The Derivative - Bridgewater, Botany & Breaking the 2&20 mold with Unlimited ETFs Bob Elliott

Starting point is 00:00:00 Part of the challenge in the replication space is there are people who approach it as a statistical exercise. Having created systematic strategies for a long of time, there is, there's a science to it. There's the sort of statistical work that's done and computer science work that's done. But there's also an art to it. Welcome to the Derivative by R. Sam Alternatives. Send it. Hey there, this is Bob Elliott, co-founder and CEO of Unlimited, here to talk about hedge fund replication and how it might be beneficial for your portfolios, the Fed and monetary policy, and maybe a deep dive into the live cattle market at the end on the derivative.

Starting point is 00:01:00 Hey, Bob. How are you? Good. How are you doing? Great. Thanks. Where are you? I am in what looks, can look to be an undisclosed location, a very sparse office in a generic roadside office complex in central New Jersey, which is not where our main offices, but it's where I work sometimes. Nice. And the main office is in New York? Main offices in New York. Yep, downtown. Love it. And what's your background? You've always been an East Coast guy? Yeah, that's right. I grew up in Detroit and ventured to the East Coast to what I thought was the big city in Boston when I went to college and have stuck around the East Coast, basically somewhere between Boston and Central Jersey. through most of my time.

Starting point is 00:02:02 So I consider myself a Detroiter by heart, even though it has been, I guess, almost 20 years, more than 20 years, since I've lived in Detroit. But weren't you ragging me the other day that you're a Vikings fan? Not a, not a Lions fan? No, not a Vikings fan. No, just a non-Bairs fan. Got it.

Starting point is 00:02:23 Yeah, just giving you a hard time about being a Bears fan, which is only second to being a lion. fans fan for 30 years in terms of ignominy. So I fortunately had the benefit of my sort of primary football allegiance to the University of Michigan, having grown up there, my parents with the University of Michigan. And so when I moved from Detroit to Boston for college was when this guy, Tom Brady, started playing for the Patriots. And so I had a few decades of Patriots allegiance, most due to my Michigan allegiance. Those teams actually had a bunch of different Michigan players on them.

Starting point is 00:03:05 But since he left, I guess I'm back to the Lions who are a bit of a heartbreaker these days. You guys took it to us last week. We had a good blog post years ago. We'll put it in the show notes with that picture of Brady from the draft. You know that famous? He looks like a weakling, nobody. And then tied it into basically like, hey, so you might be looking at these different hedge funds and don't just throw a bunch of these away because the recent performance is no

Starting point is 00:03:34 good like actually understand what's going on and if they're winners or not um so what and then where was college in boston uh yeah at harvard oh you're one of those guys so i went to some small school and in Harvard i've heard of it awesome and then i was there's something about botany in your bio what it was that all about yeah yeah no my my uh my academic training is actually uh was in the pure sciences. I thought for a while that I was going to be doing botany for a career. And, you know, after the, after months and months of being in the sixth basement of the biological laboratories, growing plants, all alone in the dark, I decided maybe I'd want to do something a little more interactive with people in my career.

Starting point is 00:04:28 That was before Matt Damon made it cool in The Martian, right? Exactly. I wonder if the botanist curve is spiked up after that. And then so decided to go into finance and ended up at another small place nobody's heard of. That's right. Yeah. I mean, I actually, part of my time in college, I spent working on public health issues and sort of increasingly recognized or public health.

Starting point is 00:04:58 is connected with macroeconomic dynamics and a lot of instances. And so I went to Bridgewater kind of with the idea that they'd pay me pretty well to get like a master's in economics. I had not really had much in the way of any formal training. And, you know, I went and really fell in love with the markets and the macroeconomy. And, and, you know, and now it's 20 years later, just like that. what kind of public health like COVID type pandemics or was more of like everyone's too fat or we're eating the wrong stuff or a little bit of both well back then probably the biggest global public health issue was the HIV and AIDS epidemic and it was an interesting time where a lot of the therapies that could help stop both the transmission reduce the transmission rate and also prolonged life were available in Western countries, but the predominant problem existed in the

Starting point is 00:06:04 Global South. And so a lot of my work was around how do you get folks in the global South to have access to it. And part of the challenge there was building enough of a national grassroots constituency that was supportive to that concept in order to put pressure on Congress and the president at the time. And sort of the peak of the success was building the grassroots constituency that helped get PEPFAR, which was Bush's AIDS treatment program through Congress, which was probably the biggest global public health success of the 21st century, probably saved, you know, saved tens of millions of people's lives and extended, you know, tens of millions of others lives. It's no longer in existence as of this administration. I thought that was Bono who did all that. That was used. We, he, you know, for, there's many rock stars who focus on lots of different, lots of different things.

Starting point is 00:07:14 So certainly his work was appreciated for sure. But it was not just him. And then interesting to hear you call it the global south. That's basically sub-Saharan Africa, or you're saying even into southern Asia and whatnot? Yeah, at the time, in a place like Thailand, Thailand had, yeah, at Thailand, Latin American economies struggled with the HIV and AIDS epidemic. And so it's sort of a way, emerging countries is more like a finance term than it is like a, public health term. And so there's other communicable diseases that particularly affect the global South that, so it's more of a statement of public health geography than it is a statement

Starting point is 00:08:05 of like economic geography or something like that. Got it. And then what was it like to get the seat at Bridgewater? Were you one of thousands trying to get there were they less known at the time like was that a hard interview is that a hard job to get yeah i mean it was it was interesting uh at the time it was it was really was an unknown um and so uh my my college roommate intern there as a technologist and was like i think you'd probably like these people and and uh and like the work and you know the sort of core um effort basically the core edge there was looking for people from non-traditional backgrounds, you know, whereas the big banks were hiring anyone with an economics major. They were really looking for non-traditional

