here was a firm that was still doing it with leverage. So it doesn’t surprise me that people are saying that, but I think it’s one of these (and it’s something we can talk about more), I think myths die really hard. It takes then a long time to die in the hedge fund land.

In the 2000s, there was this myth that was propagated of the genius short seller. So if you were known for shorting something that did badly, like David Einhorn and Greenlight shorting Lehman, or Jim Chanos shorting Enron, that halo effect lasted for 10 years.

But overall, the space, we looked at this really, really closely in the early 2010s. We had a guy who was going out and finding these funds. We could find funds and we were doing vigorous calculations. Oh, my God, look at all the short side alpha you’re generating. The moment we invested, it went to zero, at best. It was just selection bias. You’ve got 50 guys who are doing it, and you’re looking around, there are a couple of guys who are going to look like geniuses. They’re just not geniuses after you give them money.

[00:15:55] Niels

I think all of those points are fair. I guess what I just wanted to maybe clarify is that, of course, we as trend followers believe that markets move up and down, and the fact that we can participate in some very profitable downtrends is very useful for investors. Maybe the advantage that we have is that we’re diversified. So we’re not reliant on having to find single stocks that we hope will half or fall more.

But a broad bear market in the sector is very productive from a trend following perspective, and therefore, very productive for an investor to have in their portfolio.

[00:16:35] Andrew

I totally agree with that. I think the thing to remember is that the investment world is dominated by two kinds of people. One, people who build asset allocation models that are designed to move slowly, and they’re long. Their business is to be long and to be slow moving. The other is that people who still dominate the stock selection side of the business are mean reversion guys, they are intrinsic value guys.

People often have this idea that the markets have gone down 10%, I bet hedge funds are blowing out of their positions and that’s what’s driving the markets down. Most of these guys will be buying. Because if you think about what their world is, if you’re a fundamental stock picker at a place like a Viking or Lone Pine, any of these legendary stock picking firms, you might spend four years looking at a stock before you buy it.

If you like it at 100 and then something happens in the market, so you’re planning to order for 10 years. Five years, you think the market is getting something intrinsically wrong, those are the best things for you. Ron Baron not quite a hedge fund guy but buying Tesla and just riding it, his career is by far just riding that thing into the moon, or Warren Buffett with some of those positions like Apple that just keep going up.

So I think the bias of a lot of investors is when things go down, because they remember the last time. Remember the guy who stepped in and bought it, and then it recovered, because the world doesn’t blow up. So on the stock picking side and the equity long short side, I think because of that bias, something like trend following which will short after it’s already gone down. The market goes from 100 to 80 and they like shorting it more at that point because they’re not thinking about intrinsic value.

It’s an enormous competitive advantage. It’s why the alpha in the space should not be measured in terms of whether people have better models, it takes more money from the next guy, or they get into trades a little bit earlier in other trades. It’s managed futures funds against the rest of the world. So in a year like 2022, the magnitude, hundreds of millions of dollars of alpha can be generated for a period of time because the vast majority of the investment world is looking at it and they can’t do anything. They’re not built to take advantage of it. So I agree with you.

[00:19:09] Niels

All right. Well, we’ll come back to all of these things in a few minutes. Before, we will just run through the usual trend following update. Before I get into the numbers, Q1 was pretty good for trend followers. Q2 so far, some corrections without a doubt and reversals happening in the markets. I was curious to know, do you think it helps your conversations the fact that CTAs are not at an all-time high?

Do you think even in your space or the people you talk to, that they actually prefer to buy in at a lower price or do they immediately see the drawdown as some kind of problem and are not tempted by getting in at a slightly lower price than a few weeks ago? How does your audience react to these things?

[00:20:02] Andrew

My favorite ones are the ones who don’t care. They may look at the space for six months and they decide it’s going to be a 3% allocation or 5% allocation. Again, that’s the long-term thinking from a portfolio perspective. When people asked me about timing, I say if you’re trying to time this in your product, you’re trying to pick the bottom or something, honestly don’t because it’s too random, it’s too difficult.

The one thing that I have talked to some people about is, look, we had a lot of investors come in at the top in 2022. In our strategy, we also had a bad year in 2023. So it’s kind of like a double whammy they came in at the top end. But for some of those investors, I’ve said, look, if you’re thinking about making this a long-term strategic allocation, you don’t have to do it all at once.

There’s a concept called dollar cost averaging in equities which is just designed to avoid the pain of picking at the very wrong moment. so, look, if you think you’re going to make this a 5% allocation, dial in over three allocations. Do a third each quarter for the next three quarters or something. But, again, the people that I talk to in the ETF world and the RA world, if they’re thinking about this as a six-month trade, I honestly say, I don’t think you should. You’re going to be disappointed and you’ll never come back as an investor.

