The Derivative - Advanced Hedge Fund Replication with the Top Down – riding diverse ETF modeling flows with DBi’s Andrew Beer

Episode Date: February 8, 2024

Welcome to the start of a new year and another exciting season of The Derivative Podcast. We're beginning with a bang, featuring DBi’s hedge fund guru, Andrew Beer. Picture the ideal blend of Wall Street expertise and accessible insights - that's what we're delivering in this episode! We’re talking with Andrew about replicating strategies in this episode and if it works. Andrew is sharing his journey, from establishing a commodity firm to making groundbreaking strides in the hedge fund world, where he adds flavor with personal anecdotes from his financial adventures, diving into private equity and managed futures investing - providing beta for those managed futures, replicating hedge fund performance with the help of ETFs, using managed futures as a diversification strategy, unveiling his creative methods to revolutionize investing. We come at all angles in this one, questioning the risks and limitations of replication, utilizing different markets to expanding portfolios, and even getting into the “whipsaw” effect many trend followers saw last year with its unpredictable events. This episode is a feast for finance enthusiasts and newcomers - filled with knowledge, humor, and a whole lot of excitement. Don't just listen; Turn up the volume and brace yourself for an episode that's as fun as it is informative — SEND IT! Chapters:  00:00-03:17= Intro 03:18-9:55= Commodities to Private Equity 9:56-24:54= You’re not a Quant, replicating models and finding your vision 24:55-49:05= Where’s the line? MF against everyone else, asset allocation limitations and modeling flows 49:06-01:08:51= Top down, bottom up: The structure, the drivers and year of the whipsaw 01:08:52-01:19:14= 10 markets expanding your portfolio 01:19:15-01:27:27= Limits of replication & the dangers of private equity   From the episode: Replicating Babies, Trend following, hedge funds, and Warren Buffet with Corey Hoffstein https://dbi.co/news-research/ Follow along with Andrew on Twitter @andrewdbeer1, LinkedIn and visit DBi's website at dbi.co/ for more information. Don't forget to subscribe to ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠The Derivative⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠, follow us on Twitter at ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠@rcmAlts⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠ and our host Jeff at ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠@AttainCap2⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠, or ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠LinkedIn⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠ , and ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠Facebook⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠, and ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠sign-up for our blog digest⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠. Disclaimer: This podcast is provided for informational purposes only and should not be relied upon as legal, business, or tax advice. All opinions expressed by podcast participants are solely their own opinions and do not necessarily reflect the opinions of RCM Alternatives, their affiliates, or companies featured. Due to industry regulations, participants on this podcast are instructed not to make specific trade recommendations, nor reference past or potential profits. And listeners are reminded that managed futures, commodity trading, and other alternative investments are complex and carry a risk of substantial losses. As such, they are not suitable for all investors. For more information, visit ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠www.rcmalternatives.com/disclaimer⁠

Welcome to The Derivative by RCM Alternatives, where we dive into what makes alternative investments go, analyze the strategies of unique hedge fund managers, and chat with interesting guests from across the investment world. Hello there. Producer Jeff was telling me I should come up with something new this year. I don't know. I'm sticking with the Obi-Wan Kenobi line for now. Maybe we'll change it up a little bit later, but, uh, welcome back everyone. Did you miss me? I missed you to be sure. There was Thanksgiving,

then the holiday party circuit, then family here in Chicago over the holidays, New Year's Eve, some skiing. Yes, of course, some skiing, uh, Miami hedge fund week and boom, before you know it, we're here a few days before the Super Bowl. Glad to be back. All that happened since we left was a seemingly straight-up equity market. Pretty poor managed futures performance in November and December, although bouncing back here in Jan and Feb. And the floor just completely falling out of volatility,

with readings showing some of the lowest prices to purchase protection on record. We'll be sure to get into that on a future episode. What will the new year bring with stocks back at all-time highs, rates having stopped going up, sort of? Crypto making noise, the Ukraine war still going on, Middle East seemingly getting worse, not better, and all the rest? I have no idea. And to be honest, most of our guests will have no idea either. They're mostly quants modeling strategies that do what they do no matter which way the wind is blowing, which is what to me makes them so interesting. How do you do that? How do you turn off that part of your brain that doesn't really care what's going on out there in the world?

We'll be bringing you a lot of good ones this season, so go smash that subscribe button, as the kids say, which really means just subscribe to the pod, please, on your favorite platform so we can keep building that audience, which helps us keep getting these great guests. All right, enough about that. Let's get back from the swing of things here. I put to several guests throughout last year, if you can remember what they thought of managed futures replication strategies. Most run their own funds, so we're understandably dubious of the approach. Throughout those questions, I was mostly implying, if not outright saying a few times, Andrew Beer and his managed futures replication strategy. Will it work? Well, it seemed appropriate to go to the source and get his views after hearing all the pans and wonderings about how it could work from others.

So we got Andrew on here and talking through just what he's trying to do and also understand what he's decidedly not trying to do, which is not trying to end the single manager fund business. So let's get to it. Hand your beer, send it. This episode is brought to you by RCM Alternatives Managed Futures Group. Our guest today offers a product he thinks provides a beta to the managed future space. For those who are seeking to outperform that beta, RCM's team helps identify and gain access to single manager managed accounts and funds that are designed to be better than the average. They won't all be, of course. That's how averages work. But the Managed Futures Group believes with its filtering tools and ranking methodology, you can greatly improve your chances. Learn more at

rcmalts.com. And now back to the show. All right. We are here with Andrew Beer, who has the fake New York skyline behind him, even though he is in the actual New York. What's the real view? Just a brick wall or something? Do you need to cover it with that? I just moved two weeks ago. You have a largely empty room behind me. But if you heard echo, it's because unlike you, I don't have the nice furniture making my office comfortable yet. Where'd you move to?

To a place called Darien, Connecticut. So I spent decades living in Connecticut and past several years I've been in New York and other places. So I'm back. You're back. I love it. And you're still, what's the status? You're going into Manhattan for work? I do. Yeah, I go in probably about two days a week. But yeah, for the past 25 years, I've had my own businesses. So even when I've lived outside the city, I've always tried to, you know, balance getting into the city for meetings, stacking it around specific days.

But then I spend most of my time doing stuff like this online these days. Love it. And then take us a little bit through the personal background before we get into the firm. So born and raised Northeast? Born and raised in Manhattan. I'm a native. Went to school through high school. Then I went up to Cambridge, Massachusetts for college, came back to New York.

At some point there, I decided I was going to get into business, but it wasn't obvious. And so I started to work as an M&A banker, went back to Harvard for business school, thought I was going down the private equity path, and then a chance meeting in my, or chance interview in my second year, I ended up going down the hedge fund path um so i've been doing that ever since um i'm relatively eclectic in how i've

done it i started working for a very well-known hedge fund manager as a portfolio manager uh i later ended up starting a a commodity firm called pinnacle Asset Management that you've made run into in your business. That was an interesting story. Back in 2000, I started to get interested in the commodity markets. It was something I didn't know much about, but I could see a couple of things converging and tried to figure out how to make a business out of it. And that ultimately became Pinnacle. And who was the hedge fund again? I know you've said it on other pods, but share it here. Oh, the one I went for, you mean the first one that I went to work for? Yeah, the interview and the first interview.

So I went to work for this guy named Seth Klarman, who is a very well-known value investor. But my career by hedge fund standards is pretty weird. I started as a value-focused guy looking for eclectic investments anywhere you could find them. Eventually, I ended up starting both a hedge fund focused on the commodity markets, but really with a fundamental angle, so different than what we do right now. I called pinnacle asset management, and also around the same time with a different group of guys, started one of the earlier greater china hedge funds um and then my current business is is all about trying to bring um uh certain hedge fund strategies to a broader pool of investors through you know easy to invest in vehicles um well i bounced around yeah do you ever look back and be like oh i should have stuck with carmen always a few billion in the bank the with Carmen. Always. The moment I leave a firm, it's about to take off. I mean, my God, I was, you know, I was on a private equity path. And the guys, you know, that I know who went down that

path, who just stayed on the path, you know, are, I was with a friend of mine in London, who's, you know, one of the greats of the space. He was sitting across the kitchen table. He was saying, remember when I was like, raising a billion-dollar fund was a big deal? He said, we just raised a $25 billion fund. In six months, we'll raise another one. I mean, the business has just taken off. Part of my theory on managed futures as a space is that it has that kind of potential if we can fix some things

in how it's positioned. Before I let you off private equity, any worries that space is too big, too inverted, right? It used to be a premium because it was illiquid. Now it's a discount because it's illiquid. Yeah, look, I mean, I think all these spaces go through when they get institutionalized. And the whole hedge fund industry, I mean, when I look back at the stuff that we were doing at ValPost in the mid-1990s, I mean, you look at that stuff compared to what you can do today, and you should have just done everything. Because there just weren't that many hedge funds doing this kind of stuff.

