When Narratives Change Faster Than Markets ft. Alan Dunne

[00:00:01] Intro

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

[00:00:23] Niels

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

Alan, it is great to be back with you this week. Obviously, I was actually with you last week, in person, in Miami, which was even better, of course. And thanks very much for sitting in, for the last couple of weeks, while I’ve been stateside. But how are you? How are things back in Dublin?

[00:00:51] Alan

Good. Yeah, back into it here, adjusting from all the travels, and jet lag, and all of that. And yeah, we had some beautiful spring sunshine for a few days there in Dublin. It’s kind of back to normal here at the moment, dark and dreary, but at least we saw a glimpse of the spring. And yeah, it was great week, last week. Great to catch up with you. Great to catch up with so many people in the industry. So yeah, definitely well worth it.

[00:01:15] Niels

Yeah, yeah. I’m sure we’ll touch on this a little bit later in our conversation. We do have a pretty solid lineup of topics as well as a question that came in. So, we’ll be tackling this today. And, as usual, before we dive into any of that, I’m always curious to what’s been on your radar recently that is outside the topics we’re going to be talking about.

[00:01:38] Alan

Yeah, it’s interesting. I mean, last week the big story was this Citrini Research report about AI and how it was going to displace white collar workers, and be a very disinflationary force. And, I mean, a lot of people dismissed it, but we did see bond markets move up, last week, on that kind of disinflationary theme.

So it’s just note worthy the very sharp reversal we’ve seen in bonds this week. Obviously, the story now is all around the Middle East, Iran, geopolitics, the impact on oil prices, on European gas prices. But we’ve seen a very notable reversal in bond yields. US 10-year yields had gone below 4% and have jumped back up, even more so, at the 30-year end and equally in European bonds.

And again, it’s another situation we’re seeing where we’ve had a couple of days where equities have been down, bonds have been down at the same time as that kind of stagflationary fear has come back into the market. So, yeah, I’m kind of curious about the magnitude of the move and that sharp reversal in bonds because it had seemed that that kind of disinflationary narrative had gathered some speed. But again, sentiment has changed just as quickly this week. So, I think that’s something definitely on my radar and am monitoring going forward.

[00:02:56] Niels

Yeah, I agree. Although I will say, and maybe we’ll again also talk about this a little bit later when we talk about your macro view, in a sense, when you look at the financial markets, the reaction so far to all the events in Iran is actually pretty muted. Where we’ve seen the big reaction has really been in the commodities and, of course, energy in particular. But it’s kind of interesting… Well, I certainly feel that there may be more surprises to come in some of those markets at some point.

[00:03:29] Alan

It’s interesting. I spoke to Cem, last week, and a big theme there was the kind of pinning in the US equity indices and how option flows are keeping the market in a range. So, I think you have to be very cognizant of those flows in interpreting the price action.

Obviously, we did see more of a reaction in European equities as well, which is, you know, arguably driven by the even bigger response in European gas prices. But I think you’re right. You can’t kind of overly interpret it from a macro perspective. You have to keep in mind whatever’s happening from an option flow and option expiry perspective.

[00:04:06] Niels

Yeah, actually I really enjoyed that conversation. I was listening to it, and the way Cem kind of explains that. It’s a concept that is so counterintuitive, in many ways, where seemingly low vol on the surface actually means, probably, more dispersion and more vol in the underlying securities. So, if people haven’t listened to that conversation, I certainly urge them to go back and listen to that.

And also, another conversation I got some really good feedback from is your conversation with Mark, the week before, where you also touched on some very interesting topics, a little bit different to maybe what I speak to Mark about. So yeah, again, much appreciate all of that.

So, my radar topics are quite diverse this week, I have to say. I’ll start with something that’s a little bit political. And I know normally we don’t really talk about politics, but nevertheless, in the last 10 days or so, the Prime Minister of Denmark, my birth country, called for a snap election. Of course, most people will know, who follow finance, who follow this podcast, Denmark has certainly been in the news the last year or so with everything that’s going on.

And so, the election, to me, is somewhat interesting because you want to kind of get a feel for who might be the people who have to deal with all of these crises that Denmark is going through right now. And so, the election campaign becomes a point of interest for me. Anyways, I came across, last night, a program that I’d never seen before. Apparently it’s based on… The format is based on something they did in Holland for the latest Dutch election, I think. And instead of having these polished debates of all the political leaders where they just shout at each other, and they get only like a minute or two, just like you saw or you see in the US debates of the two candidates. And in Denmark we have like 12 candidates, so it’s never really that fruitful.

So what they did this time (and I thought that was really interesting), they invited all the political leaders, all 12 of them, to spend 24 hours together (and a film crew of course), and to have then debate, both in big groups, in small groups, one on one debates, on all sorts of topics that was sort of predetermined by the TV producer.

And I have to say I only watched the first episode yesterday and the next ones will come out in a few days. I thought this was really great television. I mean, to cover an election campaign like that where people actually have a real chance to debate the issues and you can see the differences and you can see their personalities because interestingly, none of their spin doctors were allowed to be at this place.

So anyways, it’s obviously not really relevant to what you and I talk about, but I just thought, okay, if politics can be made like this, and election campaigns could be made like this, actually then that would change my view on the political system.

And anyways, it’s also nice to see that these political leaders, at least in Denmark, they’re all pretty good friends away from the cameras. Meaning, yes, they have their differences politically, but, as human beings, they can talk friendly and they can be friends. So anyways, that’s one thing.

The next thing that also came across my radar while I was away, and I’m sure that it was the same for you and many of the people listening, is of course, you know, the sad news that we heard from AlphaQuest last week, not only because they’ve been around for a long time, they are a very well known very well respected CTA, but actually Nigol was one of the very first guests, like number two, three, or four on the podcast. So, he’s been a loyal supporter of the podcast for many, many years.

So, it’s never nice to see someone taking the decision that maybe this environment is just not well suited for the way we trade. At the same time, I give him all the props you can for taking that decision that it’s not. I mean, yeah, they’re in a drawdown, but it’s not a drawdown they haven’t seen before.