[00:21:36] Niels

Okay. We may come back to this in a slightly different way. Let me quickly update our audience as to what the environment looks like right now.

My own trend barometer closed yesterday at 41. So it’s kind of neutral to week, but I actually think it’s not necessarily right now tracking the trend space as well because it’s using shorter-term timeframes in its calculation. So it’s more tracking the Short-Term Traders Index I would say in terms of performance.

Anyways, BTOP 50 in June, we’re in June already, down 1.64% so far as of Wednesday night, up 7.2% for the year. SocGen CTA Index down 1.77% in June, up 7.2% as well for this year. SocGen Trend minus 2.21%, up 9.21% for the year, and the Short-Term Traders Index, as mentioned doing better. Up 10 basis points, and up 2.38% for the year.

Finally, the traditional indices. MSCI World as of last night up 1.3% in June, up 10.12% for the year. World Government Bonds were up about 96 basis points yesterday, certainly not anymore after this job number in the US. The S&P 500 was up 1.45% in June, up 12.9% for the year as of last night.

Now, I’ve got a couple of questions that came in, one from Paul, one from Joe. I think the one from Paul, I’m going to keep for later in our conversation, Andrew, because it relates to and ties into a little bit of the things we’re going to be talking about. The one from Joe, I think we could tackle now before you dive into some of the topics that you brought along. That is just maybe dealing with this thing that often is, and maybe it would be something that you would have brought up later in our conversation. I’m not entirely sure.

But there is one thing that people who look at replication as an investment product have questions about. I wouldn’t say necessarily concerns, but they have questions about it, and that is how you deal with this lag effect, so to speak. Because you don’t know necessarily when the managers you’re tracking exited certain trades and therefore change their exposure, and so on and so forth. So how do you think about that or how should you think about that when looking at replication models?

[00:24:04] Andrew

So replication will always be a little bit slower than the underlying funds. In our case, we look back at roughly the past four weeks of data. Where it’s problematic is November 1st of last year. Powell comes out and says basically the rate hikes are over and we, looking at the SocGen CTA Index, see pretty much everybody is short treasuries in some fashion. So we’ve all collectively walked into a propeller. So the question is how quickly you extricate yourself from the propeller?

So, in an inflection point like that, what made that difficult from a replication perspective was not that it happened but that it continued the way that it did. Because, again, if you think about in my very simple way of thinking about these trends, if you have something that’s been, I’ll use an this example.

Yesterday, you’ve got something that’s gone from 10 to 20 over a six-month period of time, and it drops from 20 to 18. So now your six-month window of time is 10 to 18. Still pretty good. Then it goes 18 to 16. I would call it more like an oscillation, that you’ve kind of hit an inflection point where, in this case, rates were steadily going up. That’s irresistible for short-term, medium, and long-term trading. So everybody’s all in on this trade, and then it goes.

So you get a sharp move, rates come down. Now, let’s say that the following Monday, we’re rebalancing, and now we’re looking back at 17 days of data before this happened and three days since it happened. A well-designed model will have ways of looking at the past three days and saying, that seems a little different than it was, but you’ll be a little bit slower.

Now, empirically, though, a lot of the times, that sharp move is a head fake. Everybody dialed out of their positions on Thursday and Friday because we thought war was going to break out in the Middle East or China was going to invade Taiwan, or something big macro-wise was going to happen, and then by Monday or Tuesday, we know what hasn’t happened and the markets come back.

Now, in that period of time, there will be plenty of guys in an index like the SocGen CTA Index who have pretty tight trip wires. So they’ll start derisking. They’ll have vol controls that will kick in, and they’ll have all these other things. So we’ll miss some of that. The question that I always ask allocators is, why do you care?

If people in the space had a mechanism to know when the reversal of the trend was going to continue against them, they would all get out earlier. They would all get out a week after it starts and then avoid the difficulties of the next seven weeks as it continues. But there’s a diversity of opinion in it. If I think you guys or an AlphaSimplex (and, by the way, welcome to the ETF sandbox, Katy and team), but if you guys are going to be slower getting out, I think probably, and there are other people who will emphasize to their investors that those guys will go down 10 but we’ll go down 5 over that period of time. They’re not saying they’re going to go up over that period of time, but they’ll get out earlier if that happens. So I don’t really see it as a long-term economic issue. I would put it more into the heuristic biases. What’s your loss tolerance versus long-term expectations of the returns?

Guys like that, in a period like 2022, they’re also likely to underperform. So how much do you care about the performance in a year like 2022 versus getting whipsawed on some reversals? I think it’s just not being fair to investors about what to expect.