Starting point is 00:09:00 backgrounds. And the reality is pretty much everyone who was there, who started there out of college, was from something that, you know, was quantitative and rigorous, but not narrowly tied to economics. And the truth is most of what you learn in school for economics is pretty useless when it comes to day-to-day trading of markets. Yeah, a friend of mine's at peak six here in Chicago. And they hire like poker pros and yeah, geologists, all sorts of weird stuff. Same concept. And that tells me my son's a junior in high school looking at the colleges like it's not necessarily where you go or what you're into but that just that connection right of your roommate got you into yeah yeah i mean it's just that

Starting point is 00:09:50 and um you know i think being uh curious and flexible right so like you know there's a question of whether you focus on learning skills or just interest in ways of thinking and that that matters in a in a 50 year career being curious and having sort of the uh sort of picking up the certain aptitudes, let's say, rather than skills, meaning like, you know, if you have a quantitative aptitude, your skills, like I just think about my career, like, you know, we went from running regressions in Excel to like, you know, building machine learning strategies, you know, the world has changed a lot in 20 or 25 years, but the sort of setting the foundation of having that, those sort of aptitudes are the things that really mad.

Starting point is 00:10:39 And then so somewhat, you started on the ground level there and became like yeah i actually started one seat uh from the mailroom they used to leave the mailroom door open it was in the basement and they used to leave the mailroom door open and um and even when it was very cold uh so some days i had to wear gloves uh and there's no uh there was no natural light or anything like that so i do like to say i started literally at the ground level as an analyst you left the basement of botany for the basement of bridgeway exactly Exactly. And then, but semi-quickly or how long eventually you were kind of raised right-hand man?

Starting point is 00:11:21 Is that fair to say? Yeah, yeah, relatively quickly started to work with him directly after roughly a year, give or take. And that, you know, that did a bunch of different interesting work and it really sort of accelerated around the financial crisis where, as a sort of, what was a 24 years old or something like that, he turned to me, looked at me, he says this housing crisis, it was not the financial crisis, it was the housing crisis back then, this housing issue, big deal or small deal. And so I had to quickly become an expert in banks, the housing market, product structuring, credit risk. And I came back to him. And I said, I think it's kind of a, I think this could be a big deal.

Starting point is 00:12:15 And so that was, that was a good call. And what's that in 06, 2007? Yeah. In, I distinctly remember in the, in the fall of 07, basically looking at, looking deeply at, you know, all the financial institutions and the credit risks and things like that. And basically in the fall of 07, it was pretty clear that every financial institution in America was going to be broke as a result. of the credit risks associated with this and, you know, and with the housing market. And, of course, you know, those, a lot of those institutions were super highly levered at the time,

Starting point is 00:12:52 right? So you looked at a bank, right? You know, it was at many of them on a sort of true capital basis were 30 times levered. So it's not like you had to lose that much to be broke, but it became pretty clear even at that point that that's where we were headed. And were you guys looking at it two ways, right? Of like, hey, also the, are our primes and custodians and right like not only is it market moving but we have risk on the other side of the equation too yes for sure when you when you run money you're the credit risk of your counterparties that matters a lot and well I won't talk too much about anything in specific you know what the thing that really broke Lehman was not really there was not really

Starting point is 00:13:39 the credit risk that they were holding but basically at as their CDS spread widened, basically everyone cut them off from business and forced more collateral. And so that, you know, it highlights that for any financial... Relying on overnight repos and everything. Exactly, exactly. And that for any financial institution, the thing that really liquidity matters more than creditworthiness, because creditworthiness you can deal with, meaning like you can paper it over, you can extend it and pretend, you can do all sorts of, there's lots of nonsense that you can do

Starting point is 00:14:14 to deal with creditworthiness. But if you run into a liquidity problem, you're dead. And so that was Silicon Valley Bank for a reason. Exactly, exactly. A perfect example, a bank that, you know, basically is totally fine. If anything, actually, you know, the folks who bought it got a steal for it because the credit and the business relationships were pretty good. and so all these thoughts of yours are making it into the daily observations the famous facts yeah facts or was it getting emailed what was happening yeah um it it did actually when i started there were uh there were there were still faxing um i got very good at uh working the fax machine uh uh many years ago um but yeah you're right you're right it it's uh you're right it uh it's uh

Starting point is 00:15:10 It was sort of known on the street as something that got faxed everyone. There was a whole production of faxing it to folks, which was fun. But yes, I was writing the daily observations pretty regularly. I mean, over the course of almost 15 years, I wrote hundreds and hundreds of those daily observations. Free A-I, you actually had to hammer it out. You actually had to type. And still even today, you know, in my substack, I... or Twitter content or substack, you know, people are like, well, where are all the analysts helping you or whatever, you know, who helps you or do you use AI or things like that?

Starting point is 00:15:50 And I like, no, I, I just write. I know it's a little one here. Yeah, this guy, right. Who does all the work? Me. It's very, I know it's a little analog, but it's, it's how I learned how to process what's going on in markets. And so that's what I do to this day. And was your name on those?

Starting point is 00:16:11 Were you getting credit for that? Oh, yeah. Yeah. All right. Perfect. So before we leave Bridgewater, give me, like, known for their radical transparency, all that. Was that just more PR? Or was that actually happening?

Starting point is 00:16:30 Was it weird? Was it cool? Yeah. I mean, I think I like to sort of describe the place. There was sort of, there was a small group of people. who were largely in a in a in a small building uh who ran the money uh and that and that group you know operated like any high performing financial group you know in the sense of uh people were straightforward and it was hard work and you know you you you didn't pull any punches when it came

Starting point is 00:17:01 to trying to figure out what was going on um but you know honestly not that much different than most, if you went to most financial firms that were, you know, high performing, basically the same. And then there was like 2,000 people that were engaged in some sort of social experiment, which, like, I didn't see those people. I didn't engage with those people. I'd show up to the holiday party and I'd say, who the hell are all these people? They're just like, we're not a meaningful component of what the core part of the business was. What were they doing? Who knows? Faxing.

