TTU122: New Amazing CTA & Managed Futures Series

[00:00:04] Intro

Imagine spending an hour with the world’s greatest traders. Imagine learning from their experiences, their successes and their failures. Imagine no more. Welcome to Top Traders Unplugged, the place where you can learn from the best hedge fund managers in the world so you can take your manager due diligence or investment career to the next level.

Before we begin today’s conversation, remember to keep two things in mind. All the discussion we will 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 product before you make investment decisions.

Here’s your host, veteran hedge fund manager, Niels Kaastrup-Larsen.

[00:00:54] Niels

Hey everyone and welcome to another edition of Top Traders Unplugged where today, Alan Dunne and I are going to take you in a different direction to our usual conversations and instead tell you about a new and very exciting mini-series that we plan to release in the coming weeks which focuses on the one investment strategy that beat everything else in 2022, namely, trend following and managed futures more broadly.

But first off, Alan, how are you doing? How was New Year’s in Dublin?

[00:01:28] Alan

It was good, pretty quiet this year. But nice to have the break over Christmas and looking forward to the new year 2023. So a lot going on and promises to be another exciting year in markets, I guess.

[00:01:43] Niels

Yeah. You already hear people saying that if you think 2022 was a difficult year, wait for 2023. So yeah, we’ll see what happens.

Now, since the upcoming episodes will be different from our usual episodes, and in fact, you can say it’s kind of what we did back when I started Top Traders Unplugged in the first place. We thought we were going to give a little bit of context and a little bit of detail as to what you should expect from us in this series.

But before we go into that conversation today, Alan, I was going to ask you maybe you could give a little bit of context in terms of what kind of year it turned out to be for CTAs and maybe even perhaps put it in a little bit of historical perspective.

[00:02:35] Alan

Yeah. Obviously, we’ve been talking about what a good year it’s been. Right up to the final quarter, we had a bit of a giveback for managed futures and trend following in Q4. But looking at the year-to-date numbers, the SocGen CTA Index is up just under 20% on the year. The best year on record as that index goes back to 2000. So the strongest year for the CTA index, and the SocGen Trend Index up over 27% on the year and again the strongest year there. Obviously, that comes in the context of a year where global equities and global bonds were brought down in the year. The S&P 500 was down 18%, 19% or so. and the World Government Bond Index was down double digits, I think down 12%, 13% as well.

So, it was really a year where managed futures proved their worth in terms of having that bidirectionality and trading across lots of different asset classes and the ability to generate the uncorrelated returns that investors are looking for. I think it was definitely an exceptional year. As I said, there was a bit of a giveback in the final quarter, but notwithstanding that the numbers have been very strong.

[00:03:52] Niels

Yeah, absolutely. All right. Well, let’s dive into why we created this mini-series in the first place. Do you want to kick it off, Alan?

[00:04:02] Alan

Well, partially for the reason we’ve been talking about. It was a very good year in the industry last year and it came amid a tough year for traditional assets. So I think it’s a fair trade to say that there has been renewed interest in the space in the last number of months. What we’ve generally observed with investors is very often the flows take a while to materialize. When you get a strong period of performance, that interest picks up and it tends to be prolonged.

In anticipation of more investor interest in managed futures and trend following, we thought there was an opportunity to get the largest, the best managers in the space and produce a condensed series which would be a resource for people; an opportunity to educate our listeners on how the largest managers in the managed futures industry run their strategies, and also to get their perspective on some of the big themes that we talk about fairly regularly on the podcast.

I think it’s really a very timely opportunity that we can get all of these top managers together in the space of a number of weeks and then publish the recordings over the next number of months.

[00:05:21] Niels

Yeah. It’s definitely going to be a pretty packed schedule for you and I to try and get this done. I think for me, obviously, I share a lot of the same things that you mentioned. I think for me, it’s always been about trying to give access to a much broader audience to some of these managers. And it is really because I wholeheartedly believe that all portfolios should have exposure to CTAs and trend following in particular. So I think that for me is certainly one of the reasons why we’re doing this.

