All Weather Investing with Eric Crittenden

[00:00:00] Welcome to Excess Returns. We'll be focused on what works over the long term in the markets. Join us as we talk about the strategies and tactics that can help you become a better long-term investor. Justin Carbonneau and Jack Forehand are principals at Bolivia Capital

[00:00:13] Management. The opinions expressed in this podcast do not necessarily reflect the opinions of Bolivia Capital. No information on this podcast should be construed as investment advice. Securities discussed in the podcast may be holdings of clients of Bolivia Capital.

[00:00:24] Hey guys, this is Justin. In this episode of Excess Returns, Jack and I talk with Eric Crittenden of Standpoint Asset Management about their all-weather systematic approach to investing. We talk to Eric about the use of trend following,

[00:00:34] the importance of diversification in multi-asset classes, and much more. And make sure you stick around to hear Eric's blind taste or return test study and why Dennis Rodman was perhaps one of the best values in terms of NBA players ever. I think you'll find both of those things

[00:00:47] very interesting. As always, thank you for listening. Please enjoy this discussion with Standpoint's Eric Crittenden. Eric, thank you very much for coming back on with us, second time around on Excess Returns. We appreciate it. Thanks for having me out, guys.

[00:01:00] So we wanted to... I think it's been maybe we were talking like over two years since we last had you on. And so it's always good to check in and get your thoughts on a bunch of different

[00:01:09] things. We wanted to talk to you more about all-weather investing and what makes for a good all-weather strategy, how you kind of are thinking about international assets and investing and overall views on portfolio construction and how you and your team think about sort of macro,

[00:01:29] systematic macro trend following and investing, which kind of sits at the heart of what you guys do over there. But maybe to start... Let's kind of start at a high level. Like when you

[00:01:40] think about or explain all-weather investing, how do you sort of explain it and define it? And then what in your opinion are good characteristics of an all-weather strategy? Yeah, so great topics. All-weather to me is simply being prepared for what we know as plausible.

[00:01:59] So my research typically goes back to at least 1970. I'm trying to go back further than that but the data gets somewhat sparse. But it definitely does good data from 1970 forward. And I feel like a lot of investors are essentially blind to what went on from 1970 to 1982, rising

[00:02:19] interest rates, inflation, some would argue stagflation and what they can do to a portfolio. So a good all-weather program is in my opinion, is something that's going to fill in those potholes and have assets and or strategies that can help a portfolio maintain a reasonable

[00:02:36] compounded growth rate through really difficult periods of time. And there's different ways to have difficult times. There's bear markets, there are stagflationary environments, deflationary environments, general stag nation. Last year 2022 was a good example of what can happen

[00:02:55] where you have bonds going down at the same time that stocks are going down. So having something in the portfolio that can thrive during periods like that and having it in

[00:03:04] there in size, so it really makes a difference is kind of the minimum requirement for having a good all-weather portfolio. Speaking of blind, you have this YouTube video up where you do, the title of it is Blind Taste Test but I guess it could be called Blind

[00:03:22] Return Test. And it's a really interesting video and I think it speaks to how investors kind of make decisions and when they're presented with figures, how some of their decisions might be different than what they actually do in real life. So I don't know,

[00:03:42] I just thought that I thought you'd like to kind of explain what you did in that video. I think it's cool. Yeah, so I started out in the hedge fund world and I dealt with primarily individual investors. And here in Arizona, real estate is popular, stocks are popular

[00:04:00] and global macro strategies are not particularly popular. So I faced an uphill battle of convincing people to adopt kind of an all-weather mentality for the whole portfolio. So I had this idea of anonymizing asset classes and then showing people these asset classes. I would have a spreadsheet,

[00:04:18] sometimes I would do it on an overhead, you know, whiteboard. And you would have these, you know, annual returns and columns for five, six, sometimes eight different asset classes, things like stocks and gold and global macro and bonds and corporate bonds and MLPs,

[00:04:33] think, you know, different asset classes. But I would anonymize them so they didn't know which asset class is which. They were just color coded red, orange, green, blue, so on and so forth. And down at the bottom, they could see the annualized returns, the annualized volatility,

[00:04:46] the worst decline, the max drawdown, and then the average correlation with the other asset classes. And I would say, hey, let's build a portfolio together. You pick your favorite one and that'll be, say, 40% of the portfolio. And then pick your second favorite one and that'll be 25%

[00:05:01] and then 15% and so on and so forth. So they would build a portfolio. And it was remarkable that in virtually all cases, they would build a really durable all-weather portfolio. And then I would do this, the fun part, which is reveal the asset classes. And they would notice

[00:05:19] that the portfolio they built was essentially the opposite of what they did in real life. They would have global macro typically in first place, followed by T-bills and some gold, maybe some MLPs and usually stocks represented by the S&P 500 would be in last place.

[00:05:34] And that's the exact opposite of what they do in real life. So did it work? Sort of, I mean, it was convincing because they could see the data and they could see this nice equity curve

[00:05:45] of this all-weather strategy or portfolio that they built. Did they stick with it in real life? No, which is very interesting that most they would try it. A few of them, but they couldn't

[00:05:55] stick with it. Within a year, they were right back to overweating stocks at a very small allocation and true diversifiers and basically ignoring everything else except for a little bit of bonds in there. I'm curious, why do you think it is that despite those return numbers that everybody

[00:06:11] wants to invest in stocks and bonds? I mean, is it the machine of Wall Street just wants to sell stocks and bonds? Because what's interesting is if you take a look back and look at these portfolios, these all-weather type portfolios, I mean, they really do have better

[00:06:22] risk and return characteristics than just a stock and bond portfolio. And we're seeing some of that now, but why do you think it is that everybody just wants to invest in stocks and bonds? It's because NV drives the markets, drives investor psychology, I think. That's the way