And it’s not really unusual based on their long-term volatility, but it takes a lot of courage, you know, to basically make that decision that it’s better to return the money to the clients. And, who knows, maybe it’ll show up and they’ll show up in a different format later on. You never know. But, of course, it does lead to a lot of speculation as to why has it been so difficult maybe for these type of strategies to perform.

And again, obviously, I don’t want to put any words in their mouths, so this is purely based on my own views, but I wonder (and I’d love to hear your thoughts maybe), I just wonder if the pod shops, and the rise of pod shops, and the way they trade, and the way they, I wouldn’t say manipulate the markets, but they certainly affect the markets, whether that has an influence in that space.

It’s not a space I know well because obviously I’ve always stayed in the long-term trend following camp, but I wonder if that actually has a role. And if you remember, Alan, when we spoke with Nigole, only a few months ago on the show, I think he did mention pod shops in some shape or way about some of the research they had done, and so on, and so forth.

So, pure speculation from my side. Obviously, no drama in terms of the fact that they returned capital to clients. They are doing that prudently, and I have a lot of respect for them for taking that decision. But still, nevertheless, it’s sad to see a firm like that, after 25 plus years, leave the industry.

[00:10:13] Alan

Yeah, for sure. I mean, obviously they’ve been in the midst of a drawdown but, by and large, when equities trending higher, you wouldn’t have said it was the best environment for that type of strategy, which often managers in the short-term space are more volatility expansion type strategies.

Now that said, the Short-Term Traders index has been challenged for a while but a number of the names in that space have done well in the last 12 months or so. So, it’s not all doom and gloom in the short-term space.

I guess the other point is there is a lot more differentiation, idiosyncratic models, different approaches that managers pursue. Definitely, we spoke to Nigol at that stage, and the pod shops was a theme, and he was talking about how they attract kind of capital into those high Sharpe strategies which tend to reinforce them. And that can keep going for a while but at some stage it may blow up. Obviously that remains a possibility, I guess.

But yeah, I mean it was disappointing because Nigol definitely presented a very compelling, very well thought out perspective not just on the pod shops but on how markets operate more generally and the risks involved. So yeah, for sure a disappointing outcome for the guys.

[00:11:31] Niels

And you can’t help thinking then, the week after something like the Middle east blows up again, and you kind of think, well, is this really the time where these strategies would have done really well in a situation like this? So anyways, we will never know. But I certainly wish them all the best. That’s for sure.

Now, the final thing I wanted to mention under what came on my radar, it is a little bit in jest and in fun, in a sense, and well-meaning but we have this ongoing debate between some of us including myself and the “classic trend followers” in terms of how you should size your positions, for example. That’s been an ongoing debate.

And so I couldn’t help smiling a little bit, in a friendly way, when our very good friend, Jerry Parker, on another podcast, mentioned that, actually, given some of the moves you’ve seen in the markets (and I think he used bitcoin as an example) whereby bitcoin had sold off a lot. And if it continued to go further down, actually, classic trend following, with fixed size positions based on the volatility at the entry point, wouldn’t necessarily do great because the vol is simply too high for them to get a meaningful position on.

And I think he said, I’m pretty sure he said that, in that case, you might be better off being a dynamic position size firm because here, if vol comes down, you can actually increase your position along the way and you can make it, perhaps, more meaningful. I guess the reason I mention it is it goes to show that, yes, we have different ways of doing these things. In the long run, it still seems to me, based on the data that I see, it still seems to me that in the long run maybe it doesn’t make a huge difference, but certainly it just means that these strategies will perform differently from time to time.

But, I do appreciate that Jerry was wearing his latest Top Traders Unplugged merch on the podcast, just like you and I are doing today. If people are watching this on a social media clip, they will notice a new, how should say…?

[00:13:59] Alan

Do you plan to go mainstream with selling the merch?

[00:14:03] Niels

I don’t know if people would really want to pay for this, to be frank, but it’s very comfortable, I have to say. Maybe I should ask you about that. But anyways, we’ll see, we’ll see. Okay. All right. That was that.

Now before we go to the trend following update, maybe we can tackle a question that you actually received on LinkedIn from Devon. The topic is really kind of navigating uncertain times. And what Devin writes is, “Could you share some historical data and insights on how allocators can use this strategy (meaning trend following, I imagine) to navigate these uncertain times’?

And then he has some general observations. He says, ‘I’m specifically interested in the strategy’s function as a crisis alpha by engaging in markets where the 60/40 has no footprint. And also, how does this ability to trade non-correlated assets create the necessary divergence to offset the drawdown seen in a typical portfolio during prolonged conflict?” So, as an allocator, I would love to hear your thoughts.

[00:15:15] Alan

Yeah, it’s a great question and, I mean, it touches on a few different dimensions, I think, to how you get, I suppose, value add from trend versus say 60/40. I mean, if you look at the relative performance of trend following versus 60/40, the performance profiles are very different. And actually, what’s noteworthy if you look at the historical data, is in many years trend has underperformed 60/40. But in a few years it has outperformed. And in those years where it’s outperformed, it has massively outperformed, and that is the diversifying value of it.

You know, if you look at 2022 or 2008, you know, there’s maybe a 40 percentage point differential in the performance. And so, you have to live with it. But it’s also worth thinking about where does the source of the differentiation and diversification come from?

Because it comes from a couple of different ways. So, it comes, one, from what I would call dynamic positioning. You know, trend followers do trade bonds and equities, but they don’t have a static 60/40 position in bonds and equities. So, they can either be longer in bonds and longer in equities, or less long in bonds and equities, or have a different position in bonds and equities, or be much more dynamic in bonds and equities relative to a static position.

And that’s why you’ll sometimes get that underperformance, because you might get a brief dip down in equities, and trend followers will reduce that equity risk. And if the equity market bounces back, a static 60% allocation will outperform. But there are other periods, such as 2022, going short bonds, much reducing the exposure to equities (maybe even going short). And that’s part of the driver of that outperformance versus the traditional 60/40.

But that’s only part of the equation. Obviously, the second area where you get diversifying qualities from trend following is exposure to commodity markets and currency markets as well. So, you could have the same 60/40 position in trend following just by chance, but then you are picking up long and short positioning in commodities, currencies.

