Why Most Investors Won't Buy the Best Diversifier | Andrew Beer on Managed Futures

[00:00:00] There's this nimble hedge fund strategy that's been around for 50 years. It's proven. It works. It's worked through all sorts of different market environments over time. Academics have written papers on how this thing works. Sometimes the experts are wrong. Sometimes the world changes faster. And you want something in your portfolio that's going to be more adaptive to that. People think hedge funds gravitate to complexity because it's necessarily better.

[00:00:26] However, the very best hedge fund managers and investors that I know, it comes out of simple bets. And the geniuses are the ones who can see through all the noise to what the fundamental underlying bet is.

[00:00:41] Welcome to Excess Returns, where we focus 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.

[00:00:50] Jack Forehand is a principal at Validia Capital Management. The opinions expressed in this podcast do not necessarily reflect the opinions of Validia Capital. No information on this podcast should be construed as investment advice. Securities discussed in the podcast may be holdings of clients of Validia Capital.

[00:01:03] Hey guys, this is Justin. In this episode of Excess Returns, Jack and I sit down with our friend, Andrew Beer of Dynamic Beta Investments, who's a sub-advisor to the IMGP DBI Managed Futures Strategy.

[00:01:14] We talked to Andrew about managed futures, the characteristics of alternative strategies, and the benefits and added diversification they can bring to investors' portfolios.

[00:01:22] We also discussed why the narrative around managed futures may be equally as important to the risk and return that these strategies produce over time.

[00:01:29] We also discussed how Andrew replicates the strategies of hedge funds and a cost-effective method in an ETF wrapper.

[00:01:35] As always, thank you for listening. Please enjoy this discussion with Andrew Beer of Dynamic Beta Investments.

[00:01:40] Andrew, thank you very much for joining us today.

[00:01:42] Thank you for having me back.

[00:01:43] We wanted to have you on to talk about what we think is kind of the sweet spot of your expertise, which is talking about managed futures and the strategies that go into how managed futures can be deployed.

[00:01:56] You know, I think through ETFs now, investors have a lot more accessibility to strategies that can help protect against certain types of markets that maybe they didn't a decade or so ago, or at least as being able to get strategies like that so easily and maybe cost-effectively.

[00:02:13] And so I think today we want to have a discussion with you about the benefits of managed futures, maybe what some of the misconceptions are, how investors should think about allocating to strategies like these, and just a whole bunch of stuff that you're kind of thinking about day in and day out.

[00:02:28] Absolutely, absolutely thrilled to have that conversation.

[00:02:31] Awesome.

[00:02:33] Where I kind of wanted to start is just before we get into that, and it relates to managed futures, but just you manage a strategy and sub-advise over a billion dollars in assets in it.

[00:02:45] And, you know, it's always fun and interesting to hear from, I wouldn't consider this a small fund anymore, but, you know, sort of smaller issuers and sort of what the biggest lessons you have since, you know, launching a strategy through an ETF wrapper.

[00:03:04] Sure.

[00:03:04] So, I mean, you know, to take a step back, I mean, first of all, and I can't really talk about the ETF for compliance reasons, so I'll talk about the underlying strategy and lots of stuff.

[00:03:13] But, you know, so, you know, our ambition was that a lot of the liquid alts world has kind of been nasty castoffs that have been kind of like thrown at, you know, thrown to retail investors.

[00:03:30] And if you look at kind of the broader liquid alts world, it's really underperformed hedge funds who themselves have not been knocking the cutter off the ball.

[00:03:38] All right.

[00:03:38] And so it just, there's a slightly ick feeling about the liquid alts world because it just feels like these are probably sort of kind of pushed out of the throats of investors that people thought were less sophisticated, maybe wouldn't be able to pick up on it.

[00:03:52] And so what we're really trying to do, and my partner, Bertias, and I have really tried to do is say, look, if you pick the right strategy, you can actually do better than actual hedge funds, but with low fees, daily liquidity, all these client-friendly features.

[00:04:06] And if you can solve that, right, then you are basically making a whole space more intrinsically interesting to it.

[00:04:15] So, you know, we've been doing this now for about five and a half years in the ETF world.

[00:04:19] It was the first time, you know, we had gotten into the ETF world.

[00:04:24] And, you know, the, and I think we've shown that you can do that.

[00:04:28] I mean, if people can kind of pull up the numbers and you can look at it and see performance relative to hedge funds, relative to mutual funds, relative to other ETFs.

[00:04:37] But to me, the most interesting part is not why people buy it.

[00:04:41] It's why they don't buy it.

[00:04:44] Because every single advisor that I talk to starts the conversation with, you know, 60-40 is broken.

[00:04:50] It worked forever.

[00:04:51] It's not working anymore.

[00:04:52] We need to find diversifiers.

[00:04:54] Okay, what do you want for diversifiers?

[00:04:55] We want something that has low correlation to stocks and bonds.

[00:04:58] We want something that goes up during a crisis.

[00:05:00] You know, we want something that delivers a lot of alpha.

[00:05:02] And you say, hey, I got it for you and I got it for you in an ETF.

[00:05:06] And still nine out of ten guys don't do it.

[00:05:09] Right?

[00:05:09] And so to me, the most fascinating thing about managed futures is not the statistical side of it, which we all know the answer to.

[00:05:17] And we can talk about, you know, kind of the grounding of it is, is what is it that makes it hard for the person who's managing money for people like my sister,

[00:05:27] who is, you know, always paraded out as the person who is not financially sophisticated about this stuff,

[00:05:32] but would not understand the benefits of managed futures and why she should feel good about having it in her portfolio.

[00:05:39] And so I think that's been, it's been a great privilege to get to know the allocators and others at the table.

[00:05:44] I think they've, we've developed enough trust that they tell me what's going on.

[00:05:48] You know, I love the idea of it, but I don't pull the trigger for the following reasons.

[00:05:52] But I think, and I think it's changing.

[00:05:53] And I think it's, but, you know, and honestly, the fact that you guys are asking me to come back on it suggests,

[00:05:58] I think that there is growing interest in how do people use this in a way to help what we all want to achieve,

[00:06:05] which is how do you help people grow their money over time and sleep at night?

[00:06:08] Yeah.

[00:06:09] How are you able to overcome those objections?

[00:06:12] Like, what would you say are the top three or five reasons why someone would,

[00:06:17] or advisor would consider managed futures for an investor?

[00:06:20] True.

[00:06:20] So I think, I think, I think, I think, I think the managed futures space shoots itself in the foot

[00:06:30] when it comes to the wealth management world.

[00:06:34] In that, you know, first of all, you think about the people who have set up and run these funds.

[00:06:40] They're very technical, right?

[00:06:42] I mean, they, they really want to talk about incremental changes that they made in their model

[00:06:48] and why there's been a breakout in the cocoa markets and, and, you know,

[00:06:52] and how they're going to manage drawdowns and stop losses and leverage and controls.

[00:06:56] You are so far out of the vocabulary range of the average, personally, the average advisor,

[00:07:04] but also the average person that the advisor is sitting across the table from.

[00:07:07] And, and what I think, what I think most people in this space don't realize,

[00:07:12] and the reason I say shooting themselves in the foot is because, you know, at the end of the day,

[00:07:19] somebody has to like what they have in their portfolio.

[00:07:22] It has to make them feel good.

[00:07:24] They have to, if it's a hedge fund that they got access to, they couldn't get into otherwise,

[00:07:27] they feel privileged that they've been able to join the club.

[00:07:30] You know, if it's a, if it's a, you know, a well-known stock picker,

[00:07:34] they feel like somebody is doing something very, very smart and on their behalf.

[00:07:38] Like there's, you know, you invest with Warren Buffett, you kind of believe in the philosophy.

[00:07:41] You go to Vanguard, you believe in low fees and efficiency.

[00:07:44] And, you know, you have a poster, John, John Bogle in your, you know, living room or something.

[00:07:49] But, but so, you know, so what people invest in, it's not just about the economic outcome of it.

[00:07:54] It's not about like who's got the highest Sharper issue in 20 years.

[00:07:57] It's also how do, do people like what they have?

[00:08:01] And, and I think the more technical, I think so much of managed shooters has been around these very,

[00:08:06] very small differences between what people do and highlighting all these technical differences

[00:08:11] that nobody cares about with the engineers.

