The Derivative - Allocating to Alts with RPMs Alexander Mende

Episode Date: June 11, 2020

In this episode, we’re flipping the script of our usual hedge fund manager and drilling down on the allocation side. Alexander Mende is a Senior Investment Analyst and Head of Investment Research at RPM Risk and Portfolio Management. We’re covering a lot of ground with Alexander including herd immunity in Stokholm, an allocator’s due diligence, billion dollar AUMs, picking managers with higher risk adjusted returns vs higher absolute returns, being a lead singer in a punk rock band, trend following from an allocator’s POV, fund rebalancing, and AI and machine learning in an allocator’s world. Follow along with Alexander Mende on LinkedIn, and on RPM’s website and LinkedIn. And last but not least, don't forget to subscribe to The Derivative, and follow us on Twitter, 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

Thanks for listening to The Derivative. This podcast is provided for informational purposes only and should not be relied upon as legal, business, investment, 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. 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. On top of what our managers do, so we can, we think we add value by allocating and weighting different sub-strategies in our portfolios. We think we can add value through reducing risk in the portfolio, increasing risk,

and that's only possible if you can really rely on what the managers will do. You know, you have some expectations regarding the positioning or the performance going forward given a certain scenario. All right, welcome to The Derivative. I'm your host, Jeff Malek. And zooming all the way to Sweden today to flip the script a little bit, I'm talking with a professional allocator to emerging hedge fund strategies

versus our typical guest who is one of those managers. So who are hedge fund managers trying to convince that they know their stuff and are worthy of an allocation? People like Alexander Mende, who is with us today. Welcome, Alex. Hello, Jeff. Nice to talk to you again. Last time in November, I think. I think so. You visited Chicago. So Alex is a senior investment analyst and head of investment research at RPM Risk and Portfolio Management which means he's vetting and selecting strategies for proposal to the firm's investment committee committee excuse me so we're going to be getting into manager selection due diligence

red flags and who Alex's favorite ABBA member is hopefully so thanks for staying up late and joining us from sweden alex what time is it over there it's uh 5 p.m 5 p.m and you're not that late but it's it's you know after this i'm going to go home right and where you're in stockholm we are in the center of stockholm uh yeah and um takes 25 minutes with a bicycle to go home. Nice. What latitude is Stockholm? It's going to start to stay late until 10 p.m. or something? Yeah, no, it's, you know, it's in about one month. We don't have a, you know, the sun doesn't really go down anymore. So it's pretty light outside these days.

The sun goes up at 3 a.m. in the morning these days. Really? Nice. You better be turned to the correct side of the bed so you don't wake up from the sunlight. And so Sweden's been in the news for kind of not doing the total lockdown. And so you've been going into the office this whole time and whatnot?

We, okay. In Sweden, lots of things work through people doing it voluntarily right so we are working the office here in shift so at the operations team there's you know there's always half of the stuff that's working is staying at home and until noon and then they switch with each other. We are not taking the public transport anymore. We're going by bike or walking or by car. As soon as we feel sick or a little bit, we stay at home. We work from home yeah so yeah where which side of the whole pardon me yes which side are you on do you wish they had done a full lockdown or you think it was a good move to do it as they did it

well the whole point with this getting people on your on your side and doing voluntarily is that you can do this for many months to come and yeah look i'm originally from germany and i have friends there that have been in lockdown for six or eight weeks now even you know if the second wave comes it's going to be hard to tell people to go to lock them down again so they're really sure frustrated with that and yeah we saw here in the u.s over the holiday weekend here, there was the Missouri Lake of the Ozarks, just pictures of partiers shoulder to shoulder in pools. And so once they lifted the lockdown one ounce, people flooded in there. We actually have, you know, you see groups in the park,

but you have volunteers going between those groups with a measuring instrument to tell them, okay, you guys move further away from each other and then people normally do that. So it's all pretty peaceful and nice, I would say, so far at least. Got it. And then we were talking offline, you're going on vacation right after this? No, no, no. That was misunderstanding with the vacation was last week. Last week? Where'd you go? Not far.

Stockholm area. Okay. You guys have a bunch of lakes in the area, right? We have, I think, the largest archipelago in the world. Really?

Yes. I like it. And so, you're also a lead singer and a saxophonist in a band? I'm also, yeah, that's what I do in my spare time. I'm a singer in a punk rock band.

What kind of music do you guys play? Yeah, punk rock and ska, alternative music, so to speak. In English you sing? English, Spanish, and German, actually. Really? All right. That's impressive. But that's actually off Really? All right. That's impressive. But you know, but that's actually that's off the table these days. I don't think we're going to play a show this year anymore.

There's no virtual shows? No, you can't do that really, I think because there's some latency in the transmission. So yeah. And so what else we can talk about Sweden? You've got your, all the Americans know is IKEA and LEGO, right? LEGO is from Denmark, actually. Ah, close. Yeah, close. But you know how neighboring nations are.

There's always some competition between the two. So LEGO is from Denmark and IKEA is from Sweden and ABBA is from Sweden as well. All right. So, forget Lego. IKEA has got to be hurting during this. I don't know what their stores are doing, but I think they're not. I don't know. I haven't bought anything there for years.