And obviously this question was in the context of crises events and energy market disruptions. And we have obviously seen that in the past where trend followers have been able to directly capture those events both on the long and on the short side. So, we’ll remember the big run up in crude oil prices in 2007, and into early 2008. And trend followers made money on the long side. And then you had a big sell-off as we went into the global financial crisis and they made money on the short side.

So, volatility in commodities and in currencies, we saw it again 2014, 2015, another very positive period for trend following, capturing that kind of volatility in currencies and commodities. That’s the second source of diversification and differentiation versus 60/40.

So, actually, it’s quite difficult. I mean, you’d to go and look at a P&L in every year of a trend versus the static 60/40 reallocation to pick out, is the diversification coming more from dynamic positioning in bonds and equities or more from trading in currencies and commodities? Certainly, in those… I think what we saw in some of the big crises events, like 2008, it was obviously commodities was a huge driver of performance there. In 2022, it was probably more dynamic adjustment in bonds and equities even though long dollar was also a big driver there. But that’s the point. It’s hard to disentangle the two effects. But there are two distinct effects that I would point to.

But looking at it in aggregate, obviously, we can see very clearly in the historic data that low correlation between trend and 60/40 and, as I say, those periods when 60/40 really suffers are some of the very best periods for trend. And that’s really the rationale for having all three in a portfolio.

[00:19:17] Niels

And I can add to that, I’m pretty sure, and I’m a little bit unsure which firm it was, I won’t mention any firms, but one of the very large CTAs did, at some point, do a study where they had looked at sector attributions during crisis periods. And it was, from memory, and I’m pretty sure I’m right on this, it was very clear that the main source of returns during crises came from the commodity part of the portfolio.

And I think just maybe for Devon’s benefit and anyone else who’s interested in that, we have to accept the fact that usually, when an equity crisis… And we’re still talking mainly about equity crisis, it could certainly be a bond crisis at some point, but right now we remember the equity crisis better. And I think it’s important to realize that, more often than not, equities will be a losing proposition, or a losing position, for trend followers in the initial phase. And that initial phase can be quite long. It depends on how the markets turn, how quickly, how slowly, and on a few other factors.

So, it’s definitely not an area where we normally see a lot of performance pickup during crisis. That comes from other places, as you rightly pointed out. So, I think that that’s why we are so strongly believers in this diversifying strategy and that not very many other strategies can really claim to be consistently as valuable as these strategies when it comes to, and I wouldn’t necessarily just call it crisis alpha, but just generally when there is uncertainty, and so on, and so forth. But at the same time that they can actually also deliver positive returns during periods of very strong equity performance, which is something a lot of the other risk mitigation strategies don’t do. So, yeah, I appreciate that, Alan.

Now, yesterday… Let’s stay on the topic of trend following for a little while longer. So, yesterday my trend barometer finished at 55. And that suggests that we’re still in a pretty strong environment for trend following. And of course, February’s early numbers confirms that for sure. But also it’s interesting to see what it really means when I say the trend barometer is high.

It means that it’s a very broad participation because it actually measures the percentage of markets within that 44 market portfolio that it tracks that are “trending”. So that’s really what’s important, that we have more opportunities at the moment.

Maybe just going back one step to the comment before about where sources of returns often come from. I think people might be surprised to know that, certainly if I look at the data I have access to, the equity sector in itself is not necessarily a great sector for trend following. Then you might argue, okay, maybe that’s because you trade indices instead of single equities. I don’t know. I’ve never seen a backtest of single equities from a trend following perspectives. But, but it’s definitely not one of the stronger sectors.

But the other part of the 60/40, the 40 actually is, or has historically been, a pretty good sector for trend following. I just wanted to add that when you talk about the adaptive nature of trend following in those two sectors.

So, so we just finished February, a few days ago, while you and I were in Miami. Obviously, you know, the returns coming out so far, the early returns, look pretty strong. Any thoughts from you on kind of the beginning of the year, in February particular, that you stood out to you?

[00:23:18] Alan

No, I mean obviously we’ve seen a big run-up in performance over six months or so; six, seven months longer. I mean, at the start of the year, you know, I mean, you touch on that kind of dynamic risk sizing, and again, we have seen some dispersion linked to that in kind of metals prices, obviously.

So it is, it is an area where you’re seeing much more volatile performance in some managers to the upside and the downside, net/net on the upside, driven by that more static position sizing. So, that’s one thing that’s coming out again.

You know, I think we’ve seen a broadening out of opportunities. I mean, it’s across equities, metals, all of those bonds. Now obviously, as we’ve come into March, we’ve seen some corrections again. But, you know, as I guess reflecting your trend barometer, we’re into a trendier environment over the last number of months, which is evident in the data.

[00:24:17] Niels

Yeah, absolutely. Well, since we are on this topic, let’s broaden the conversation a little bit and talk about maybe some of the observations we had at the largest hedge fund conference of the year, which is took place in Miami, last week. Was there anything that kind of stuck with you from your conversations, your meetings over there?

I mean, I should say that when this conference originally started, and I say this conference, it’s obviously changed dramatically since the early ‘90s when it was an “MFA conference”, and now it’s MFA, but it’s really an iConnections conference, I would say. Back then it was a pure CTA conference. Nowadays of the, I don’t know how many thousand people were there, but it’s like 5% are CTAs and the rest is all sorts of other strategies. So, yeah, anyway, I’m curious to hear what stood out to you.

[00:25:23] Alan

Yeah, I mean, a couple of things. I mean, one thing that I’ve been thinking about since then is, I mean, we’re in this very… There seems to be good interest in hedge funds. And I think there was a positive mood. It felt like there was new allocators there and optimism around a lot of strategies.

And in a sense, for a lot of hedge fund strategies, it’s the sweet spot because, you know, they can point to good performance in recent years and still talk about kind of being diversifiers. You know, talk about the equity risk and the need for, you know, looking at something different, i.e. a hedge fund.

But in reality, you know, will many of these strategies do well if we see a sustained reversal in equity? So, there is this distinction when you’re looking at hedge fund strategies, you know, don’t examine performance in the context of standalone performance during a bull market. It’s think about, okay, it’s not necessarily the strategies that have done best over the last three, five years. If you’re a new allocator to the hedge fund space, it’s understanding which ones.