[00:08:14] And it actually makes it harder for people to adapt to it.

[00:08:16] So I think, I think what happens, the biggest thing is that people sit and say, you know,

[00:08:21] God, I love the idea of this in terms of what it, what it can do for my portfolio.

[00:08:26] But how on earth am I going to explain it to Bob and Mary across the kitchen table that why they should be happy

[00:08:32] that $100,000 of their hard-earned money and savings is allocated to a strategy that I'm not sure I understand

[00:08:41] the language for and why it's doing well or not doing well.

[00:08:43] But then how do I explain it to them?

[00:08:45] So they look at me back across the kitchen table and say, you know, hey, thanks, Andrew.

[00:08:49] Thank you for bringing this to me.

[00:08:51] And so, and I think, I think that's the great challenge with this space is, is it's biggest challenge in space is,

[00:08:56] is as much, I mean, part of it is product structuring.

[00:09:00] There are a lot of not great products out there.

[00:09:02] There's some that are very good.

[00:09:03] But a lot of it, I think, is narrative and education.

[00:09:09] Do you think a lot of, I was thinking about this because I was trying to explain to my dad the other day.

[00:09:12] And I was trying to focus more on what it does and what it is.

[00:09:16] So I was focusing more on, well, this is something that doesn't have major drawdowns most of the time.

[00:09:20] This is something that when you need it in a bear market is there for you.

[00:09:23] But then when you get into, well, it's long this and it's short that, that's when you let it use something.

[00:09:27] It's all over.

[00:09:28] I'm wondering if maybe that's the answer.

[00:09:29] Like you have to focus maybe on what the thing does more than what's sitting inside of it.

[00:09:33] Absolutely.

[00:09:33] So the thing is, so in Daniel Kahneman's book, Thinking Fast and Slow, buried in, it is a long, dense book.

[00:09:42] But buried on like page 295 or something like that in the middle of it was a great example,

[00:09:47] which was that when people get asked a question that they don't have the answer to,

[00:09:52] they often ask themselves a different question and answer it.

[00:09:54] And so I think where it relates to this is that it's also like when people hear something that they like,

[00:10:06] when they hear a story that they like, like when you say, oh, we're going to invest in high yield.

[00:10:10] They don't say, well, what's the default rate?

[00:10:12] You either like high yield or you don't.

[00:10:14] Right.

[00:10:15] You know, well, you know, it's private credit.

[00:10:17] You know, it's illiquid.

[00:10:18] Okay, well, how am I going to get out if I need to?

[00:10:19] It's like you either like it or you don't in the beginning.

[00:10:22] I think managed futures, as you say, lacks that.

[00:10:24] So what I think with managed futures, and I think there's also this question with, you know,

[00:10:30] when you're talking to professionals and say managed futures generates all this alpha.

[00:10:33] Like it's crazy.

[00:10:34] You can line up the alpha of managed futures relative to all these different hedge fund strategies.

[00:10:38] It has more hedge fund alpha than almost anything but multi-strats, basically.

[00:10:44] Except when you tell it to people, they're like, eh, you know, whatever.

[00:10:49] They're short the yen.

[00:10:50] Like, so it's not even that the alpha is not there.

[00:10:54] It's that they almost don't believe it.

[00:10:56] Because what they really want is somebody to say like, you know, and I, you know, plowed through the footnotes of this company.

[00:11:01] And I found out, you know, some problem with their receivables from their fake Asian subsidiary.

[00:11:07] And therefore, I shorter said, like, they want to hear some sort of narrative around it.

[00:11:09] And here the trades kind of tend to be in plain sight.

[00:11:13] And everyone's got the same information.

[00:11:15] There's no information advantage between one guy or the next.

[00:11:19] So I think the way, I think you're exactly right.

[00:11:22] The way you have to get there is get as far away from the technical sides as it was possible.

[00:11:26] And say, why is it, why is your portfolio at the margin going to be better for having this in it than not?

[00:11:35] And the answer there is not sharp ratio.

[00:11:38] The answer there is something that when you say a sentence, they're like, that makes sense to me.

[00:11:46] And so your dad was not a buyer after this?

[00:11:51] Not yet.

[00:11:52] But I also think, and I think it might have been you that mentioned this when you were on the podcast last time.

[00:11:55] It's almost like it needs another name.

[00:11:57] It's almost like it needs, you know, futures.

[00:11:58] And, like, people associate futures with options and complication.

[00:12:02] And, like, I don't even know what the name would be, though.

[00:12:03] I couldn't come up with anything.

[00:12:04] But it's almost like the whole space needs a name that, like, my dad could understand.

[00:12:08] So, and I think what you're also highlighting is that there are also different narratives at different levels and different language at different levels, which is also sort of complicated.

[00:12:16] So, to me, the way, what I basically said is, and I would say, I don't think I have a sentence here.

[00:12:23] It's a little bit more of a conversation.

[00:12:25] I say, look, there's this nimble hedge fund strategy that's been around for 50 years.

[00:12:31] It's proven.

[00:12:33] It works.

[00:12:34] It's worked through all sorts of different market environments over time.

[00:12:38] Academics have written papers on how this thing works.

[00:12:41] And at its core is that we're all trained to, you know, hold, to not pivot, to not change what we do.

[00:12:51] Right?

[00:12:52] That everything else in your portfolio is a long-term investment.

[00:12:56] And most investments should be long-term investments.

[00:12:58] You're trained, you know, the whole growth of model portfolios is designed to help people counteract their two worst heuristic biases, which is to panic and sell at the bottom.

[00:13:08] And focus obsessively on single line items that, you know, to the point of kind of their own psychological ruin and portfolio destruction.

[00:13:17] And so model portfolios were dealt where the whole narrative around model portfolios was, no, you know, calm down, be the steady hand of the wheel, let the diversification work over time.

[00:13:28] The one thing that's missing from model portfolios because they're slow-moving is any sense of nimbleness.

[00:13:35] And so the story has to be something where people are like, that makes sense.

[00:13:39] And as you tell people that, you know what, sometimes the experts are wrong, sometimes the world changes faster.

[00:13:45] And you want something in your portfolio that's going to be more adaptive to that, that's going to shift.

[00:13:50] When inflation comes back, it's not going to wait until everybody agrees that inflation has come back.

[00:13:54] It's going to try to find a way to do it, to capitalize on it.

[00:13:58] But, and I think, and that's actually, I think is actually the source of alpha in this space as well.

[00:14:03] So when you're talking to somebody who's building a model portfolio, it's not just that the reason this as a storyline or narrative makes sense is because your greatest strength is that you're the steady hand of the wheel.

[00:14:16] And every now and then it's a weakness as well.

[00:14:20] And adding something to this portfolio, I came up with this expression in 2022, you know, there are periods of time when diversification is not working, right?

[00:14:29] Everything's going down at exactly the same time, like 2022.

[00:14:33] But here you've got a nimble strategy that's just like beacon of green in the sea of red.

[00:14:38] It gives you, and it's not just, and whether it's a 3% allocation is not going to change your clients' lives.

[00:14:44] It's not going to change your portfolio.

[00:14:45] Great.

[00:14:45] You're not down 18%, you're down 17%, right?

[00:14:47] It's not like these things happen very much at the margin.

[00:14:50] But it can be very powerful in terms of the psychology of managing clients who are sitting there worried about, you know, if I lose another 20%, I've got to like really, really, really, it's going to really have a big impact on my life.

[00:15:02] So I think this, and I think the narratives, you know, when I talk to people about investing in this space, it's getting the narrative right based upon what your clients know and what they expect.

[00:15:14] Because everybody's got a different story as to why they're, I mean, you know, we think about this kind of very homogenous industry.

[00:15:20] I don't find it homogenous at all.

[00:15:22] I find, I was talking to an advisor who actually discouraged him from investing in the ETF because he's got $400 million of clients who have bought into their argument that they're diversifying away from gross stocks into dividend-paying stocks, and they're putting a bond letter next to it.

[00:15:43] Right?

[00:15:44] Right?

[00:15:44] So his clients have bought into that.

[00:15:46] That's their definition of diversification.

[00:15:49] You then come with an ETF with futures in it.