[00:28:01] Niels

I think that’s perfectly fair. A couple of thoughts on that. One is I think, interestingly enough, that although trend followers, to a large extent, have become longer term in terms of our lookback periods and so on and so forth, that’s I think pretty universal across the space. I think some of the innovations among managers have been more in terms of how we can react a bit more quickly on the exit side, meaning risk reduction. I don’t mean just from volatility. That in itself is of course true, but just on other things as well. That’s just my hunch from talking to people, that that’s where a lot of research and innovation has been focused.

[00:28:50] Andrew

Do you think it’s helping? I know people are doing it. I don’t see a lot of evidence that it’s actually… I don’t see higher Sharpe ratios. I do see lower drawdowns. But I see you’re getting lower drawdowns but you’re adding a different type of whipsaw risk, and I think you’re probably hurting your Sharpe ratio over time. But I’m curious to hear what you think.

[00:29:16] Niels

Well, let me put it this way. I think it’s very hard to say whether it’s helping or not because we don’t necessarily know what performance would have looked like if everybody had just not changed their models for the last 15 years. So we haven’t really got anything to compare with. If I look on our side at DUNN, some of the changes we have made have certainly helped and improved our Sharpe ratio.

I think generally speaking, a lot of people have always said oh, yeah, trend following is like a 0.3 Sharpe. It’s not. If you look at the managers today, the last 10 years, it’s not 0.3, even though we went through a difficult period of time. But it’s higher than that. So I can’t say for sure if it’s helping. It was just my gut feel that maybe it’s some of the things that people have been focusing on from a research point of view.

[00:30:01] Andrew

On the replication side, I think one of the things that people, to use that analogy I said, on one Monday you’ve got 17 stale data points and three fresh data points. So replication is moving too slowly. You’re not getting out of some of the positions. Again, granted, what’s going to hurt replication is not if one of 10 or 15 positions whipsaws and goes against you. Generally, it’s because there’s some underlying market theme. It’s either two skis pointing in the same direction or you’ve got 11 skis pointing in the same direction.

So when it happens, it cascades across market. So now go forward another week. Now you’ve got 8 data points that are current and 12 that are not. So what does a replication model do? It says, “Oh, I missed it last week. I’ll catch up this week.” So you might miss it for a week. What I always liked about replication is when you’re wrong, you’re never that wrong.

Just in our case, we started replicating hedge funds back in mid 2016. We went to the way that we’re most well-known for doing it and we haven’t changed a thing in almost eight years. Because the model itself doesn’t change, but it is inherently adaptive because you’re always getting new data and you’re adapting to it. So if you’re a little bit wrong one week, the model doesn’t keep drilling that same dry hole, it dynamically readjusts.

It’s a very strange paradox, in our business, in that I often tell people, if we’re doing it right, and then we’re having a conversation 10 years, they’ll say, what have you changed? We’ll say, we still haven’t changed anything.

But when you talk about all these things, if the entire space figures out a way to predict whether there’s going to be a drawdown tomorrow (to see the wave cresting and get out at that point) then my guess is in the returns of the overall space we will not do as well capturing the overall returns of the space because there will be more periods when we go through these drawdowns or underperformance relative to slowness.

Personally, I’m skeptical just because I think it’s really hard. People have been studying this for years and years and years. The dream is not that you have a stop loss, it’s you have a stop prevention. But that’s really costly and you end up giving a lot for that.

[00:32:37] Niels

Absolutely. All right. Andrew, you said you had brought along some some topics. I have some of them, but I think you also had some brand-new material from this morning. So I have to just go with the flow and see how we go. It’s exciting. It’s very exciting for me as well. What are we going to talk about?

[00:33:00] Andrew

Years ago, I started writing for more of an institutional audience. The first thing I wrote was an editorial in the FT about hedge fund fees and how hedge fund fees consume 80% of alpha. I came up with this thing as to how to make it more investor friendly, of which no one listened to it. Basically, people went outside and continued to burn money for fun over the next 10 years.

But then just on our side, on the business side, we ended up really focusing on the wealth management space because we found that the appeal of what we do is going to be very dependent upon the job of the person who’s looking at it. If the job of that person is to decide what combination of you guys and AQR and Man AHL, etc., then we don’t really add much value to them.

But in the wealth management space, particularly in the ETF world where you’ve never had what I would consider to be institutional quality products or things that should make people’s lives better, we had the opportunity. I’m turning my attention back to the institutional space because I’ll tell you some statistics.

By the way, just by way of background, when people throw around data on the hedge fund world and hedge fund indices, the very, very best, most comprehensive data is published by a firm called PivotalPath. Jon Caplis started this firm, PivotalPath.

PivotalPath basically is not really a hedge fund database company. They work with global pension funds, family offices, etc. They do all of this work for them to help them understand their underlying hedge fund investments. What they do is they don’t share information outside but they have the very best information as to the holdings of these firms. For example, in a normal hedge fund database, you won’t see Citadel Wellington.