[00:06:38] I see it. So what you said, a good all-weather kind of multi-asset portfolio has competitive returns over the long term. That's a true statement in my opinion, but does it have competitive returns at the precise moment that people are staring at their accounts and making

[00:06:55] emotional decisions? No. The all-weather portfolio will underperform during a recovery, but you'd like to think it doesn't matter because a good all-weather portfolio didn't go down very much prior to the recovery during the crisis or during the disaster when risk portfolios

[00:07:13] are down 30 or 40 or 50 or maybe even 60%. A good all-weather program might be down 20 or 15 or 18 or something like that. So you don't need to make the really high returns on the other side

[00:07:24] of the chasm, but that's the moment in time that people are paying the most attention to their portfolios staring at those year-to-date returns. And it just so happens and I'm not sure why, that's when emotional decisions get made. So in practice, the all-weather portfolio makes

[00:07:40] sense, but you don't get to jump to the end and just hold it for 10 years or 20 or 30 years. You've got to survive the path traveled along the way. And a lot of people can stick with

[00:07:52] an all-weather portfolio and prefer it, I think, but when you show them the individual components and they see the diversifiers sometimes being flat when the stock market's up for the year or having forbidding down a little bit, they feel like they're getting left behind and make

[00:08:06] that emotional decision to abandon true diversification and go back to pure growth investing, usually at the worst possible time. This is the challenge we face with the kind of portfolio. We run some portfolios like this too. And this idea of line item risk is a huge issue.

[00:08:19] It's like your portfolio as a package has actually done a pretty good job, but now I'm going to dig in there and I'm going to look at each individual component and I decide, well,

[00:08:26] that one component's not working right now, so I got to get rid of that. And that's a challenge with investors because they want to pick, they don't want to just look at the whole package, they want to pick apart those individual items.

[00:08:35] Yeah, in fact, there's another experiment that I used to do where I would show people aggregate results of a portfolio. I even did it in different contexts like real life rather than just financial assets like assembling a team, maybe working at a corporation or sports team

[00:08:50] or whatever. And they would look at the aggregate results and say, that's fantastic, I'm really on board. And then on a different day, show them the same thing but don't tell them it's the same thing, but show them all the intricacies inside and they start picking apart

[00:09:03] all the things that look like problems. Anything that's down this quarter, anything that's underperforming, and then they want to abandon all the diversification and ram it all into the best performing assets, which we know is a really bad idea

[00:09:16] long term, they can't help themselves. So in one context, their response is, this is great, keep doing what you're doing. In a different context, the same thing, it's the exact same thing, you gave them transparency into each line item and now all

[00:09:30] of a sudden they see problems where there really are none. Do you imagine this idea before about all weather portfolios are good about dealing with what's plausible? And I'm wondering like that's something we struggle with as well is this idea

[00:09:41] of when you see something for 30 years that doesn't happen but it is plausible, it's hard to explain it to investors. Now it's easier to explain it now because now we're seeing it, but do you have any things you've done around that that would help to

[00:09:54] you know, have investors see the wide range of things that could happen even if they haven't happened in a long while? So let's put this in context. I think what you're referring to is for 40

[00:10:03] years now up until 2022 stocks and bonds have had a negative or at least non-correlation and bonds have been a great diversifier to stocks and for a long time they actually were a great hedge and you got paid to hedge meaning the 10-year treasury I think yielded 7% annualized

[00:10:24] for 40 years and like a negative 30% correlation with the S&P 500. So it was just a unicorn situation where stocks and bonds were the ultimate marriage. So how do you convince people that that's not always how it is and that that 30 or 40 year period that they're looking at was

[00:10:41] actually the anomaly because it's hardwired into the system. I mean all of Wall Street, all financial advisory basically is relying on this assumption that stocks and bonds are the ultimate marriage and that bonds belong in a portfolio at any level of interest rates,

[00:10:58] any level of debt, you know, any level of unfunded liabilities. Well there's an easy way to do it. You just go back to the 1970s and show them from 1968 to 1982 which a 14-year period you had an absolute nightmare ride for a 6040 portfolio. Stocks and bonds were positively correlated,

[00:11:19] they had huge drawdowns, real returns were negative. If baby boomers get a 14-year run like that starting last year that's not going to be a good experience and I'm willing to almost promise you they won't nobody will be singing the praises of a 6040 portfolio if you get that

[00:11:36] environment again. So that's one answer as you can simply show them that outside of this 35, 40 year window you're looking at these assumptions don't hold up and you can go back further in time and see that over really long periods of time the expectation is that stocks and bonds

[00:11:52] are positively correlated not negatively correlated. So and if we get that and we saw the first hint of it in 2022 if you get a decade of that people are going to feel very differently.

[00:12:02] Yeah on that point of correlation you know one of the things that there's been a learning experience for me and I think a lot of investors don't totally understand is this idea that you know if

[00:12:09] you've got your stocks and bonds and you've got kind of your long-term return of each one of them if you've got say a third asset you want to add to that portfolio and let's say that

[00:12:16] third asset has a lower long-term return or expected return than stocks and bonds but that asset is uncorrelated with stocks and bonds you actually can increase the overall return of your portfolio. Can you talk about that a little bit because I think that's something a lot

[00:12:28] of people miss. Yeah good luck that one's tough man it's really difficult because it doesn't make intuitive sense to people so I've tried and you given enough time and some illustrations

[00:12:41] you can demonstrate that so when I try to relate it back to the real world I have two kind of metaphors that that I use one is basketball so I don't know if you guys are

[00:12:51] old enough to remember Dennis Rodman. Yes oh sure yeah Pistons. Dennis Rodman's statistics were not very good you know he was not me he was a good rebounder but statistically speaking he was not

[00:13:03] a breakout player that you know you want to sign to a big contract however nobody in the history of the NBA added more value to a team indirectly by making all the other players around him