Obviously, the ones we talk about here; trend following, managed futures, but also things like macro, and commodities, and volatility trading, things like that structurally have that benefit, or at least that proven track record, in major equity downturns in the past. So that was just one observation.

I think generally, you know, other strategies that I think are in vogue; global macro for sure, there seem to be a lot of interest in that. And the managers in that space seem to be attracting a lot of attention.

I mean, the other factor that I was hearing a lot of still, in our space as well, was portable alpha, and return stacking, and managers presenting their track records both on a standalone basis and using other indices and packaging in that way, which is totally fair enough, but just is symptomatic of the environment we’re in where equities are doing well. So, any strategy coupled with the S& P tends to look pretty good.

I had a little bit of a chat about Total Portfolio Approach, bumped into David Dredge, and we were comparing notes on that. It’s certainly been a bit of a topic. Again, some managers, I suppose, positioning their strategy in the context of the greater amount of conversation we’re having about TPA and drawing the inference that it should lead to greater allocations to the pure diversifiers. Again, the kind of strategies that we’re talking about here. Whether that is the case or not, time will tell.

And then beyond that, a bit of talk about AI. Obviously the Citrini Report last week on AI, what’s the impact from an economic perspective? Are managers using it in their business? Yes, seemed to be the answer. And that seemed to be where we’re really seeing the impact at the moment. Less so in terms of alpha generation, but more and more novel ways of using it. Even say from macro managers and stuff like that. So, certainly a big topic, but, I would say, no clear takeaways on that one.

And then interestingly, as I said before, there wasn’t a huge amount of talk around geopolitics. So it’s funny how the macro themes change very quickly. So, last week was much more about deflation and disinflation and AI. Now we’re into geopolitics. Things change quickly.

But yeah, overall, I’d say definitely positive mood towards hedge funds and yeah, and equally a reasonably positive, I would say, mood towards CTAs as well. Notwithstanding, CTA has been a bit of a laggard in terms of performance last year. I think people are taking note of the run-up in performance recently. Sentiment can change pretty quickly when equities start to wobble. And at the same time CTAs are doing well and people can see trends developing. It doesn’t take much for sentiment to shift pretty quickly.

[00:29:24] Niels

Yeah, absolutely. Just to comment on a few things you mentioned there. First of all, both you and I have been doing this for a very long time and you kind of think, well, we’re not going to see anything we haven’t seen before. But, actually, what was interesting about how the month of February ended, at least from my perspective, and this is from a Dunn perspective, is the fact that we actually equalized a record set back in 1999 with eight consecutive positive months. I mean that is very rare in this strategy.

And the reason I mention it is we saw the headlines last summer, right? People were really, really negative about it. And they were really saying, well, now this time for sure, CTAs and trend followers must not be able to make money in a Trump 2.0 world. Not because of him, but because of the way policies were done, and tweets, and markets moving and reacting quickly to what could seem like completely erratic policies.

And then, the strategy goes on to deliver, not just in our case, many of our peers, certainly also the SocGen Trend Index, one of the strongest periods of performance and one of the most consistent periods of performance in history. So, it should be a lesson to the journalistic community not to rule this strategy out. There are so many examples of that. So that’s one thing I just wanted to mentioned.

You mentioned AI, and there’s one thing I should have mentioned in ‘what’s been on my radar’. I came across, I don’t know if you’ve seen this, I came across this interview with the CEO of Anthropic. It’s only a few days old. And it was very unsettling because, essentially, what he was saying is that, yeah, we have this great platform AI, we’re selling our AI to US ministries or various agencies, and so on, and so forth, and it’s really helped them. And of course, a lot of people are focused, because of the Iran conflict, on the military use of this.

But then he was saying, well, now the US Department of War basically have said, well, now we want full access and you cannot control what we use it for. And apparently Anthropic has said, well, there are two things you can’t use it for, and that is mass surveillance of US citizens, and to have autonomous weapons, meaning that they shoot and decide who to shoot at without any human intervention. It’s a very interesting interview on CBS, also pretty frightening, that we are this close to those kind of things. So that was just a point about AI.

But just going back to the conference, I agree with your sentiment. I thought it was very constructive conversations. I mean, on TPA, I certainly met with a couple of sovereign wealth funds as well, and one of them had been using TPA for quite a while. And, I think it will be, as we’ve talked about before on the podcast, I think it will be a boost for our industry because there’s so few strategies where you can truly see the benefit to the total portfolio by investing in a strategy like trend following, that’s one thing.

But I also came across investors at the conference who really explained very well all the things they had done to kind of deal with this environment. And it was very interesting. They seemed very well prepared. The portfolios had, you know, changed a lot, but seemed very well prepared. But it always reminds me, and maybe it’s because our booth was, once again, straight across from Dave Dredge’s booth at Convex Strategies. So, I was always reminded to ask them, yeah sure, but what have you got in your portfolio if you’re wrong, as he always reminds us.

And so, I agree with you. I think a lot of people are thinking about this environment, that it is that, probably, they do need a different portfolio. Whether they’re quite ready to fully embrace what we do, not sure yet, but I would say a lot more openness, a lot more, you know, let’s call it understanding of the properties that we offer within a portfolio context. So, that was very useful and very positive for sure.

Maybe just one comment before I get to the performance numbers, but (and I’m generalizing right now, I can’t say for sure that this is the case), one thing that probably was interesting about February was, I have a feeling that many trend followers flipped their energy position from flat short to long. And that obviously was pretty important given what has happened in with energy markets in the first few days of March.

So with all these events that suddenly come out of the blue, even though people will say well this was all in the cards, the initial move or the initial performance is pretty random because we just don’t know how we are positioned going into a conflict like this.

But this time it seems like, despite some sell-off in some of the precious metals, it certainly seemed like the energy sector was on the right side of this. Maybe with the exception of the nat gases, but those positions are probably quite small given the massive volatility that we have in those markets. So, I thought that’s an interesting little takeaway from the positioning that you and Cem talked a lot about last week.