When we do the Systematic Investor Series every weekend, a lot of it is an ongoing conversation about the space. We don’t always look at it from 30,000 feet, and it’s obviously biased in terms of it’s our opinions.

I think with this series, sure, we can voice our opinions but there’s always something new, there’s always something exciting when we get a guest on, because a lot of these people are colleagues from our industry. It’s fun and very educational to hear how they have evolved, how they see the challenges in the industry that we all face, so to speak. So I do find it quite fascinating to speak with these people every time.

Also, the other thing I was thinking of was, I think to the outside world, I think trend following, in particular, can look quite similar, just different shades of gray, so to speak. But then once you start listening to these managers, you do find nuances, you do find differences, that the numbers, the high correlation we all have to each other may not show. I think that’s incredibly insightful and educational. Of course, it shows up at the end in terms of maybe not the direction of our monthly returns, but certainly the amplitude of the returns. So I do think it is.

So for me, there’s always a chance to learn something new. It’s like getting an MBA in trend following and CTA strategies when you talk to many people, essentially about the same topic but from each individual vantage point, so to speak. So I think that those are the reasons why we wanted to do this. The other thing we wanted to share in this little teaser episode was what we hope to achieve by doing the series. I’m actually quite curious to hear what you’re hoping for here, Alan.

[00:08:03] Alan

Well, as I said, in terms of what we hope to achieve is that these series of conversations will be a resource for people, that they will serve as a reference point that people who are interested in allocating to the space have an opportunity if they haven’t met these managers directly to hear their story and get their perspective. As you said, we’re certainly hoping to highlight the diversity in the space.

There’s lots of different ways of approaching managed futures trading, trend following. It’s not all the same even within trend following as you said. You tend to get a lot of dispersion in performance. I think it’s important to highlight the diversity and the diverse approaches that you have. There are a number of topics (we’ll get into the topics in a moment), that, again, I think you’ll get diverse responses in terms of how people think about some of these big issues.

Myself and yourself and all of you guys, we talk about this on Top Traders Unplugged fairly regularly, but this is the opportunity to hear how the practitioners think about managed futures strategies and the various issues that arise as you run these types of strategies. So it’s all about bringing those perspectives together in an accessible way.

[00:09:27] Niels

Yeah, absolutely. Also, I think for me, I really hope that we can touch on a lot of the different aspects of each manager and what they do really to continue to deliver above-average returns. Because let’s not forget, some of these firms have track records that are like 30, 40, almost 50 years. You don’t really find this level of experience in any other hedge fund strategy than in the CTA space.

Maybe we should talk a little bit about the kind of managers we’ve invited. So for the most part, the managers are among the largest CTAs (as you mentioned, Alan) in the world, and most of them are part of the SocGen CTA Index where, by the way, the cut-off AUM to be part of the index for 2023 is $1.97 billion. That’s up 60% from last year. I’m kind of curious about why it’s gone up that much, but anyways. There are 20 programs across 19 firms that are included in the index.

We’ve invited one firm that is not part of the index but does have one of the longest track records of all of them I think, and some of the listeners might even guess who that might be, but there we are. So it really is the best of the best. My hope, deep down, is of course that more investors will learn from these conversations and ideally consider reaching out to them and find out more. As I mentioned earlier, I truly believe that all portfolios need some kind of trend following component as we so vividly learned in 2022.

That’s what I’m hoping to achieve. Now, we’ve talked about what we hope to achieve, maybe we should talk about what we expect from these conversations. I don’t know what your expectations are. I have a few thoughts, but I’m curious about yours.

[00:11:28] Alan

Well, I think what we’ll hear is, as we’ve been talking about, different perspectives. For one, we’re talking about the SocGen CTA constituents, it’s not all trend following. So you have quant macro, short-term systematic, managers who are more pure trend followers, diversified trend followers, more multi strat. There’s the fact that you have that diversity, that brings different perspectives. I think you’ve got lots of interesting topics.