And so it was kind of a handful of guys against the world and the opportunities were plentiful. Now, you know, every one of those guys has had 20 or 30 guys who've learned at their knee and have now gone off to start new businesses or gone to other firms. It gets it gets immensely more competitive over time. Private equity is the same thing. Private equity used to be Henry Kravis taking some guy to a box at the opera who happened to run a big conglomerate, doing a handshake deal, taking over one of these undermanaged subsidiaries at four times cash flow and having 99 to one leverage.

But the business has evolved. And what private equity has also done by pivoting into something like tech stocks is these are really smart guys who figure out how to evolve and adapt over time. But clearly, the great opportunities that put these things on the map, those are long behind us. Right. So would you recommend your kid goes into private equity or not? I don't know. I mean, that's the tough one. I've got one of these two right now. I've got two daughters who are not interested in business in their twenties and I've got a two year old. So I'm going to have to,

I'll let's talk about the two year old about 15 years. Right. That's a big spread. Well, there even be jobs then he'll just be like, yeah, exactly. Basic income for him.

A little bit of that background and we'll get into the firm in a minute but kind of funny to me that you're kind of running a quant firm quant model right that has to replicate these strategies but you're not necessarily a quant so not at all like once not at all a quant i was being polite but so how do you square that? How did that work out? So actually, so I met a quant in, I was pretty well known in the early 2000s as an entrepreneurial guy who could kind of, because like, I wasn't a typical hedge fund seater. I was basically finding an area of the market that I found really interesting and then scrapping together, you know, the people and the business plan and the money and going out and talking to investors. It was kind of, it was, it was fun. I mean, it was, but it was, it was in my thirties and super active. And in August, 2006, I had a meeting with a guy who really was a quant and he does PhD from MIT.

And he was talking about some sophisticated trading strategy that I said, I just, I don't know. I don't, I don't know how to evaluate it. And then he brought up this idea of hedge fund replication. And I said, what do you mean by that? And he described it in, I mean, look, I'm not a quant, but I almost did a doctorate at Harvard. I would have had to clean up some of my math, but I'm, I'm very comfortable numbers. It could have been a quant. Could have been a quant, right? But he described hedge fund replication, which is really simply just using risk models to figure out kind of the big hedge fund trades. And this was Andrew Lowe? No, this was a guy named Jerome Abernathy.

But it was actually, it happened to be the same month that Andrew Lowe published his paper. And for hedge fund guys, that was obvious. We had just come out of the dot-com crisis, where if you were long small cap value stocks and short large cap growth, you preserved capital through the great bull market. It wasn't like, oh, I only bought the three value stocks and shorted the bad. I mean, you got the areas right. Hedge funds have always been betting the areas right, even the 1990s. I mean, when Baupost was finding really esoteric ways to make money,

they were doing things like buying Russian privatization vouchers. Well, again, it was so cheap. Things were one one hundredth of what they were worth in the West that it almost didn't matter what you bought. You had to find the right areas. So the idea that you could apply a risk model and say, hey, these are the big hedge funds, big trades of hedge funds, and we can copy it cheaply was for a hedge fund guy and not just me. Like I went around and talked to a lot of guys, including Valpost about this.

And they're like, well, of course. The question is is are those the areas that we would be in because we do more esoteric things if you're going to do it with futures contracts so um so what i thought i did because because it was sort of obvious to me from a non-quantitative perspective then when i looked at the numbers and um uh you know over time got more comfortable with how you interact with quants and you work with quants um uh you know over time got more comfortable with how you interact with quants and you work with quants um uh you know i was i was certain that for certain hedge fund strategies this was the most simple and straightforward way to deliver kind of broad-based returns um and the thing about

hedge funds in the 2000s was that the whole space was great. So everyone was just thinking about, like fund to funds, like Rovner had 45 underlying investments like in your backyard, right? I mean, it was super diversified. Just give money to everybody because everybody's going to do well. And so it was a lot about access and fees

and liquidity and other things. And this was just, it seemed to me pretty obvious. And so after about 45 minutes, I'd agreed to basically take a controlling interest in his company, fund it. And that by that weekend, I was, you know, trying to write a patent on this thing. Quick aside, what's a Russian privatization voucher? How does that work?

So when the Soviet Union collapsed, some academics, including many of whom were at Harvard, got this idea that basically the way to take it from a Marxist-Leninist dictatorship to a capitalist economy was you take all the state-owned enterprises and you create tend stock in them called vouchers. And you distribute them to the population in some sort of a scheme. And so because there was no corruption involved in that. It was people with bags of cash, you know, going around to babushkas and, you know, giving them money for stuff that they had no idea what it was worth. And so, look, it was a, was a you know i mean the story's been written on that one yeah indeed i'm jumping all over the map here sorry but do you think some of the where your comment of like all the hedge funds were working we moved to this period where that's obviously not the case and you have is it more of a case of we've just expanded, we've grown, we've evolved,

right? Of now this funds were maybe doing these 50 things. Now they're doing 50,000 things, right? And the categorization and all the different flavors, we've just added way more flavors. So it's hard to say that all are doing something just because there's so many flavors. I don't think it's so many flavors. I think it's actually that just information and knowledge gets disseminated. Take Man of Shooters, right?

I mean, if you were, if it's 1990, like who becomes a Man of Shooters guy in 1990? You're probably in Chicago with you. You're probably connected to pits. You probably like to program, right? So you're the weirdo on the floor and that you like computers. And you're, you know know and how do you and then you've got to figure out like futures roles and do all this stuff like it it was hard to do it back then yeah now um you know uh guy from the wall street journal bob henderson just wrote an article about the fact that you've got these

kind of uh things you can pull down these programs you can pull down and build all of your own trading strategies overnight. And you can trade, right? I mean, like, you know, one of the things about even a strategy like merger ARB that seems so simple and obvious today, that was esoteric. You know, you had to go call a prime broker and borrow stock. It just, so a lot of the right now interactive brokers borrow against your holdings bargain i mean so so the whole um you know the industry goes to this the technology improves access improves i mean even like the whole gamestop saga

right here you had people on you know reddit in reddit chat rooms talking about the delta of options at various levels like that was like you know if you were talking like that in 1990 you were a senior guy at goldman's or some other place you know now it's somebody named hello kitty or something who's doing it did you watch that movie i didn't know i haven't seen it yet either i gotta maybe on the plane this week um right another way to ask that would would john henry have made his billions and own the red socks and everything if he had started today right like yeah probably not probably not right just i actually did that back a year or so ago when chat gpt was becoming a thing just a few keystrokes like hey write me a basic trend following model and then i'm like add this filter add this but right it

wasn't even a programming tool or anything it was just spitting out actual good code for a basic trend following model my comment my comment in bob's article in the wall street journal is basically now millions of people essentially now millions of people can do what they've what their uh their hedge fund idols have always done, which is create things that look great in backtest and lousy and once they go live. True democratization. You can be as dumb as your idols.

Listeners have heard me say this on the pod many times, but when I started my first business, Attain, I was showing my dad this spreadsheet. Like, we're going to do this. He's like, nobody's ever lost money on a spreadsheet, son. Yeah. Okay, perfect. So fast forward, you leave the hedge fund business.

You have this meeting, learning about replication. Yeah, so I think we're going to find a way to create almost index-like products for the hedge fund space. So first problem is everyone I spoke to hated it. Hated it. I'd never been really on the fund-to-fund side of the business, the consulting side of the business, or the wealth management side of the business. I didn't really know those things. And as I got to know those sides of the business, I realized,, oh, you love like all these myths you guys talk about hedge funds. Well, hedge fund guys don't believe that.