Starting point is 00:17:38 Faxing each other. Yeah, who knows. And honestly, the people who were running the money didn't have the time to worry about what all that other nonsense was. We were just focused on running the world's largest hedge fund at the time. So one of those 2000 couldn't come into your office and be like, you're doing this all wrong and here's how it should work. Like that is kind of the perception from what you read of like anyone could do anything. Yeah, I think there are a lot of people outside of the core of the business who were doing those various activities, but the core of the business was, you know, it was just, as I said, just basically normal. I mean, normal in the sense of, you know, consistent with any high performing organization, which isn't necessarily right for everyone, but it is if you've been in any of those seats, you know, you know what it's like.

Starting point is 00:18:31 If you worked at a, you know, on a trading floor, uh, you, you probably know what we're talking about. I did. Yeah. Right. Um, right. Um, right. Normal for running $180 billion or whatever, whatever you go. Exactly.

Starting point is 00:18:46 Uh, something in that order, man. Which always annoyed me. I was writing blog posts about managed futures, uh, Barclay Hedge would report the managed futures AUM. It was like 380 billion. And I would, I finally like, dug into it. And 180 of it was Bridgewater. Oh, is that right? I didn't realize that.

Starting point is 00:19:06 Yeah, it was before. Yeah, not real. That doesn't seem right. That's not. That would not gotten a big fight with Saul Waxman over there and was like, hey, you got to take Bridgewater out. And he's like, well, we can't just take Manus Futures assets from 380 down to 200 overnight. It was like a slow wind down of like, pulling.

Starting point is 00:19:25 Oh, that's interesting. Yeah, yeah, that's interesting. But I was like, I think if like, would you have considered yourself, manage futures at the time? No, no, no, no. Systematic global macro would have been the way I would have described it at the time. You were using futures, but yeah. Yeah, exactly.

Starting point is 00:19:43 I mean, futures are just an exposure tool, but not, you know, just a way to implement a view, but not, not, you know, and I think actually sometimes when I talk to people, they get sort of confused. There's natural confusion. I was actually talking to an advisor yesterday who asked a simple question, like, what's the difference between macro, global macro and managed futures? It seems like it's the same positions that you're trading or the same markets that you're trading. And it really comes down to the way in which the views get constructed. So like, you know, let's say traditional sort of managed futures is really focused around price trends and movements pretty strictly, whereas global macro trades the same markets and may even look at price trends as part of their. approach, but they're also looking at like concepts of value, intermarket action, you know, what's priced in to the, you know, when it comes to the economy relative to what's likely

Starting point is 00:20:41 to happen with the macro economy, you know, dynamics like that. What's going on with policy moves can shift what's going on with global macro views in a way that might, you know, lead or not be reflected in price trends. So macro in some ways is like a, I'd say a more strategy diversify way of approaching the same markets than traditional trend following approaches. I 100% agree. I also sometimes say, like, macro can be long, short, flat, whereas trends are going to be more long short,

Starting point is 00:21:15 and they're just going to take a position, regardless of what's going on, whereas a macro man or woman might say, hey, hold on, this looks scarier. This doesn't look risk-worthy. Last bit, we'll dive into more of this stuff, But on Dallio, you got one or two words? Was he brilliant, quirky, eccentric, all the above?

Starting point is 00:21:38 Well, I think I'd say when I started my career, you know, he was, it was great to work with him to develop a really good understanding of, you know, the macro economy and markets and the insight. I'd say the insight to systematize macro was, you know, a pretty unique insight at the time. You know, it was sort of the time with where if you sort of were in the macro milieu, you'd sort of say, oh, well, these are people taking huge concentrated bets and in a discretionary way, you know, trying to break the pound and stuff like that. And the insight, exactly, the insight to basically say, no, actually a better way to run money is to have a 55, 45, 45. probability of being right and diversify over 100 markets or 120 markets, that was a smart way to manage money and a differentiated way to manage money. And so, you know, I thought when I started my career, it was a great place to start my career. The other thing actually, which I think probably doesn't get enough credit in terms of building the business, which I'd still use today,

Starting point is 00:22:49 is just the investment in communicating investment thinking clearly on a day-to-day basis to your clients and helping them to both help them understand what's going on. And as part of a process of helping them manage way more, you know, manage any single manager is going to be a tiny slice of any portfolio, right? And so how do you help managers manage the whole book? How do you help them, A, sound smart to their either higher-ups or clients, and B, how do you help them manage their whole book? A lot of the business, a lot of the stickiness of the business was built around that sort of strategic partnership. Both the daily observations were essentially a tool in that regard and, you know, the longer-term strategic relationships beyond just whatever the return was, was important.

Starting point is 00:23:42 So that's, you know, a lot of, I still like that sort of ethos of how to build. a business is, you know, in many ways, at the core of what we're doing at unlimited in what I do in a day-to-day basis. And so I think that probably doesn't get, if people talk about the running of the money, but that building of the business part probably doesn't get the credit that's due. Yeah. Which it seems to me he kind of went too far that way in the last few years. He's promoting a book and doing all this stuff. But yeah, yeah. I mean, I, you know, I mostly focus on, on the, for me, the strengths of, it was a great place when I was starting my career. It was a fast-growing, and we went from being the challenger to the incumbent, like, it was a great place to, you know, it was very interesting time in markets. And so you put all that together. It was, you know, it was a great foundation for, for a career for sure. Yeah. And they, it definitely became the like, you don't get fired for buying IBM kind of thing, right? To your point of like, hey, that was the result of all that work.