We had the paper from Cliff Asness recently talking about what is the role of a CTA. Is it absolute return plus crisis alpha? There’s lots of different perspectives even on what managers are setting out to achieve in the first place. So, certainly, my expectation is we’ll get a lot of different perspectives and I think, as well, that there might be a perception out there that trend following is all the same or that there isn’t that diversity within the space.

Going back a few years, there was a perspective that it’s pretty simple. Anybody can do trend following, but once you get into it, you can learn all of the different ways that different managers can differentiate themselves and the different approaches to take.

So I think certainly the expectation would be that we will highlight that diversity in the space and I think the rigor, in terms of the research processes, as well and what it takes in terms of institutional technology operating infrastructure to run these types of strategies very successfully.

[00:13:16] Niels

Yeah. I think we’re going to have some pretty open and quite frank conversations. That’s what I expect. I think the different managers will probably see certain things in a similar way. But also, there will be some differences, especially in the investment process. So I’m very curious to learn about that. Maybe you and I will push back a little bit on some of the points and dig a little bit deeper to better understand why they believe what they do is a better way in approaching the strategy. I don’t know, we’ll see.

I also expect to learn a few new things. As I said earlier, I do learn a lot from having these conversations with our peers. It’s one of the best things about the CTA and managed futures industry really, namely that most of the people we get along quite well with. We don’t really see ourselves as fierce competitors, but rather as colleagues working in the same industry.

Then in the end, I expect, as you have pointed out, that these conversations will form an important part of an educational journey for investors, but also that they could be part of a due diligence process where investors who are looking and considering investing in the space can use these conversations as references in their own decision-making process. So, that’s what I expect.

Alan, maybe we should talk a little bit about some of the topics that you and I have been thinking about bringing up. Now, I will say, it’s a long list and so we’re not going to be able to talk about everything with everyone. We’ll spread it around. and so on and so forth. But if I give you kind of the big picture bullet point, maybe you can talk a little bit about some of the interesting points we have around each of them, if we could do it like that.

The first topic that we wanted to bring up is investment philosophy. What are your thoughts around that topic?

[00:15:27] Alan

I think you have different views on this and it’ll be interesting to get the managers’ perspectives on, say, particularly from the perspective of trend following. Why do markets trend in the first place? Why is there a source of alpha, a source of returns that can be harvested from trend following? Why is it reasonable to expect that to be persistent? What you tend to hear, with managers who do trend following, is that (on the one side) you have people who take an academic perspective of saying historically, you can see in the data the serial correlation, versus the more, call it the old school capturing outlier type of perspective.

So, I think there are multiple philosophies that can lead you to running a trend following portfolio. So, I’m very interested to hear those first principles from managers. Why is it that they are using these types of strategies and why do you think they can be profitable over time? And then how do they think about their own philosophy being may be slightly different to other managers and how that manifests itself in their trading.

[00:16:41] Niels

Yeah, exactly. I think you almost sort of touched on the next bullet point and that is the objective of their own strategy. What are they trying to achieve with the way they’ve designed it? Is that what I hear you say?

[00:16:54] Alan

Yeah, exactly. As I touched on a moment ago, for some people is it generating absolute return or is there a second objective of having this crisis alpha characteristic as well or is that just a feature of the historical performance? So yeah, I think all of that and I certainly expect to have different views on that as we go through the series.

[00:17:24] Niels

Another topic that we want to dig into, with some of these guests, is a topic that we’ve discussed quite a lot on the podcast and that is, this pure trend following versus diversified trend following. You already mentioned Cliff Asness’ paper, but it is along those lines. We just want to understand where people are placing their minds.

[00:17:47] Alan

Exactly. You’ve talked to the likes of Rob and Jerry and Rich, over the years. Should you be adding carry to trend? Should you be adding short-term, quant macro? What’s the rationale? What’s the impact of combining different systems? Does it make you less of a pure trend follower if you do that? Does it impact the convexity of the program if you go down that route or not? So lots to delve into on that side.