But you believe that because that's how you've sold your portfolios of hedge funds to your investors. You know, I found that there were it was deeply threatening what we were doing, right? Because if it worked, the entire multi-hundred billion dollar fund-to-funds industry was essentially worthless. I mean, in fact, one of Grosvenor's competitors in Chicago, who shall remain nameless, but nearly as big, I found out years and years later that they ran internal replication models

to see, you know, could we actually do better than our portfolios of these flags you know our portfolio of greyhounds could this robot dog do better than our portfolio of greyhounds and it did better so they shut it down didn't tell their clients about it because it because it's an existential threat for them yeah destroy that computer yeah so so what i although why couldn't they run it and still right yeah they could have just run it and charge the same fees who knows well or you know or you integrate it in some fashion, but again, the people who've gone into that business, you know, they like picking funds.

You know, you're, if you're running a fund of funds or you're a consultant at who's covering hedge funds, you get really rich and powerful people who will come and kiss your ass to get your attention, to get approved, et cetera. And you have to fly to Florida and go to the conferences and everybody wants to talk to you. It's a very heady experience. When you then say, oh, and by the way, now I could be compared to this really cheap, simple way of doing it with six futures contracts.

If that does better than you, then you're stable of carefully selected thoroughbreds. Not a good look. And then if you do it and you didn't do the thoroughbreds, then you look bad as well. Anyway, so it took years and years and years and years to find a market for what we did. And like a fool, I stayed with it and paid everybody to come to work with me for about 10 years as we were trying to figure this out. There you go. You got to have a vision. You got to have the faith.

Yeah. Not a great vision. But talking about that, is the vision that this can, the replication model, and we'll get into the details in a second, but is the vision, the replication model can be better, perform better than the average, than the top greyhounds, as you called it, then what is it trying to be better or cheaper or in that it's cheaper, it's also better? Well, it's so, and that was sort of something. So in the beginning of replication, 15 years ago, it was hedge funds are amazing. We don't care about fees because they're magicians. And so if we could just get what they're doing after fees, but with liquidity and low fees, it'd be wonderful.

People don't think they're magicians anymore. And so one of the actual, the funny things about replication is when you look at the broad industry, is the broad industry really isn't that interesting. You look at these guys over time, equity markets go up by 10, they go up by 3. Equity markets go down by 10, they go down by 3.

So what it did in a sense is replication actually shined a light on the fact that across the overall industry, hedge funds as an asset class is really not that interesting um and when it's a broad brush of hedge funds mostly we're talking what i would call equity long short event driven relative value now look now there are some within it that are superstars right i mean ken griffin happened to be in my college i don't know the guy um but happened to be in my college class you know that's a guy who he's the michael phelps of investing like i mean just wired somebody called him the elon musk of money like it's just the guy's just

incredible and he will do things at a level that this is why he's the greatest of all time. But the other 99 out of the other 100 people you put in the pot, probably they're going to do well, but you're not so much if you invest with them. So the thing about replication, right after the crisis, we started thinking, just taking a step back and thinking about GFC. I mean, we started thinking about like, you know, what do we do with this tool? Right. I mean, hedge funds thinking about like, you know, what do we do with this tool, right? I mean, hedge funds are not covering themselves in glory. And we sort of realized that actually, no, I think we can actually do better, right? If hedge funds make 10, you get six. Now, replication is not perfect by any means. It's an approximation, but we're pretty good at getting eight or nine out of the 10. And if we can do that efficiently, maybe we'll give you seven.

Maybe we'll give you eight. Sometimes we'll even give you nine. So it became this very, very interesting thing where you can, by being efficient, you can outperform that which is expensive. Now, if you're a sovereign wealth fund who can go to hedge funds and command fees because everybody wants Adia to invest in them or something, we don't bring as much value. But if you're a high-net-worth investor, if you're a wealth advisor, et cetera, who by the time our

product gets to you, it's either watered down or has high fees or something, then we can offer you something of real value. So the big pivot in our business was really around the mid-2000s, late 2000s, mid-2010s through late 2010s, we realized we need to be talking to people who build model portfolios in the wealth management space. Those are the guys we can help. Instead of endowment, whatever. Endowments, pension plans, et cetera. Because look, we're basically a, you know, how can we ruin your career allocation? Yeah. That's right.

Cliff Asness was at the Managed Futures CME Award night they used to have here in Chicago, that big shindig I'm blanking on the name but they gave him the Lifetime Achievement Award and all these CDs were in the crowd snickering he's the one who launched models with low fees, are we sure we should

be giving this guy an award? Yeah Touching on Citadel or Millennium like there's certain places and certain ones you can't replicate right whether because of their scale or their access like where do you where does that line get drawn or do you care by the way i would say like every six months for a number of years people would come to us and say can you replicate uh this not to be named fund? And it's millennium. It's always millennium. And we're like, the only thing we can replicate, when you do a factor analysis of that fund, you don't find any visible factors except money. The factor is they have a money tree in the back.

So, no, because so, you can't do that. You can't do illiquid strategies. They're really only two things you can replicate really reliably, which is equity long short and managed futures. equity exposure, they get out of, you know, value into growth, they pivot from the US to international, it's those kind of big shifts that happen pretty slowly. And, and that, you know, but again, that would be the equivalent of within that group, there's always some guy who's killing it this year. And there's other guys doing terribly. So it's really designed to kind of give you really index like exposure, which which for a hedge fund allocator uh it's not very exciting but for if you build a model portfolio and you're saying i've got these you know 15 different asset classes and one sleeve of it is equity long short it's a way of getting almost diversified low-cost exposure to a strategy where you think because

of the fee differential, you're likely to kind of consistently outperform over time. That's compelling. So it works in really equity long, short, and it works in managed futures and people have tried in other areas and it doesn't work. And what are your thoughts? I can't remember if I was Corey Hofstein, I would have the author and the date of the paper. But there was the paper that once a factor becomes known, basically the factor ceases to exist. And it's hard to make money off that factor anymore. So what are your thoughts? I think the paper had long short equity was one of the examples of right up like if you put all these fact classic long short equity factors they're well known now and the the premiums come way down if not negative or flat um yeah i mean i guess my so i know cory really well he's a super friend of mine and i and and and he actually has jumped into he he used to invest with us now he's jumped into the replication business so he has etfs

that uh compete with us and i'm we had a pod with him last year called replicating babies and something else. So don't listen to him. Yeah, he was having a baby. He had a baby. So replicating humans. So look, and we are all in favor of it. Anybody in this space will tell you that I'm all in favor of more smart people coming in

and trying to figure out ways to deliver it. I guess I would differ with him on two points. One is that by the time the papers are written, it's probably already all over. Not that it's known by then, but that the world changes. So, you know, so by the time Fama wrote his great value paper in 1992, there were no Fama value stocks left. I know because when I went

to work for Seth Martin, I was looking for them. And I also knew on the LBO side, if you had these big fat pitch companies sitting there with a lot of assets on it, and you could borrow nine to one leverage from, I forgot the guy's name, who was the big guy at, I think it was at Bank of America. He was doing all of this, the senior I forget the guy's name, who was the big guy at, I think it was at Bank of America, he was doing all of this kind of the senior tier of leverage, leverage buyouts, then you had junk bonds filling the rest. Well, they bought them all. They're all gone. Right? So value didn't exist by the time Thamma wrote the paper. Momentum didn't exist by the time Carhartt wrote his paper the way they talked about. Now, you can argue or you can, if you want to be a little bit more cynical, you'd say nobody writes papers that where the end result is, sorry, guys, we looked and it's all noise,

right? Everybody has to come up with- David Schawel That one goes in the drawer. Right. Peter Robinson But I think as it relates to hedge fund, it's this, it's in part that, but it's also this just, it's also, I mean, there are a zillion hedge fund guys now. You know, there were dozens of firms, not thousands of firms in the early 1990s. I think what's interesting about managed futures, though, because I think people, like, I think managed futures has been in a 20-year process, 30-year process of commoditization. It's easier to get the information. It's easier to build the models. More and more people have, as great as Man AHL is,