So, I'm all set up at home. So, I don't know. Awesome. So, let's get into your background a little bit. So, what was your education and whatnot and how'd you end up in this business? All right. I'm from originally from Hanover, Germany, and that's where I did my PhD in economics at the Leibniz University there in 2005. Then I moved to Sweden because I

had a Swedish girlfriend at the time and I found a job here at RPM and have been with them ever since. So that's so not so long my background. Did the girlfriend become the wife? No, no. But you're still in Sweden? I'm still in Sweden. I like it here. I like the culture. I like the... it's very clean here think, compared to continental Europe. People are more, I don't know, more straightforward. So no nonsense. So I like that. And it's not so warm. I'd like to visit someday.

I've never been to any of the Nordic countries. So that's on my bucket list for sure. Yes, I think you should do that. And then RPM found you. So give us the elevator pitch on what RPM does and what your role is within the firm.

All right. So RPM, Risk and Folio Management was founded in 1993. So long before I joined, it was originally a management buyout from a company,

similar company owned by the Wallenbergs and Johnson families. But since then, we've been independent and we're basically doing the same stuff since day one. We are a fund of fund specializing in different products and services in the CTA space.

So we do everything right now from risk management services for managers themselves. So we do everything right now from risk management services for managers themselves. So we have actually some managers where we do the independent risk reporting for. We have a platform business. We were pretty big in the structure product business with Japan like 15 years ago. But we also have two actively managed funds with our name on it where we actually have full discretion about choosing manager, allocating between managers, changing the

overall trading level of the portfolio, the leverage and so forth. And the DNA from the beginning has been kind of CTA trend following. Yes. Yes. There basically was all trend following in the beginning. And that has expanded that universe as we do something that we call strategy balancing. We think there is more than trend following in the managed futures space. So currently we have three diversifying strategies.

One is what we call short-term trading. So that's technical non-trend. We have systematic fundamental so global macro kind of strategies and we have also since 2017 mixed volatility traders and right now we are looking into commodity only technical strategies so not no discretionary strategies at all and so no discretionary across the all. No discretionary across the whole book. So everyone's got to be systematic. Everybody has to be systematic.

I have to admit we've tried discretionary managers, but it's really, you know, it's not easy to repeat everything over and over again for a discretionary program. And what we think our edge as RPM is to be able to add value

on top of what our managers do. So we think we add value by allocating and weighting different sub-strategies in our portfolios. We think we can add value through reducing risk in the portfolio or increasing risk, and that's only possible if you can really rely on what the managers will do you know you have some expectations regarding their their positioning or their performance going forward given a certain scenario yeah and i agree the problem for me with discretionary managers is when they're in a drawdown right of you don't there's nothing to tie your hopes to or say, okay, right.

He may be going through a divorce or having some other issues and you don't know whether he's, he's in a bad mental space or whether the, his strategy quote unquote is, is struggling. So I agree. That's difficult. And so how many millions or billions of dollars in AUM agree that you guys do this well and have an edge? You mean how much money we manage? Yeah. Okay, so in the RPM evolving CTA fund right now, there are 100 million only, and that's invested across 11 different managers and there the smallest allocation is 3 million and the largest I think is 12 at the moment depending on the underlying volatility. And then but the overall firm is how big? The overall

you know that's as I said before like platform business management that's more like advisory capital that's more in the area of 1 billion US dollars but and I must say that this RPM evolving CTA fund has a certain... The edge is to invest the managers in their evolving phase, which we come up with the term to like small and young

managers. So not emerging managers. We don't provide seed capital. We don't want an equity state or anything like that. And we don't want to analyze any simulated or back-tested data. So we have to have one or two or three years of real track record. There has to be some money in that. That's not only prop money.

So we want to be early-stage investors. And that's, of course, for our investors, which are mainly pension funds and family offices from Europe. For them, that is in addition to their existing CTA exposure. So most of the family offices or corporate pension funds, they already have some CTA exposure to, the typical names would be

trans-trend aspect here in Europe. And we are, in addition, actually, we are diversifying that bucket. So let's dive into that a little more. And you guys have done the research and found that there's an alpha there to these evolving managers? We started that research in 2010 and the actual fund was launched in june 2013 and we find that smaller and younger managers there is statistically there is a small cap risk premium so to speak there is some kind of

outperformance for smaller managers even if you uh subtract all the reporting biases in the databases like backfill bias, survivorship bias and so forth. So there is still a significant 1.2% annualized outperformance for smaller managers over larger managers. We find that all the large players today generated their outperformance and subsequently their assets inflows in their early years so there's also it's like some kind of young premiere so to speak. So we don't believe that every single Manchester that we pick will be the next winter or next Bridgewater or the next

star or something but we hope and that one or two dimensions that we've chosen over the years have shown that they have actually grown to large shops, like, for example, John Street or ADG. Yeah. And so do you feel, what do you attribute that premium to? Sometimes it's just, in my experience, sometimes it's just that they are taking on more risk. So is it higher absolute return or higher risk-adjusted return? We're talking higher risk-adjusted return.