You’ll sometimes see Millennium, sometimes you don’t see Millennium. You’ll never see the firm that I worked for, Baupost. So, hedge fund databases overall always have this incompleteness issue. So it’s a long preamble of saying PivotalPath has the best hedge fund data, and I’m going to tell you some hedge fund data. I think in managed futures, institutional investors are ridiculously underinvested in managed futures and I don’t think people have looked at this data.

So here are some stats. Out of the overall hedge fund space, the way PivotalPath defines it, managed futures represent about 6% of the assets. Going back to the point about equity long-short, equity long-short is 37% of the assets. The multi-strat area, which we all hear about, and everyone wants to throw money at multi-strat funds, is 20% of the space. Now, you can look at that data, and PivotalPath data gets excellent, starting in September 2015, when they basically went live with all their data.

So their managed futures category has 58 funds in it, whereas the SocGen CTA Index has 20. What that means is that they’re talking to pension plans, family offices, etc., and they’re saying, hey, I’ve got all these guys, and all these guys are not all in the SocGen CTA Index. So when you look at the correlation of let’s take those three categories; managed futures, multi-strategy, and equity long-short. Managed futures has a correlation to equities of zero, multi-strategy has a correlation of 0.5, and equity long-short strategies have a correlation of 0.75.

Then the whole point, in this world today, is how do we diversify our equity risk? The beta is a little bit different. The beta of managed futures is zero, again. Multi-strategy is 0.1, because these guys, they have a higher correlation, but they have much better risk controls, and equity long-short comes in at 0.3 to 0.4. Now, alpha is where it gets really interesting. Because managed futures, even including you’re talking five years of the long winter and the years since then.

Managed futures is 340 basis points per annum of alpha to an allocator in stocks. Multi-strategy, viewed as the alpha generator par excellence, has 280 basis points of alpha. So managed futures actually generates more alpha to a portfolio than the multi -strat hedge funds that people are clamoring to get in the door, and the equity long-short space has flat to slightly positive alpha over that period of time. So, to me, what I find fascinating about this, and what you’ll see me writing about more, is why is that? It’s right there.

Now, a couple of things are the volatility is higher. So you compare managed futures funds versus the multi-strats, you get 75% of the returns but double the vol. So you end up with a much lower Sharpe ratio. Okay. But relative equity long-short, it’s much more comparable. So to me, the question for the whole matter of future space, and this is what I’ll be writing about is, why is that allocation so low? Why is it at 20%? Why is it at 30%? How is it something that hasn’t added value?

We talked about short selling. It hasn’t really added value to these portfolios for years and years and years. It’s still almost 40% of the assets. So what I’m hoping to do is get everybody in our business to spend less time shooting each other, trying to argue that they should get more and more of this finite pool of assets, and focus more on trying to understand why that 6 doesn’t go to 20 over the next period of time, and where it should come from. Anyway, that’s my mission du jour.

[00:39:11] Niels

Obviously, I completely agree with the mission of expanding the pie. That’s what I try as well with all these hundreds of conversations. But one question though, when you say it like that, and I know you mean really what you say in terms of trying to grow the pie, and I see the work you do for that. But if you think about it, you’re also taking pie away from the managers, right? That’s just how it is, because you’re coming down and saying…

[00:39:49] Andrew

We don’t have $1 of capital from people who otherwise would have invested.

[00:39:53] Niels

I would disagree with that. Obviously, none of us know for sure. But my sense is, though, that when you come out and you say, Listen, I can give you the same return, actually, I can give you a bit of return, 300 to 400 basis points more, because we have low costs. Some people will say, “Okay, I prefer that than paying 1.5 and 10,” or whatever the number is you pay.

So I think there’s definitely a risk. So we can’t say for sure you’re taking some of the pie from the others, but there’s the risk, you do it as well. You probably can’t avoid it, but I think that’s also one thing we need to recognize.

[00:40:41] Andrew

In the US, we manage an ETF. I know the people on the other side of the table very, very well on the institutional side, I had breakfast last week with the head of one of the largest consulting firms in the world and we have these conversations about it. It’s like, why don’t you do what we do? Why is what we do interesting? The reality is that he is a great guy, an honest guy, but his business is very specific.

People come to him and to his firm because they’re probably the best in the world at evaluating hedge funds and private equity firms. That’s what they want to see. So when they build a portfolio, it is not going to be a hedge fund, hedge fund, hedge fund, ETF, hedge fund, hedge fund, hedge fund. The clients don’t want it. That’s why I’m talking about this side of it.