you've got Man AHL descendants sprinkled everywhere. You've got Winton descendants sprinkled everywhere that's a funny man cubs versus tiger cubs man cubs also known as babies and uh but yet it had its best year ever in 2022 right and so because like by that same logic right equities are commoditized you know bonds are commoditized um so the fact that the fact you can easily access something or create strategy right like how hard is it to create a long only equity strategy today right you and i could do it by the time this podcast is over yeah but it doesn't stop the asset class from being interesting. And so what I think people miss about managed futures is people like to look at it in isolation and, you know, this guy is

building a model that's going to beat that guy over time, or that guy's model is better, or he's made some tweaks to it. But to me, it's managed futures against everybody else. Because there aren't many flexible and nimble strategies out there that are good at pivoting and changing their positions when we go through these big regime shifts. Because every one of those pension plans, endowments, advisory firms, model portfolios, etc., they have sold their clients on it's good to be slow. Our job is to be slow. Slow is fast. With a steady hand at the wheel. We don't panic. Sometimes you should panic. In early 2022, if you have a 60 40 portfolio you should have been panicking but their job is not to panic now the beauty of managed futures is beyond a certain point like you know i mean

because they're always looking in the rearview mirror they don't have memories they don't care they didn't tell people that they had some great macro call and rates staying low so so it's it's low. So I fell in love with it as a strategy, as a non-quant, because I realized that every instinct that I have as an investor, something goes down, I want to buy it. It's got to be tethered to some intrinsic value. Something goes way up too much, it's got to come down at some point. And if I were to build a portfolio, it's going to be built around those kinds of principles. But the nature of diversification is you don't find a lot of guys who think like you. You find people and strategies that do things differently. And so managed futures to me is just so interesting in that it's the single most valuable thing that I found to bolt onto that 60-40 portfolio. It really adds some value to it as opposed to most private equity doesn't add value to 60-40 portfolio.

It's equities. You could argue you could swap the 60 with it, but yeah. I've always thought, let me know your thoughts on this. Maybe the factor would break. Maybe it does break from time to time in managed futures because it's so well known. But because of the drawdowns, because of what happens in the normal managed futures profile, people flood back out, which then reinstates the factor back to, right? You know what I'm trying to say? Like, is the natural cycle of it, keep it from breaking long-term?

Like if everyone stood with it through the tough times, would it quote unquote break? I don't think so. I mean, think of the big trades in 2022. You short the yen. You buy oil in the first quarter. You're short treasuries throughout the year. Maybe you're shorting equities at some point.

I don't think those were capacity-constrained trades. Now, the guy who's trading softs, he's going to start hitting a capacity wall much faster. But the space as a whole, I just don't see it. it i mean the space really hasn't grown in 10 years and everything else has grown a lot the risk of it is the same proliferation risk that you see in every other strategy in that you know by the time we get to or it's it's it's the fact that um uh you know sometimes man and shooters are like mosquitoes toward a flame except they're going toward a propeller basically yeah and you know and so by the time you know the flame doesn't sound so good either yeah it's like equally bad a flaming propeller yeah um the you

know in early 2022 there was talk about inflation coming back. But in terms of putting money behind it, it was still a very contrarian trade. It's why certain macro hedge funds had their best year ever. It's why certain, because most people who had told everybody by the end of 2021 that rates were never going up, it's very, very hard to unwind. It's very hard to call your clients and say, three months later, sorry, guys. Because again, it wasn't obvious at that point. But again, managed shooters have this beautiful ability to just lean into it once they see the

tea leaves. They're not worried about getting whipsawed. They're not worried about being embarrassed. They're not worried about the trade running on too long. So the absence of those characteristics is very, very powerful. By the time you get to the fall of 2022 or end of October last year, that instinct also sets them up because they've got their chin out. While human beings are saying, I don't't know you know the you're still short treasuries across the board yeah you heard about that there's a lot yeah have you looked at the you know leaving indicators recently nope because i'm a computer exactly so um but again even in the last two months of last year, which was a terrible time for managed futures, because it was really like the mother of all whipsaws on the rate side, was still, that's okay, because everything else in your portfolio went up.

Right. You know, if everything in your portfolio, stocks and bonds had a correlation above 0.8 last year. Corporate bonds had a correlation to the S&P of 0.9. High yield had a correlation of 0.9. REITs had a correlation of 0.9. Right. This is not good for- Bitcoin.

Yeah. Bitcoin has a correlation of 70, if it's possible. But that was mathematically conceivable. So, you know, I think, so I guess it's, to me, I'm always thinking about it as this is a tool in our broader portfolio set. And when you talk about, you know, people sticking with the investment, it's got to have a role like that. You know, it can't be a trade. It can't be, I'm going to get in and, oh, as soon as there's like sunlight coming up, I'm going to, you know, dump it and a trade it can't be i'm gonna get in and oh as soon as there's like sunlight coming up i'm gonna you know dump it and go back into equities which is now a huge trend right of like i'm gonna put it with the equities in a single investment to hide that

line item risk because people are too behaviorally stupid for lack of a better term to stick with it have you had have you had eric eric Crittenden on? Yeah, multiple times. Second podcast in a row, I'm going to say the guy's a genius for saying that. I mean, he is. No, he's absolutely right. And Abbey Capital has a fund that does it as well. It's, you know, people invest in things that they like. As investment managers, you know, we want to try to convince people of the logic of it.

Here's an ETF with a negative correlation to the S&P 500, 800 basis points per annum of alpha. If the investment is scary and they're going to have trouble explaining it to a client, if they make a 5% allocation to something like that, it's not meaningfully going to change their clients' lives. It's going to meaningfully make their lives better if their clients like it and feel like it's valuable in their portfolio, and it's going to help them to grow their assets and to sleep at night. But zero of those clients in 20 years are going to go back and say, can we do a comparative analysis of what that conversation we had in 2023 as to whether this raised my Sharpe ratio over the subsequent 20 years? It doesn't happen. As you say, you can't spreadsheets versus reality.

I've always loved the efficient frontier and the Sharpe goes up 0.02 or something, right? And you're like, does anyone really care, right? Their volatility was 50 bps higher, and their return was 10 bps higher, like, okay. ticket is going to meaningfully change the risk return of that portfolio. You're going to have a 98% correlation to that which you had yesterday. And if you kill it during the next crisis and this asset outperforms by 20%, you're going to have changed your life by 1%. Yeah. So I think, I mean, a lot of asset allocation is, um, I mean, back to your point, I was on a, a, um, uh, I was asked by a university to help them look at proposals and they had, uh, eight consulting firms have made proposals to their existing portfolio.

And every one of them completely changed the portfolio like this is terrible we should change this change that change this change that add these 12 different asset classes and it was like the same sharp ratio yeah and and so but but that business exists because there's an audience for it right the person at the foundation has to report to trustees and they want to be able to show them an analysis that shows, I mean, it's very much of, it's very theatrical, asset allocation is very theatrical in a lot of ways. And I think what Eric did and what Corey is trying to do now is to take, and we're doing it, trying to do it in different way is to is to listen to the audience you know and and one of the great problems of managed futures i think is that they haven't cared about

the audience that they that that they're used to talking to the family offices you know the european family offices had managed futures since the 1980s and will always have managed futures yeah and they're used to talking to the institution where they've got a consultant, a guy who covers only macro funds and loves to go around and talk to all the 20 constituents of the Sock Gen CTA Index and write reports on who's doing what and who's not. And that works in that audience. It doesn't work for somebody

who's not neck deep in the space. And I think Corey is addressing something around, you know, where are you going to take money to put it into managed futures? You've got to take money from something and that raises the risk that you're wrong. So you take it from equities and then equities outperform, you look bad. You take it from bonds and bonds outperform, you look bad. So maybe you don't have to take it from anywhere.

Eric's addressing a separate issue, which is you and I both agree this is a great investment and you and I both agree it can be awful in certain years. We both agree you won't stick with it during those offers. Because

the business of people is not winning an argument the business of like advisors is not winning an argument to prove to their clients that they would give them the better shortwave it's to keep their clients happy yeah and it's to keep their clients engaged etc so a cynical view would be it's even to like reduce the number of phone calls which is honestly if it helps the clients not to get anxious about the underlying investment. Yeah, make that call. The asset management is very weird in that the out there that do long only stock picking have added zero negative value to clients over the past 50 years. But people still do it.