Starting point is 00:24:49 enough on those guys. You left for a reason. You hung your own shingle. So tell us about unlimited. Well, it's interesting in a lot of ways, having sort of been in the two and 20 business for a long time, I sort of increasingly recognize some of the challenges of the two and 20 business, particularly, you know, given the fact that two and 20 businesses are pretty good for the manager and not necessarily that great for the investor. And the reason why that is, It's a couple of different reasons. I mean, the core reason why that is is the fees are too high, meaning, you know, managers. Two thousand people.

Starting point is 00:25:27 Right, exactly. Managers that charge two and 20, it just doesn't make sense for particularly when you see strategies that are run that sort of bond-like risk. The fees are too high. And so the manager, you know, I like to say, hedge fund managers generate plenty of alpha. It's just they take it all for themselves and their clients never see it. And, you know, on top of that, starting to think about whether there was, you know, seeing that a lot, for a lot of folks, they're totally locked out of hedge fund strategies for a variety of different reasons. And so that got me to thinking with my co-founder, Bruce, about whether there was a way to bring sort of concepts of diversified low-cost indexing and bring it to the world of two and 20.

Starting point is 00:26:12 And, of course, you couldn't, to do that well, you can't invest directly in managers, right? You can't build fund of funds because you pay the managers and then pay yourself and now we get too many fees where are your problem? It's even worse than that structure. And so our idea instead was to build technology leveraging our experience, having built these strategies that looks over the shoulder of how managers are positioned in real time and then takes that understanding and uses it to hold long and short positions in liquid securities that can back things like ETFs. And if you put those strategies into an ETF wrapper, you know, both not only does that open up the door for, you know, essentially any investor to have access to these sort of approaches, but because we're using technology to run it, we can offer it at a much, much lower fee point than what typically exists. And we can also target the return to be something away from not just, you know, institutional like returns, which is like. like cash plus a few hundred basis points. We can actually take the same understanding and target something like equity risk,

Starting point is 00:27:22 which has a much more, which is much more cash efficient and a much higher return potential that's in a portfolio. And so that's the core of the business. We've been around for three years and have, you know, over the course of that time, proven out that our replication tech is working well. And, you know, in the recent period, have launched some of these individual sub-strategy ETFs, meaning things like Hedge, like Global Macro, Managed Futures, Equity, Long Short, but doing it at a 2x target return in a way that makes it a pretty, what we think is a pretty compelling pairing in a lot of client portfolios. And I love the name. What was the, you guys sat in a room, sat at a room.

Starting point is 00:28:13 bar went through a list of 20 yeah well the idea naming is a real pain that's what i would say you find a great one you're like damn it someone's got them yeah exactly so we needed something that was uh that you could spell so unlimited you're right you could spell easily which was which was important um something that uh that wasn't already taken um and then also what uh what it is is it's a little bit of a play on limited partnerships, you know, we're unlimited because anyone can invest. And then are you, which was designed here, you can see in the background here, has the up and to the right, that line that's up into the right is reflective of what an ideal return profile looks like that we're trying to help people go up into the right. And you couldn't very well try and disrupt 2 and 20 with like some fancy Greek word that all that. the two and 20 guys use, right?

Starting point is 00:29:12 Exactly, exactly. Like, yeah, we're not, yeah, there's always people trying to get two ways too clever. Like, I need something that someone can spell, you know? And then interesting to me, you didn't write with your background, you didn't come in and say, hey, I know how to build these models. We're going to build the next great macro model based off my expertise and run it in an ETF, right? Like, you should have easily done that as well. What was that decision of like, I think replication is better than my own ideas?

Starting point is 00:29:46 That's right. And I think part of having lived the experience of a individual manager is recognizing that any one manager, you know, there are going to be times when it's doing well relative to the index, you know, to their peers. And there's going to be times when you're not doing well relative to your peers. And I think in many ways, the world of allocators thinks that if they try hard enough, they can find the managers that do better than other managers over time. And the reality is quite compelling that there is no single manager outperformance persistence among a group of hedge fund peers. There's plenty of alpha generated by hedge funds, particularly gross of fees, but no one man. manager does particularly well. And I live that life up and down around, you know, through my time at Bridgewater. And if you take that as a reality, which there is no manager outperformance

Starting point is 00:30:46 persistence, I should say beyond random chance, then the best way to approach running money, the best way to extract the alpha from hedge funds is actually to diversify and lower fees rather than try to either pick managers or do it yourself. And so that was, that's sort of the core idea is, you know, in some ways, the humility of saying, hey, look, I can probably, you know, I can generate health over time. But if you really want the best return that you can get, you actually don't want to pick me as an individual manager. You want to, you want to use the wisdom of the crowd and get a more consistent return. And we've had Andrew beer on the podcast before who's doing replication on friends. And we dove into and interested

Starting point is 00:31:32 your thoughts like, but you need those other guys to stay in business in order to replicate them. So it's a weird concept of like, I'm trying to disrupt that and take all these assets. But also I need them to keep replicating. So it's a little weird of like, well, we're going to take some of your money. Don't we're not going to take all your money. You need to stay in business. Yeah. I mean, if you think about the hedge fund industry, there's $5 trillion of assets in hedge funds.

Starting point is 00:31:57 Like if we got 1% of that, like we would be one of the most successful. you know, startup, uh, asset managers in the last couple of decades, you know, so we're, we're good. But if everyone's trying to do the same replication, right, then it becomes like a, I don't know, it's like a splinter in my mind a little bit of how do you, how do you square that of like the thing you're trying to replicate needs to exist? Well, I think if anything, actually the benefit is, uh, that there's probably, uh, the evolution is actually beneficial over time.