Anyways, from a performance point of view, we’re recording on Thursday, but as of Tuesday night, which is the last day we have published performance from (and I would just add that yesterday was probably a good day for CTAs as far as I can tell). But the BTOP50 so far in March was down 1.56%, but still up 5.29% for them for the year. SocGen CTA index down 1.94%, but still up 6.22% for the year. SocGen Trend down 1.85%, but still up 6.78% for the year. And the Short-Term Traders Index down 0.25% so far in March, but up 3.56% so far this year

Whilst in the traditional land MSCI world is down at 1.5% ish as of last night in March, up 1.5% ish so far this year. And the S&P US Aggregate Bond index down 57 basis points so far in March, as you rightly pointed out there’s no offset to be seen right now, but it’s still up about 1% so far this year. And then the S&P 500 was pretty much flat as of last night in March and up 56 basis points so far this year.

Some of the standout markets so far in March, really heating oil, up about 33%, but crude oil (Brent oil), and gasoline (ARPA) up and are some of the leaders on the classic futures scoreboard, so to speak, for March. While the losers are actually what have done well, so far, this year. Silver, platinum, palladium, and even also the Nikkei, as at least so far, was hit a little bit harder along with some of the European indices, I think as you already mentioned.

One thing I just want to mention before we get into your topics, Alan, is that with AlphaQuest returning their capital to clients it’ll be interesting to see how Societe Generale will handle that in the index because they are part of the SocGen CTA index and I’m not entirely sure what happens in the case a manager drops out during the year but we will hopefully get Tom to fill us in at some point.

All right with all of these things we’ve discussed already your macro view, Alan, what are your thoughts?

[00:37:48] Alan

Well, I wanted to talk about AI a bit, and really in the context of two things.

One is this Citrini Report, which came out last week, which really got a lot of attention and which, I guess, a lot of people will have read it but if you haven’t it’s kind of presenting a possible scenario. They are a research firm and they were at pains to emphasize that it’s not their base case scenario, it’s more of a kind of an outlier, or a plausible but unlikely scenario to consider whereby, instead of AI being a positive force, we could see very significant white collar unemployment and other effects. Many businesses might see their moats being eroded by the impact of AI.

And I think this is interesting in the context of the change that we’re going to see at The Fed pretty soon because we’ve got Kevin Warsh coming in in May… Well, he’s been nominated. So it’ assuming he can get through the nomination process as new Fed Chair. And I think it’s interesting because Warsh has already said… He was on CNBC last summer, and he said AI is a game changer. It’s going to change the economy, it’s going to make everything cheaper. He also has a lot of links with Stanford and Silicon Valley. So, he is embedded in that kind of technology sector. So, he does seem to be a believer in the kind of productivity benefits and the lower cost implications of AI.

And this is interesting because it has got a lot of people thinking back to Alan Greenspan. Actually… a shout out to Alan Greenspan because it’s his birthday tomorrow – I was reading, 100 years old tomorrow. But Alan Greenspan is back in our minds because of the 1990s and the new paradigm. So, Greenspan also had this kind of dilemma, in the 1990s, whereby you had a new technology coming in, more adoption of PCs. And in 1996, Greenspan felt that productivity was increasing. There was a lot of pressure to raise rates and he held off on raising rates. He said there’s no need because productivity is going to keep inflation in check.

And this is kind of the example that Warsh is pointing to, that if you have a productivity boom, it keeps prices down and not only do you not have to raise rates, but in the case of Warsh, he’s saying you could cut rates, which is obviously presumably the reason he got the job, is that he has that view because the administration want policymakers who are in favor of cutting rates. So that seems to be his framework coming in.

Now, it’s interesting, Jason Furman, who’s another guest we’ve had on the podcast, he had an article in the FT talking about the real lessons of Greenspan for Warsh. One of the lessons is that, actually, from an economic perspective, this framework is incorrect because what we saw in the ‘90s, yes, the productivity boom did initially cause inflation to keep in check and was a reason for the Fed not to raise rates. But by the end of the decade, Greenspan was actually raising rates, in ‘99 and 2000, because the economy was overheating and inflation was picking up.

And this is one of these economic theories or arguments. The reason is, yes, you have an initial supply shift, but then you also get a demand reaction. The demand reaction comes because you get this new technology. So, you get a huge investment in capex and not only that, consumers become more optimistic and they spend more, their wages rise, and you get a wealth effect via the stock market.

And actually, if you go back to Greenspan’s 2000 Humphrey Hawkins testimony, if you’re the kind of person who likes to go and read these things, you’ll see him talking about this. So, I’m in the process of writing a piece for my substack. So, beyond the cycle, keep an eye out.

So, I was reading this, but Greenspan outlines it very clearly. He explains, you get this supply shock, but then you get this response from demand in terms of more investment and more consumption.

But when you think about it, I mean, that was exactly what happened in the 1990s, but it’s not what always happens. And I suppose the point of the Citrini Report is, in a benign scenario, yes, workers might share in the productivity gains via higher wages, but in other scenarios they might not. And the gains would go to the holders of capital, the capital owners, the business owners.

And actually, if you go back to the 1800s, we had what was called the Gilded Age, and it was an era of very strong productivity growth as well. So, productivity boomed. It was the Industrial Revolution, and actually that was an era of deflation. The US was on the gold standard. There was no Fed to offset it, so prices fell, but it was what you would call a benign deflation. Unemployment stayed steady, but again, the gains accrued more to the holders of capital as opposed to growth in real wages.

So, the point is that you have very uncertain supply impacts. One, we don’t know how big of an impact AI is going to be, Two, who are going to get the benefits or not? And three, what’s the demand response going to be? Will we see that CapEx boom or have we already seen it? We’ve already seen the hyperscalers investing a lot in CapEx. And more recently, the stock market reaction has started to get negative as investors have seen more and more CapEx, have started to see, is this excessive? So, there is that question whether that economic framework is still the case.

But I think the other interesting thing here is the policy reaction and the macro context, the political context, and also the Fed’s operating framework. Bear in mind that the Fed has an inflation target. So, if AI truly is disinflationary, or deflationary, by its own mandate, the Fed has to counter that to try and bump up inflation via more stimulus. So, this is the dilemma that Greenspan also had in the 1990s of, should you keep policy accommodative in the midst of a stock market bubble or not?