Yeah. Because, I mean, if you ask me. I do it. I have a little play account. It's fun. You get that. Woo. get the rent. If you ask me, do I think it's a good use of my time to start pulling up 10Ks and looking at companies and try to figure out where I put incremental dollars?

Absolutely not. I have much better, much more important, but not more important, but much more valuable things that I can be doing like this um the uh so the asset management industry as a whole offers something of value that is not economic in nature and and i think you know the etf business in a sense and and a lot of the evolutions in asset management has been hearing like like for instance private equity right there's this this this you know journalists started writing a few years ago about And a lot of the evolutions in asset management has been hearing, like, for instance, private equity. There's this, you know, journalists started writing a few years ago about like, you know, watch the markets have gone down in 2022 and private equity firms aren't going to mark down their assets the way they should. And yeah, and it's, you know, they're pulling the wool over their client size.

OK, so I called some guys who run private equity firms that I grew up in the business with. I'm like, talk to me about this. And they're like, seriously, we don't care. Like, we really don't care what our year-end mark is on XYZ company. You know who cares? Our clients. And if we're co-invested with those guys over there and they mark their investment up, same investment more, more than we do, they're more aggressive on the way up and more aggressive in not marking the way down. It actually makes our investor look bad to his investment committee. Right.

So it's, I think there's this, this, I think, you know, what I've learned over time, going back to, you know, my foolhardy decision to get into this business and not really understand what the end audience really cared about, which I think was very naive. My 15-year education has been, listen really hard to what people are saying. And think about, is what they're saying they want what they really want? Does it really make their lives better? Because you get people throwing out things like, oh, I want something that has no correlation to equities. Sure, yeah.

But why? How does that actually make, if that's a 3% allocation in a portfolio, how does that actually make your life better? And I think it does in many circumstances, but it's not always obvious. Circle back to something you said before on the capacity and different positions. Curious of your thoughts, because you're kind of modeling flows essentially, right? Into and out of different markets of when you see these articles of, oh, the CTAs are all going to get short here. They're all going to get short here they're all going to go long and they're all going to exit and that's what caused the sell-off and i'm seeing books of actual positions i'm like that's not happening whatsoever so yeah that's look that's

like the media version of of cta is like it's when you read the headline it's like um you know you know trump lied biden stumbled like it's like yeah come on guys the um uh cta's big sellers down huge sellers you know this is this is the point at which they're all going to go short it's gonna it's gonna be 30 billion dollars of selling yeah which has absolutely no impact on anything right tomorrow could be 130 billion of buying for some other not neck and yeah so so we um uh yeah i i think that i think it's i know a lot of journalists i'm very very good friends with a lot of journalists and competition in that space is around finding exciting things to write about and in the same way that you know you go to publish an academic paper

you have a huge incentive to make it interesting paper, you have a huge incentive to make it interesting. You know, journalists have a huge incentive to make it interesting. If you read about hedge fund positioning, you know, it's often like, you know, record reduction in net long exposure of equity, long, short hedge funds from 38 to 37 in one week. Like, here's the weekly moves. And we've never had a 100 basis point move. And it's like, it's natural for people to do it. But I think as investors, and I think where I think within the managed future space, it's more slow moving and more obvious than I think most people think, at least when I look at

our portfolios. Now, what we're doing is very different, right? So the way I think about the managed future space is that you've got a lot of really smart guys who build what we call wave detectors. You know, the markets are going up and down everywhere, and they're looking for waves in the markets. If something's going down,

they want to be betting on it continuing. This, in general, if it's going up, they want to bet on it going up. And so the bias is, you know, well, would it be better to analyze 100 waves than 10 waves? Because what if wave 97 is the great wave this year? And I think there are two reasons people do it. One is there is some evidence that diversification beyond a small number of instruments does help your risk-adjusted returns. But I think it also sounds great, right? I mean, oh, you know, 430 markets. Have you seen the moves in wheat last month, you know, or, and, and, and, but the thing is also

when you go to a hundred instruments or more, you also don't bet the farm on any underlying instrument. So our view, when we looked at the space was that actually that information is really valuable. But again, as somebody who also started a commodity business, commodities move in clusters. If oil goes up over the next five years, natural gas isn't going down. It may go up 2x, it may go up the same amount or something. Or if their underlying things like interest rates are going up, that's going to reverberate through a lot of different markets. So the idea behind replication is not to worry about whether we're picking up on trade 72 or 73, et cetera, but rather to say what portfolio of the deepest, most liquid instruments, two-year, 10-year, 30-year treasury futures, S&P 500, IFA, EM, Euro, Yen, crude oil, gold, these really, really big, deepest, most liquid instruments

are representative of those clusters. Because the nice thing about those instruments is you have nearly unlimited capacity. And you also, they're incredibly efficient to trade. And when you have a portfolio, it's not that hard to understand. You can look at it and actually get a feel as to when you look at the markets, whether we should be up or down today. And so I think if you think about it from that framework, and then you think about this idea of if CTAs flip from long to short, which by the way will happen much more gradually than people expect, then you see that it's, this is, this is not a strategy that I see having a huge impact, like driving,

like a tail wagging the dog. Talk for a second. I get them confused. So you're a top down. We're top down. Yeah. Top down. I've always thought until somewhat a couple years ago that most replicators were, I'm going to bottom up, I'm going to build a strategy that mimics the index. So you could do it both ways.

You found top-down better? Yeah, so we looked at bottom-up, and we actually run our own models. But we use our own models and sanity checks. But we run simple models, right? Like, you know, 50 in 10 days and, you know, 150 and 20. I mean, like all sorts of things to look at it because it gives us a sanity check on what we're seeing.

We are totally top down, right? So we're taking daily performance data of hedge funds and their ilk, and basically looking at a big diversified pool and inferring what their positions are today. And then we wait a week and then rebalance again. So Corey, for instance, uses that as part of what he does. Now, the bottom up says, well, that's kind of incomplete. You know, what if in early November or mid-November, it looks like, wow, this is the big one on rates. This is the big pivot. Well, we've also got shorter term models in here. We've got other things in here that are kind of be picking up on that, which you wouldn't pick up on in a sort of simple replication. The reason we didn't do those is because we think the greatest landmine

for a lot of investors investing in this space is single manager risk. You have a space with massive dispersion between the winners and losers every year compared to most other asset classes and with no persistence of returns, no persistence of alpha. So the guy who did well last year is statistically no more likely to do well this year. And often, you know, often he was wildly leveraged into some trade that worked really well last year, more so than the next guy, and then gets tanked this year. So even if you build a bottom-up model index, like Mount Lucas has a very good one. They have an ETF called KMLM. You have to make a lot of decisions as to how you want

to do it. And in general, when you're doing bottom-up replication, you can't keep changing your mind every six months because then you're not a replication. You're just a single manager firm. So they're very rigid in the approach. And we don't think the space is rigid. We think the space is more naturally evolved. So the reason we like- So your bottom up might work for six months and then it's outdated. Yeah.

I mean, KMLM has been, Mount Lucas has been on a tear for two years. They had great numbers the past two years um and but if they started three years or five years before that you'd have a much more mixed picture right and same thing happens with our our models and i think it'll happen to corey it'll happen everybody else does it so they're great in that they tend to be cheaper and efficient and transparent and easy to understand uh but they have limitations now my classic example is the wisdom tree futures that pick trader vix model that didn't go short energies and like literally

after they launched it there was the huge 2014 sell-off in oil and they way underperforming like well and they look at in 2022 right they had a a. They added Bitcoin, I think, at the end of 2021. Bitcoin cost them a lot last year and made them the top performer in 2022 and made them the top performer last year. So the whole point is that when you're investing in space, and that can be great fun for allocators, because you're always trying to figure out how do I mix and match these guys to put them together into some sort of a diversified package. Our view was there already is the diversified package. It's the Sock Gen CTA index with the 20 largest hedge funds. It's the Barclay index. So you already have measures of the diversified portfolios. And again, this is a little bit of the difference in what we're trying to do.