Starting point is 00:32:32 And in that sense, like, the reason why that is is because what replication would do, will do over time is it will knock out a bunch of marginal managers, meaning managers that don't really justify their two and 20 fees. And it will create selection towards managers that do justify two and 20 fees. And look, there's lots of reasons why you might want the two and 20 fee structure. You can tailor it. There's all sorts of things. You know, if you're a, if you're a institutional investor, some mandates only let you invest in fund structures or, you know, you have to invest in individual managers, all sorts of institutional reasons why that is. And so my guess is that there's always going to be a demand for, you know, hedge fund strategies. It's just the people who should be worried are the people who are not worth their fees, right?

Starting point is 00:33:27 So that's that's what we're really going after. And then for our wonky nerd listeners, you're doing top down or bottom up? I think per our discipline right here, you're doing top down? Yeah, that's, if someone knows the off the cuff, the difference between the top down and the bottom's up, it's a framework that Corey offstein highlighted, which I thought is frankly like a helpful framework, which is, you know, this idea, bottoms up meaning, you know, in some ways, is. basically saying, replicate the decision rules, right, versus top down is replicate the or infer the positions. And so predominantly, I say any replication is a little bit of a combination of both because in some senses, even the selection of the exposures is a bit of a bottoms up concept,

Starting point is 00:34:22 meaning like for our replication, for each individual hedge fund strategy, we tailor the positions, the plausible positions based upon the style. So equity long, short, you know, is sectors, factors, size, geographies versus global macro, which is, you know, global currency, commodity, fixed income, et cetera. So there's sort of a bottoms up part of it there through the selection of what the exposures are. But we predominantly focus on a top-down approach. And the primary reason why that is, is at least in things like global macro, but really pretty much in any of these strategies, other than,

Starting point is 00:34:58 maybe managed futures, you, there's some, there's a combination of discretionary, systematic thinking that goes into positioning at any point in time. And so you don't want to be too stuck in rules. It's like one of the reasons why a lot of that sort of smart beta or factor type stuff has been kind of mediocre because, like, as a, you know, something like Kerry, carry is good in certain circumstances, it's bad in other circumstances. And it's sometimes it's irrelevant. Like if, you know, an administration is trying to impose a bunch of tariffs instantaneously on the economy, you know, carry probably doesn't matter at all relative to whatever that dynamic is or if there's a pandemic or all those sorts of things. And so we like to

Starting point is 00:35:43 infer the top down. It also allows us to sort of follow on in terms of as managers are getting better and better because they're constantly investing in capital to create more alpha. we're agnostic to that process because we're just following their positions. So if they find better and better ways sources of alpha, we're just following the positions and essentially following their evolution rather than getting stuck and trying to replicate their decision rules. But you don't actually know their positions, right? So that's the machine learning and the technology of inferring, as you say.

Starting point is 00:36:17 Okay, they made 6% last month. It's probably a high number. They made 0.6% last month. Right. That was likely due to these 20 long short equity positions, and you can run this regression analysis and basically find what position would have resulted in that return. Yeah, so that's right. We're inferring the positions from the path of returns. And so the thing that is sort of the core insight in terms of how we approach it is that positioning is continuous, meaning like hedge run managers don't flip them.

Starting point is 00:36:53 positioning instantaneously. Any one hedge fund manager doesn't because you take transactions costs and certainly, you know, if you talk about 500 global macro managers, they're in aggregate not flipping their positions instantaneously. And so that actually gives you like that spaghetti chart and you're looking for the middle of the of the chart there. Yeah. I mean, that gives you like that means because positions are continuous, it means they're path dependent. And so there's actually a lot of information value in the path of returns because the outcomes today are a function of today's positions. Today's positions are adjacent to yesterday's positions and yesterday's positions can be seen through yesterday's returns. And there's only so many portfolios

Starting point is 00:37:34 probabilistically that describe today's outcome and an adjacent portfolio that describes yesterday's outcome. And then functionally what we do is say, and all the adjacent portfolios back for the last 25 years, all the way back up to today, what are all the portfolios with probabilistically that are describing the returns. And so the good thing about that approach is it solves one of sort of the core problems of replication, which is most replications or traditional replications are using back histories, meaning using regression approaches where you have to have back history. So you're really average, you're getting a sense of the average positioning over a time frame.

Starting point is 00:38:13 Because we're using, essentially, you think about it like sophisticated Monte Carlo simulation, like a Bayesian approach, what we saw for is actually today's portfolio, but in the context of the previous portfolios, but not averaging the previous portfolios. And so, you know, our view is that that gives us a much better sense of the tactical alpha positioning from these managers. And then how often are getting your inputs? It's just monthly data from the indices? We get daily performance information, some weekly performance, and some monthly performance

Starting point is 00:38:44 that we're all putting together, you know, taking into consideration. consideration. The daily stuff is a little smaller in terms of the coverage, but very correlated. Same, you know, with the weekly and then the monthly is pretty much the best in class stuff. But we're in many ways, we're constantly getting performance information and we're, you know, updating our views on how managers are positioned as a function of that. And then, you know, trading to when, you know, our view of that is sufficiently divergent from our held positions and it makes sense to trade. And then how do you protect against the model shooting out like, oh, you're supposed to be short natural gas? And that explains these long, short equity returns or something of that, right? Some serious correlation. Yeah, part of the way that we do that is by tailoring for each hedge fund strategy to ensure that we don't, you know, equity long short. Right. Yeah, equity long short managers don't trade natural gas.