Of course, there are managers that have quite high volatility in there, but we combine them in a way that, you know, it's even out or over the different strategies so the the target risk in our involving is uh 15 percent and that's we are quite close to that have been since inception um what i think is most of the managers that we meet and that are starting young have been working somewhere else. So they come from a big shop like Aspect, for example. I'm just, or Winton or Campbell in the US.

And they think they want to try something new, but they have maybe want to have developed the system further and have not come through their investment committee to start this, you know, at larger institutionalized managers, things take longer time. That's, that's natural for, for larger corporations than for two, three people sitting in one room. And so a lot of times larger investors I speak with, they say, yes, I get it that there's that premium to the evolving managers, but the dispersion in the returns is so high, basically, that it's not worth it for me to try and capture that premium. Because if I'm wrong in my selection, I'm really wrong.

That's exactly where we come in because we take this risk and we think we have such a long history and corporate experience with picking managers that we can mitigate this risk. And that's also the reason why we're not investing in emerging managers but evolving. So there have been around, there is actually some data to analyze. There is an audit and track record. We have around north of 150 manager contacts per year maybe not this year after with corona but who knows but uh normally so uh we meet quite a lot of different managers

and we think we are quite good at picking at least the managers that don't fail that's the most important thing right yeah and so evolving to what is there a minimum asset number they have to have or just this time and actual track record we have like we up we have flexible age and size criteria for different managers belonging to different sub strategies so let's simply speaking a trend following manager can be much larger than a short-term technical kind of strategy. That we would still consider them young and small.

So it's kind of, they have the same percent of capacities sort of concept that a trend could be a hundred million and still is very small percent. Or even 500 million actually these days. But a short-term trader above 300 million, then it's not so small anymore compared to the other small-term traders in the business. And then the size component is, do you believe when the managers get larger,

there's two different concepts there. One, they just want to sit on the money and not take as much risks and just get paid an annuity, so to speak. I don't know if that really goes on. That's sort of a perception out there. It's difficult for systematic managers, right? They have a system. Yeah. But two would be they've just become better, right? You've learned to identify risks and eliminate those risks. So you just become better and you, you kind of take the risk out, which also brings the return down, but the risk adjusted return remains higher, goes higher. Well, it's a philosophical question.

Our research shows that it's actually goes hand in hand, that it's not really, you know, there's, it's a circle of life, circle of strategies, circle of trading ideas. So I think it's important that there are new ideas and people try new ideas. And the new ideas are, if not better going forward, they are at least more diversified within one portfolio. So if you pick, let's say, 10 small managers, they are doing much different things compared to each other than if you pick, let's say 10 small managers, they are much more doing much different things compared to each other than the, if you pick 10 large names. Right. And almost by definition,

they need to do something different to be a valuable entity, right? If they're just doing the same thing, they never get ahead of the guys in front of them. And I must say from this, you know, managers that are, that we are interested in, there's always some edge to it or something. Their story, they tell me, even the trend following managers we have, they do something different from all the other trend following managers we've talked to throughout the years. And the latest addition to our trend following book, example is uh does something that i have never heard before but i think as soon as i heard it from that manager i was like yes makes sense why

why does everybody do it like that so it's very exciting actually for me as an allocator to meet those uh new guys right can you tell us without giving away the secret sauce what that is? Well, it's a trend following system. So the main, the first trade is always the strongest trend following signal. But the second trade they put on is not the second strongest trend signal. The second trade they put on is the one that's most diversifying to the first trade and so forth and so forth. So the builder build in a hatch and allow themselves to have more flexible, more larger stop losses so they don't get stopped out so often. Because they count on this diversification, which of course not always works, but it's very different from what I've heard from other managers.

Right, which you see in a classic trend follower, right? They go long 30-year bonds on Tuesday, long 10-year notes on Wednesday, long five years on Thursday, long the bubble on Friday. So those trades, yes, tend to cluster as the whole sector. So they would not put it on that. They'd wait for something in another sector. I like that. And so this gets me thinking. So if the premium is when they're younger and smaller, if they get bigger or older, do you take them out of the portfolio? Well, there's no hard, you know,

we don't, you know, happy birthday to you, five-year track record, goodbye. No, that's not how we do it. But I would say if a manager has especially reached a certain size, so size is more important than age, I would say if a manager has especially reached a certain size so size is more important than age I would say if we just certain size we start looking for a replacement okay and yes I just want to circle back on that size component so why do you think size hurts a manager? Well from the large management I have met so far is that a large chunk of the research capacity goes into trade execution how

to best do your trades without leaving a trace in the market. And there's lots of studies these days that actually the large allocators including TrendForeign not only CTAs but large allocators that actually drive the price around different role periods and there are smaller

managers that basically try to front run these trades as a trading idea yeah so it's zero-sum concept of it it's zero-sum concept. If it's a zero-sum game, if you're the biggest person pushing it around, it hurts your... And then there's also position limit issues too, right? They can only have so much size in certain markets.

What we see about our smaller matches is that they are, on average at least, faster, 5 to 10 trading days faster turning around the position that if you just if you stick now with the trend following guys And They have a larger commodity exposure often as well Which is sort of again by they they can have it right because there's yes Yes, of course your multi in your multi-billions, you have to be in financial assets. Yes.