[00:15:53] You're kind of, you're actually, even if it raises his Sharper ratio by 0.03 over the next five years and gives him something that works in a different environment, I'm not sure it's what his clients actually want.

[00:16:09] So it's all these kind of like very, very complicated and thorny relationships.

[00:16:14] I would love to come up with a three-word answer or the new name for this space and have it just resonate like private credit or private equity.

[00:16:21] I just haven't found it yet, and I'm not sure it exists.

[00:16:24] Flexible something?

[00:16:25] No, I don't know what the right word is.

[00:16:28] I like the beacon of green and the sea of red.

[00:16:31] Try to capture that in some type of product name and you got a winner.

[00:16:35] Yeah.

[00:16:37] Yeah.

[00:16:37] You float.

[00:16:38] These are floaties.

[00:16:39] Yeah.

[00:16:40] Keep the seats.

[00:16:41] And even though I wasn't able to convince my dad, I was able to convince myself because, you know, we've run a version of the permanent portfolio for clients for a long time.

[00:16:47] And, you know, when you look at that, like in a spreadsheet and you start introducing managed futures into that, even a portfolio like the permanent portfolio, which already has, you know, limited drawdowns relative to the 60-40, like there's no way not to make that better.

[00:16:58] Like you could argue about the percentage, but there was no, like version of testing I can come up with where there was the conclusion, don't add some managed futures to that.

[00:17:08] Oh, it's utterly statistically obvious.

[00:17:11] Right.

[00:17:11] Right.

[00:17:12] And so here's also positive development, right?

[00:17:15] So what do model people hate more than anything?

[00:17:18] They hate when they build a model and their clients focus on line items.

[00:17:22] Right.

[00:17:23] So and this is actually a very, very important development for the managed futures space.

[00:17:29] If you are saying I've got stocks and bonds as my starting point and I'm going to add the managed futures to it, it helps you statistically, but it creates a very awkward question of where's the money coming from and what's the downside of doing that?

[00:17:43] You take money from stocks and I guarantee you the moment you do that, stocks will outperform managed futures.

[00:17:49] It's like it's just the market gods have that kind of sense of irony.

[00:17:54] Or you take it from bonds, the moment you do it, you'll have a drawdown and bonds won't go down or something.

[00:17:59] So one of the great problems was always where do I take the money to fund this?

[00:18:04] Because bonds were supposed to be rock solid and never go down.

[00:18:07] Of course, that's not true anymore, but it was true for 20 years.

[00:18:12] And equities, it's the growth engine, people that return and people and their stories behind it, et cetera.

[00:18:17] A huge positive is this idea of going from 60-40 to 50-30-20.

[00:18:24] And what's driving it?

[00:18:26] Okay, bonds just aren't working as a diversifier anymore.

[00:18:28] Let's just say it out loud, right?

[00:18:30] I mean, the volatility has doubled or tripled.

[00:18:33] You've had the max drawdown has gone up 4 or 5x, what it was until 2022.

[00:18:39] They're not earning more than cash.

[00:18:41] I mean, they're just not really working.

[00:18:44] And they may work on a going forward basis, but you're never going to get away from this period of time where they worked as badly as they did.

[00:18:49] So in the context of that, this idea of now you're saying, okay, I've got 50-30-20 or I've got 40-30-20 or 60-20-20, however you're configuring the portfolio.

[00:19:04] The key for managed futures adoption is that you're now compared to the rest of the 20.

[00:19:10] And guess what?

[00:19:10] You look a lot better than the rest of the 20.

[00:19:14] You compare that to an equity long short product, a lot better.

[00:19:18] You compare it to a multi-strat mutual fund, you look much better.

[00:19:21] So it's once you get people to have made the decision that they're going to add alts.

[00:19:26] Like how do all these hedge fund categories survive, right?

[00:19:29] Somebody's made a decision that hedge funds is a bucket in a category, and they almost never get rid of a bucket entirely.

[00:19:35] They change it over time, but they really just add buckets over time.

[00:19:39] And so that will be very, very good from a narrative perspective because then it won't be about how is this line item doing relative to my stocks and bonds.

[00:19:51] It'll be in the context of this diversifying market, which has its own narrative.

[00:19:56] That makes sense.

[00:19:58] I don't know what you think, but I think the idea of return stacking is interesting too.

[00:20:01] The idea of like maybe not having to decide whether you sell your stocks and bonds, maybe using a concept like that to free up space for something like this.

[00:20:09] Yeah.

[00:20:12] Product innovation is alive and well everywhere, right?

[00:20:15] I mean even crazy 2X.

[00:20:19] I had lunch with Matt Tuttle like six or nine months ago, and I'm like, no, no, no, let me pay, let me pay.

[00:20:24] I'm like next time he is paying.

[00:20:25] Okay.

[00:20:29] He's paying and he's tiring me a card I don't know.

[00:20:35] But in Corey's case, I mean, of course you have this very, very valuable thing.

[00:20:41] And what he's doing is basically building a product that is geared toward the innovative financial advisor model builder who's thinking about, all right,

[00:20:51] how do I squeeze out excess returns in my portfolio and ultimately how do I achieve that in an efficient way?

[00:20:58] It's great.

[00:21:02] In a sense, Managed Futures is stacked on cash.

[00:21:08] And so when return stacking really kicked off, it wasn't part of the fact that that was a lousy thing to have in your portfolio.

[00:21:16] Nobody wanted any cash.

[00:21:17] So you're taking money from bonds and putting it into something that was earning zero and then dropping a bunch of futures contracts on top of it.

[00:21:25] That was really not great for a long time.

[00:21:29] But, you know, so the irony is now today the cash has been a pretty great asset to have.

[00:21:37] Now, you know, a very slightly awkward thing for the Managed Futures space in 2013 and now 2024, they're underperforming cash, which is not a good look for the space.

[00:21:47] That once cash returns go up, you're underperforming cash as an overall space.

[00:21:53] Replication is obviously doing a bit better this year.

[00:21:55] But, again, look, I think, I mean, financial innovation, I think, is, you know, is trying to figure out, again, with this heterogeneity of what investors want.

[00:22:06] You can build products to address specific parts of it.

[00:22:10] And on a standalone basis, they can be huge, but they don't necessarily have to replace 60-40.

[00:22:16] Do you think we get to a point ever where this is sort of mainstream?

[00:22:19] Like, if you think about, like, target date funds and stuff like that, do you think we'd ever get to a point where this stuff is in there?

[00:22:24] Because I'm just thinking about, like, we've had Mike Green on the podcast, and he's helped us realize, like, how important that is.

[00:22:29] Like, the default options and 401ks and the money just goes into the target date funds and, you know, the passive flows and all that.

[00:22:34] I mean, do you think we ever get to a point, because it makes complete sense for this to be in those types of things.

[00:22:38] Do you think we ever get to the point where they're in there?

[00:22:43] So, yes and no.

[00:22:45] I mean, there will always be.

[00:22:47] And part of it is.

[00:22:48] So, the irony is everybody in the ETF world is rushing toward active, right?

[00:22:52] So, we did active.

[00:22:53] We're actually rushing in the other direction.

[00:22:56] And in that active is great for bringing things to these portfolios that haven't had them in the past.

[00:23:05] But what do you do if you have a passive ETF-based, super cheap portfolio of stocks and bonds?

[00:23:15] You really can't diversify at that point because there is, like, you know, why is BlackRock and State Street, why are they talking about bringing out essentially passive ETFs for these different categories?

[00:23:26] Because the process that somebody wants to go through when you're building a model is you have to decide whether you want the asset class to begin with, and you need an index for that.

[00:23:38] Now, why do these guys love passive products?

[00:23:41] Because normal portfolio construction is a two-step process.

[00:23:45] You decide how many buckets you want and in what weights.

[00:23:49] That's step one.

[00:23:51] And then step two is how do you fill them?

[00:23:53] But if you decide you want a 25% allocation to the S&P 500 and you buy an S&P 500 ETF, it's not only, like, basically free.

[00:24:04] It's you're never wrong, right?

[00:24:07] You've taken away one part of your decision-making process.

[00:24:10] Now, in an area like Managed Futures, we'll have guys up 10 and guys down 10, you know, over the span of months.