Starting point is 00:39:40 And so the way that we approach that is we have a defined set of exposures tailored for each hedge fund stock. which is reflective of the type of exposures they have on. And in that process, we use what we call a parsimonious but comprehensive set, meaning we're not going to try and over-optimize our process to any specific subset. What we're trying to do is say, here is, you know, the largest scope of different possible positions that are within the scope that they normally trade in order to come up with the positions. I think you should have named it parsimonious

Starting point is 00:40:17 ETFs instead of Parcimonious ETF Yeah that would be hard to say Yeah That would be hard to say. And then So it started with the What was your first one?

Starting point is 00:40:34 Just the Head phone replication? Yeah, our first Our first ETF We basically built the technology which is seven underlying sub-strategies individually created. And our first ETF, we basically put those seven strategies together into one

Starting point is 00:40:55 ETF, a multi-strategy. And our goal was to match the index, was to match the index performance with lower fees. And so it's sort of run at bond volatility. And it's consistent with the index. And so, you know, we've, it's done what it's supposed to do, which is, you know, track the hedge fund industry returns. It's just it didn't, you know, it didn't really blow anyone out of the water. And when we talk to a lot of advisors, they basically said, look, we, we like the strategies, we like the diversification. We see that you can do what you're saying you can do because you've shown it for the last few years.

Starting point is 00:41:36 Is there any way to either break out the individual strategies or turn up the expected return so that it's a little more cash, efficient. You have a little less line item risk in the portfolio and it sort of compare with equities more effectively. And so that's really what our three. Right, right. And that's and that's really what our strategies are that we've launched. We've taken the same exact decision rules, technology, the same thing we've been running for three years that's worked. And we're just breaking out the individual sub strategies and then targeting a 2x target return in, in our newest products that we've launched this year. That's funny to me, right? They, just like, wait, I had no idea.

Starting point is 00:42:14 Hedge funds are so boring. Yeah, they just, it's a lot of money and they chug along. Yeah, yeah. And, you know, if you're an institutional allocator with the mandates that you have, you know, you're not really looking for something that has equity like risk because it's inconsistent with your mandate. I think for a lot of, you know, you know, retail oriented advisors, you know, meaning like

Starting point is 00:42:42 people who have less than $50 million or something like that, you know, they're not trying to, cash plus 200 would be disappointing to their, to their clientele over time. And so, you know, they want return streams that are complementary to things like equity index risk. And so that's what we've built. Yeah. And also, you've kind of doubled down on your fee discussion there, right? Because now you're getting 2x for the. Ah.

Starting point is 00:43:12 Yeah, don't tell our backers, our financial backers, but yes, by launching it a 2x, I essentially cut the cost in half. And overall, just for context, like, it basically takes, you're getting 2X to the target return of a traditional hedge fund exposure, and instead of 400 basis points of fees, you're paying 95 basis points of management fees. And so that's about an eighth the fees. And then, of course, in the ETF wrapper for taxable investors, it ends up being roughly half the taxes. I have that argument with people at the time.

Starting point is 00:43:49 I'm like, well, your fee as a function of your volatility is extremely high. Like, here you are compared with all these other managers in our portfolio and you're 10x. And they're like, well, you can 4x our returns. I'm like, yeah, but I'm 4xing the fee as well. Right. So kudos to you for doing that. Um, what, you have a favorite of them all? Or they're just, uh, doing what they do.

Starting point is 00:44:15 Like, it's like asking, yeah, asking, asking what your favorite kid is. The reality is every parent does have a favorite kid. Yeah. Um, they just, they just don't talk about it. Or at least they don't talk about it to the kid's face. Uh, for, for us, um, you know, I think we've, we've found the most resonance with, uh, advisors, uh, most resonated with the global macro strategy. I think because it pairs nicely in a traditional 6040 portfolio, it's got some of the defensive, if you look back through time, macro managers have shown some of the defensive properties of things like managed futures because they can trade short, you know, like in 2022, they could trade short stocks and bonds and traded that period quite well, and the same way managed futures did.

Starting point is 00:45:02 In an environment of good performance and risky assets, it's still a diversifying strategy in positive. risk asset markets. And so that's kind of the, that's the one that most people have liked. Some other people find the equity long short strategy compelling too because it's equity like returns are better with lower volatility. So it's more of an equity replacement than it is sort of an absolute return strategy. And then, of course, you mentioned managed futures, but we have managed futures at 2X, which in some ways. So folks have found compelling because it reduces the line item risk of managed futures, right? That's the challenge with it is, you know, you have to, if you just match the index,

Starting point is 00:45:45 you basically have something that you have to put a lot of capital to get the juice out of it. And so we're basically saying, well, you know, you put half the capital and reduce the line item risk on it. How do you think advisors are coming along to these concepts? It's been, right, you mentioned Corey Hofstein. He's pushing this like, hey, we're creating these products that already have this built in, leverage is a scary word, but we're not borrowing money. We're not, we're just using.

Starting point is 00:46:10 We do higher target return. We don't do leverage. We do higher target return. There you go, right? But, right, it makes way more sense of like, then you don't have to put as much of your, you don't have to sell down as much equity. You don't have to do, right? It makes their lives much easier, but it seems they're slowly getting there.

Starting point is 00:46:27 Yeah, I think. There's a question in there, but, yeah. No, no, I, I, I, I, even in the few years that I've been doing, and, you know, someone like Andrews has been doing this for a long, time in some ways he's like the um you know he's he's he's the ogy uh in this space uh that's for sure um you know i see i see a increasingly rapid uh recognition that these strategies make sense um particularly in the etf wrapper you know folks are really starting to kind of accept that as like a somewhat as a given to say hey look this is this is the best way to do it and you can do it and

Starting point is 00:47:05 And, you know, the, there's a lot of compelling reasons for why it is. Part of that, I think, is paired well with increasing push towards model portfolios, particularly from the independents who don't really necessarily want to spend money on a Black Rock model portfolio. They also don't, they want to be differentiated from the Black Rock model portfolio. And so they've had a good, you know, they find these strategies beneficial because it's essentially a way to create a model portfolio, add diversification, and differentiate from other advisors. So, you know, we've seen a lot of interests there. The, yeah, the wirehouses and the

Starting point is 00:47:46 big custodians have seemed slower to patch up. They think they see leverage was bad. No. And you're like, no, this isn't the negative 2x Nvidia play. This is actually smart target return. I'm going to, I'm going to borrow that. Can I have that? You're going to have that, yeah, for sure. Yeah. What's your thoughts on the current market? The Fed, are they locked in a box? What can they do?