In the institutional world, we are at an enormous disadvantage to ever attract any capital. I’ve been doing this business since the late 2000s and I spent six or seven years talking to institutional investors. I could show them that we could do better than their hedge fund portfolios by distributing fees. We often had better drawdown characteristics than we do with daily liquidity and I barely raised a penny.

A typical person in that space whose job is to be a hedge fund allocator, we don’t make their life better. Now, somebody who oversees an entire hedge fund portfolio, who has to worry about evaluating equity long-short and credit and these other things, in his look-through basis, here’s the 6% allocation to managed futures. That guy, how much of his time does he want to spend trying to understand whether AQR is better than Man AHL versus this firm and that firm?

Does he really want to have three or four different funds for diversification purposes in the 6% allocation. Maybe replication helps that guy and makes his life better. But if you think about the person at a consulting firm or a family office, they like their jobs. If you are the head of macro at one of these consulting firms, and you’re 33 years old, and you express interest in meeting Chris Rokos, Chris Rokos is probably flying to the US to talk to you. It’s a very heavy experience.

When you know all of your other friends in the consulting world and you’re talking about getting whispered on market things from leading hedge funds and they’re evaluating long-only stock picking strategies, your status is pretty high. It’s a pretty good place to be. So, long before we were trying to do what we were doing, the space wasn’t growing. We weren’t a viable option.

The space hasn’t grown for a very, very long time. I think the interesting thing is why. I think because I’m an outsider, I have views on it that I think some people think are controversial, but I’ve got to tell you, I think the space should be bigger.

[00:44:00] Niels

I’m curious on two things, because I completely agree. The space doesn’t seem to grow. I agree with that. At least not the space we can see, let’s put it that way. I’m sure more big pension funds do internal trend following. I’m pretty sure of that, but we don’t see those kinds of numbers. But tell me why you think that is, but also tell me how you plan on achieving the mission of growing the pie.

Who do you think will be the most obvious candidates, etc.? But let’s start with the why from an outsider’s perspective, even though you’re becoming more and more of an insider I would say, but let’s leave it at that. Why do you think it hasn’t grown?

[00:44:49] Andrew

So I think the first thing is, it’s funny, I went to my college reunion last weekend.

[00:44:57] Niels

I heard rumors about that, yes.

[00:44:58] Andrew

Some of my college classmates are private equity barons. They are playing at a level that you would not believe. One of them flew a DJ in from London for a small party. It’s like they’re living in a different world. I almost wanted to leverage my own business. It was the leveraged buyout business. It was hostile takeovers. The connotations of the business, in the early 1990s, were really negative. These guys were outsiders. They were storming barbarians at the gate. They were storming all this stuff.

A generation came into that space. They tried to understand the audience and what the audience wanted. One of the things they realized was that what they could offer was a gift to a typical pension plan allocator. We will leverage your equity returns and we’ll collectively pretend there’s no risk. It wasn’t pulling the wool over people’s eyes. This is what people on the other side wanted.

I think about myself, if I was working at a pension plan and the market has gone down 20%, would I rather have something that got marked down 5 in that period of time, even if in reality, if we marked it to market, it’s down 30 or 40? Again, my constituent is an investment committee that is not financially sophisticated in general.

When you see these businesses grow and they go through this kind of geometric growth potential, there are dynamic conversations between allocators and the asset managers as to what are the issues that you’re confronting and how do we help you to solve them. Now, this may be happening with other people with allocators than I do, but again, I’m coming in from my seat.

So one of the things with managed futures, I think the nomenclature is very difficult, that managed futures does not have an inherent positive connotation. Leveraged buyouts become private equity. That sounds good; it sounds exclusive. The way these guys presented themselves and how they talked about their products is very different. That’s why they talk about this kind of private versus public thing.

But the thing is, they have a willing audience who, sitting on the other side of the table, is hearing things that they want to hear. Junk bonds became high yield. High yield sounds better than high yield plus high defaults and no covenants. So I think, on the managed futures side, one of the things that I find consistently is it makes people anxious. They’re thinking about, I know this is going to go through some annoying drawdown at exactly the wrong period of time.

They’re role playing in their minds, and they can see themselves within an investment committee staring at them, a patriarch of a family office staring them and saying, “Why is this guy down 5%, last month?” They’re trying to figure out what their narrative is. What’s the short sentence they say where the person on their sides says, “Oh, okay. Fine. I get it.”

So imagine you’re with an equity long-short hedge fund manager and they go through a bad period. Why are they down? Oh, they’re down, but don’t worry, they’re cheap stocks just got cheaper. The last time this happened, if we’d gotten out then, we would have missed the rebound, we would have missed the recovery.