[00:24:19] You've never really had the ability to put something in there that can reliably fill the bucket.

[00:24:25] We have tried to do that with replication, except we're trying to do that with replication relative to the hedge fund index.

[00:24:31] Now, in this past summer, SockGen, that publishes the primary hedge fund index, built and launched an index around our replication engine,

[00:24:45] the DBI replication engine.

[00:24:46] So in two years, if you've never looked at the space and you're one of those guys who's trying to decide how do I invest in the space,

[00:24:55] what you'll do is you'll take this index, the replication index, because it is inherently investable.

[00:25:02] If you decide you like it, you can buy a product that will match it with a 98% correlation.

[00:25:08] So in a sense, where you're doing it and you decide that you want that in your portfolio,

[00:25:13] then you essentially have passive ways of getting exposure to it by employing the same kind of index.

[00:25:20] And that's how it'll happen, basically.

[00:25:23] Because Vanguard won't put 5% into something and that takes a ton of single manager risk.

[00:25:31] So the idea of the new index, basically, is that the current index is very hard to track in the real world.

[00:25:36] And so the new index is like a trackable version of the old index.

[00:25:40] Is that sort of the idea?

[00:25:41] Yeah, exactly.

[00:25:42] So, I mean, so the...

[00:25:45] SockGen's hedge fund index is, I think it's probably the gold standard of indices.

[00:25:49] It's got great data that goes back to 2000.

[00:25:52] But you decide that you want to invest, you build your capital markets assumptions as a model guy around that.

[00:25:57] Well, what do you do with it, right?

[00:25:58] You can't actually invest in that index.

[00:26:01] So if that's going to be your benchmark, then you've got to go pick someone's fund to get you exposure to it.

[00:26:09] And plus, the index is reported net of all hedge fund fees.

[00:26:12] So the return profile is okay.

[00:26:14] It's not great over time.

[00:26:15] And so the point is, if you could go back 25 years and say, how would we want this to be most effective for model guys?

[00:26:29] You would give them an index.

[00:26:30] You'd have the hedge fund version.

[00:26:32] And you'd have the investable version, the simpler, cheaper, whatever, investable version side by side.

[00:26:38] And then the institutional investor, the Cambridge Associates, the bursar, et cetera, would use the hedge fund index for what they do.

[00:26:46] And then anybody who's in the wealth management other world would use this other index because it's actually actionable.

[00:26:54] And so if history cooperated, we all would have started there in 2000.

[00:26:58] And then we would have a nicely bifurcated world.

[00:27:01] You've got your private markets index over here, your hedge fund index over here for people who invest in hedge funds and the other one over here.

[00:27:08] But that didn't happen.

[00:27:10] So we're basically kind of putting the building box back into place today for that.

[00:27:18] You mentioned State Street and BlackRock and Vanguard.

[00:27:20] Do you think, and I guess there are some moves going now into the space.

[00:27:24] I mean, do you think they'll be like participating in the managed futures space in the future?

[00:27:28] It's a good question.

[00:27:29] I'm surprised.

[00:27:30] I mean, you know, the thing about managed futures is there's stuff you see above the surface and a lot that happens below the surface because anybody with a team of quants probably has somebody sitting around thinking about how to build trend-following products.

[00:27:45] So I think if you walked into BlackRock and said, I want exposure to trend, I'm sure they've got a whole rule book or game, whatever, like the various cards they can throw at you for their, you know, are this trend-following product app.

[00:27:59] Like I said, again, you know, BlackRock had a whole business that was very prominent in doing alternative risk pre-care products, so long-term products and derivatives-based products and index-based products.

[00:28:11] They haven't come with an actual product yet.

[00:28:16] And, you know, Vanguard hasn't as well, but Vanguard's sort of in their own – they've got their own issues to deal with.

[00:28:24] And State Street, again, I don't know.

[00:28:29] I'm guessing a lot of these guys think that, well, it's only a $20 billion mutual fund business and it's a few billion dollar ETF business.

[00:28:39] It doesn't really move the needle for them.

[00:28:41] I don't think they're looking, A, at the fact that the hedge fund industry is $300 billion.

[00:28:47] And if there was one strategy that you could actually make work really well at ETS mutual funds, et cetera, this is it.

[00:28:54] And the $300 billion is still $300 billion because these guys are marketing to the same people that they've always marketed to.

[00:29:03] So the pie hasn't grown in a long time.

[00:29:05] So if I'm right and there are not stupid people who think we're kind of 10 years ahead of these guys in terms of thinking about this stuff, if I'm right, then actually eventually they'll realize – as they realize the difficulties of some of the stuff they're doing, they'll start looking at managed futures.

[00:29:20] They'll see this just a bit and realize that, well, if you can turn the ETF space into a $100 billion space or a $200 billion space, it starts to get their attention.

[00:29:30] It should be.

[00:29:34] And so, look, I think as usual they'll come in.

[00:29:37] The question is, in terms of their priorities, they're not there yet.

[00:29:41] I want to ask you about just alternatives in general in the ETF space because managed futures is something that makes a ton of sense in an ETF wrapper.

[00:29:48] We're seeing a lot more, and I think we're going to see many more, different alternative type things being launched as ETFs.

[00:29:54] And, I mean, I think there's even been talk of, like, doing private equity in ETF, and I don't know how that's going to possibly be done, but I guess the people smarter than me will figure it out.

[00:30:00] But I'm just wondering, like, since you're inside the space, if an individual investor is evaluating these new alternative ETFs as they come out, like, what are the major things you'd be looking at to determine if this is a good product, if it's a good product in an ETF wrapper, those types of things?

[00:30:15] Well, it's a good question.

[00:30:16] So, I think there are – the ETF world is very different, I think, than the mutual fund world in certain respects.

[00:30:30] One is the mutual fund world still has a lot of industry architecture out there that kind of feeds off of revenue shares and things like that.

[00:30:37] And so they're kind of all these gated communities.

[00:30:40] But the ETF world is kind of divided between people who are the model builders and people who are the gunslingers.

[00:30:46] And so the gunslingers are taking, you know, Tuttles, NVIDIA stuff to, you know, whatever, whatever, or Defiance's, you know, whatever that the Bitcoin mill is.

[00:31:02] And – but then on the model side, the mentality is very different.

[00:31:07] You know, they tend to be very risk-averse.

[00:31:11] They tend to have spent their whole lives looking at stocks and bonds.

[00:31:16] And the problem with most alternative products is they're too boring for the swashbuckers and they're too unpredictable for the model guys.

[00:31:28] Because – and that was sort of the – if you look at the train wrecks or the, you know, the battlefield is littered with bodies.

[00:31:35] It's probably a better metaphor.

[00:31:37] A product where people said, like, that sounds really good.

[00:31:40] I'm going to go, you know, long growth and short value or long value, short growth or this, that, or that kind of other things.

[00:31:45] But then now you're talking to a bottle guy.

[00:31:48] It's really complicated.

[00:31:50] It's got kind of a low cash plus something return profile.

[00:31:57] You know, they're not that – they're not eager buyers except to be – where do you actually put it in your portfolio?

[00:32:01] Yeah.

[00:32:05] So a lot of us depend on what products people come with.

[00:32:08] One is if somebody says this has worked incredibly well as a hedge fund and we're putting it into an ETF, I'd give you a whole list of questions.

[00:32:16] You know, like, you know, what makes you think it's going to work well at an ETF?

[00:32:20] How have you had to change the strategy to make it work?

[00:32:23] You know, do you – I mean, I think my general reaction would be wait three years, see if it's working well then before buying.

[00:32:31] I think my favorite question is, can you show me all the mutual funds you've launched over the past 15 years and how those have done?

[00:32:40] Because a lot of them are going to come with product mills.

[00:32:43] Ben Johnson from Morningstar has this great expression in the spaghetti cannon, and that's very true in this space as well.

[00:32:48] You know, most of the players in this space have launched product after product after product.

[00:32:53] And, you know, they're kind of relying on investors to be goldfish and have no memory of what – of the pitch that they heard two years ago.

[00:33:01] And it's kind of hard to find dead funds when they're already gone.

[00:33:05] But that's the key question because if somebody's had three train wrecks in a row, they're offering you the fourth one.