And then are they mostly trading US markets? No, not, yes, but European, we have a manager that is very focused on Europe and we have another manager that's very focused on Asia. So I would say it's pretty mixed. I have no idea what a normal distribution would look like regarding market exposure or exchange exposure in that case. But I would say it's pretty evenly distributed.

And so that's the evolving fund. And then what's, isn't there another fund, the Galaxy fund? There's another fund, Galaxy. That's basically offering several large names put together for the price of one that's how that's how we market it but that that portfolio has actually not grown there is actually there is an interest people buy the idea that smaller managers might have an outperformance uh component in there that smaller managers might have an outperformance component in there, that smaller managers are more diversified with each other, and therefore we have seen influence in the outcome evolving, but not in our managers' performance.

Got it. And that's mostly trend following, the Galaxy? That's mostly trend following, yes. And what are your thoughts overall on trend following? Like it's come through this recent crash, not looking so great. Oh, well, the recent crash. Okay. Okay.

Let's talk general first and then about the recent crash. Generally speaking, trend following managers profit from something that's called time series momentum. And this Moskovitz paper from 2012, we call it trendiness or have had to be called trendiness since 1995. And you can show if you look at the, if you measure this trendiness or this time series momentum that the intervals of market trends have become, you know, there's more non-trend

environment that the environment has become more non-trendy and the trip once the trend gets underway it's always cut short at least since 2011 and you know, that's basically central banks intervening to provide more liquidity or promising to buy corporate bonds or anything that cuts the The trends that we profit from mostly on the bearish side that cuts those trends short. Right. So that kind of begs the question, is that the new normal and

you should not be looking at trend or this is just, it's affecting it until that all blows up and then trend is going to be the star for the next decade? Well, last year, trend following was our best strategy. So last year was despite all the choppiness in the equity markets, there was some trends to catch and follow. Yeah. 2014, second half, also a good example. I actually think that trend following mentions even the large ones and the small ones have become better

and exploiting that little time series momentum that there is. So that's one thing. And you know, we at RPM are convinced that this cannot last forever. That's basically how. So we are true believers and hope that will return. But what do you see from investors? Do you get more calls of like, oh, I'm not interested in trend following these days

than five years ago, than 10 years ago? I would say it's a constant interest. The interest is constant, but to the actual, you know, let's pull the trigger, let's invest in RPM or in trend following in general has been, it's a harder threshold as long as the equity markets are climbing to new highs every year and there's nowhere else to you

know you need to be so it's even now in this crisis you know how much is S&P is down seven or on the year something that's not really my view with a crisis going on yeah and I think that's back at all-time highs i believe yeah so if you want to talk about the corona crisis or some someone called it the great corona crisis gcc i know it needs a name i've been trying to get a name going but nobody i heard gcc yes so that actually lasted only 15 or 20 trading days, depending on how you view the first week of March before Trump's famous speech. The first week of March, equities were actually going up again.

So that was kind of the rebound there. And if your typical trend following system has a trading horizon of 30 to 60 days, that's the medium-term trend following system, the standard one. Yeah. Then you cannot catch a 20 days move. So actually the large…

Even worse if you get short, right? If you get short at the end of that 30-day move and then it rallies back. Yes, that's actually what happened in our portfolio as well. It wasn't so bad that we were down in March, but that's happened. The last week was actually, we got hurt more by the rebound than the actual you know sell in the first three weeks which seems to have been the case i tell my son is 11 i tell him we've we've been in trend following it's been a drawdown your whole life which it seems like it's been right since oh wait that it's been one big drawdown,

little tiny maybe peaks to new highs, but essentially, and it's just because of that of many, many false breakouts in whipsaws. So the question just comes back to, you know, is that the new norm and they need to move to shorter timeframes and they need to be able to either identify those whipsaws or step aside. From what we do in our portfolio is, yeah, exactly. As soon as you divest, then it's going to be the greatest year for trend following ever, right?

So no, but what we do in our portfolio and what I've seen that works is that we have allocated away from the medium term space. So we have lots of, not lots of, but we have our portfolio rates are more on the long term and on the much shorter term than 30 days so we are we have short-term traders and short-term trend following managers in between like daily trading to up to 15 days and then we have two really long-term managers that are have a-term trading horizon than those 30 to 60 days. And that combination has worked quite well so far. Yeah, in a perfect world, you would have right across basically every conceivable time frame

and getting in as the trend evolves and then slowly getting out as it dissolves. So, Alex, you also mentioned something about adding volatility traders and some different types, not just trend following to the evolving series. So tell me what other strategy types you're looking at there. Well, we always, you know, we're trying to optimize the overall portfolio by adding different kinds of diversifying strategies to the main trend following block. And that started 20 years ago with systematic global macro managers. We added short-term traders in 2007, 2008. In 2017, we've added VIX volatility trading strategies. We had been looking at this strategy block since 2012, I think, actually. But the manager we had put our eyes on didn't accept the way we want to do business we only in can only scan West's through separately managed accounts so if you mention you

don't willing to do that for us so but then by 2017 we opened two managers two accounts with two volatility managers both both US-based. And very different from each other. And as the research has shown, that's why we picked those two managers. The combination of the two is exactly the managers that we wanted to have in the first place. So that's... Perfect. And what are some of the difficulties you see in analyzing those?