[00:18:14] Niels

Absolutely. Another thing that I really look forward to discussing, another topic, which is something we’ve discussed as well on the show for the last few months is, can these strategies be replicated? That’s been a big discussion. And so we’re going to hear, hopefully, some different considerations about this. Is that your expectation?

[00:18:18] Alan

For sure. It’s really a topic that’s really come on the radar, obviously, in the last year. But interestingly, some of the managers who we’ll be speaking to have run and probably continue to run replication strategies. So they can not only give a managed futures perspective, but they can give a quant replication perspective on the merits and pitfalls of running replication strategies. I think that’s definitely highly topical at the moment.

[00:19:17] Niels

It is, and actually, it will be fun to hear whether they like being replicated or not. Because in the SocGen CTA Index, you are being replicated by a certain individual that we all know and love well and who’s going to be on the show soon again, so it’ll be interesting. Now, we’re going to jump into your wheelhouse, I imagine. What you were doing back in the day when you were interviewing and digging deep into the research of these managers. How’s that going to be for you?

[00:19:52] Alan

It’s an interesting question because if you think about it, you have a lot of managers investing a lot of resources in terms of having data, big teams, having alternative data sources, investing in infrastructure to be faster or slower in terms of execution. So there is a question, does it all matter? If you had a simple trend system that you applied more rigorously over the long term, how much value do you add by having the more sophisticated system?

Then there’s the more generic question of what does a good research process look like? How do you manage that process? How much optimization should you do? What does it take to change a program? Obviously, managers do evolve their systems, but how do you avoid overfitting? How do you avoid style drift? What’s the right balance between harvesting new ideas and improving a program or just changing the parameters in response to a changed market environment?

So I think I’m very interested to hear what people have to say about this and what are the merits and pitfalls of that.

[00:21:14] Niels

Yeah, I think that’s going to be super fascinating of course. There is another topic that of course we can’t go without mentioning and that is something we’ve discussed a lot on the podcast as well. That is, how many markets should you trade? I don’t think there’s much you can add to that topic, so to speak, but it will be something we may bring up with some people, the pros and the cons and all of that.

But then we’re also going to dive into something that is much more… I wouldn’t say much more, but something that’s really, really important, and that’s the risk management side of things, and also how you manage your drawdowns. What are you hoping for in this area?

[00:22:00] Alan

Obviously, what we see in managed futures is periodic periods of tough performance. What that often motivates managers to do is to think about, is there a way to produce a smoother return profile for managed futures by combining different systems? But then are you giving up some of the favorable characteristics of trend following by doing that?

I suppose in relation to drawdowns as well, can they be anticipated in any sense or are they just purely random? Obviously, what you tend to see. At least there might be a perception that historically, when we’ve had flows into the space such as after 2008, then we saw drawdowns following that. So, are they related or are the drawdowns just purely random and something that you have to live with?

[00:22:51] Niels

Yeah, well, let’s hope they’re not related. Anyways, there’s another couple of topics that are actually quite important, I think, that are on many people’s minds especially. As you just mentioned, there is a big inflow into these strategies following a really strong and amazing period in 2022. The topic is the capacity of strategies but also what goes with that is the liquidity of the markets we trade. So what are some of the things that you look forward to in this area?

[00:23:29] Alan

We’re getting into very much the tactical operational parts of running trend following here in terms of how do you know when you’re bumping up against capacity constraints. Everybody asks managers, what’s your capacity? But how do they come up with those numbers and how would you know that capacity is becoming an issue?

Managers often think about capacity in terms of their own program, but if lots of trend followers are raising assets at the same time or lots of managed futures are gathering assets, how does that impact capacity for the overall industry? Obviously, liquidity is always out there as a topic.

We’ve heard in the last number of months about concerns about liquidity in the Treasury market, etc. I’m curious to hear if it’s a risk that people are thinking about. Obviously, the standard response is CTAs are trading deep liquid markets so it tends not to be an issue. But yeah, let’s hear what the managers have to say.

[00:24:27] Niels

You mean deep liquid market like the gilt?

[00:24:30] Alan

Well, yeah, exactly. Yeah.