[00:13:16] better so he was an ingredient that when added into the team yielded championships he yielded playoff appearances for a reasonable cost and it's because he just was this weird glue this this

[00:13:28] magic ingredient that when added in made everyone else on the team you know one two three standard deviations better at their own game and he never got credit for that and there's a couple other

[00:13:39] people peers my peers in the industry that appointed this out that that's a good metaphor so I did not come up with that I'm stealing that from them so like your credit to them I wish I could

[00:13:47] remember their names but that's one way and you know people can relate to that and say yeah I had a I'm a Royals fan or you know I'm a Raiders fan or whatever and when they added in a couple of

[00:13:58] people then I wasn't excited about it first the whole team got better you know whether it's special teams people or alignment on some heroes is what I call them another metaphor would be from chemistry right where you have this ingredient that on the standalone basis doesn't seem

[00:14:14] like it's particularly desirable but when you add it into the compound it makes or you add it in and now the compound becomes something it's useful so I'd like to tell the story that when you're walking

[00:14:25] through the desert you find someone who's dying of dehydration they don't need hydrogen and they don't need oxygen they need those two things mixed together and that's that's the solution so hydrogen is useless and then oxygen has already got enough oxygen you mix it together into right

[00:14:39] proportions and you've got a solution to their problems I don't know if that helps but yeah I know those are actually two good ways to your way was much better explaining it than my way it

[00:14:48] was explaining it how do you think you know on this idea of sort of the 64 versus all weather products you know we're seeing a lot more you know you've had yours out for a while

[00:14:57] now but we're seeing more especially in the ETF space like at these types of products coming out and do you think that's going to help in terms of you know people now understanding what these

[00:15:05] products are and then potentially considering like putting them in a portfolio versus like a 6040 now that they're more available to the average investor absolutely I mean results matter right so we've been around we're coming up on four years now people are looking at it and saying

[00:15:18] well yeah and that makes sense to me you know they look at what we did during COVID and then the recovery and then last year so that these can get a feel for what we're talking about so

[00:15:27] being able to demonstrate value people can look at it objectively you know figure out whether it actually adds value to their portfolio or not so I welcome the products into the marketplace you know I'm not afraid of competition because the all weather category doesn't exist yet so we

[00:15:44] need to create it so we need more products so that people can actually have things to choose from and minimize their manager risk and whatnot so I hope more people launch more

[00:15:53] products similar to ours yeah it's one of those things where it's kind of a win-win right now because all you guys that are educating people on all weather strategies you're benefiting each other

[00:16:00] by taking this thing that wasn't on investor's radar and you know putting it on investor's radar so everybody kind of wins in that situation for now yeah so we'll be at each other's throats five years eventually they always happen to wall street I guess to some degree

[00:16:13] I'm in the desert we're not wall street here so I'm just wondering benchmark wise do you do you have any tricks in terms of having people not compare these things to like the 6040

[00:16:24] portfolio or the S&P 500 you know that's one of the things I mean those those are kind of arbitrary benchmarks but it's something that everybody sees on CNBC every day and everybody's kind of using

[00:16:33] you know to compare these things when these things are really geared to do sort of a very different thing than what those types of portfolios do so do you have any tricks in terms of how you think about how people should benchmark these strategies not really

[00:16:45] you know it's just be honest with people and do business with the people that don't want to just invest everything in stocks really I mean the S&P is essentially free that you can get

[00:16:55] it for three or two basis points now in various different formats so I view that as not a competitor at this point so but there's a healthy segment of the marketplace that wants something that looks and feels like an absolute return multi asset all weather approach

[00:17:13] and my advice would be just find those people I mean if they've got more money to invest than you and I could ever manage we're talking about hundreds of billions of dollars and it's still you know a

[00:17:23] drop in the bucket relative to the whole marketplace and let the performance chasing stock people just go ahead continue to do that I mean educate as much as you want but if it

[00:17:32] doesn't resonate with them and it's not what they want you can't force it yeah one of the things I think you've done that's unique and you can correct me if I'm wrong on this

[00:17:41] but this whole idea of you know if people are going to judge you against stocks and bonds you can give them a portion of stocks and bonds in their portfolio and then you could take something like

[00:17:51] managed futures that looks really different and you can kind of add it on top of that so the behaviorally that's a better package maybe than just managed futures or somebody can you talk about that a little bit yeah I mean that's essentially what we're talking

[00:18:02] about right that blind taste test was my way of giving people access to different asset classes and forcing them to be objective so that the and then showing them that what they end up

[00:18:13] building is very similar to what we're offering which is an all-weather product but all rolled into one program with capital efficiencies all managed eternally so you don't have to deal with the line item risk you don't have to deal with the rebalancing you don't have to deal with

[00:18:31] the tactical aspects of it so yeah it behaviorally it makes a big difference that's what you're talking about earlier where it's like well people like the solution but then if you crack it up and

[00:18:42] show them all the line items they lose their minds so rolling it all up into one all-weather program is a way to insulate them from that on the managed futures side I'm just curious there's

[00:18:53] been a lot of debate going on like podcasts and stuff recently in terms of how do you construct one of these strategies because there are so many assets out there you can invest in and

[00:19:00] you know some people think you know just get the big big muscle movements just get the major stuff and you pretty much you know done what you need to do and then other people build really

[00:19:08] really wide diversified portfolios across a lot of stuff so how do you think about that I'll use a sports analogy again there's there's different ways to make the playoffs that win a Super Bowl you know there's a west coast offense and then there's the old nfce style

[00:19:23] they can both work so neither side is wrong I mean they may have some minor assumptions that might be frivolous in some cases but either way can work I'm stuck right there in the middle

[00:19:36] you know I don't I'm not trading 300 different markets like some ctas or managed futures guys want to do but I'm also not distilling it down to four components the way some of the