Because just the VIX came out later so the track records are shorter. Well VIX is a totally different animal from all the other financial time series. It's not trending so much or not it's not on longer time periods and the underlying pricing is different. So but most greatest problem for us is that we are no volatility experts. Definitely not. So, you know, I know what it tries to measure. And I know that people, you know, buy VIX futures because they think it's protection against any crisis.

But it's actually only against equity crisis. Exactly. So, but, you know, the managers that we have were quite convincing in explaining what they do and why they do it, what they do and, you know. And would you, but is that still a trend following type profile? So like a positive skew? One manager is a relative value play on the VIX curve. And the other is volatility neutral, but taking a long or short position in volatility every day. So basically has a fundamental input or flow input and then decides to be long or short volatility. They could be short volatility.

They could be capturing some of the decay. Yes. Yeah, which was a great match with the trend following portfolio because that's typically when they're getting hurt, right? Yes. Turn followers get also hurt when the VIX spikes on these typical VIX days like 2018 was just VIXmageddon,

VIXplosion, VIXmissile, what you have like February, October, December. So we're actually adding right now uh a tail risk volatility strategy so measure that's actually a protect protecting our portfolio when volatility spikes perfect yeah hopefully that works and to me people investors like some of those better because it's less path dependent right so it's just hey if this happens structurally this fix is going to go to x and you're going to get a payout versus classic

trend following where it's hey we're going to need if we're not already long equities and if we're not short bonds and if you know there's 10 ifs that if those all line up then we'll make money on this on this down move in stocks. Yes, but all those ifs are also quite new, also since quantitative easing and since the last crisis. Yeah, but it seems like who knows if we'll ever be out of quantitative easing now, right? We just added another, whatever, three, four trillion globally. But maybe they're finally getting close to out of bullets. You think so I'm I'm not an expert in anything so I can just accept the second point it's something that goes against the fundamentals or I kick

him down the candle the road you know at some point it has to stop but that's the old case saying Marcus can be irrational longer than you can believe it. I would never take a guess on the timing when these car market environments unravel. I don't know. All right. So let's move into due diligence and what that looks like. So you mentioned you meet with over 100 managers per year. Well, we have managed a context that includes obviously conference calls.

And these days, even more conference calls than before. We normally attend CTA conferences like the one in Miami, for example. Yeah. And we also, at least that's the policy, pre-corona, we have to visit the manager on site at least once before we can invest. Do you feel, I feel like this crisis is going to kind of do away with that. I feel like the fancy New York hedge fund address is going to go by the way, and you're going to have managers all over the world now. You'll be like, I'm going to set up shop in Jackson hole or. Right.

That's actually funny. You said that I just had a conference call with a manager from Jackson hole last week, but, uh, in our. Yes. Yeah.

We know. All right. Good. Great. Uh, actually in our smaller manager space, it's much more over the place than with the larger names you know the two people out of a garage i don't know maybe the wrong description but the two people can afford to

have a proper office in new york downtown they sit somewhere you know upstate new york or this they can do everything with their computer from home from their lovely rocky mountains uh mansion so yeah i think i think that's just, this is going to push that further along and you're going to see more of that. So you have the hundred people on your list and then you meet with some subset of that. And then what is that?

Yeah, we have split the due diligence in three parts. The first is the screening. So we always want to know what's going on so and we have we subscribe to the Barclay Hedge slash CTA database and we scan the database we have some algorithms that scan the database for new entries and rank them by performance and by performance per strategy and so forth and if there's any manager coming up that we don't know or never heard of then I normally book a meeting with them to get to know so

that's the first thing for a manager that wants an allocation from us is to start reporting to the Barclay Hedge database or send me an email you know this is my program I have a track record here. What do you think? Let's book a call. So that's, that screening goes on, can be quite, you know, because we're looking, because we're looking at smaller managers, we can't, we don't have the luxury to do one due diligence per manager. We don't do this anymore. We, since 2013, we do this in batches. We basically collect four to six interesting names, four per strategy.

And then we do five managers or five programs at the same time. So if we have, let's say, only three managers on the short-term trading to watch list, we're not going to start a due diligence round on short-term trading. And those managers might get impatient. You know, we've been in contact for one year now, but, if i did have this group together first got it and that has to be not just the number in that sector but the number that you're interested in and why yes an interesting means for us that there are as i said some kind of edge some kind of some kind of innovation they should also know what they're talking about they They should be able to explain it to me

what they're talking about. It always helps to, if the manager knows herself what their strengths and weaknesses are. So that's something that I can do in the number crunching and check if that's true. Sorry, go ahead.

I was going to say, if they just have good numbers and can't talk to it at all, they're out in your opinion? Yes. If they can't explain where it's coming from, then, I don't know, that's not for us. That would require too much digging, which we can't really do, right? Yeah, and I think a lot of managers feel like, I don't need this narrative.