They are armed with a narrative, not just on the initial investment, but how to manage it over time. So I don’t see the same development in the managed futures space. I see efforts to do it. Crisis alpha is I think a great expression. The problem is it gets people focused on the issue that you described, “Should I buy it today or next month, and maybe I should get out.” As opposed to this is going to be your portfolio today, it’s going to be in your portfolio in 10 years, it’s going to be in your portfolio for 20 years. It’s just going to be there.

So it’s all these complicated issues. I’ll tell you a story that I did, well, let me pause for a second because otherwise… I feel very passionately about this. But I’ll tell you a story that you may find crazy.

[00:49:25] Niels

No, go ahead. I wanted to bring up two topics with you because I can. I’m allowed to challenge you, because you’re a good sport. Of course, I do come from the trend following manager side and not from the replicator side, so I have those that I wanted to ask you. But if you have a story now, it’s fine to share.

[00:49:50] Andrew

So in my world, the measure of success of this going mainstream is imagine you’re a financial advisor in the US and you’ve got 400 clients that you have to deal with. On average, you’ve got $2 million for each of those clients, and you’ve got a whole team and everything around your whole business. You manage $800 million. Going through your mind is, if I put managed futures into the client’s portfolio, let’s say make it a 5% allocation, we talked about 5% versus 40% last time.

The thing to remember is the world is going from 60/40 to 50/30/20. It’s happening. But the 20, there are a lot of options in the 20. People are going to have gold because it sounds good. They’ll throw TIPS in there, a little infrastructure. There are a lot of different things in there. So how much of the 20 is managed futures? I think it comes in at 3% to 5% of the 20% because I think it’s the best of the options, and I will be sending that message.

But the measure of success for that advisor is that you’ve made a 5% allocation in Man AHL or AQR or somebody else or an ETF or whatever it is in that space. That person is looking at you and thinking, “I’ve got $100,000 of my hard-earned money that I socked away for years and years and years.” It makes a huge difference to them what that $100,000 is doing. So why do they feel good about having $100,000 of their hard-earned money in this?

Because I will tell you, what happens is in most of the cases, if the advisor doesn’t think he can describe that $100,000 in a way that makes the person on the other side feel warm and happy and look at them glowingly across the table, they just won’t do it. I wouldn’t do it either because I’m not going to disrupt. The reality of the 5% allocation, that everybody has pointed out, obviously isn’t going to save a portfolio if there was a major bear market.

But it’ll help at the margin, and you can point to something that we call a beacon of green in a sea of red. Something’s working when nothing else is working. The story is, I was actually invited to go talk to the client, so I did a dinner. One of our investors asked me to come out and talk to their clients. It was a lovely dinner in a house in the city. He was describing the investment that they have with us in this ETF that we manage.

He started talking about replication and managed futures and stuff, and he said, “Can you tell people what you do?” I said, let me tell you guys a story. In late 2022, my sister, who was not financially sophisticated, we were having a conversation and I was trying to describe to her what I do because I kept popping up on all these news feeds and stuff. I get about 25 minutes into it and I realized she doesn’t know what an ETF is, she doesn’t know what a futures contract is, she doesn’t know. It’s a completely different language for her. But it’s also a language that when you don’t know what it is, it creates anxiety.

Money is packaged anxiety for most people. So about 25 minutes into it, I realized that she doesn’t know. I said, let me try to frame it in a different way. Let me see if I can say it in a way I think you will understand it.

In the 90 minutes before we started talking about this, we were talking about what a mess the world is. We were talking about the return of inflation. This is when they were talking about gas rationing in Germany, social fragmentation, political chaos, possible war, the Ukraine war, supply chain disruptions.

We were talking about all these things in the world, and we were talking about how they’re bad, and how they’re going to hurt us, and are they’re going to hurt people that we know, and how it’s elevating our anxiety. I said, what I like about this strategy is that there are guys who sit there and think these might be opportunities. I just called them macro investors. Macro just means the world.

They’re looking all over the world at all these changes and dislocations. While the rest of us are worrying about the negative impact of it, they’re saying, maybe there’s an opportunity. So what we do is never going to be a significant part of your overall portfolio. Your portfolio is going to consist of owning stocks with CEOs of companies that are trying to grow those things over time and investing in bonds of companies that pay you coupons and you get your money back over time.

All those things are going to be long-term things. But this is a way to just have a little bit less… It’s a strategy that helps you to worry a little bit less about the world. It’s a strategy that is designed, in a sense almost, to worry about the world so you can worry less. Somebody recently told me, and they said there’s a way to talk about this.

I had lunch with the people at Abbey yesterday, and apparently, they said this a long time ago, which was, it’s a way to help to manage your future. Because that advisor sitting across the table, his relationship with a client is emotional. It’s trying to help them deal with the anxiety of money, and he’s selling them on a vision that I’m more than the next guy, I’m somebody you can trust, and I’m going to help you to grow your assets as much as we can safely and help you to sleep at night in that process.