[00:19:48] replicators do there's a cost and a benefit to both approaches but a happy medium in the middle it gets you you know 90% of the diversification at you know say 30% of the operational headache

[00:20:02] is the way to go our philosophy standpoint is to go for scale so we want to participate in you know at least 80% of the liquid what we call risk transfer markets and those are going to be

[00:20:13] futures markets and forward markets so things like metals and grains and energy bond futures currencies soft commodities so on and so forth and we want a good representative healthy sample of the global risk transfer markets and you can get that pretty easily

[00:20:30] with just sticking with futures markets do we then need to go out and create a synthetic market through spreads and start trading obscure markets like you know Japanese platinum or South African maize you can do that but they're not big enough to make a meaningful difference because of

[00:20:47] the way we run our program is it's everything is liquidity weighted these smaller tiny markets I could add them in but they don't even produce a rounding error the overall performance so

[00:20:58] other people want to trade them hey my hat's off to them if you don't want to treat them it just doesn't make much of a difference yeah it kind of you know it made me think about what

[00:21:06] we do in factor investing when you were answering that because a lot of people get trapped in the same thing which is like I'm the mind little minor factor tweaks and stuff everybody gets wrapped

[00:21:14] up in that and you miss the big picture of you know most of these things are doing pretty much the same thing you know whether they're tweaking it here and there like you've got to get the

[00:21:22] big picture and you know get into the type of get into the strategy I would assume you know with managed futures the biggest thing is you know being in managed futures and not necessarily you know picking and choosing every little minor thing yeah the big trends

[00:21:32] are where the money's at you know during COVID it was short energy and after the recovery it was being long risk assets in 2022 it was being short every bond on the planet are there some

[00:21:44] ancillary trends around that that also worked sure but is the scale there no so the key is you get when the big trends happen you got to be on the right side of those and they're going to be in

[00:21:56] the deep liquid markets if you want something that's scalable so I understand your point in factor investing there's what three four maybe five factors that account for 90 percent of all the alpha potential focus on those at least get the blocking and tackling right on those before

[00:22:11] you worry about the small stuff one of the things that I noticed about your portfolio that's unique is a lot of people have seen around these strategies tend to be us centric and you have some exposure

[00:22:20] in the international space and you know that's been sort of a big debate recently in just overall in markets is because international you know markets have struggled a lot a lot of people

[00:22:28] don't have any international exposure and have gotten away from it so I want to just talk about like what you do from the perspective of using international assets in the portfolio and what your thoughts are in general on using international assets and international diversification

[00:22:40] well having been born in the US and lived here my whole life it's really easy to default to the home country bias if it's if you're going to default to home country bias it's safe as to do

[00:22:50] it in you know the United States of America that being said you know I'm a data guy so I look at the data and the last I checked global GDP only about 24 percent of it comes from the US

[00:23:01] so there's a lot of stuff going on in the rest of the world and my answer to that is why not why not incorporate trends and risk premium from Europe and Asia and other places if it's a creative to

[00:23:16] the portfolio and I find it to be very accretive there's some markets that we trade over in Europe like carbon emission credits huge deeply liquid market trends beautifully highly profitable and

[00:23:26] then you look most macro guys in the US and they've even heard of it and don't don't have it in their portfolio so there are opportunities overseas as long as they're not harming the portfolio

[00:23:37] I see no reason to exclude them they're a little more cumbersome to trade because you have to do currency conversions but I mean we set that up a long time ago I've been trading that

[00:23:45] way for 15 years so it's it's it's not a lot more work to include all that extra liquidity all those extra risk premiums that are overseas yeah it's interesting like the way the way like

[00:23:57] trend followers like you look at this and the way we look at it is so different but I mean we're getting to the same place like we look at it from the perspective of you know well emerging markets

[00:24:04] are cheap or something so I should invest in them you know you guys tend to look at it from the perspective is it a diversifying asset does it trend and if it's a diversifying asset it

[00:24:11] trends you know for you it makes sense you're not worried about the long-term expected returns or anything like that because you're going to be long and short and in and out and it's just an interesting the different perspectives on it yeah that's fair we're

[00:24:21] participating in the risk transfer markets what you're talking about are the capital formation markets like stocks of bonds overseas and revaluation and certain factors matter a lot and it is important question you're asking because there are times where foreign markets

[00:24:37] dramatically outperform us markets and that can drag on for more than a decade who knows we might be entering a period of time like that maybe not but I can tell you that that relationship between us outperforming x us outperforming it's pretty cyclical and the us

[00:24:53] has been outperforming by a large margin for a long time so it won't surprise me at all if it reverts back like it always has in the past going forward one of the interesting things you know

[00:25:02] investors are typically pretty familiar with stocks and bonds and commodities and the types of things that are in trend falling strategies but currencies is one that you won't see your average investor trading but you guys do and I wonder if you talk a little bit about what

[00:25:12] the benefits are having a currency you know currencies inside of a strategy like this yeah they're just another liquid asset for us where we go to try to collect a risk premium

[00:25:24] I mean if you look at a currency you know cross-rate it's really just a hybrid fixed income trade in my opinion or at least that's the majority of it and it's that country's risk-free rate

[00:25:33] versus your country's risk-free rate so it's kind of a hybrid fixed income spread trade I find them to be great diversifiers they oftentimes will have big moves that are unrelated or at least they're somewhat unrelated to what's going on in the macro

[00:25:54] view of your own portfolio of stocks and bonds at least on a delayed basis I mean they've been timed through the yen it's just an amazing trending vehicle and you could pick up risk premium there the euro has been a great trending vehicle for for years now

[00:26:08] you know the british pound the australian dollar the kiwi there's just a lot to choose from and you can get a lot of valuable diversification if you know how to invest in those things

[00:26:20] why other people don't I think of macro guys do I mean currencies are a big portion of most macro managed futures portfolios your average investors retail investors and financial advisors just don't see them as assets to own they're just from their perspective they're just currencies