I don't need to explain it. I just want to show my numbers. And you're like, well, the people allocating the number the money want to know the story as well yeah that's also for us then helping to allocate to the strategy and managing that allocation over time so what let's dive into the act some more of the due diligence so you're getting the story from them you're crunching the numbers what are some of the red flags that you'll see that knock people out um well our diligence process is split into two parts the investment religions and operational due diligence and in the in the investment due diligence i basically try to summarize the trading strategy in my own words

and to find okay market episodes market periods when this ready should work and provide diversification or provide performance and when it shouldn't and that's what I'm gonna check basically on a monthly and daily databases so for example how does a component performance react to VIX spikes and slumps and VIX how does the performance react to spikes and slumps in time series momentum a red flag in that case would be if we compare performance numbers like sharp or sotino or also indices over different data frequencies and there's a large gap

so basically the sharp ratio on monthly data is much higher than the sharp ratio or ALSA indices over different data frequencies, and there's a large gap. So basically the Sharpe ratio on monthly data is much higher than the Sharpe ratio on daily data. That's a warning sign that there's some underlying volatility that I don't understand. You walked into that there. So you guys use the Sharpe ratio? It's been, right? We use it for a, we use it as a,

for our data frequency analysis. We don't rank portfolios by their performance, you know, but, but it seemed like, like a Sortino or a Marr ratio is more relevant to me. Right. Then the Sharpe,

because it's, but what I'm talking about is just the difference between for the same performance measure for different data frequencies. Yeah. I like that. And then if they can't explain why that is right there. And what else? So you want it,

you want them to have an edge or a perceived edge. Well, the only thing you can come in our portfolio is you replace an existing manager or you add it to the existing portfolio, right? So if you are added to the existing portfolio, then you have to do something else than our existing managers already do. Meaning you can't just bring another slightly different flavor of trend following. It's got to either be totally different or have a very new, like you said, another very different flavor of trend following.

Yeah. Or the second reason why you could be in the portfolio is that you're replacing the existing manager. That is maybe too old or too big or has breached some of the predefined stop losses. So it has not performed as expected. And then do you consider background and pedigree and things of that nature?

Well, it's always interesting to know where people are from, what kind of education they have. And it's always a plus, I think, if they have, what would you say, learned the business at a larger company. So that's always something we like. Normally, well, I don't want to, I'm directly from university myself, but normally the guys coming directly from university are very ambitious

and have not so much experience with what's actually going on. Yeah, which we've seen in our, yeah, they'll get frozen in front of the screen or they'll forget to code something. We see that a lot. And so what are some of the tips you could give emerging managers to get to pass some of this due diligence? Or does it, at the end of the day, if the strategy doesn't fit what you're looking for, it doesn't matter how good they are in a due diligence meeting yeah the most important

thing is that it's a fit for us that's something that we need in our portfolio in a way and the second thing is that we are we ourselves provide data liquidity and transparency to our investors so they can on a daily basis check positions and what are the managers performances and everything. And obviously this is data that I want to have or what to collect for the due diligence process. So if you have your data and everything in order, you don't have to produce it just because I asked for it. That's obviously a plus. So, you know, have your sector exposure,

sector performance, sub model exposure, sub model performance and everything ready on a daily basis that helps the process time wise a lot actually and what do you say to we run into this a lot of people like oh i don't want to give up my secrets and whatnot i kind of always say like we don't care that much like i don't have the time to recreate your model no No, exactly. No, we know it's, we are happy to sign any confidentiality agreements, but at the end of the day,

we are managed account investors and managed account investors only. So we're going to see the daily positions and performance anyway. So if you don't want to, you know, don't trust me now for the analysis, then we can invest. Yeah.

And speak to that, if some managers are afraid of even having a managed account because people can see the positions, what do you say to that? If that's silly or whatever, if that's your view? As I said, we don't have the time to, you know, we want to be a manager of managers. We want to add value on top of what our managers do. So we don't have the time to try to ref, we want to be a manager of managers. We want to add value on top of what our managers do. So we don't have the time to,

to re trying to refigure what they're doing. And our investors, of course, see only the daily positioning and of the aggregate portfolio, right? They see the manager performance, but there's position. So there's no way they can trace which manager has is responsible for this.

I don't know, long stock exposure or something Yeah, and even if you even if you had it by manager, would you want to trade on a day? Delayed basis, right? You're gonna see the business at the end of the day who knows what happened in the hours since then Yes, like that seems like a recipe for disaster to me Although they that exists right those ETFs that track the hedge fund filings and get into the same positions the hedge funds are in yeah i heard that we're not you know we can only invest in surges that trade exchange rate futures and options and ethics forward so we don't know etfs or swaps or alternative markets or anything and what do you have any uh has the

pandemic come into your due diligence of like what are your work from home policies or what is the your preparedness for well that's would be part of the operational diligence right and there the first step is to get like references which are some some managers are also reluctant to provide references references to their investors but that's also something we would require we need to talk to at least two guys or two people what what's their experiences with with you and and then it goes more down to a quality quality analysis of the of the people behind there you know what what you know who are those guys yeah another part of the operation diligence is to get a verified track

record from a third party. So we compare what the numbers that we analyze are actually true or verifiable. And is it enough for them to just be subject to audit by the NFA? Or does it actually have to be audited? Normally we get the third party performance figures from the administrator. Yeah. the third party performance figures from the administrator. And then let's talk briefly about how you guys rebalance and view that piece of the puzzle. So is it monthly rebalancing, quarterly? It's typically a month reallocation at the end of the month we base we have you know we have a top down bottom up allocation process so bottom up

obviously is okay what do the managers do themselves how do the who are how are the positions in the portfolio so basically if a manager is constantly underperforming its peers then obviously we we would consider reducing the allocation if all the managers are into long gold at the same time and we have high concentrations before that's also warning sign where we would consider reducing manager allocations in a way that we can reduce this risky position yeah and top down, we have some in-house indicators and other outside macro, more macro market indicators that we use to manage the overall exposure and the sub-strategy weights of our managers.