So it’s easy to see how, if we do see some of those positive impacts of AI in terms of pushing down prices and being disinflationary, that could be quite destabilizing from a macro perspective if the Fed actually did stick to its inflation targeting framework. Because the natural upshot would be to try and stimulate to bring inflation back up to target.

And bear in mind, as we’ve been saying, that the administration is already putting a lot of pressure on. So, if it can also see a justification for lower rates via falling inflation numbers, it’s definitely going to put the pressure on. So, I think there’s a huge range of estimates out there as to the possible impact of AI.

What’s interesting for me is like a year ago we were debating was it going to be 0.1% of productivity growth or 0.5%. Now, as we moved into this year, there seems to me much more sense of certainty that it will have a bigger impact. But actually, what’s interesting is that there’s no consensus on the appropriate policy response to it.

And actually, a lot of the policy response is probably more solving the mismatches that you might get in the labor market. Whereas if you get big stimulus in response to a disinflationary impulse, that could really pump up asset bubbles again.

So, in theory, it comes at a time that’s very beneficial because we’ve been talking a lot about the supply constraints in the economy which are inflationary. So, in theory, AI can solve those, but that’s at an aggregate level. AI may displace white collar workers in software, but can they go and retrain as healthcare workers? Probably not. So, you can still have those imbalances in the economy.

So, I think the takeaway for me is, one, economists don’t even agree on how this impacts the economy. They don’t agree what’s the policy response. And you have a new Fed Chair coming in who appears to already have made up his mind as to what is the best way to go.

So, I would say the risk of some policy error there has been reasonably strong and we could have quite significant repercussions from that. It’s probably not a story for this month, next month, but certainly later in the year and into next year.

[00:46:40] Niels

So, on my travels, recently, I also attended a really, really good conference organized by one of our previous guests, Grant Williams and Stephanie Pomboy. A really great lineup of speakers. One of them was also a previous guest, something I really love are her insights to politics, and that was Pippa Malmgren, and actually what she said (and obviously it would be great to have her back to explain this in much better than I can), what I didn’t know is that… I did notice that the appointment of Kevin Warsh came kind of suddenly, and I think you and I even talked about that the prediction market, so to speak, actually had favored someone else leading up to this. But then suddenly an announcement comes out and it’s Kevin Warsh.

What she was saying is that there was a lot of things going on in the background and from, let’s just say, from what I recall of her presentation was that he’s actually someone that kind of belongs to a certain part of the Republican Party, namely the George Bush group, which is not necessarily strong supporters of the current president. But that, because of certain things happening where they would stop pushing back on Trump, Trump then gave them Kevin Warsh as the next Fed Chair. So, I have to say I’m very… It’ll be very interesting to see what happens next. And by the way, the C in FOMC is not chair, it’s committee. Right? …

[00:48:31] Alan

I mean, that is the argument.

[00:48:32] Niels

He has to convince a few other people to go along if, indeed, that’s what he still wants to do. I mean, everybody has the right to change their mind and maybe things have changed.

[00:48:43] Alan

You’re right. I mean he is well connected in Republican circles. I wasn’t aware of him being part of that particular segment.

[00:48:48] Niels

Neither was I. Neither was I.

[00:48:50] Alan

I mean, there was a suggestion that, because all of this happened just after the Fed started the proceedings against Powell in relation to the renovation, etc., and that tension that arose, and then kind of the view in Congress was definitely that Kevin Hassett just wouldn’t get through the nomination process in that context, he would be seen to be… So, there was that element too that kind of put Warsh back in as favorite. But yeah, who knows? There can be a lot more going on behind the scenes.

[00:49:21] Niels

There always is.

[00:49:22] Alan

But yeah, I mean, as Dario Perkins said on one of our podcasts, it’s hard to see the Fed Chair, given that Powell was threatened with going to jail for raising rates or not cutting rates, it’s hard to see, hard to imagine that this isn’t in the chair’s mind as he’s making these decisions, you know.

[00:49:42] Niels

Absolutely, absolutely. All right, well, we’re already 50 minutes in and we still have a little bit of ground to cover. Not least something that you’ve been writing, again, I think this time on your LinkedIn profile, an article choosing an analogy that I obviously feel very strongly about which is football, or soccer as they would say stateside, and the missing midfield player. So, who is the missing midfield player?

[00:50:13] Alan

That’s a great question. Maybe, before we get to that, I mean the reason I wrote this is I wrote a piece in my LinkedIn newsletter, back in July actually, you know when trend following was going through the struggles it was going through, and I just say, at the time, the sentiment was negative.

And true to form, there was a Wall Street Journal article that appeared just at that time (not to write about trend following the rest of the time), but it came out then, and then fast forward six months we’ve had a big change in sentiment. So, there were two elements to my blog. One was about what are the lessons from that episode in 2025? It was stating the obvious. Timing is difficult because very few people were upbeat in the middle of 2025. It’s about the pearls of following narrative, and the narrative was quite compelling. As you say, people were saying, this market environment is not good for trend following. It’s choppy tariff on, tariff off.

But I guess, in reality, the administration nearly went from being a source of reversals in markets to also being a driver of some of the trends, like, if you think about gold and the debasement trade, it’s related to reduced credibility or concerns about the outlook for feed currencies generally and the dollar. So that’s the pearl of just looking at these things from one perspective and ignoring others.

[00:51:40] Niels

But Alan, I have to interrupt you here because I’m curious, because we always say this, you know you can’t time trend following. But given your long history in this space and mine, and I know our researchers would definitely not agree with me when I say this, and that is usually when these things kind of get near to their worst-ever drawdown it’s really not a bad time to invest.

So, I know we say, well, you can’t time it but I think there are certain times where the risk of getting in, the risk of topping up, is certainly a lot more compelling than when we’ve just had a good run and making new all-time highs. Or am I completely wrong here Alan?

[00:52:34] Alan

Well, I mean if you’re at all-time highs, I’m sure all of the CTAs will trot out good research showing that investing at all-time highs is a good decision as well. So, they can have it both ways. But I mean, I think the problem is this was a drawdown that went on, I don’t know, it’s gone on 24 months, whatever it was. I mean, I do remember reading in the middle of 2024, people saying, buy the dip in CTAs, you were having a bit of a performance dip now at the time.