[00:26:36] and that's the difference between our risk transfer market and capital formation market can you talk a little bit about portfolio construction you know we hit you pick obviously the first step is we want to pick the assets you want to have is to potentially include in your

[00:26:48] portfolio but then you've got the idea of how do I construct a portfolio how do I wait these assets things like that can you can you just talk about how that works yeah so when I was younger

[00:26:58] that's primarily where I spent most of my research time was trying to figure out the most intelligent ways to construct portfolios to reward uh non-correlated markets and take away from from highly correlated markets I've done seems like thousands of my eyes and bled from the

[00:27:17] amount of research I've spent on portfolio construction and what I found over the years is that it's a little overblown um what you need to do again get the blocking and tackling right

[00:27:28] and that first first step is go find diversifying assets that are liquid and scalable and bring them into your portfolio so get foreign bonds you know get aluminum and copper and nickel and and get

[00:27:41] energy markets and get foreign currency markets just go out there and find the big liquid markets that are statistically different from what's in your portfolio and pull them in once you've got

[00:27:52] them in um if you want to scale like like we do at standpoint you have to wait them according to their liquidity yeah you can't treat the the New Zealand dollar with the same kind of size that

[00:28:03] you can trade the euro you know once 30 times the size of the other one so if you want to be able to maintain your strategy as you grow you need to essentially market cap weight or open

[00:28:13] interest weight these positions uh so get them in wait them that way first and then take a look at is there anything else that you can do in your portfolio to spread the risk units around

[00:28:22] in a more intelligent way what i find is just liquidity waiting a portfolio made up of the most liquid futures markets in the world it gets you 80 percent the way there it's almost always

[00:28:33] very balanced and diversified and that's just because the economy is the way they move the the risk units around and the open interest goes up and then it goes down volume goes up it goes down you pretty much always end up with a balanced and diversified portfolio occasionally

[00:28:48] you'll see correlations like to an uncomfortable level and then you can intervene and say you know why that's everything's getting too unbalanced or imbalanced so a lot of people will use a correlation overlay to to limit you know how much how concentrated they're well they're willing

[00:29:04] to get into really extreme trends but 80 90 percent of it is just getting those diversifying assets into the portfolio in the first place and how do you think about measuring trend i mean

[00:29:15] there's a lot of indicators you can use as all the different look back periods i mean do you think of like a composite type approach is that how you think about it i do however this one's a big

[00:29:23] deal short-term trend following can look very different from long-term trend following and it often does medium term trend following can be different than both of them so that's why you see all this performance dispersion you know a lot of people say oh i hate managed futures

[00:29:41] because some managers are up 20 out of the year others are down 13 like i don't know which one to pick and try some crazy most of that can be attributed to whether they're a short-term trend

[00:29:50] follower medium term or long term makes a big big difference so my bias is towards long-term trend following you know i have this thesis that in these risk transfer markets we collect a premium from commercial hedgers you know because that's the service we're providing that they like to

[00:30:07] sell rising markets and by falling markets we do the opposite giving them the liquidity to lock in input costs or to lock in output profit margins that works a lot better in a medium or long

[00:30:22] term context however i cannot deny that when you look at the data i go back to 1970 short-term trend following works pretty damn good too so and it tends to work better when long-term is

[00:30:34] struggling so it's important to diversify so you're right i built a composite where i mix short-term medium term and long-term trend following all all together in one portfolio to try to smooth it out and not try to pick which one's going to be a hero

[00:30:49] this cycle around case in point i told you my bias is towards long-term trend following since standpoint went live at the end of 2019 our short-term trend models have been far more profitable than the medium and long-term trend models so i'm glad i had the fortitude

[00:31:06] to diversify and make sure i had all the bases covered i'm just curious and this they may be unrelated but people always talk about this idea that like the market is sped up does does that have

[00:31:15] anything to do with the fact that the short-term ones are working better or those kind of unrelated concepts yeah i don't think i agree with the concept that the market is sped up it depends

[00:31:26] you know so many things in life depend upon a context because you know you might say well eric i've heard you say that since you know you launched the fund we've had you know four market

[00:31:36] cycles we had bull market and we had a brutal fastest bear market history and then the recovery and then we had stagflation and now who knows what we have now that's true but that's not speed

[00:31:47] speed to me is the speed of the trends and the speed of the reversals yeah co-vint was fast that definitely was a sped up but if you look at all the data say you go back to i don't know

[00:31:58] 1995 and you look at all this data and think to yourself wow this is so crazy look how fast markets are go look at that same data in the 70s you'll see even more speed you know less liquidity

[00:32:08] but even more speeds have they sped up or are we just getting something like the 1970s after a long period of low volatility meandering uh in the in the after 2010 i'm not sure so it depends

[00:32:21] on your definition of sped up can you talk a little bit about leverage you know when people hear the word leverage they kind of freak out they think like i'm adding tons of risks to my portfolio

[00:32:30] when i use leverage but people who are in your space have used leverage forever and have used it in very you know efficient smart ways so can you just talk about how you think about leverage when building

[00:32:38] a portfolio yeah so leverage is basically a tool and yeah it's it's a word you don't want to throw around very often because it scares people because they all heard of somebody who leveraged up a single position or a single asset class and then their 20 drawdown became an

[00:32:52] 80 percent drawdown so but and that that you can do that right it's not very smart but people do do it companies are leveraged you know when you buy the stock market you're buying companies that have leveraged balance sheets and these financial companies have eye popping amounts of leverage

[00:33:09] in the context of a diversified kind of multi asset portfolio though it can make sense to use modest amount of leverage because a lot of the assets are too far from cash you know when

[00:33:21] you buy two-year treasuries or the german shats or you know one of the australian three-year bond or whatever it's not too far from cash and it may trend nicely but you know a 50 million