Starting point is 00:48:24 The broader macro economy story is that we're sort of late cycle. The economy was slowing very gradually. someone is a function of high rates eroding the strength of the economy, even before the new administration, and then the new administration has implemented a number of negative growth policies related to constricting immigration and hiking tariffs, which are effectively just a tax on businesses and households. And that that is, you know, that slowed the economy in the first half. We grew at 1.8% in the first half, which is quite a bit lower than the sort of two to three that had been consistent in a few years prior. And so it's not surprising given

Starting point is 00:49:08 that slowdown that we're seeing weakness in the labor markets and from there, you know, weak job growth. And the Fed, you know, the Fed has a dual mandate. But, you know, anytime, it seems increasingly that any time there's a tension point between those two, you know, the dual mandate, the employment and inflation that they tilt towards, you know, expressing concern about employment relative to worry about inflation. And so, you know, the transition, I, you know, there's a lot of noise around here, but in some ways it's kind of the same, in some ways it's kind of the same thing that we saw last year, which is, you know, everyone sort of says that was a big political move, but like, you know, unemployment rate started rising. I think smart

Starting point is 00:49:55 people recognize that it was probably not persistent, but if you were sitting in the Fed shoes, you saw the unemployment rate rising, you were a little worried about it. Inflation was elevated, but not extreme, and so you cut. And that's basically what we're seeing now, which is the unemployment rate, the unemployment rate's very modestly rising, but also labor market conditions are clearly soft. And, you know, inflation's up, but it's not crazy high. And so why not, why wouldn't you sort of cut into that dynamic? And that's basically what's happening.

Starting point is 00:50:23 that's that's too boring come on I want some like you want something you want something to get rid of pal yeah no I mean and the the thing that I think is interesting from a financial markets perspective is in the last two months we've really priced in a fair amount we've priced in basically the most amount of easing that the Fed's going to deliver without without conditions getting really bad meaning basically all financial markets have been lifted from the decline in the discount rate. Like, I mean, it's interesting. Like, these are the sorts of times where everyone thinks themselves as a genius.

Starting point is 00:51:01 They're like, I'm a genius. All the, my assets are up. And it's like, everything's going up. But if everything's going up because of the Fed, because everyone's recognized that the Fed's going to ease in some ways a little bit proactively, you know, that's basically what's driving everyone's genius. The real challenge is it's hard to sustain those moves. After they cut, what do you do?

Starting point is 00:51:22 Right. It's hard to sustain those moves because it's hard. In order to get the continued discount rate decline, you have to have, essentially, policy, be easier than what is already priced in. And the challenge is policy that's easier than what is already priced in would require growth that is meaningfully weaker than current environment. And so if you're sitting there holding equities, you know, you don't really want growth that's weaker than what's going on right now, right? That would be a bad outcome for you. And you would probably have more of a negative influence than any further declines in the discount rate. So that's kind of the question is basically like, how do you get sustained asset appreciation from here now that you've basically gotten all the sort of benefit from a doveish fend?

Starting point is 00:52:13 But that's literally the game we played for like dozens a year. Like how do we keep this machine going? We'll figure out a way. just buy um and do you like derogatorily derogatarily we'd call you a macro tourist right like you're giving all these thoughts and all that but like you're saying it helps you inform right the models are doing what they do regardless of what you think right yeah yeah i mean i i i i i what i the way i'd say it is that um we run our products based upon in a systematic way based upon the you know are views of what the aggregate hedge fund positioning is.

Starting point is 00:52:53 And in a lot of ways, you know, I think part of what I'm doing with any personal discretionary macro views, they aren't influencing how we're running the money in those ETFs. They have two sort of primary values. One is it is important to, from as a portfolio manager, as part of the process of understanding whether our technology is working is to understand what's going on in the markets, why folks would have views that they might have, and constantly be triangulating both systematically but also discretionarily, meaning talking to hedge fund managers, stuff like that, to understand

Starting point is 00:53:31 whether we're capturing the essence of what's happening. And so that's part of it. The other thing is, in the same way that, you know, tying back to the earlier, conversation that a real business benefit that Bridgewater brought to the market was giving high quality insight into what's going on in the markets to clients to make sure, you know, to help them sound smart, to help educate them and sound smart in the market. That's a big part of what I do on a daily basis is going through that process. And so that starts with my own insights and commentary about what's going on. And I, you know, I had a client recently who,

Starting point is 00:54:15 reached out and said, you know, that my view on the economy was, let's say, more bearish than, than the, you know, the wisdom of the macro investment community. And I said, yeah, that's, that's right. And the wisdom of the crowd has beaten my understanding in the last few weeks. So isn't that what you want? But yeah, you're good at it. So I'm glad you're not just, There's a lot of these people, replicator or systematic traders are just like, I don't care what the market does. I don't need to know. Right, right, right. Surely you have some opinion.

Starting point is 00:54:53 Surely you're reading the inner webs and have a, have a standard. And I think part of the challenge in the replication space is there are people who approach it as a statistical exercise. And I think about some legacy replication products that are out there that, like, If you talk to the people who created them, like, they couldn't tell you that the Fed's meeting today. Like, they couldn't tell you anything, right, about what's happening in markets. And having been, having created systematic strategies for a long of time, there is, there's a science to it. There's the sort of statistical work that's done and computer science work that's done. But there's also an art to it because you have a lot of implicit decisions that are going on.