[00:24:32] Niels

All right. One topic that we may address, maybe not with everyone, but ESG is a big (I wouldn’t say it’s a big topic), but it’s something that people talk a lot about, generally speaking, in the broader investment community, maybe not so much in our world. However, I’m curious to see what people think about ESG when it comes to our kind of strategies, how relevant it is, and so on and so forth.

Then another topic that definitely is in your wheelhouse for sure, and that is the role of trend following (or CTAs, let’s broaden it out a little bit), in a multi-asset portfolio. Where are you going to go with that?

[00:25:20] Alan

This is something we obviously talk about on the Allocator Series a lot. When you speak to allocators, one of the questions you often get is where does it fit in the portfolio? Is it return generating or is it just a portfolio diversifier or is it even portfolio protection? In the extreme, people might refer to it as a hedge, which we know it’s not, or insurance. We wouldn’t claim it’s that. Is it more than just a diversifier and is it a return generator?

Maybe going back a few years, there were concerns over that side. Then what’s the right level to allocate? That’s always the topic that comes up when you speak to both institutional and private wealth investors. And then, can you time the allocation? So I think in terms of where it fits alongside other strategies and other assets, they’re the main questions that tend to come up. I’m very curious to hear what the practitioners themselves have to say on that.

[00:26:21] Niels

Yeah, then there’s a couple of nerdy points we also wanted to bring up. (I say nerdy with a smile), and that’s what people think about expected returns; whether they think what we do is alpha or is there beta and stuff like that. So, a little bit of the nerdy stuff that we may want to dig into and find out what people think.

[00:26:44] Alan

Absolutely. I think this relates to the role in a portfolio. Obviously, depending on your view on the return, the expected returns under your return profile, would inform how you position an allocation to managed futures in a portfolio. But there is a general question down around (and it’s probably related to the replication a little bit), and it’s, is there a trend beta?

Going back a number of years, that was something that was very much to the fore. But obviously, what we’ve been saying is that there’s lots of ways of approaching trend following. So maybe it’s hard to define a beta. But if there is a beta, then is there an alpha and a beta, or is it alpha, or how do people think about that?

[00:27:27] Niels

Yeah, definitely. Then there’s a little bit of a funny topic people might think when it comes to diving into systematic strategies, and that is cash management because, of course, we don’t live in a zero-interest rate world anymore. But these strategies tend to hold lots of cash because of the very nature that they’re structured using futures. So, I am personally quite curious to see how managers think about what to do with the cash nowadays. So that’s just a topic that we wanted to dig into as well.

Some firms are more prone to running big funds, some firms are more prone to running manager accounts where it’s less of an issue. So it’ll be interesting to find out. Then we have a couple of general questions, which I don’t think I’m going to reveal quite what they will be. We want to keep that in suspense a little bit.

There are going to be some general questions and then I think we’re going to finish off the number of topics to choose from with a look into the new year of 2023 and hear some of the expectations from these great firms and what they’re expecting based on the conversations they’re having with clients, potential clients, other financial intermediaries they deal with, what’s on their radar, etc., etc. Is that fair?

[00:29:03] Alan

Yeah, for sure. Absolutely. Obviously, as we’ve been saying, it’s been such a strong year and there is growing interest in the space. So it’s certainly interesting to hear how managers are responding and the trends they’re seeing from that perspective.

[00:29:24] Niels

Okay, cool. As everyone can hear, listening to us today, Alan, there’s going to be a lot to talk about, and of course, we won’t be able to cover, as I mentioned, everything with every guest. So basically, it just means that if people want to get the most out of it, they simply have to listen to all the conversations, which is hopefully a good thing.

When it comes to listening to these conversations, I’m thinking not wanting to disrupt our traditional pattern of the weekend edition of the Systematic Investor Series and our midweek episode, because we have some great conversations coming up in that. So I’m thinking at the moment that this mini-series on the CTAs managed futures world will come out Mondays and Fridays.