[00:33:35] dollar position might not be big enough you know i mean in with futures it's super easy to get the leverage and you're not that borrow to pay for the leverage you know it's just implied

[00:33:44] it's inside the contract already so a typical macro guy four to five x leverage is what i've seen over the years our program is not risk seeking like that you know we're more like two to one

[00:34:01] typically and on the macro side but it's not because we're taking a lot less risk it's because we don't trade a lot of those close to cash vehicles like short-term interest rates all in

[00:34:11] where you have to leverage them if you want to squeeze out a return so now if you're leveraging bitcoin clearly you're crazy if you're leveraging to your treasuries well that's something very

[00:34:20] different so it's not enough to say leverage is bad it's what are you levering how much are you levering and in what context is it in the context of a diversified portfolio are you leveraging some property out in the suburbs you know right before 2007 hits these are two

[00:34:35] very different things so for us yeah we use a modest amount of leverage when it makes sense but we still feel like that's considerably less risky than just use an unleveraged position saying the s and p 500 where the underlying companies might be leveraged considerably more

[00:34:51] than we are i'm curious i don't know if you've done any work around this but one of the things that's interesting to me about these sort of all-weather type strategies is it seems like they're really they would really be great for retirement portfolios especially you know

[00:35:02] when you're dealing with sequence risk in retirement when you're dealing with that big drawdown at the wrong time can really kill you it would think i would think these these systems with more consistent returns would lead to higher sustainable withdraw weights and i'm just wondering

[00:35:13] if you have any thoughts on that yeah in fact i went down that road and tried to do a whole bunch of money carless simulations and show that to people um and they all agree when they're

[00:35:21] just looking at the results they all say yeah that makes total sense i mean the sequence risk is really reduced because an absolute return all-weather approach takes a lot less uncompensated cyclicality risk which is what they're trying to get rid of right the boom bus cycle

[00:35:38] uh because the timing of this drawdowns matter 2022 was very unfortunate for retirees and if we get you know a couple more years like that is really going to screw up their retirement plans with no resolution to that right you have drawdowns now and it screws up the plan

[00:35:52] um that being said um in the retirement planning community uh the bureaucracy is such that you know alternatives just really aren't considered it's stocks bonds and t-bills um and i think it's just going to take a lot of pain for them to be open-minded about doing something else

[00:36:13] unfortunately and that's just how bureaucracies work just one more for me before i hand it back to jesson notes i don't think you use these but i'm just curious you've been seeing

[00:36:22] you know especially with what happened in 2020 you've been seeing a rise of a lot more tail risk type strategies um you know strategies that you know seek try not to lose money when you know during

[00:36:30] normal times then have like ridiculous returns when you get like a 2020 drawdown and i'm just wondering do you think those types of things can make sense like in an all-weather type strategy

[00:36:38] or you know have you not seen you know anything from them that would indicate that yeah i think it could make a lot of sense um they're a bit redundant so a good trend-oriented macro

[00:36:49] program is going to share a lot of the qualities of tail risk hedging at those inflection points where tail risk hedging is paying off um and the idea is to do it with less cost of carrier drag

[00:37:02] when tail risk hedging isn't paying off pure tail risk hedging no takes it a step further and says we basically want to guarantee something closer guarantee that if um you know what it's

[00:37:12] the fan we're truly going to make outsized returns uh and that can be worth it uh to a lot of people um that's another thing you're kind of going to bury in the fun right because a lot of

[00:37:23] line item risk basis tail risk hedging is by far the oldest as a hardest asset class to to hold on to i think CalPERS ditched theirs right before covid if i remember that correctly

[00:37:33] so yeah it can make sense but i've looked at it and found it to be mostly redundant though with what we're already doing on the trend side at least when it matters yeah i always use them

[00:37:42] as like uh just as an example of like when you talk about how with a lot of these non-diverse undiversified assets you have to rebalance to get the value out of them you know tail risk is

[00:37:51] like the extreme example of that because you know if you go through 2020 and you get that return and you don't rebalance you know you're going to lose the entire benefit of having the strategy so

[00:37:59] it's just a good example i use for investors when to show an extreme example of rebalancing and how it plays a role with these uncorrelated assets yeah um some of my peers in the

[00:38:08] industry that i think are really smart you know the guys at Mutiny and Rosal that knew found i've done a lot of research on that type of strategy and um and i i've looked at their

[00:38:21] research and concluded that yeah it looks correct to me tail risk hedging can add a lot of value if that's what you're looking for it can make a lot of sense it's just hard to hold on to

[00:38:31] you've obviously done a lot of uh back testing and studying of different investment strategies over time and you were on the um i think it was the picture perfect portfolios podcast where you were talking about back testing and you kind of made the point that

[00:38:50] you know with back tests you want to look for like robustness but you don't want to you know add so many additional rules and criteria in because it kind of can detract and actually

[00:39:01] hurt the strategy do you just want to talk about that a little bit yeah so how often do you guys see ugly back tests zero yeah nobody ever shows you an ugly resume so back test like resume in a sense

[00:39:20] a back test is a way of taking your rules today and going back in time and answering the question how would this thing likely have performed historically the problem is is that you know

[00:39:34] what happened historically so you have to insulate yourself from perfectly fitting it to what happened historically which no one can really do um and then people will tune the parameters so that it works even better historically and then they'll get carried away often and they'll over tune

[00:39:53] the parameters and come up with new parameters to make it look even better historically and what they're doing is they're fitting it perfectly to history which will work great if the future is a perfect repetition of what we had historically but oftentimes usually completely fall apart um

[00:40:10] if the future zigs and zags a little different than the past we know that the future is going to zig and zag differently than what it did in the past so there is a happy medium though where you

[00:40:19] can use historical data and you can you can create rules today to find out what where the structural risk premium appeared to have been like what market conditions led to returns um