Yeah, when you get to a level of drawdown that is comparable to the largest we’ve ever seen for the SocGen Trend, yes, you would have to say that. But the first job, I , for CTAs in that environment is keeping investors in, never mind convincing them to top up. But I do agree with you, and I am aware of some managers who have clients who do very successfully time it. So, it’s not to say that nobody can do it, but I think for a lot of investors it is difficult.

[00:53:29] Niels

It takes guts for sure.

[00:53:30] Alan

Yeah. And I think the point is you have to not assign the narrative, the prevailing narrative that you’re hearing and just ignore that narrative and look at the statistics. But it was another period of showing that it’s diversification, not insurance.

You know, obviously trends suffered last year. I mean, that’s a pretty obvious point. But also, it showed some of the positive benefits, positive and negatives of trend, in a sense. Trend is an adaptive strategy and we saw it adapt last April. When we had to sell-off in equities, it adapted. Now, in that instance that didn’t generate returns. That proved to be a cost.

But this is the classic example of what’s called resulting. Annie Duke calls it resulting. You can’t evaluate a decision based on one outcome. So, in that instance, trend following prepared for a much more negative outcome last April. In the event we had TACO. Trump turned around and the equity market went back up and then trend adapted again.

But then later in the year we saw the benefit of a different feature of trend following and that’s the ability to stick with a trend. Look at the move in gold. I mean a lot of people have been bullish in gold. It hardly has been an out of the ordinary kind of idea to be long gold in a kind of a debasement trade and concerns about like the administration and geopolitics, all of that.

But how many people have been able to stick with it? You know, I mean certainly you might have said at US$4,000 it’s over, done. now we’ve gone through US$5,000.

So, I mean that’s the other characteristic of trend following that often gets overlooked is that ability to, you know, not second guess how long these moves can go on and not try and time the top. So, there are, I think, some of the lessons.

But also, I think, overall, when we started to see this positive performance in the second half of last year in an environment where equities are doing well, it did highlight to me, again, why this analogy of trend following, it’s less of a pure defender, more of a midfielder in the sense that trend can go on the attack in terms of be a positive contributor to returns in the pro-risk environments, but equally can shift back and be the factor that tilts the overall portfolio into a more defensive stance in more defensive period.

So, I think that’s something where, for a long time, I think in the 2010s, obviously a lot of the narrative was around crisis, risk, offset, etc. But I think this is, to my mind, a more intuitive explanation. Now, of course, we can debate what kind of midfielder, which is where I start to get out of my depth as more of a rugby fan. You know, I did have to ask some friends about this and we settled on Steven Garraed more than Roy Keane or Sudan. But I also got the suggestion of Clarence Seedorf. So, you know, everybody will have their own idea. Maybe there’s some great Danish midfielder you think is more appropriate.

[00:56:38] Niels

I can certainly think of a few and I guess Seedorf, that would definitely have come from our friends at Transtrend, if I’m not mistaken.

[00:56:45] Alan

You’re not wrong.

[00:56:48] Niels

Yeah, I mean a great piece, a great reminder, and some really good points that people should go and remind themselves by reading your article.

But let’s finish off with a couple of things that came out, not from any of us, but actually from some of our esteemed peers in our space, namely Winton. They released a couple of papers that came on our desk. One is kind of on the theme of how to build a portfolio of CTAs, and then the other one is very kind of relevant, from our discussions with Andrew Beer, in terms of how do you track an index and how do you invest in it and all that stuff.

Now, we don’t have massive time left, but I would like for you, maybe, as an allocator, it would be really good to hear your view on those two things. It’s so relevant for all the investors who listen to our conversation because they will be having to deal with these questions in terms of how do I select, who do I select, how many do I select? And also, if I want “the benchmark”, how do I go about doing that? So, I’d love to hear your thoughts.

[00:58:08] Alan

Yeah, two interesting papers, two very important topics, and I mean quickly on the benchmark one, it’s probably less in that one than in the other one. But it does highlight the tracking error that you get from maybe just picking two trend followers. I mean, this is something I definitely hear from investors, and they’ll say, okay, we’re going to pick these two trend followers, or one (two is good because you’re diversifying) and then is that enough?

So, what the Winton paper does show is you get a tracking error of about 5% per annum versus the SocGen Trend index, if you randomly selected two managers. So, it’s quite an amount there. If that’s your objective is to track the index, then you need more than two.

I think it shows you outperform by about 3% per annum or underperformed for anywhere up to about 3%. So that kind of range, which can obviously compound over time. I mean, one of the challenges with, as they point out, the index and tracking the index is managers run at different levels of volatility. So that accounts for some of this dispersion.

So, two things to it, one is, if you adjust for that, you can get closer to the index. And two, if you focus on picking the most correlated managers, you would also get close to the index, which makes sense as well. But I mean, there are other things you could consider that they don’t touch on in the paper.

So, one of those factors is, as they say, it’s an equally weighted index. So, effectively the higher volatility managers have a higher percentage of portfolio risk in the index. So, as an allocator, that might be something to think about. Do you want that or not?

And you could also, instead of picking the most correlated managers, you could look in terms of building a portfolio of less correlated trend following managers, and you would get a diversification benefit of doing that, and you could run that portfolio at a slightly higher level of volatility than the index and probably realize a similar level of vol.

So, there were just two perspectives I had, for investors to consider, as an alternative to trying to get very close to the index.

[01:00:24] Niels

Right, but equally, they point out that this is not an easy thing to do. But, as we’ve also seen with replication strategies, it’s not easy to actually replicate very tightly. I mean, you’re going to have tracking error unless you go out and buy all 10 managers. That’s just how it works.

[01:00:41] Alan

Exactly.

[01:00:41] Niels

So, you have to accept that. And sometimes those tracking errors, even in replication land, can be significant.

[01:00:49] Alan

That’s right.

[01:00:50] Niels

That’s just how it is.

[01:00:51] Alan

Yeah. The second paper then is how to build a portfolio of CTAs. It’s quite an interesting topic as well because, I would say, as they say, maybe the convention and wisdom is to pick a lot of different types of managers. So, the paper is maybe saying, that may not be the best way. Whether you agree with that or not, we’ll get to.