So we have like, like the time series momentum based indicator. So basically if there has been high time series momentum in the markets going forward, it's less likely that they's going to be more trends. So we're going to reduce allocations to trend and vice versa. Those are discretionary decisions or it's formulaic and it'll automatically do it? It's a structured process.

So without the indicators doing anything, we can't do anything. And if we have several indicators, if more than one is pointing in one direction, like sending a risky signal, a warning signal, then we have to act. But the whole process is not automatic. It's not says, okay, this manager A, B and C get a reduction by X amount. That's something that- There's a bit of art to the process instead of just pure science, right? So a mix of art and the science you know we

we've been living with some of the indicators for 20 years 25 years so we think we have a good hand in that and we are you know we communicate we are transparent going forward we couldn't communicate all tactical reallocation how we call it with our investors in advance so we tell them our indicators which they can see that by themselves as well as on our dynamic RPM website. So they can see the indicators themselves. Yeah.

Okay. This is a risky environment for Trendfunk now. So we're going to think, you know, starting next week or something, we reduce allocations. What is that reading right now? Without going into it. I can tell you it was actually sending a

warning signal by mid-february already so we started reducing risk by mid-february and all through March obviously we started putting risk back on in mid April and this reallocation has actually added 1.4 percentage to overperformance. So that's the reason we're up this year still. Great. And now in May, we are at long-term average risk regarding portfolio risk level, but also sub-strategy weights. The trend, what's called the time series momentum indicator is a very low

level. And going forward, forward we are we are expecting another wave of trendiness if that's come come tomorrow or during the summer at some point i don't know but going forward it's more likely that trend's going to pick up from here and how do you guys view the the portfolio risk and the correlations uh do you treat the correlations as you see them or do you assume they might move to one in a, in a Oh, we have different risk measures like the typical VAR for different look back periods where we, where we consider correlations obviously, but then also stress and undiversified risk

where we put everything to, to one or minus one. So we have a risk basket to risk. So basically you measure correlations over for all the instruments you, you trade, and then you build the correlation basis of those and how, how concentrated in one correlation basket you are and what else we have. So it's simplistic example of that would be just take each manager in the portfolio, assume they hit their worst max drawdown all at the same time.

Yeah. Am I, each manager in the portfolio assume they hit their worst max drawdown all at the same time yeah am i am i comfortable with that risk number as kind of a worst case scenario yes and so what does that number look like for you guys what are your what's your risk tolerance on the downside in terms of a drawdown uh num oh i don't have that number right here no so yeah it's it's actually we are in a drawdown, so it's, you know, trend following is cyclical, or CTAs are cyclical, so it's quite low, actually. Quite low, but you're right, you're not willing to take a 50% drawdown or something. No.

Yeah. Lower. All our managers have a predefined stop loss regarding maximum daily loss, maximum monthly loss, maximum drawdown deaths, and maximum drawdown length. so that's on a manager basis they'll be automatically cut if they exceed that happened in march with one machine learning short and training manager unfortunately i really like the strategy from yeah uh as you mentioned it what are your thoughts on ai and machine learning and adding those types of managers?

Well, as Mars has shown, you know, it was an hour. It was the fastest spike of trendiness and the fastest slump of trendiness since we started measuring since mid 95. I heard it was the largest slump in equity markets since October 87. Back then there was hardly any daily data around. I doubt that there are many machine learning AI algorithms out

out there that could have been trained on this scenario. And then it becomes an out-of-sample problem and from what I've read is that machine learning did not so well during this. What does it look like from an investor standpoint of allocating to these machine learning where it's, you know, maybe you could understand processes in the past, but it seems we're getting to the point where unless you have a PhD and can really dig into their black box, like it's almost impossible to know exactly what's happening inside some of the AI strategies. We have come across two types of machine learning programs. One is basically the black box and the manager is not really able to explain

themselves why the signal is the way it is. That would have been a no-go for us anyway because we want a manager to explain, understand their own strategy and explain it to us. And the other part of machine learning is basically where you use the machine learning to weight your signals or your submodels or what have you. For example, there's a fundamental manager here in Stockholm, which employs two X RPM guys, actually, so we like them.