He’s got to do it, as I mentioned, to 400 different people. If he makes a small allocation to something that he can’t explain in the next quarterly meeting, it’s confusing. It’s layered with all of these and it’s adding to the anxiety of the client, he’s not going to do it. I think that, at least in my world, and I’ve talked to Katy about it, I’m talking to Corey about it, I talked to the Simplify guys. I’m like, let’s come up with a way of helping because this shouldn’t be an anxiety-provoking space.

People should feel good about having $100,000 to do it. How do we help advisors to talk to their clients and make their clients have a warm and fuzzy feeling for having this allocation as opposed to it being what I think it is right now, which is people attach anxiety to it. So how that translates in the institutional world, I’m not there yet.

[00:56:28] Niels

What I like about the way you talked about it just now is that I feel there’s a shift in how you explain things. I feel, rightly or wrongly, that a couple of years ago when we started our conversations, a lot of it was focused on I can save you 300 basis points in fees. What you’re talking about now is something that I think is different. By all means, you could say that these new products, the ETF world that you represent so well, is going to open the door to all these benefits to lots of people, not just because of the fees, but just generally speaking.

Since you and I have spoken last time, we see many more trend following or CTA ETFs making their debut. So this is not meant specifically at you and your product, but it’s a concern that I have. Sometimes people will say to me, “Well, Niels, aren’t you a little bit too negative when you talk about these ETFs and these replicators?” Maybe I’m a little bit guilty here.

I’m kind of the defending the industry that I’ve been part of for so long. But be that as it may, I do have a concern that I wanted to ask your opinion about at least. When you came out with your product a few years ago, as I mentioned, there was a lot of focus on it was cheaper, right? What I’ve noticed in the last few offerings is that they’re actually cheaper than yours. So everything gets cheaper all the time.

This morning when I was thinking about what am I going to talk to Andrew about, I thought, maybe my real concern is that it feels a little bit like when we were introduced to the low-cost airline world, where everything was about getting it cheaply and prices were cut and you can fly to Barcelona for 49 euros or whatever. So on one side, you could say, well, that’s a great thing. People can now travel, it’s cheap, it’s available. You could say that’s true. You could certainly say that is true.

On the other hand, something that people may not pay attention to, and I travel a lot as you do, my experience of traveling has changed. I don’t think traveling is as enjoyable as it used to be because now all the airlines, that I tend to fly with, have to compete with these low-cost airlines. Everything gets cheaper. The food is worse, and the seats gets smaller. So it’s not very enjoyable, frankly. So that was one thing. I thought maybe there’s a risk that we’re turning the CTA industry into a low-cost airline industry.

The other thing I thought of, which again may not be specific to your firm, but I was thinking, the airlines that offer these low costs, maybe they don’t make so much money, so they have to cut costs somewhere, they have to cut something. I remember watching, I’m not going to mention the airline, but it’s public. It was on television. It was on Channel Four in the UK or something where they were following different airlines and so on and so forth.

On one of these trips, they come into the cockpit meeting the pilot and the captain. The captain is 24, and the first officer is like, 20. I’m thinking, “Holy, Moses.” I’m not going to go into flight where there’s so little experience in the cockpit. These are the things that you don’t see. You as a passenger, you don’t go and check how old and how many years of flying have these pilots gotten.

So all I’m saying, in my clumsy way, is that I worry. I truly worry that if we make this about just getting it cheaper, and cheaper, and cheaper, we’re going to end up with worse products. Again, this is not specific of any one firm, I want to make that absolutely clear, but I feel this is a concern for me.

I was wondering whether you could just put me at ease and say, well, you’re completely wrong here, Niels, because that’s not going to happen, and this is completely irrelevant. But I can’t help thinking that that’s a pretty good analogy between different industries.

[01:01:18] Andrew

Boy, I have a lot of different things to say on that. There’s probably no more scathing critic of the liquid all mutual fund world. For over 10 years, I’ve basically written that low fees are not necessarily good. Lower fees in hedge funds are not necessarily good. If you are buying a crap product with low fees, then…

I did all the original work. If hedge funds are making 10 before fees and you’re making 6 after fees, but then you end up buying mutual funds that are making 6 before fees and 3 after fees, then great, your fees are a little bit lower, but you’re going to hate it.

The ETF world, I would say, first of all, active ETFs are not going to zero. There are a lot of structural issues that are going to prevent it. BMF, the ETF that we manage, is priced at 85 basis points. That’s consistent with a lot of the active ETF world. So I think there’s this kind of misperception that Vanguard and BlackRock or Fidelity are offering ETFs for free. People aren’t going to do this and not get paid to go to work.