I mean they highlight how the main differentiators for CTAs, in the trend and managed future space, are kind of speed, universe of markets traded, whether you have diversifying non trend signals or not, and risk management. I mean, they rightly point out like managers run at different levels of speed and you’ll have some fast, medium, long.

So, as a multi manager, generally the approach is to blend, but by blending you are effectively getting an average. So, you kind of are picking at one ultimate speed, on average, that you’re getting. So that is true.

Their argument is that you might be better off picking, if you are with one manager, they will do the research as to what’s the optimal level of speed. So, I don’t know. I mean there are pros and cons to that.

I think where it got even more interesting, they talk about non-trend and, actually, they had some quite interesting data around the non-trend side, and they look at what is, effectively, the SocGen non-trend index. So, taking out the non-trend managers from the CTA index, and looking at the performance of those, and actually the performance has been good, interestingly, in aggregate. But they do show how managers come and go a lot more in that space than in the trend space where there is a lot more of stability.

And they do make the case for why there are benefits to accessing non-trend signals in a diversified manager as opposed to having a trend manager and a non-trend manager. There are obvious ones like fee netting, capital efficiency, and if you get exposure concentration, you can manage that.

I mean, they’re all valid points. I guess the flip side of that is, if you just go to that one manager, you’re just getting the IP that’s available within that manager. Where you know, I would certainly be of the view that in certain specialist sectors there are different ways of doing these things; there are different ways of approaching carry, there are different ways of approaching quant macro.

Sure, if you allocate to a distinct quant macro manager you do have that fee, you don’t have that netting, but you do get the additional benefit of the different perspective on portfolio construction. And, bear in mind, that’s the whole philosophy behind the multi strats. Put a lot of different people with different approaches together and you get that benefit. And also, there are strategies you might want to add that are not systematic, something like discretionary macro as well as quant macro.

So, you won’t necessarily get everything you want within one manager. But I mean, I think it is the trend, the way things are going, with a lot of allocators, because it is time consuming, as an allocator, to build relationships with lots of managers. So, I think this is part of the reason we’re seeing the growth of solution businesses where larger managers are saying we can offer you everything.

There are benefits. But I still do believe there are benefits and accessing niche intellectual capability at smaller houses as well. So, I’m not sure if I’m fully in agreement there. I accept the point. But yeah, I think you could debate that one.

They also talk about alternative markets, whether it makes sense to allocate to trend in traditional as well as alternative. Obviously you’re expanding the opportunity set by going into alternatives, but again, does it make sense to have that in one portfolio or two distinct portfolios?

And again, it’s kind of the same argument because some of the alt markets trend followers will, I suppose, present their capability in terms of being able to access certain markets or their operational infrastructure, etc. So, it’s a value call as to whether you think it is something that requires a specialist manager or not.

So, definitely a very interesting paper, worth looking at. Yeah, you could definitely debate some of those points.

[01:05:00] Niels

Well, maybe we’ll have to debate them with Simon J. Coutts when he comes back on the podcast.

[01:05:06] Alan

For sure.

[01:05:07] Niels

I’m not sure he even wrote this paper or not. But yeah, and the other thing I think they mentioned was, and correct me if I’m wrong here, they do also mention, that I think is a valid point, that once you start doing a lot of these things to try and “replicate an index” or whatever, I mean, you might actually lose the very thing that you want from your CTA, which is convexity and all of those things.

So, yeah, sometimes you might just want to go with one or two trend followers who’ve been around for a long time and just stick with it, so to speak, instead of just trying to always get the smoothest ride, because that smoothest ride might not be exactly what you want in the long run.

Final question on this before we wrap up. They put forward a certain thinking. You just mentioned that there are certain things you agree with, there are certain things you don’t agree with. The other thing I was going to ask you here is, given that you’ve been doing this for a long time, are there certain things that, in more recent time, you have changed your view on compared to maybe how you did things 5, 10 years ago? When you construct portfolios today, are there things where you say, yeah, maybe we shouldn’t have done it that way, we should do it this way? Is there anything that springs to mind?

[01:06:35] Alan

I mean, the one thing that does spring to mind is kind of the cost of maintaining multiple relationships. So, I can see that benefit of getting more embedded with a number of managers, a smaller number of managers, and really understanding, because the more you really understand the program, its nature, it’s positive, it’s easier to understand the performance and stick with it. So, there is an inherent tension there between wanting to look across as many as possible, but there are limits on that.

So, that is probably the one thing where I can see that there is that benefit in some situations. I can see, certainly, for large institutions, why that might make sense for them.

[01:07:20] Niels

So, I asked Chat GBT about this article, and there was one thing that stood out at the very end of its response, and I don’t know, frankly, I don’t know if I have an opinion about it, but I will throw out the question that it posed, and it says, is CTA beta stable enough to be benchmarked in the first place?

[01:07:43] Alan

Well, that’s interesting. I mean, you know, is there a CTA beta? You know, that’s something we debated for a long time. We wouldn’t agree that there necessarily is. So, whether it exists at all and then whether it’s stable enough… I mean, this is a classic Chat BGBT response because it sounds like something that makes sense, but it actually doesn’t. It’s just they’ve taken words and put them in an order that looks like it makes sense, but it actually doesn’t, you know.

[01:08:10] Niels

No, absolutely, absolutely. Well, this was great, Alan, again, thank you so much, not just for today, but also for sitting in for me and, you know, I think for people listening to us today, please show your appreciation for all the work that Alan has put in by going to your favorite podcast platform and leave a rating and review for this conversation and any of the other conversations, of course, because it really goes without saying that all the co-hosts put a lot of time into producing these episodes each and every week. Now, next week I will be hosting the show, but I’ve completely forgotten who is coming on. But I know it’s going to be a great one.

It could be Rich, actually. I wouldn’t be surprised if Rich is back from down under. But in any event, whoever it is, it’ll be a great conversation. And if you do want us to handle some of your questions, just like we did today, do send them to info@toptradersunplugged.com and I’ll do my very best to remember to bring them up in the conversation.

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

[01:09:23] Ending

Thanks for listening to the Systematic Investor Podcast series. If you enjoy this series, go on over to iTunes and leave an honest rating and review. And be sure to listen to all the other episodes from Top Traders Unplugged.

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