They have decided, okay, we're going to be just global macro, so we're just going to do flow analysis and interest rate differentials and all that stuff. But the weighting of those models, that is up to an AI machine learning procedure. And that I totally buy. The machine has much more capacity to quickly adjust, okay, these kind of models don't work these days, and these will have a better performance expectancy, so forth. And that's something that we consider investing in. Yeah, and I think we see more of that on our side as well,

machine learning used to build portfolios or add on risk instead of pure black box signal generation. And we were on the one of our pods with a resolve asset management. We were joking that for the black box guys, they need to build a black box that generates a narrative around the trades as well so let the ai generate some narrative of here's why we took these trades and that's all ai black box based as well uh we'll maybe one day see that great let me uh so you got anything else you want to share about the strategy or anything or get wrap up with our favorites no No, just, you know, we just had a manager that we really like to have in the portfolio, but they got really impatient with our, how much time our diligence process takes. So it's

a very long process and we are never in a hurry because we have an up and running existing portfolio. So please be patient with us. And what does that time look like? Months? Weeks? Yeah, months. Well, now maybe it's even, it can be faster because

we don't, we can't do any on-site visits now, but before it was like, you know, I can do all the number crunching I want in the investment committee. You can love your strategy, but I have to go to, I don't know, Chicago and check out your office. And I won't just fly to the United

States to see one manager either. So again, I have to have a group of managers which I can visit. What was one of the most remote places you visited to do an on-site? I would say Logan Uta okay yeah I know who's there as well yep

yeah yeah those guys are good great let's move on to some of your favorites all right favorite ABBA song Great, let's move on to some of your favorites.

All right. Favorite ABBA song. The one with the money? I don't know. I'm not an ABBA fan at all. Right. How do Swedish people feel? Well, you're German,

but how do the Swedish people you know feel about ABBA? We love them here in the States. I mean, if you say something offending, I guess they would get upset. But it's not a daily topic that people talk about or listen to or anything there. Sweden is one of the few countries that exports their music and imports music. So we have a lot of, what's to say, current artists that are more on the radio or people's minds. Got it. Favorite investing book? Investing book?

Yeah. Or book having to do with investments or strategies or portfolios. It's called, I don't want to, it's called Gut Feeling. Gut feeling. Okay. Yes. What's the synopsis? I think the guy's called Gernot Hitz.

I don't know. I don't. Does he recommend just use your gut? No, but he says some complex problems, it's easier to have like a chain of decisions to make that brings you faster to your goal than building a complicated model. Yeah, yeah. Favorite Swedish athlete, or I'll take German athlete.

All right. That's also, well, in Sweden, it's of course, Zlatan Ibrahimovic. That's, you know, that's the one everyone adores. In German, I don't actually. Björn Borg. Oh yeah, I have a, you know, he has a famous sports gear and underwear company or that was his name.

So every second suite you see in the gym has some Björorn borg underwear and where do you follow uh the what's it called the uh bundesliga i follow the bundesliga and the swedish version version is called alsvenska but the alsvenska is still closed down due to corona and germany had to start again so with no fans and they're testing no fans no fans just but also no public viewing. So I don't really... If you didn't go to the match, then people normally would go to a sports bar or anything

and watch matches there, but that's not... But it's still televised, right? Yes. Yeah. All right. Favorite Fika spot in Stockholm? I don't even know what that means. Fika basically means it's a don't even know what that means. Fika is basically,

means it's a verb and it means having a coffee. So that's, and normally you have some kind of pastry to it. I don't do fika so often. I do it at the office here, but fika bar is called Vetekatten. So wheat cat.

That's a famous spot in Stockholm. Weed Cat, I like it. And then how long did it take for you to learn the language and the customs? So you've been there since 05, you said? I moved here to 05, I started taking Swedish lessons in 2003. It's a Germanic language, just as German,

so it's pretty close. I will never be able to speak it so that people won't recognize I'm not a born Swede. But to be able to communicate in a restaurant or on a train or something like that, or in a meeting, takes maybe two years. And your English is excellent. Did you learn english in grade school and primary school and in germany you have to yeah you have to start at the fifth grade yeah the uh i think that's it fate you how about podcasts you listen to a lot of podcasts you got a favorite one no i don't actually i don't so uh i have started with a history podcast from the bbc history now our time now I think it's called

I do the revisionist history ones good too and then wrap it up favorite Star Wars character oh I have to just point you I don't, I'm not a Star Wars guy either I have seen the first three

when I was like a teenager so I like like a teenager. Okay. So I liked them a lot. But as an adult, I figured it's more like a, it's basically a Western movie with science fiction out costumes. Yeah. They call it a space.

Yeah, exactly. So, but the guy I like most, I guess it's Han Solo. That's the. I like it. He's good. And our Star Wars investing infographic, he equals managed futures. All right, so there you go. Deals and commodities, so-so background,

shows up in a crisis, Han Solo. All right, Alex, thanks so much for your time. Thank you very much, Jeff. Where can people find the website and how to get a hold of you and whatnot hopefully you don't get 10,000 new managers calling you tomorrow oh it's rpm.se for Sweden okay great and we'll look for you once lockdown's over we'll hope to see you back in the states or or me over there I actually booked a vacation trip for September in Europe, but let's see.

I'm still hoping that will be possible. I hope so. No second way. All right, Alex, all the best. Thank you for your time. Thank you.

Bye-bye. Bye-bye. 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 rcm alts and visit our website to read our blog or subscribe to our newsletter at rcm alts.com if you liked our show introduce a friend and show them how to subscribe and be sure to leave. We'd love to hear from you.