A typical guy in this space is like, how am I going to generate the most returns and capture the best trends? It's very focused on them. Our appeal is that we're trying to be the index, the benchmark. We're trying to become the default allocation. If you want to invest in managed futures, we want to be the most simple and straightforward way to get broad-based exposure. What does that mean? It means not betting on Fred or Harry or Jana or whomever else. It means having broad-based exposure to the managers in space because three years from now,

when you're sitting in front of your ic or your clients and they're evaluating how well this strategy did yes they'll care whether it went up or down over that period of time but if the benchmark is up five a year and you're flat that's a much bigger problem than if the benchmark is up five a year and you're up seven right and if the seven comes from just being cheaper and more efficient uh then um uh then for a model allocator we think that's what they were trying to do because that's what we were trying to do in one of our own portfolios the and where do you where do you think or where do you aim to land well two questions one i'll go

back to dispersion. Don't. I've always had a little bit of issue with this of the dispersion. If I look just inside the trend index, right, the dispersion is not as great. No, no. Trend is much tighter. Yeah. So it's a little like, yes, CTA, but that's because we have 72 different things inside the CTA index, some short term, some discretionary, some.

So putting that aside for a second, and there's many things you can do to lower the dispersion of like, okay, if I vol weight them and I have guys that only have five-year track records, there's a few things you can do to really tighten in that dispersion. Unquestionably, we're not a sea change from what people do. So an institutional investor is going to pick six guys in the Sock Gen CTA Index, obviously not all six long-term trend guys. And they're going to mix

their bets around. And that package, though, is going to look a lot like the Sock Gen CTA Index over time. Because that's where they're trying to get diversification. If you only love trend and you think that actually the real driver, and I personally Because that's where they're trying to get diversification. If you only love trend, right? And you think that actually the real driver, and I personally think long-term trend is the most valuable thing within the managerial space, most durable thing. You can pick Alpha Simplex. You know, you can pick, if you're brave, you'll pick Dunn Capital.

If you, you can pick a lot of people in the space, a low-course market trend fund. There are a lot of things out there that'll give you that. Now, they're all going to have, because the big driver returns of something of the benchmark, the SockChance ET index, is trend and long-term trend. That's a bigger driver returns than anything else. You'll have an 80% correlation, 83% correlation over time. That's going to be my question. Why not just take the index and pick the guy with the highest correlation? We would be the highest guy with the correlation.

So we're 90, right?'re we're we're a bit better but but again it's not a it's not night and day and you know we've also tried to make it cheaper and in an etf which nobody else has really done so so okay i'm in there i've got the high correlation in any one period do you have a goal of like i want to be above average i want to be average i want to be in the top five i want to be right like how are you explaining to investors like by definition you're probably never going to be the best and probably never going to be the worst but you're somewhere in between there yeah and usually i would say we're consistently in the second quartile okay right so and i mean i don mean, you have to pick like how much of a rolling, you know, time period you want to pick.

But again, my goal would be whatever the index is up over three years, we're hoping to be ahead of it. You know, one, two, three, 400 basis points, depending upon it. Last year, we had a terrible year by our standards. We underperformed, right? It was the first year that we'd gone through that. You know, so what I also tell people is replication is a simplification. It's not perfect.

There are two things that can go wrong with replication. Well, three things. One is you can do a bad job of modeling it, which fortunately we haven't done. We've been doing this forever. But you can get very cute on the modeling side, and that's what tends to blow people up. The second thing is we're going to miss traits. So if you think about those clusters, sometimes you're going to have a, just think about it simplistically. If we're picking up trades, big trades, the largest 10 trades, but across the space, you've got another 90 trades out there. Most of the time, some of

them will be going gangbusters in their favor, and some of them will be getting whipsawed and punished on them and so they kind of average out over time so our argument is that most of the time 90 or more of the time just by efficiency will tend to outperform in january february of last year a whole bunch of things that we weren't exposed to went up at the same time mexican peso canadian front end of the canadian interest rate curve um uh uh what uh nike went up like it all this was all we softs were going up all these things that we weren't touching were going up at the same time so we underperformed but the key is the question then is is that something structural right is for the next 10 years are these guys going to be making money only in these markets slightly more far field markets or less central markets? Our view,

having looked at this for a long time, is that's probably not going to happen. That actually the big clusters, the big drivers. So we didn't change anything. And then we came back in the second and third quarters and we outperformed. Or we can be too slow second risk is we're too slow because everybody in the managerial space is looking in a rear view mirror but we're looking in a rear view mirror of their rear view mirrors and so you know we will we can be now half the time being a little bit slower, works in our favor. You don't get whipped in and out.

You don't get that whipsawed, right? Because people talk about vol controls and short-term models. Like take an American Beacon man, AHL, and PIMCO were great in November and December on a relative basis. Because they have a lot more shorter-term models. They have vol controls. They have all sorts of bells and whistles that basically, you know, somebody's pulling the shoot board. Right. But it means that by the time they get to Jan one, you know,

it looks like they're now long bonds. Right. So they've, they've, they've pivoted faster, but then now they're betting that rates are going to keep going down and then it reverses. So the same thing happened in March of last year, they pivoted out of things quickly and it took them forever to reestablish Rates are going to keep going down. And then it reverses. So the same thing happened in March of last year. They pivoted out of things quickly. And it took them forever to reestablish their positions. And rates started going back up.

So our investment and research conclusion is that both those two risks are manageable over time. And are outweighed by the amount that we tend to outperform. So just, we started doing this in 2016. We outperformed in 2016. We outperformed in 2017. We outperformed in 2018. We outperformed in 2019. We matched in 2020, outperformed in 2021, outperformed in 2022 by varying amounts, right? Sometimes it was by more than we would expect, sometimes a little bit less than we'd expect. i'll throw in a past performance is not necessarily indicative of future results well and look last year we underperformed by by more than we would have expected because it was like you know it felt like but it's very frustrating i've got i do these videos by the way we talk about it on on uh if you go to dbmf.com i talk about this stuff

because it's you know we're very open with our investors. And I was, I had 23 flag to talk about, so we can jump in there. What made 23 so difficult? I'm seeing some reports. I'm going to get around to writing a blog post about it. Like the worst year for trend falling of all time, perhaps. Is that what you're seeing in your models and your. Well, having lived through it, it felt like the year of the whipsaw. falling of all time perhaps um is that what you're seeing in your models and your well having having lived through it it felt like the year of the whipsaw like it's it's i mean it just felt like like every time you know you felt like you really had that kind of momentum that you felt

in 2022 because i mean i mean 2022 was was a historically good year but it was scary right i mean you're you're you're still holding your yen short down at 150 yeah when you know when the bank of japan's like saying all that stuff yeah like yeah i mean i mean it's i mean managed futures is like that though right i mean you're you're often particularly if you're a trend follower you're going to be in a trade after the money's been made when when when the commentary is starting to pile on that we're due for a big reversal. Now, in 2022, because you had this underlying regime shift in rates that went on for 18 months, basically, it was the right thing to do. Last year, we start with the markets utterly convinced in January

that we're going to be tapering by the second half of the year then then and then february comes around and it's going to be higher for longer and now just as you're kind of like like you know it's starting to work then svb happens that was and you have like a three and you have somebody said it was like a 13 sigma move in treasuries which i think is you know i have a higher likelihood of getting hit by a comet before this call is over um but um so and then and then you're making money back right and and and and by late summer it's it's oh with rates going up you know they the the conversation is about oh with rates going up the market is doing the job for the fed the fed doesn't have to raise any more but they're definitely not not lowering rates anytime soon and then Powell surprised the crap out of everybody on November 1st and so then rates

start to plummet from there and it's a huge whipsaw which because by the time if you think from a trend falling perspective right you basically had steadily rising rates since uh since April and so if you're a short-term model your short rates if you're a short-term model, you're short rates. If you're a long-term model, you're really short rates. And then it starts to go down. Now, one of two things can happen. Either Powell can say they can start to jawbone. I thought they were going to.