[00:33:10] God, just end the meeting.

[00:33:12] Go home.

[00:33:13] They're better things to do.

[00:33:23] And then there's others that just throw them all out there.

[00:33:25] And whatever sticks, you know, they throw five out there.

[00:33:27] If one does really well, they end up doing really well, but they get rid of the other four.

[00:33:30] Well, and that's the way you support large distribution teams, right, is that you have to – it's too risky to have a big distribution team around one product.

[00:33:41] So, yeah, another question that I think is great is what was your favorite idea three years ago?

[00:33:48] And what was your favorite idea three years before that?

[00:33:51] And how did those do?

[00:33:53] Because that – it's just a different way of asking the same question because people in this – I mean, people are trying to force feed people products in this because, you know, in general, they get paid more when they sell more expensive products.

[00:34:06] They get paid up front.

[00:34:07] You know, they don't – their commission is not contingent upon this fund actually doing well.

[00:34:14] These incentives are all screwed up in the industry.

[00:34:15] But I would say, look, on our end, we shut down one of our ETFs.

[00:34:19] So we had – we were replicating equity long short.

[00:34:23] We actually were doing better than hedge funds replicating equity long short.

[00:34:27] And our only competitor in this phase really was First Trust and the product that they had.

[00:34:33] But we told our partners, look, we think we should shut it down because people would always ask me.

[00:34:38] I'd go on the phone to them and say, you know, you have this big ETF and you have this other ETF, you know, compare and contrast.

[00:34:44] I said, this one's better.

[00:34:45] It's like, you want my opinion.

[00:34:48] I think it's better.

[00:34:50] It has a lower correlation, more diversification bank for the buck.

[00:34:53] I like it more.

[00:34:54] And I'm only going to tell you – I'm going to be honest with you about it.

[00:34:57] This one – this other one is great.

[00:34:59] But it's a diluted equity exposure.

[00:35:03] And you're betting on an area of the hedge fund space, equity long short, that I think it's best days are behind it.

[00:35:10] And yes, we can beat actual hedge funds.

[00:35:13] But I'm not sure that's really going to help you that much.

[00:35:16] I want to shift back to talking about, like, my dad and people who follow these strategies.

[00:35:20] Because you mentioned line item risk before.

[00:35:22] And that's, I think, one of the big risks with this is, like you said, on a spreadsheet, it makes 100% sense to add something like this to a portfolio.

[00:35:30] The challenge is, when it's the thing that's not working, how do you get people to not look at that?

[00:35:35] And I'm just wondering, do you have any tips on that?

[00:35:37] Because it's something I struggle with a lot with our clients is, you know, you could have – like, I think it's Brian Fortin who says, like, diversification is having to always say you're sorry.

[00:35:44] Yeah.

[00:35:45] Because something's not working.

[00:35:46] I love Brian.

[00:35:47] You know, and I think people are more understanding when the stocks and the bonds aren't working because they know what they are.

[00:35:52] Whereas they're a little less understanding when something they don't know what it is is not working.

[00:35:55] So I'm wondering, do you have any tips in terms of how you would explain to investors or how you might coach them to be able to stick with a strategy that includes these types of things?

[00:36:01] Sure.

[00:36:02] So one thing I would say, it's not just that stocks and bonds.

[00:36:06] It's that stocks and bonds have a narrative, a simple narrative.

[00:36:09] You know, like, ask an advisor.

[00:36:11] You know, my bond portfolio is down.

[00:36:12] And they're like, you know, they snap their fingers and they say, you're going to get your money back.

[00:36:19] Right?

[00:36:20] You know, it's only mark-to-market losses.

[00:36:23] It's – like, there's a narrative as to why it's going to bounce back.

[00:36:26] And with equities, you know, it's always like never sell at the bottom.

[00:36:29] You know, like it's – so they have these kind of recovery areas.

[00:36:32] Managed futures doesn't have it.

[00:36:34] So I actually think it starts on how you talk to your clients at the beginning as to why they have it in their portfolio.

[00:36:43] And I think the narrative – so I think it starts with drawing analogies.

[00:36:51] You know, do you remember when we put REITs into your portfolio?

[00:36:54] And you were wondering, why am I going to have real estate in this part of my portfolio?

[00:36:59] Or we're talking about infrastructure.

[00:37:00] We're talking about anything like kind of like these kind of changes you've made.

[00:37:03] Whatever history you have with your clients.

[00:37:06] I think the way to describe this – it's a little bit self-serving because I think we do a better job of this than other people – is you want the space.

[00:37:14] You want the category.

[00:37:15] You don't want the manager.

[00:37:17] Because what happens with the single manager is that most advisors feel pressure to bring diversification because you have looming behind you Vanguard who's basically saying, if you're not diversifying, we're going to do everything in your business for free.

[00:37:34] And, you know, and so advisors want to build on that and bring more diversification to the table.

[00:37:42] And so they're kind of a receptive audience to it.

[00:37:45] But they have a second sales process of then going and convincing clients why the client should be happy about it.

[00:37:52] And this happens with institutional consultants, et cetera, is that people tend to bid themselves up when they start talking about it.

[00:38:00] You know, like he was up 25% last year.

[00:38:03] Or, you know, they're the best managers in the world.

[00:38:06] And what they do is they come at you with excitement.

[00:38:09] You know, this is why we should – man, AHL, they've, you know, they would go back to the 19th century or something.

[00:38:15] And they've got, you know, like a zillion people on the smarts.

[00:38:17] This is how many PhDs.

[00:38:19] But the more you hype it on the front end, the more pressure it's going to place every quarter because they're going to be saying like, okay, how come, you know, how come Messi keeps whiffing on goal, right?

[00:38:31] It's like it's – so the way I think about it is it's the narrative.

[00:38:38] You have to think a lot about the narrative on the front end to take the pressure off during those periods of natural underperformance.

[00:38:44] That – and where it becomes an asset class and you frame it – like there's a lot of psychology around the first time you're introduced to an idea.

[00:38:53] You get anchored to it, right?

[00:38:55] So if you introduce it as something exciting, it's very hard then to say, you know, don't worry.

[00:39:02] It's not going to be exciting all the time, et cetera, et cetera.

[00:39:05] And that's why like the limitation of a beacon of green and a sea of red is sometimes we're the beacon of red and a sea of green like last year, right?

[00:39:12] So it can definitely go against you.

[00:39:14] But I think if they view it as a long-term investment and just a part of their portfolio and it's not going to hurt you and that's why, you know, in terms of the sizing of it, I always come in a lot lower than people come in theoretically.

[00:39:28] Like I came in at 3% to 5% for a typical portfolio.

[00:39:32] Because to me, if you're going to have 20% in alts, I think you make an argument to have a 5% of the 20 or 3 of the 20 depending upon how many other things you're going to – you're going to be putting in there.

[00:39:42] But in part, it's because people have to feel like it's not – when it goes to these periods, it's not – it's not – you know, it's not damaging them in the same way.

[00:39:53] And that – so I think in that context, I think also, you know, just sort of human contact with people is very, very important.

[00:40:01] I mean, the reason I do these videos, I do videos once a month where we do a series of slides and I talk about performance.

[00:40:10] I do this in the U.S.

[00:40:11] I also do it in Europe.

[00:40:13] And I think it's really important for people to hear a human being talk about this stuff.

[00:40:16] You know, like if I'm – if I send somebody a fact sheet with, you know, generic language about stocks and bonds going up and down, this is what happened with the portfolio.

[00:40:27] And what most people do in this space is they'll say, you know, and our biggest gaining position was wheat and our biggest losing position was, you know, cocoa or something.

[00:40:37] I don't think that makes anybody more comfortable, as you say, in the strategy.

[00:40:42] That just – that's – there are too many words and things that I don't understand.

[00:40:47] I don't know if you're comfortable.

[00:40:48] It feels like you can come back and bite me on that.

[00:40:49] And if somebody sits there and says, yeah, man, that's really frustrating.

[00:40:53] You know, we're on the wrong side of the Trump trade and we, you know, look like we had everything right.

[00:40:57] And then, you know, and then we got kind of, you know, whips out on a bunch of things.

[00:41:02] But look, this is what happens in the strategy and there's kind of like somebody emoting and feeling it.