[00:40:33] and then you could ferret out these generalized rules of thumb and then you can walk them forward on future data in real life and if they continue to work you can build a theory as to why they

[00:40:44] work that's what i did with the trend following provides liquidity to commercial hedgers therefore is entitled to a risk premium that they're paying for that insurance like protection by shorting rising markets and buying falling markets um so how do you keep yourself from doing it well there's

[00:41:01] a couple things you need to do correctly when you're backtesting one is make sure that what you're looking at actually looks like what history actually looked like a lot of times when

[00:41:10] you buy data today it's been claimed and it's been uh perfected uh but real life is dirty and messy and you don't get the revisions until a month later or a quarter later whenever so

[00:41:21] you need to recreate history as it actually looked because that's what you would have been trading on so the convenient packaged data products and backtesting products generally won't do that for you in fact they do the opposite and they think of as a selling point to give you

[00:41:35] clean data after the fact well that's like knowing the winning horses after the race is over it's that's not a good start the other thing is that you need to include all the dead markets

[00:41:45] you know if you try to pull up a chart today of andron you'll get an error and say it doesn't exist I promise you andron existed I was trading it along with lee man and a whole bunch

[00:41:54] so you need to include delisted markets because by kicking them out you're creating an idealized version of history that didn't really exist and you'll come up with rules that only work on an idealized version of history and you're not going to get an idealized version of history

[00:42:10] going forward and then there's a whole bunch of other errors like post-ictivary where people say oh if it crosses the 200 day moving average I'm going to go long if it falls below

[00:42:18] I'm going to go short but the bar that the day of it crossed so it says hey you're long I know you're getting long the next day you can't be long that day because you need to make sure that you're taking

[00:42:28] action after the signal you'd be surprised how many people make that mistake and then the curve fitting component is torturing that data until it gives you the answer you want is I'm just gonna say it's always a mistake and having realistic expectations you know

[00:42:44] it's something that says to make it 30 returns a year with 10 drawdowns is not real you know just look at the professionals the most successful asset managers in the world can barely maintain a sharp

[00:42:56] ratio of one you know and very few people compound over 20% a year uh and very few people have a calmar ratio better than one so if your back test says you've got a sharp ratio of four and

[00:43:08] a calmar of two I'm pretty sure you didn't figure out something that all the hundreds or thousands of PhDs and their super computers didn't figure out before you so that's your first hint that you

[00:43:20] might be overfitting your back test yeah I think that that idea you made that you talked about that you can't unknow what you know is so important because you know I know stocks and bonds had an

[00:43:30] incredible 40 year period I know value investing has struggled over the last decade like when you're constructing a back test it's so hard to do it and like take that stuff out of your mind

[00:43:38] that you know actually happened so what I did um well one I went back to the 1970s so included that nightmarish period of time I also anonymized all my markets so and I did all kinds of stuff

[00:43:52] where I would denominate the markets in different currencies to change the path traveled I created fake markets with without me knowing you know which ones were which and anonymized them so that when I was building the standpoint macro system I really reduced the likelihood that I would be

[00:44:09] picking and choosing markets based upon you know my knowledge of that after the fact it's not a perfect solution but it was a great step in the right direction it actually shows me a few things that were my biases otherwise would have been contributing to the end results

[00:44:26] it seems to me like if you're an investor being presented with a back test um all those points you made are I think are excellent um but would you also and and I would

[00:44:39] imagine anyone that that's presenting you with a back test is going to be able to explain it rationalize it tell you but but I think like it would be very important that whoever did the back test or conducted the back test there sound economic principles and theory behind

[00:45:02] why this strategy works or maybe didn't work in an environment if someone I'm kind of asking you here you know if someone can't explain that to you then that's probably a pretty big red flag

[00:45:12] right I want to say yes um but no one ever does I've been presented with hundreds of back tests over the years and I can't recall anybody giving me a good economic rationale for

[00:45:26] for why it should work um yeah I just can't sell but yeah that's what I'm looking for yeah I'm looking for realistic expectations um you show me a sharp ratio of four I'm not buying it I mean I'll look

[00:45:39] at it but it's just the first one in the history of the world that's that's cranking out of four um you know a lot of these like factor strategies you know I just ask a simple questions are the

[00:45:50] delisted stocks in there 99% of the time they're not do you have the delisted futures contracts what'd you do pre-euro conversion do you have transaction costs that were you know five times

[00:46:00] higher in the 70s no no no so I send people back to the drawing board and then they never come back so once they're connected for these issues they saw it they're like not making 30% returns anymore they're making 12% returns with 12% bull and 15% drawdown and then

[00:46:15] they're like now that's not good enough but it is it is it makes it with risk assets and you roll it out as an all-weather program it's more than good enough but it just it's not exciting

[00:46:24] to them so so that kind of plays into my next question which is if you were looking if you're if you were an investor today and someone came to you with an all-weather strategy they were

[00:46:34] running and you weren't running your own what would be like the major things that you would look at in that strategy yeah the first thing I would look at is what assets did they bring in

[00:46:44] did they bring in what I think of as true diversifiers that's super important right because a lot of these I don't want to get into fight with the all-weather crowd but you know they primarily it's

[00:46:56] some form of risk parity you know stocks leveraged bonds maybe some commodities and whatnot and that's okay but it does have a big blind spot and that I think macro fills and why does macro

[00:47:08] fill it well because macro has access to metals and grains and soft commodities and energy and all these other things that can truly have big outsize moves they're uncorrelated with your risk assets you're not just relying on negative correlation between stocks and bonds and you're

[00:47:22] not relying on commodities to be an inflation hedge sometimes you can be short commodities when there's inflation so I would look at their market selection first and foremost and if they didn't have the true diversifiers in there I would I wouldn't I would be much more