[01:02:41] Niels

That’s fair. I just want to say one thing, quickly. You and I spoke offline. We’re not going to mention the firm, but you and I spoke about some of the things that are being offered at the moment. When you drill down on those costs, either the costs don’t add up when they say we can do this for whatever, 80 basis points, and you look at, well, how do you pay for all of that for 80 basis points?

But if it is true that you can do it, then all I can say is the managers certainly are not making more than a few basis points frankly, because otherwise, there’s no room for paying that. So you may be right that the overall total expenses won’t go to zero. That’s fine. But certainly, from a manager’s point of view, you’re going from a certain level down to a much, much, much smaller level. Anyway, I just want to throw that in.

[01:03:29] Andrew

Look, we’ve obviously made a bet. We’ve made a bet on scalability. I don’t know exactly what the right price point is. Somebody new comes in, they’re trying to find all these little ways.

There are other replicators out there who basically say we’re going to do not just what these guys do. But how do you come into a market? You’ve got a market leader, basically, in this simple, straightforward way.

You can’t really come out with a pure copycat of that because it’s already established, it’s already there. They already have a longer track record. So people are going to come in and they’re going to say, “Okay, we’ll try to adapt part of that and then we’re going to add in some of our own special sauce, and maybe we’ll cut a little bit pricing here and there.”

There are structural issues that I mentioned. First of all, it’s costly to run an ETF, but it’s not that costly. A small ETF you’ll lose money on until you get up to a certain scale. So, people will fund it for a period of time and it gets up to scale. If it starts to get up to scale, it’s going to cost 10 to 15 basis points to really run it. You’ve got to pay people too if you want to market it. You’ve got to pay marketing and distribution expenses. So there just are certain expenses associated with it.

Obviously, there are not a lot of managers who are going to run an ETF where every dollar that’s made on management fee goes out to others. So there’s going to be some, I don’t know if it’s 60 basis points, 50 basis points, there are some dollars. By the way, in the ETF world, so you take it and you get it onboarded at a major wealth management platform. You get on board with Merrill Lynch. Well, they want their cut too.

By the way, in terms of the broader adoption of the space, or the ETF world versus the mutual fund versus the hedge fund world, those guys love the hedge funds because there’s a lot more money to spread around on the hedge fund side. You go to the mutual fund side, well, they like it a lot less, but it’s more liquid, you don’t have K-1s, you don’t have all sorts of other vendors. Then you go to the ETF space and they’re like, they don’t think it’s a good thing that these products are cheaper.

So there are huge impediments at every step of the way. I was just talking to a journalist yesterday who’s trying to make sense of this, and I said, you’ve got to understand, the US wealth management business is a whole series of walled gardens. There’s a price of entry into virtually all of them. There are different firms who control advisors and who control capital. So all of these things mean that pricing is not going to zero. I don’t know where it’ll end up.

Now, of course, at Vanguard, Salim Ramji, who just joined Vanguard as a CEO, if the ghost of John Bogle breathes through him and he decides that he’s going to come in and take everything to zero in the space, that’s different. But in terms of the current players, it’s not going to happen.

But look, like pricing is not everything. Just on the replication side, there’s a reason we haven’t launched other kinds of products, there’s a reason we don’t have lots of different products in the market. It’s because a lot of things that are cheaper are not worth doing.

[01:06:53] Niels

I’m going to stop you there because simply I have a hard stop today. But as I said, I love these conversations. I love the fact that you’re open to my skepticism on one side, but I’m also really loving the fact that I see a change in the way you talk about this thing. Actually, the whole focus about growing the overall pie is obviously something that I fully support.

[01:07:15] Andrew

Maybe we’re not the scrappy upstart anymore. Maybe we’re becoming establishment.

[01:07:18] Niels

You’re certainly the market leader in the ETF space.

[01:07:26] Andrew

I’ve realized though that it’s got to be positive. The whole space needs a massive injection of positivity because there is just this Hunger Games thing of trying to bump other people out of portfolios to take it. I think my theory is that interferes with a meaningful expansion of the pie.

[01:07:47] Niels

Yeah, absolutely. This is great, Andrew. As always, thank you so much for all your preparation and showing up, having these conversations, candid conversations, I would say.

If you like these conversations, head over to iTunes, Spotify, Amazon, leave a rating and review. Tell Andrew how great he is so that more people can discover the podcast.

Next week, I will be joined by a true trend follower, so to speak, namely Rich, and he will no doubt have some things to say about trend following from his perspective. So if you have questions for him, send them to info@toptradersunplugged.com and I’ll do my best to present them to him.

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

[01:08:44] Ending

Thanks for listening to the Systematic Investor podcast series. If you enjoyed 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.

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.