[00:41:09] It humanizes a bit.

[00:41:10] And I think that's really important for people.

[00:41:12] You know, look, that's why we – active management is still what it is.

[00:41:15] And active ETS is people, you know, we're social animals.

[00:41:19] So we want – if we could just – if the computers were so good that we could just turn over to computers, fine, we would do that.

[00:41:26] Except they don't – you know, it's – I think we want something more in our interaction with our advisors and our managers to help us to understand how we should react to it.

[00:41:40] You know, and what I've tried to convey to people, at least in it, is that, you know, I'll tell you what I'm frustrated about.

[00:41:47] I'll tell you what's working, what's not working.

[00:41:49] And – but if I – if you see that and you see somebody responding to it like that, it makes it easier to then feel like, okay, this is just a temporary thing.

[00:41:59] Because, look, unfortunately, I mean, you know, trust is very hard in this business.

[00:42:03] All right?

[00:42:03] You have – talk about the liquid alt space.

[00:42:07] Everybody's been burned in liquid alt space.

[00:42:09] We manage a fund in Europe for a firm called SEI, you know, 50-year-old asset management firm here.

[00:42:18] And the guys in the U.K. said one of the greatest benefits of this fund that we built and manage for them is that in nine years now we've been doing it, there have been no surprises.

[00:42:32] And for them, they're – you know, for them, the best alt is something, as you can say, you can talk about it when you want to talk about it, when it helps you in your client relationship, et cetera.

[00:42:42] But not getting dragged into conversations about it the rest of the time.

[00:42:45] And particularly in Europe where, you know, funds have gated and suspended and unexpected drawdowns and everybody piles into a fund that does terribly.

[00:42:52] It's – you know, they basically said, look, to have something that allows us to keep clients centered on the overall portfolio and the longer-term objectives.

[00:43:02] And yet in a year like – for that fund, in a year like 2022 when we were up and everything else was down, it was – it's – but, you know, it's – the lack of surprises is critical for these things to be long-term investments.

[00:43:20] I apologize in advance to my dad.

[00:43:22] This is my last question before I hand it back to Justin.

[00:43:24] But we're going to lose my dad here because as much as I like the basic stuff, I'm also the nerdy quant guy who enjoys digging into the details here.

[00:43:30] So I want to talk to you a little bit about how you construct these strategies because there are a bunch of decisions behind the scenes in terms of how you build, like, a trend following or a managed feature strategy.

[00:43:39] And the first thing I want to ask about is the idea of short-term trend versus long-term trending.

[00:43:43] Whenever we talk to trend followers, we always get, you know, different opinions on this as to how much you weight them or whether you include one or the other.

[00:43:49] Like, how do you think about that?

[00:43:50] To clarify what we do, what we do is totally different from what everybody else does.

[00:43:54] So they are actually in the managed feature as trend following business.

[00:43:58] They are building models.

[00:43:59] They go into the office.

[00:44:00] They are trying to figure out are we buying heating oil or selling heating oil, et cetera, et cetera.

[00:44:05] We're actually in the risk model business.

[00:44:08] So we would walk in every Monday and we have very, very good risk models that say, okay, let's synthesize what everybody is doing in this space down to 10 more positions.

[00:44:20] And – but what we're trying to estimate is not what they're reporting but what we think they're earning before all these trading costs, before these management fees, before these incentive fees.

[00:44:30] So the whole – the craziness of it is we're going to aim for average, but we're going to aim for average so efficiently that we'll come out hundreds of basis points ahead.

[00:44:40] That's the whole theory behind it.

[00:44:42] But if you like sports and you like statistics, the analogy is – did you see this talk that Roger Federer gave over the summer?

[00:44:51] Yeah, it was the Dartmouth commencement speech.

[00:44:53] Exactly.

[00:44:54] Yeah.

[00:44:54] Yeah.

[00:44:55] That's replication, right?

[00:44:57] So Jack, so what – so Federer gets up and he gives us commencement speech.

[00:45:00] I don't remember.

[00:45:00] I didn't – I don't remember exactly how he opened it.

[00:45:02] But it was something like like I lost almost half the points I ever played.

[00:45:06] And in reality, it was – I think he won 53% of the points that he played, like barely more than 50%.

[00:45:12] But over the course of a game, he won 60-something percent of games.

[00:45:17] You know, he won – we should take that into sets.

[00:45:19] He won 80% of sets or 70% of sets, which meant he won 90% of games or – I mean of matches.

[00:45:26] That's replication, right?

[00:45:28] Replication is a one-week bet that we can figure out the core positions of what these guys are doing, the core exposures.

[00:45:38] Be so much more efficient, hundreds of basis points more efficient in terms of trading costs, implementation, et cetera, and fees that by the time we get to the end of the week,

[00:45:47] we'll have a 53%, 54% chance of coming out ahead with plenty of noise and dispersion.

[00:45:54] You do it over the course of the month, we're in the 60s.

[00:45:56] Do it over the course of the quarter, we're in the 70s.

[00:45:57] Do it over the course of the year, we're in the 80s, right?

[00:46:00] So that's nothing – that looks nothing like what other people do.

[00:46:05] The awkward thing is, is that you do that for five years and you've got performed 80% of actual hedge funds doing it.

[00:46:12] You do it over eight and a half or nine years, you've got performed 90% or more of hedge funds that actually do it.

[00:46:18] And you can do it in an ETF, mutual funds, usage fund, et cetera, as efficiently as you can do it.

[00:46:26] So – but when you're doing that, what we're picking up the way the models work is primarily medium-term trend, medium-to-long-term trend.

[00:46:34] Now, short-term trend, we've looked at it.

[00:46:37] So we run our own risk models.

[00:46:40] We can tell you, based upon whatever, we would be longer, shorter, this, et cetera, that, today.

[00:46:44] And we do it across a lot of instruments because it's one of our risk management tools to see if what we're getting in our top-down factor models is reasonably accurate.

[00:46:56] But when we've looked at shorter-term versus longer-term, shorter-term sounds great.

[00:47:01] And it's great the moment Powell – the day SVB happens, of course, you wish you were in short-term models.

[00:47:13] The moment Powell pivots, goes from hob to dove, you wish you were in that.

[00:47:18] Because at the sharp inflection points, you really love shorter moments.

[00:47:21] They sound great, right?

[00:47:23] A trend is going to start, and I'm going to get in earlier than the longer-term guys.

[00:47:28] And I'm going to hold it almost until the very end.

[00:47:30] Then I see it start to move, and then I'm going to get out first.

[00:47:33] And these other guys are going to kind of get – the longer-term guys are going to get whipsawed.

[00:47:37] It's a very, very compelling story.

[00:47:39] It's just not real.

[00:47:41] Because what happens is as that trend is going up, there are – it's up and down, up and down, up and down, up and down, up and down, up and down over the course of that trend.

[00:47:49] Right?

[00:47:49] It's – you go two forward, one back, three forward, two back, et cetera, et cetera.

[00:47:54] And the more sensitive the model is, the more you get head-faked and whipsawed out of positions throughout the course of it.

[00:48:03] So our conclusion, and I think – interestingly, I've heard this repeated by some very, very serious quants in the space – is that short-term models are much less attractive from a short-term – from a sharp ratio perspective, from a short-term perspective.

[00:48:18] But people still will use them because they're trying to address an investor concern about getting whipsawed because the whipsaw is what feels painful.

[00:48:31] So our view is that if we're picking up – I think medium to long-term trend is actually the alpha driver of the space.

[00:48:40] And I don't think – I don't see us missing a lot by not – by having less exposure short-term.

[00:48:46] If you feel very strongly about short-term, you can get exposure directly.

[00:48:50] So the idea is whatever the people in the index are doing, that's effectively what you're doing by replicating the index, and that tends to be medium to long-term.

[00:48:56] Is that –

[00:48:56] Yeah.

[00:48:57] Yeah, look.

[00:48:57] Yeah.

[00:48:57] Look, if short-term was a sharp ratio of 0.8 and was better at capturing the trends, guess what the 20 guys in the index would be doing?

[00:49:06] Or women in the index.

[00:49:08] They would be doing it.

[00:49:08] They don't.

[00:49:09] There's a reason they're a medium-term trend.