[00:47:38] skeptical going forward and then the other principles we talked about like how to construct it is a scalable a lot of people have these kind of small spread rate programs that work great with 50 million bucks but you try to fit 500 million in there they've got no chance

[00:47:52] so they're not scalable yet if they're successful people are going to throw money at them and then they have to change the program a lot of fan of that approach you know the realistic expectations

[00:48:03] is important to me you know if they if they believe they're going to get a sharp ratio of three my confidence in them is exponentially lower because I've never seen anyone do it or at least

[00:48:13] explain to me why you deserve it what is it that you're offering to the marketplace where the marketplace is going to reward you with a sharp ratio of three sure you can get with an

[00:48:21] arbitrage strategy it's just that you know one day you're going to have a 50 or 80 percent drawdown out of the blue would not have enough time for you to do anything about it if you accept that

[00:48:29] and you're aware of it I can at least respect to you I don't want to invest in that myself personally but I can respect it but for the people that think they've got to figure it out

[00:48:37] and that they've just going to have risk adjusted returns that are off the charts and they don't know why that's not good enough sorry two more questions here one uh is a little bit

[00:48:47] more I think short term oriented or I guess topical for today's investor and then the last one's going to be long term and evergreen but what would you say to an investor that says you know what I'm

[00:48:58] allocated to this type of strategy or maybe some other risk managed strategy today you know well why don't I just throw in the towel and just buy treasuries and get my five percent yield and

[00:49:14] and not have to worry about sort of any type of tracking error or performance what how would you answer that question well it depends on the investor I think for there's a segment of the

[00:49:24] population for which that's actually probably the right thing to do but then I would ask them you know what are you going to be happy or what will happen if inflation's a

[00:49:36] and you've locked in five and a half are you okay with that so for some people they would say yes I'm okay with that for my answer to that would be it's your money it's your life if

[00:49:44] that suits your utility function that's the right thing to do for yours for you financially then go ahead four people that view that as just its pure return it's free returns well it it's not

[00:49:56] you know you need to inflation adjust in my opinion and fee adjust if you're paying a financial advisor 100 basis points that you and t-bills we're giving up a 50 your returns you know you're you're basically paying a 20 percent performance incentive so inflation transaction costs

[00:50:13] fees all the whole cost to carry everything needs to be factored in and then look at what you're left over with and model that out going forward and then look at your cost of living and model that

[00:50:22] out going forward and if that's acceptable to you sure go for it for most people though I think if they did an honest assessment of that in taxes too because you pay taxes before inflation

[00:50:34] if it's taxable money so I'll share with you guys a story that might be a real big surprise to you the 10-year treasury compound that has 7% a year up until covid for 50 years I think it was 50 or

[00:50:48] 40 years I can't remember 7% but for taxable money you know you're paying taxes on the yield there and its ordinary income rates so that brought it down to like four and a half percent

[00:51:04] and then inflation was 3.6 I think so I got it down to like 1% if you're paying an advisor 1% I got it down to zero and if you're paying any transaction the real total net net net return after taxes

[00:51:16] and inflation was negative even though the bond itself is compounding a 7% a year so that's how much the cost to carry matters and that applies to everything including t-bills so I would just

[00:51:28] ask people to be honest put all that into a matrix and calculate it through and just see how much you're left over within the end because it could be a real steep price you're paying for

[00:51:38] for certainty and a less volatile path traveled in closing we like to ask all of our guests sort of a standard closing question and that is if you could teach one lesson one lesson to your

[00:51:51] average investor what would that be oh it's hard to pick one you can do two or three go for it well no I want to pick one because I've never actually done that I read I saw that

[00:52:05] and I didn't come up with an answer I think that what would help people the most more than anything else is an appreciation for realistic expectations and I know that falls on dead ears and it's not

[00:52:18] exciting but let me try to make it exciting if you have the data I have if you could look at every hedge fund every SMA every variable annuity ETF mutual fund CIT in the world that has ever existed

[00:52:33] and you put all that into a massive database and you calculate up what are the sharp ratios what are the annualized returns calmar ratios drawdowns volatility all that stuff and you plot it you will be shocked how humble the elite managers actually are in terms of

[00:52:48] what they've delivered meant when I said earlier where you know a sharp ratio greater than one is very very difficult to maintain for more than a decade very difficult elite managers sharp ratio 0.6 is actually an elite number so I find that very liberating because it keeps you

[00:53:10] corralled and away from chasing things that aren't real so and you can see it in in the personality of our firm and our products you know all weather is really just saying look this is the

[00:53:21] best we can do and it solves a problem for people and it's pretty good if you actually hold it for a long term we're not trying to win any awards we're not trying to be famous we just think

[00:53:33] this is the is the best way to have the highest compound to return at the end of the marathon not trying to win the individual sprints along the way and what allowed me to think that way is

[00:53:43] an honest view of reality so I would say realistic expectations while not exciting liberates you from all the bad habits or helps liberate you from the bad habits of chasing gluars and things that

[00:53:58] just aren't real. Eric this has been a good honest straightforward discussion you know the word keeping things in context I think came up a lot throughout this throughout this talk so

[00:54:12] you know we appreciate it and thanks so much for coming back on. Thanks guys it's always a pleasure you asked great questions and I'm glad I was able to tell you some of my fun stories. This is Justin

[00:54:24] again thanks so much for tuning into this episode of XS Returns you can follow Jack on Twitter at at practicalquant and follow me on Twitter at at JJCarbonneau if you found this discussion

[00:54:35] interesting and valuable please subscribe in either iTunes or on YouTube or leave a review or a comment we appreciate it. Justin Carboneau and Jack Forehand are principals at the Lydia Capital Management the opinions expressed in this podcast do not necessarily reflect the opinions of Lydia

[00:54:48] Capital no information on this podcast should be construed as investment advice. Security is discussed in the podcast may be holdings of clients of Lydia Capital.