Maybe we’ll try and get two episodes out per week so that we get it all done in the first couple of months of the year, travel schedules permitting, and so that people can confidently move into 2023 knowing as much as they can from the best minds in this space. Now, before we wrap up our little chat here today, Alan, I’m curious what you might be most excited or interested in finding out from these conversations. What are you looking most for?

[00:30:54] Alan

It’s hard to pinpoint one thing. I think what’s interesting is that we’re going to get all the responses together. We’re running all of these conversations in a very condensed period, so within a month or two, and it’ll be time labeled Q1 2023. So, it’ll be great to be able to look back in a couple of years to say well, this was the perspective on these issues at this point in time. But I think it’s the learning opportunity to get to speak to the CIOs of all of these top firms and to get their perspectives on all of these topics. So, I think that’s what I’m most excited about.

[00:31:31] Niels

I think for me, maybe it’s a little bit selfish, but I actually think it’s trying to figure out and find out how these managers are different. I think there’s going to be lots of things that they agree on and where they look similar, as I mentioned. But you know, when I’m out, every single meeting I have with a client or potential client, people are always going to ask me, “How is DUNN Capital different from all the other trend followers?” That’s what people want to know. So I’m really looking forward to seeing if we can learn how these great colleagues of ours see that. I’m sure they must be getting the same questions. I think that’s probably my number one.

Also, generally speaking, I will say, I am looking forward to catching up with a lot of our friends from the industry that many of them, both you and I, have known for quite a lot of years. So I can’t really wait to get started.

I think we have our first recording already tomorrow, if I’m not mistaken. So that’s going to be exciting. I don’t know, before we completely wrap up today, whether people coming into this maybe for the first time listening to the podcast or not who may not know exactly why they should even consider investing in managed futures, trend following, but I think some of the things we’ve seen work out really well.

Feel free to add to this little list. But the flexibility that CTAs have in terms of long and short exposure, and not staying within one little sandbox, but having the financial markets as well as the commodity markets, I think that makes them incredibly well positioned for this environment that we’ve been talking about for the last more than a year, because we were expecting a lot more volatility in the end of this “carry regime”.

So I think that’s one reason why people should consider it. Also, generally speaking, now that we have inflation coming back and where central banks will have less control over how investors feel and react to the markets, you need some of these different types of strategies to add to your portfolio returns, and trend following has generally shown through history at least that they’ve done well through these inflationary periods.

We’ve seen these bull markets in stocks and bonds for so long and now we may be back into this period where the business cycle is a little bit different, like in 2002, 2008, 2022, where stocks and bonds actually are not going up. So what do you do in during those periods? I think CTAs can help out on that.

And then of course, something that you and I have mentioned many times on the podcast and that is the whole foundation really of doing systematic investing not trend following specifically, but there is this beauty of removing emotion and biases from the investment process. I think this is underrated. I don’t think people really think of that as a huge asset when they think about the trend following strategy, per se. But I think when we go through uncertain times, I think it’s actually a very important part of the diversification process, namely that you can diversify across different types of investment processes. I think trend following definitely has an edge in that.

The final part would be just the fact that we are adaptive. The world is changing. What we saw between 2020, that kind of environment may not be what we’re going to see in the next 10 years or the next 20 years for all I know, and so you need something that can adapt to this new environment.

Any final thoughts from your side, Alan, before we wrap up for today?

[00:31:35] Alan

I don’t disagree with anything you say. I think the case for managed futures and trend following, all these strategies are well known. So, it’s a good opportunity to make that again and get that perspective from some of the biggest and best names in the industry.

[00:35:54] Niels

Absolutely. Excellent. Well put.

On that note, we’re going to wrap up our conversation today where we’ve taken a little bit of a peek into the upcoming CTA-focused series, which we can’t wait to share with you the listener.

From Alan and me, thanks so much for listening. We look forward to being back with you on the first episode of this series and take a deep dive into the CTA industry. In the meantime, go and check out the show notes for this series and all the other resources that you can find on the TTU website.

Until you hear from us again, take care of yourself and take care of each other.

[00:36:36] Ending

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