[00:49:12] And if you get somebody like Katie Kaminsky on this who's at Alpha Simplex, that's kind of where – that's where – even Corey, I think, would say that.

[00:49:21] That's where the primary – that's where the research shows up.

[00:49:24] But there's also – look, there's a reason for it as well, and it goes back to this idea of the world being populated by slow-moving models.

[00:49:34] So, again, as I mentioned before, the weakness of a model portfolio is when inflation starts to happen.

[00:49:42] Okay.

[00:49:43] The job description of most people who control money is not to change their mind fast.

[00:49:49] So, inflation starts to come back.

[00:49:51] And I wrote this paper on inflation in early 2021, possibly if inflation coming back.

[00:49:56] And I spoke to a lot of – and I said if it comes back, it's going to be great for managed futures.

[00:50:00] And I spoke to people about it.

[00:50:01] And I realized after a while that if you're an advisor who three months before had told your clients that inflation was never coming back and you were – they should be glad that you were buying doubly rated paper at a 1.5% yield with the 10-year maturity.

[00:50:15] And you started to get inklings that inflation was going to come back.

[00:50:18] You couldn't change your mind anyway at that point.

[00:50:22] So, what happens is because every institutional portfolio, every pension plan, all this whole 60-40 world, all of this kind of automatic rebalancing portfolios, because it's all designed to move so slowly, when there are these inflection points in the markets, it's like people are just shaving off pennies and throwing it at more nimble investors.

[00:50:42] And so, it's not a surprise that in 2022, there were hundreds of billions of dollars of alpha that was created by macro hedge funds, by CTAs, et cetera, because the probability of inflation coming back.

[00:50:56] That's what Stan Druckenmiller said in 2021.

[00:50:58] He said – he was being interviewed by this guy, Tony Pasqualello, who's the head of the prep brokerage group at Goldman Sachs.

[00:51:05] And he didn't say, like, you know, I know inflation is coming back.

[00:51:08] That's not the way he talks about it.

[00:51:09] He said, look, the market's not pricing in inflation coming back.

[00:51:15] And inflation was coming back.

[00:51:17] But that whole period when inflation started to come back, the market was underpricing it.

[00:51:22] And so, it left this huge alpha opportunity for other people to invest in.

[00:51:26] But that's – you don't need to be super fast to pick that up.

[00:51:30] That plays out over months and quarters, not over days and weeks.

[00:51:36] What's your view on the evolution of a strategy over time?

[00:51:41] Like, do you – you know, there's some systematic investors that sort of say, we have a strategy.

[00:51:48] Maybe it's built on some type of backtest.

[00:51:51] They've been running it.

[00:51:51] Add a sample.

[00:51:52] So, they have actual performances behind it.

[00:51:54] You know, I'm not going to tweak it.

[00:51:57] I'm not going to change it because it might – maybe data mining comes in or they just don't feel comfortable doing that because they have the add-a-sample track record with the actual strategy in place.

[00:52:10] Where do you fall in terms of investment strategy like yours evolving over time?

[00:52:17] So, we've always believed that if we're successful, we don't change a thing.

[00:52:22] Right.

[00:52:23] So, we – the strategy underlying our ETF and our usage fund was launched in July of 2016.

[00:52:31] Yeah.

[00:52:32] We came in on a Monday.

[00:52:34] We looked at recent data on the index.

[00:52:36] We ran the model, put on the portfolio.

[00:52:39] We waited a week and did it again.

[00:52:41] Waited a week and did it again.

[00:52:42] Again, we haven't changed a thing in eight and a half years.

[00:52:46] Not a line of code, not a factor, et cetera, et cetera.

[00:52:51] Now, why?

[00:52:52] All right.

[00:52:53] Well, one, it's working.

[00:52:55] Right.

[00:52:55] It's worked and worked and worked.

[00:52:57] And not necessarily day to day.

[00:52:59] Right.

[00:52:59] I mean, there are limitations in what we're doing.

[00:53:01] It's a massive simplification, et cetera.

[00:53:04] But eight and a half years later, so it's weathered all these different market environments.

[00:53:08] But it's also about this idea of the index ideal.

[00:53:13] Right.

[00:53:13] If you are trying to – if you're talking to an allocator, a model allocator, who is looking at – wants to look at 25 years of data and then be able to project that data out for another 25 years, if you're constantly changing what you're doing, it becomes – I mean, there are shades of gray here.

[00:53:34] Right.

[00:53:34] The S&P 500 changes over time.

[00:53:36] And people are right about it.

[00:53:38] You know, indices, underlying indices change over time.

[00:53:41] How companies function change over time.

[00:53:43] Accounting – I mean, so things are naturally going to change over time.

[00:53:45] But more stability for anybody who's building a model portfolio is better.

[00:53:50] And so the reason when – you know, I was very excited when StockShop launched this index was because normally when somebody launches into index, it's all backtested data.

[00:54:02] Right.

[00:54:02] You launch it on Monday and everything – Friday and everything before is somebody is sitting there turning to dials.

[00:54:09] And often, you know, the knock on it is if it's all hypothetical data, it's going to look unrealistically good.

[00:54:15] You're going to be – somebody is going to be disappointed and wait for five years to see if it's really working as people expected.

[00:54:22] But in the case of – you know, by handing the replication engine to SockGen, basically, what we're also giving them was the credibility of having done it for eight and a half years.

[00:54:33] And so, again, you know, our view is that we look at what's going on in our models all the time trying to understand it.

[00:54:44] But it's like, you know, we are on constant alert to see if we think something in the world has changed that would cause us to want to change.

[00:54:53] So, for instance, I mean, let's say a year from now, every guy in that managed interest index has 20% of their portfolio in cryptocurrencies.

[00:55:03] Right.

[00:55:04] You know, we have to think about that point.

[00:55:07] Like, do we need to include direct exposure to cryptocurrencies to be able to then accurately match what they would do?

[00:55:14] And we would make that decision at the time.

[00:55:16] But I think what we've been able to show for a long period of time is that the stability of the model is actually a huge benefit if you're in the business of trying to make long-term asset class predictions.

[00:55:33] I'm curious.

[00:55:34] How often do you find yourself – it's always like – well, it's not always, but oftentimes it's obvious after the fact.

[00:55:42] Like, if you see the commodity exposure increase, you know, and you're sort of starting to see that tick up, how often are you actually thinking about the why?

[00:55:53] Or does the why not really – like, after the fact, it might be like, oh, yeah, inflation was here and we – you know, it wasn't transitory and commodities do well in an environment like that.

[00:56:03] But do you find yourself developing that narrative for the investors and the people that you're talking to?

[00:56:10] Or how does that work?

[00:56:11] Oh, absolutely.

[00:56:12] I'm always trying to understand what's going on.

[00:56:14] Like, what's driving it?

[00:56:16] And – but this is also something about – you know, people are – Manitou just can be very disappointing to advisors because they're waiting to hear a story about it.

[00:56:32] You know, the reason we're short the euro today is because, you know, these guys have some special insight that the, you know, whatever.

[00:56:42] If you have France is – like, government is going to fall apart or something terrible else is going to happen.

[00:56:48] But it's not what they do, right?

[00:56:50] And so if you go in pitching, if you set expectations that there's going to be a clever story around it, it can be – I think clients can end up being disappointed.

[00:57:03] I think Jack's dad will be disappointed if the answer to why – you know, why is – you know, why are these guys short the euro?

[00:57:09] Because the euro has been going down.

[00:57:12] I think what you can say instead is that the world is constantly evolving and changing.

[00:57:20] And there are a million different, you know, things going in different directions.

[00:57:25] And that – you know, and usually when you see these big shifts in the portfolio, it's because there are big changes in the world.

[00:57:32] And the portfolios are trying to adapt to it.

[00:57:34] But on my end, what I do try to do is for advisors when I do these videos is just to give them some sort of talking points about like in July we were long equities basically, you know, would have benefited from rising inflation and we're long the dollar.

[00:57:51] That was the Trump trade, right?

[00:57:53] And so if you look at our performance, you could point to that and say, you know, that the market was coming around to a view that Trump was going to win.

[00:58:05] There was going to be a red wave.

[00:58:06] The guy survived an assassination.

[00:58:08] Like it looked like a lock at that point.