They're going to jawbone and say the market's gotten too far ahead of itself. It's something, something, something. And in which case, the short-term guys would have been caught flat-footed. But instead, what happened was he basically piled on. You know, he had that second thing where he said, yeah, yeah, yeah, we're done. And then the market, you know, again, because it's not just a change in fundamental information. It's people racing to catch up. You know, allocators all over the world who have had no duration going

into it yeah especially the end of the year maybe have some oh my god they don't want to sit in front of their investing committees and look like they missed it so yeah i'm in there look yeah oh yeah look yeah december 14th and then and what did your book look like so we i think we mentioned before you're only in 10 positions ever right yep so for most of that most of that pain experience was what the 10 year the 30 year which bonds are part of those 10 what's it's the two tens and thirties and it was across the board yeah i mean it was uh no it you know this is the funny thing about last year, and I think this is sort of interesting, is to us, at least, when we looked at it, it was truly a one trade market. So interestingly, the very best replication we came up with last year was not a 10 factor model, was not a 15 factor model.

It was a one factor. One factor. It was the two yearyear treasury, actually. The two-year treasury. Everything in the markets was moving on the basis of what they thought was going to happen to short-term U.S. interest rates. And you had a correlation of 93% or 94%, and you just tracked along the SockChain CTA index.

Obviously, we wouldn't run that as a strategy because the moment we implement it, it will fail miserably because the market gods hate that stuff. It's too cute. But it was just really interesting. So basically, it wasn't just when the reversal happened, it also cascaded through currency markets.

If you're short the yen and then Powell says that the rate hikes are over, guess what's going up? The yen. reversal happened it also cascaded through currency markets you know if you're short the yen and then Powell says that the rate Heights are over guess what's going up the end um so you know so with managed futures you know when they lose money this is when um it's usually because they have a lot of instead of having three or four different distinct clusters you've got kind of one big cluster expressed with lots and lots of different positions. And that's what happened last year. Two things on that. One, having the three rate markets, twos, tens, and thirties, how do you square that with the concept of like, no, we're just trying to have one market per sector or one, right, when they're clustering

and I want to identify that cluster with one market, or it doesn't have to be one obviously so the the research that we did back in 2015 2015 2016 was to do this well uh you need all four asset classes equities rates currencies and and uh commodities uh and that's but even within the context of that, uh, the first models we ran were only four factors, one in each market. And I published a short note in institutional investor last year, showing the results of that. It was one market per sector, one mark, one market, one instrument per market. Um, and yeah, look, it worked.

It works embarrassingly well for a business that sells itself on on on complexity on 78 market yeah yeah but but um we are very very very um we try very hard not to fool ourselves and and and the great problem in modeling is how easy it is to fool yourself that you found something special and sustainable so we looked at a million different ways we looked at different combinations of random instruments um and i think i think what what got me comfortable you know the first guy that i worked for wrote this book called margin of safety and in a sense on the statistical side you know we're trying to find something that has what we'd call statistical margin of safety if you if we took our 10 factors

and replace them with 10 different factors our results don't change very much um if we changed our window lengths that that we're looking at over time. It doesn't change very much. We change the way. So that for somebody who's modeling is our measures of stability and durability. And then is there kind of an underlying rationale behind it? So we wanted to, we're trying to fight a balancing act. We want to expand it so we get more diversified exposure. And there's sometimes, you know, sometimes happening like this month where we've been long the S&P 500 and short emerging markets against it. Working great. Good trade.

Good trade, right? That would be an awful lot better than just having the S&P 500. You know, knowing these markets, it could hurt us in a month or in a week or something. But so it was really, and we were also very sensitive from day one to liquidity and execution costs. So we're fairly big. We probably got a billion and a half dollars

in managed future strategies. And my guess is relative to anybody else in this space with those kinds of assets, we are a very unattractive by brokerage client. Yeah. Because we only,

we just don't trade the stuff where they make a lot of money in. So let's quick go over the 10 markets. Sure. 2s, 10s, 30s. 2s, 10s, 30s. Crude oil, gold. S&P 500,

IFA, and emerging markets. And then, Euro and Yen. And then, so the IFA and emerging must be, and then Euro and Yen. So the IFA and emerging must be your thinnest markets? Yes. Out of those futures? Yeah.

And then this popped into my head as we're saying that. So if 23 was bad because basically there were a bunch of disperse, the dispersion expanded and there was some outlier moves like you could argue that that whole post 20 2008 great period for managed futures volatility came down fed cut rate to zero that whole period that zero rate period i could argue made it all one trade kind of right like things you didn't have all these multiple bets, especially in trend following portfolios. So if you modeled it during that period, any concern that if that Jan-Feb kind of,

right, we start to see way more dispersion, do you have to expand the portfolio? Yeah, we look all the time at whether we should. One of the things that, and we will expand it if we feel like we need to and there's a good underlying basis for it I'll give you an example

in I think September 2021, maybe September 20 natural gas was up like 34% and oil didn't move much. So going into that, the way our models would see it was basically, let's say you've got a dollar in natural gas and a dollar in crude oil, we're going to see $2.2 of crude oil or something like that basically in an initiative and so so our exposure didn't participate at all and when we read it we said what if we had we were like why don't we underperform yet the the suction ct index last month and it was pretty obvious right

it's like okay well because we don't have crude oil so if we'd had crude oil sorry we had natural gas in a seven percent position and so we would have made two points right so now the question is okay do we think september is unusual or is there a reason to believe that somehow crude oil and natural gas which are normally very similar yeah are now somehow going to be moving in a lot of different directions. And we didn't think there was any fundamental or economic reason. And so, you know, then we go back and we look at 20 years of history and we say, let's do it again. You know, what if we'd had natural gas? Would it have made the models function much better?

And our conclusion, whenever we look at this stuff, almost has always been, sure, there are going to be periods of time when it helps. And there'll be periods of time when it hurts. And in some, does it meaningfully improve our correlations? Does it meaningfully improve our returns? So we have a pretty high bar for changing it. And, you know, when I talked to clients about it, I said, you know, the measure of success, right, we started doing this seven and a half years ago and we haven't changed a thing, right? And we've outperformed maybe 90% of the constituents of the SOC Gen C etiology since we started. Because if you do a little bit better, a little bit better, a little bit better, a little bit better over time, you kind of climb your way up in the second quartile, well up into the first quartile. But that's very unusual in Quantland because usually they come to you and say,

oh, we've made all these great changes to the model. You only make changes to the model if the thing's not working. You don't say, oh, God, we have this thing. We're killing it on these trades, but we're going to park them aside for now because we think it's too much of a good thing. So we're going to introduce these new things on top of it.

So it makes it very hard if you're trying to evaluate something over a long-term perspective and the investors we want are thinking about, I want this in my portfolio for 10 years, because I can look back and see 23 years of history of the space and however long we've been doing it. For those guys, consistency and stability ends up being quite important. So our goal would be, our hope would be 10 years from now, we can say we still haven't changed the model. Because if we're saying that, it means it's been working well enough that we don't have to. And how many people do you run into that just blows their mind? Like, wait,

no, you can't do this with 10 markets. What are you talking about? And you're a month delay, right? Do you rebalance weekly or monthly? We rebalance weekly. Weekly. So you're a week behind by definition, up to a week. Yeah, because the space is a lot of daily data. So we're seeing Friday's numbers by the time we rebalance on Monday. But we're looking at a couple of weeks.

So there's a week or two of delay in it when when you when you just sort of average it out um it was uh smart alligators like phd caliber allocators who are seasoned grizzled hedge fund allocators think what we do is obvious yeah um right they just think you're a marketing for like okay you put this in a nice package and are selling it. Yeah, look, it's... Some of them have done the same analysis themselves and it doesn't surprise them at all. If your job is to pick individual funds,

you know, it's more challenging for people to buy into it because a lot of their manager selection is around the 10% that makes this guy different for the next guy. And people in the space. At first, when I started going on podcasts after the ETF was launched in early 2022, I did this thing called Top Traders Unplugged with Niels from Dunn Capital. And a lot of, I think, people in the States were very skeptical. And they were highlighting a lot of the limitations of the strategy. And we're very open about the limitations of the strategy.

So it's not like it's, but it was, but I think it's caused a shift in thinking. And the reason I wrote that thing in institutional investor was because people would say, you know, 10 is you're not getting enough diversification with 10. You need to have a lot more than that. And then I said, well, actually, you're not that far off if you do four as well. So part of, you know, part of my job though, is that as you, you know, what we're doing is a bit of, you know, part of my job though, is that as you, you know, what we're doing is, is a bit different, you know, it requires a lot of time talking to people and explaining it and

why we made the decisions that we made. Um, but again, and I think also, look, I think it's also for me, it's, it's, it's talking to an audience that where we can be helpful. And then my flip side of that question is how, what percent of your assets do you think don't even know that it's replication or don't they're just seeing a number and knowing the category and like what you're doing? I think I've spoken to most of our investors. You know, I think, I think the investors fall into I'd say probably maybe three broad buckets.

I think there are some people we have who just probably see the numbers and invest in it. It's easy to invest in the CTF and they just go buy it. Another group are more sophisticated and we have these one-on-one conversations about what we're doing. And often they think, okay, you know, it's, it does something very valuable, very efficiently, but I want to pair it with something else. You know, look, I mean, hey, it's not, I mean, ManHL or PIMCO will do better

in the last November and December, will do better than this month. Like there's sort of predictable. So it can be kind of one plus one is 2.2. So we just become a tool in their portfolios. And I think the third group, though, are people who, even though they're investing in a quantitative product, like if I was an equity long short manager, they wouldn't be trying to look over my shoulder and say, did he calculate EBITDA correctly there? How do I know he's reading that footnote correctly? Exactly. They hear me talk about how we tried to build something,

first for ourselves and one of our most important clients, and then brought it into an ETF, why we make decisions that we make, that there are human beings who don't sleep a whole lot because they want to make sure this thing is doing what it's supposed to be doing and if we could be very clear about what its objectives are how we think it can work in their portfolios um then whether yeah nobody's mechanics of replication the number of instruments doesn't really matter you know it's like it's like oh i'm not going to invest that

in that equity manager he's only got 17 positions not 43 you know it's just it's it's it's well he must well it's funny you mentioned that because that is often articles of like they're not really doing anything they're only in four positions or right for some of these equity positions for a long time but it's but you know the thing is like when you're it's hard not to do things in this business yeah you know and that's that's one of the that's one of the things that plagues quant investing hard not to add bells and whistles and yeah i mean so look you mentioned kind of the things that plagues quant investing. Hard not to add bells and whistles. Yeah. I mean, so look, you mentioned the bottom-up replication stuff.

A lot of that started with banks in the mid-2000s, early to mid-2000s. And the stuff they generated on average was garbage. Yeah, the risk-premium platforms and all that. The risk-premium platforms. I mean, this stuff had negative sharp ratios um on average it was the the studies that were done showed that they'd show you a back-tested number it would go live that the sharp ratio would drop 60 or 70 percent um and so but why right the incentive structure is all wrong yeah yeah you've got you've got quants there who have 37 different products there's great pressure to crank out the next one

you make it look as good as it can the marketing goes guys try to go sell it they hope it works you're probably not going to be at the bank in three years when right just get stuff on the shelf we're getting out so it's not surprising it's gonna be bad you know i mean the fact that i'm i'm the the fool who got into this business, you know, 10 years before. It was interesting. It actually gives you some gravitas that, you know, this is not something we just jumped into to try to sell somebody a product. And last bit here, along those lines, what do you think the limits of replication are like we both know what guy here in chicago does like uh venture capital replication and he's working on

healthcare replication uh i was at a talk where the guy's like here's how you can trade lithium futures when there are no lithium futures by replicating it with copper and short gold whatever it was so like what what are your thoughts on just some of that more esoteric stuff of are there limits to it or what are the dangers of that right of like hey i can replicate x by doing y yeah so the only the only one i know well it's private equity replication um you're talking about dsc out there are those guys yeah great guys and and and terrific firm and they've been doing and they've actually made some important innovations in in in what they've done the um uh and they have i think a very credible

way of going about this um the uh when you look at private equity it's a lot harder than it sounds. There are some, this whole industry, the problem with this whole industry is we have a massive selection or survivorship bias problem in that when something is working, you will have no problem finding out about it. When it stops working, people bury it quietly and hope you never look, don't look too hard. And so you can go back and look at some credible people who launched private equity replication products that did much, much, much worse. Same thing with the risk premium products. If you went to an AQR or a BlackRock and said, as they were launching their multi-strategy

products and said, what do you think is the probability that you'll be down 30 peak to trough in the next year or two they would have told you impossible zero right it's impossible we're doing six percent a year with a six percent standard deviation no correlation anything and then it happened right if if that was a stock picker that's the guy who His first three picks are frauds, basically. And so, but... So private equity replication has... can have some of those issues. People have tried to do it. So, look, lithium... I know nothing about lithium futures.

They may or they may not work. But... Well, there are none. That's what... Well, yeah, but I'm saying, like know, like, so our sense is that replication works very well, at least the way we do it, in very limited circumstances. And I never went down the private equity route because I think you're taking away the thing that people like the most about private equity. And I've had enough conversations with people at institutions who their very favorite thing about private equity is it doesn't go down as much and they mark it up and it's slow moving and they don't have to watch it every day. They

don't get any surprise calls from investing committee members figuring out what's going on. They love that it's not mark to market yeah and so you make it liquid well you could replicate that like hey just turn off your computer and don't look at this thing for six years that's a replicated product that that was buffett's argued about the sp500 yeah you know he's put 95 of the sp500 and don't look at it um but they can't not look at it right because they have reporting and and um so we did we reporting. And so we didn't do it for that reason. And I think there's some arguments that there's been a huge, guys that I know in this space, I think there's been a transfer of wealth. By the time you got into the mid-2010s, the typical bond investor was so outclassed by the private equity guys, and they were so desperate to put money to work that they were issuing bonds with no covenants and crazily risky companies with 5% or 6% yields. These guys were designed to sweep up that opportunity. So I think that, you know, the answer is that I think these things

always change over time. And I just, private equity at replication, I think you can make it work. It's not something we decide to really try to make work. Awesome. I think we'll leave it there. We've had you along enough.

Any last thoughts before we go? No, well, look, I mean, I hope the year of the whipsaw was an anomaly. We've had you along enough. Any last thoughts before we go? No. Well, look, I mean, I hope the year of the whipsaw was an anomaly. I hope the firing on all cylinders of 2022. I mean, I personally, I think the world is going to be a lot more volatile. I think it's much harder to get diversification than it was for a long time. And it's probably going to continue. And there's actually a very good editorial in the Wall Street Journal today

about the market seemed kind of calm when you think about the smoke coming out of the windows of various corners of the world right now. Yeah, exactly. And so my guess is that we're in one of those periods right now where there was this collective sigh of relief that Powell wasn't going to deliberately drive the economy into a ditch. But then now we're going to start, even as we're seeing with, you know, maybe rate hikes are going to be around.

Wait, the government's not going to stop spending money. Maybe people are not going to stop spending money as fast as we thought. I think you could see, I think it's going to be a challenging number of years. A lot of headwinds to pay soon. I was listening to a Chicago interview where some consumer in the grocery store was like, the government's saying inflation's down to three. This stuff, price hasn't changed. I've been coming here every week. The price of, I can't remember what he's pointing at, a can of soup or something. He's like, this price hasn't changed. It been coming here every week the price of i can't remember what he's pointing at a can of soup or something he's like this price hasn't changed it's not down at all

and so it's like i think he's talking about the rate of change like we're not going to wade into that but yeah but people have that right they're like prices aren't down they've just stopped going up well i mean like powell is you know powell may have pulled out the unthinkable yeah right i mean i don't know of a serious macro guy who thought you could you know land this plane on a postage stand which which he may have done or you know it's or or or we're going to see some you know more interesting happen at this point but awesome well thanks andrew it was great talking thank you so much for having me on it's great to talk you up next time in new york and i'll be in chicago uh next month i'll give

you a show awesome appreciate it all right all right that's it for the show thanks to andrew thanks to all of you listeners for giving us that two-month break i needed it thanks to jeff burger for producing please go subscribe and be sure to catch us on the next episode. Peace. You've been listening to The Derivative. Links from this episode will be in the episode description of this channel. Follow us on Twitter at rcmalts and visit our website to read our blog or subscribe to our newsletter at rcmalts.com. If you liked our show, introduce a friend and show them how to subscribe. And be sure to leave comments. We'd love to hear from you.

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