[00:58:11] And that was going to have various implications of the market.

[00:58:14] The market was steadily pricing that in.

[00:58:17] And it was great, right?

[00:58:19] Because everything was working.

[00:58:21] And then in a short period of time, though, and, you know, the Democrats did this switcheroo.

[00:58:27] And my God, everyone's shocked.

[00:58:29] It looks like it's working for a while.

[00:58:30] You know, the economic numbers came in really bad for a couple of weeks.

[00:58:35] And Powell basically said, you know, I'm doing what nobody expected.

[00:58:39] I'm going to do, you know, start dropping rates right into the election.

[00:58:43] Right?

[00:58:44] Because so you had these like legitimate surprises that came into the market that then caused, oh, and then Japan, you know, sort of like tossed a match onto the fire with its intervention on the end.

[00:58:56] So when you're going through a bad period, yes, the stories can be very helpful just explaining why.

[00:59:02] You know, and it's not, it's not, it's just the world changed over some, over some short period of time.

[00:59:08] Have you seen anything?

[00:59:09] And this might be an unfair question given what you just kind of said, but anything since the election?

[00:59:14] I mean, it's only been a few weeks, but has anything sort of started to creep up in the portfolio that has you kind of perked up and says, oh, that's kind of interesting that, you know, this area of the market or whatever has, you know, has a little bit of momentum?

[00:59:32] Not yet?

[00:59:33] Well, I guess I would say the narrative of the past several months has been like, it's very annoying to miss a trade.

[00:59:40] It's probably more annoying to have been in the right trade and get the timing wrong.

[00:59:44] Right?

[00:59:45] And so the things that were working in July were the things that were working in October, November.

[00:59:51] And, but the intervening months meant, again, the way these guys operate, they'd gotten out of both the positions and people reach.

[00:59:58] And, Jack, back to your point about short-term, right?

[01:00:00] It's probably more painful to be particularly sensitive to short-term moves around these whipsaws.

[01:00:10] But, you know, it's a little hard to tell from what we do because we see kind of these big simplified aggro did exposures.

[01:00:17] It's definitely felt over the past month that the Trump trade has come back.

[01:00:23] But it feels nervous to me.

[01:00:26] It feels like it's, I don't know, it just, it's felt more confident in July.

[01:00:31] Now it's, now, I don't know, it's, but again, this is my very human interpretation of what I'm seeing in the portfolio.

[01:00:38] And, again, when we see, because of the way these factor models work, like if we see the portfolio being very short the euro, again, it's just doing a correlation map over these price series.

[01:00:51] It's not necessarily drilling down and saying, hey, we think, you know, man, HL and AQR and everybody else really dialed up their short euro position.

[01:00:59] So it's a little bit, it's a little bit hard to draw that, those kind of straight arrow connections.

[01:01:05] Just two more quick questions here as we wrap it up.

[01:01:08] Are you thinking at all about artificial intelligence and how AI might sort of come into the investment process?

[01:01:13] Or is that not really something the firm is?

[01:01:16] My partner is very, very, very focused on AI and its applications.

[01:01:24] Our house view at this point is we don't see it improving what we do.

[01:01:28] It may make certain research things more efficient if we want to.

[01:01:33] I mean, it makes programming a lot more efficient.

[01:01:36] It can make various aspects of our business.

[01:01:40] But, you know, there is a firm out there that does replication using AI.

[01:01:45] Okay.

[01:01:46] And this goes back to the ridiculous absurdity of fact tests.

[01:01:51] They say their claim to fame is they're using AI to replicate better.

[01:01:55] And they're showing numbers from 2005.

[01:01:58] Okay.

[01:01:58] So it's a little bit like when people show trend following models before, you know, before computers existed.

[01:02:05] You know, it's like it's the...

[01:02:11] So I don't think it...

[01:02:13] I mean, our general view is that what we're doing is building factor models, trying to understand how people are positioned is not a new science.

[01:02:20] It's completely tested.

[01:02:22] It's every Wall Street firm, every bank survives on the basis of these things working pretty well.

[01:02:27] It keeps Millennium and Citadel and everybody else afloat.

[01:02:31] Even Renaissance said that, you know, getting simple factor regression...

[01:02:35] Simple regressions right was their, you know, their true secret sauce.

[01:02:40] I think what will happen is that this will be one another area like machine learning, like big data that had an enormous amount of process.

[01:02:49] And that by the time we get to the end of it from an investment side, they'll find that we'll find that the information is so polluted by people who are using this in ways to...

[01:02:59] Like, do you really want more Twitter data to determine whether you should be investing or not?

[01:03:07] At the same time that people are getting, you know, propositioned by bots all day long?

[01:03:12] I mean, it doesn't...

[01:03:12] So our house view is right now the simple, straightforward product that we have we think is going to work well through a period of AI.

[01:03:24] But, you know, we reserve the right to change our mind if this works better than we thought.

[01:03:30] So you're telling me there's no signal in the Twitter data?

[01:03:35] There's no predictability?

[01:03:37] Unless it's off.

[01:03:38] Exactly.

[01:03:40] Shut down the feed, shut down the API, then that's maybe where the awful will come from.

[01:03:44] I changed something in my settings and I just was bombarded with, like, you know, security footage camera of people dying.

[01:03:54] I mean, it's like, I was like, this is just really dystopian.

[01:03:57] Yeah.

[01:03:59] Blue sky is the new place to be, I guess.

[01:04:02] All right.

[01:04:02] So just in closing here, we like to ask all our guests a standard closing question.

[01:04:06] We've already asked you the first one we had.

[01:04:08] So the second time around is, what is the one thing you believe about investing that majority of your peers would disagree with you on?

[01:04:16] Simple usually works better.

[01:04:20] Yeah.

[01:04:20] I mean, I think people think that hedge funds gravitate to complexity because it's necessarily better.

[01:04:30] The very best hedge fund managers and investors that I know, it comes out of simple bets.

[01:04:36] And the geniuses are the ones who can see through all of the noise to what the fundamental underlying bet is.

[01:04:44] And, you know, as it relates to our business, we made a simple bet.

[01:04:51] You know, we made a simple bet that we could accurately figure out the big exposures in such an efficient way that we would have a structural alpha advantage.

[01:05:04] By cutting out what we saw were a lot of fees and expenses, we wouldn't be right all the time, but we would have.

[01:05:11] But going back to that model of being right often enough.

[01:05:15] And if that works simply, why would you change it?

[01:05:19] But that's disappointing to investors.

[01:05:22] A lot of allocators, because they're so used, they're so conditioned to hearing.

[01:05:27] And, you know, and I end up always asking the question, like, you know, what, if quants are so good, if quants are so good, how can so many quants products are so bad?

[01:05:36] And if complicated products are so good, why don't they generate better returns in the S&P?

[01:05:43] And so I think, you know, that's, you mentioned this quote about Renaissance, who's, you know, sort of the quant investing gods.

[01:05:52] This is a great quote from one of the early statisticians who said, you know, that their superpower, in a sense, was just doing these simple regression models.

[01:06:01] But they were pulling people who were doing field theory, you know, string theory at Harvard to do, because it's about asking the right questions and getting it right and resisting the temptation, as you say, to keep, because, you know, with models, people love to keep changing them.

[01:06:16] It's very, very hard.

[01:06:17] And there's pressure to change them, because investors want to see that.

[01:06:22] And so, you know, for years, when we were talking about it, it was the fact that we weren't changing, it was viewed as being, you know, we're being lazy, we're not paying attention, we're this, that.

[01:06:31] And it's hard.

[01:06:33] It actually ended up being a very contrary bet, but I think people are coming around to it now.

[01:06:37] Great.

[01:06:38] Thanks so much, Andrew.

[01:06:38] We really appreciate it.

[01:06:40] Thank you, guys.

[01:06:41] My question is all.

[01:06:42] This is Justin again.

[01:06:43] Thanks so much for tuning in to this episode of Excess Returns.

[01:06:46] You can follow Jack on Twitter at Practical Quant and follow me on Twitter at JJ Carboneau.

[01:06:52] If you found this discussion interesting and valuable, please subscribe in either iTunes or on YouTube or leave a review or a comment.

[01:07:00] We appreciate it.