Starting point is 00:55:40 And so in a lot of ways, what I like to say is like, we are, my co-founder, Bruce and I, we're basically, you know, we have 50 years of experience having literally built systematic strategies across these funds. And we're applying that thinking and that understanding because we understand how funds actually operate, how they actually think about these things. And using that to craft a systematic approach. So it's a bit of an art and a science that, you know, a lot of the replication stuff that's out there is. is mostly science and the worst case, you know, lab science rather than practical reality having done the work in the past. Right. Like, does your global macro include foreign indices, equity indices?

Starting point is 00:56:25 Of course, yep, yep. So that would be an example, right? Like, if I'm just in a lab, I'd probably just have the S&P. Right. Right. And actually one of them. 20 years, like why include anything else? Yeah, one of the things, some of the markets that have delivered some of the best

Starting point is 00:56:38 performance this year, Japan, China, you know, which basically started talking about Chinese stocks and everyone kind of looks at you like you're a crazy person. But those are all, you know, but those are markets the global macro managers trade. And so, and to be frank, I've traded in my career. And so, you know, they're important components of how we think about the overall replication approach. And to be frank, for me, are way overdue for a, or a reversion to the mean. What kind of rabbit hole you've been going down recently? Well, one of the interesting things that I like about having a managed futures product is trading all of these markets that I wouldn't, you know, I wouldn't otherwise have at the top of my,

Starting point is 00:57:37 the top of my head. And so I've got to give you quick props of launching a managed futures product in the midst of a historic 18-month drawdown. That's right. That's right. Well, the best time to buy is after some pain. Blood in the streets. Blood in the streets.

Starting point is 00:57:55 So I recently went down a rabbit hole on the live cattle market, which was, which actually added a fair amount of positive return, both for our managed futures product as well as are as well as global macro. And, you know, I, it's a very interesting, it's a very interesting market. For instance, you probably don't know that, that the herd size today is at its lowest level since 1950. And, you know, that has created a real tight supply in the market. Or, you know, we talk about macro and the impact of tariffs, but, you know, a lot of our beef imports are from Brazil. And at a 50% tariff, that's actually a big problem because a lot of those costs are growing up in sort of, let's call it the cheap beef that's coming into the U.S. market or like the fast casual burgers.

Starting point is 00:58:52 Exactly. Exactly. It's coming from Brazil supply and that's 50% tariffed. And that actually is a real problem when it comes to prices. Or, I mean, not to mention the Mexican screw worm, which is, you know, really caused some challenges with Mexico. supply. It's not a joke, people. There's an actual thing called Mexican screw.

Starting point is 00:59:12 Not a joke, not a joke. So anyway, this is, this is, it was a little bit. I wrote a, I wrote a blog piece about it recently as well, just kind of getting into these markets that I, you know, I wouldn't normally spend any time thinking about, but either bigger, live cattle's been sort of a march up into the right, pretty much more than any other, any other agriculture. commodity. And so I went down the rabbit hole on live cattle, which is an odd because grains have been going down into the rate massively, right? They're at all-time lows, which you would, right, that's what the cattle are eating to fatten up. So usually those two would be more correlated. So yeah, you outed yourself, though, as not a avid listener of the podcast because two pods

Starting point is 01:00:02 ago, we had a guy on talking all about live cattle. Is that right? Oh, my gosh. Well, I should go back and listen to that. I actually, the, I occasionally do, I do a radio program called Agrotalk. Shout out to all the Agrotalk listeners out there. Now, there's probably not so many. But it's the largest syndicated, farm-oriented show in the country in Middle America. And so I always love it because we, you know, we sort of talk Main Street macro dynamics that are going. on, which is helpful for folks, but I always enjoy the segments ahead of time where I'm learning

Starting point is 01:00:43 about, you know, the soybean yields in southwest Iowa or whatever, running into, running up into what I come on. The basis trade's blowing out in Pierre, South Dakota. Exactly. One more blog post. I'll mention we had a blog called The Picture from Space that proves why commodities are non-correlated. And it's basically 10, 15 years ago, there was a snowstorm in July in Wyoming, and the cattle hadn't, maybe it was August or September.

Starting point is 01:01:15 The cattle hadn't grown their winter coats yet. So like 70,000 cattle basically died, froze to them from this freak blizzard. So it's like, yeah, that kind of stuff's not priced into equity, PE ratios and all that. That's why you need. Right. Right. And it's a great, you know, live cattle, I think is great because it, it both, like, You know, when you look at it, there's sort of like fundamental reasons why you, why there's been strength in the market.

Starting point is 01:01:41 But there's also, if you're a trend follower, if you're, you know, then you've picked up this price trend that's been, you know, running quite well. So it, it sort of speaks to the value of both traditional fundamental analysis, but also price trend analysis as, you know, ways to find opportunities and markets that you otherwise wouldn't find. And the weird, the cattle, it cure for high prices is high prices, right? Everyone will start slaughtering their cattle to grab those high prices, but that hasn't seemed to happen yet. It's happened a little bit. Supplies increased, but, you know, the thing that is incredible is the insatiable demand for us, for Americans for, for hamburger meat and such. And it's kind of incredible. Watch your commercials over the next couple weeks, listeners, too.

Starting point is 01:02:30 like you'll see McDonald's, all these chains pushing chicken. Ah, that's interesting. Like a guy mentioned that to me and like I'm starting to see and I go to McDonald's like five times a week for just to order a Diet Coke. But it's popping up in my app and on the, on the menu of like, order a chicken today.

Starting point is 01:02:48 Or that's, that's interesting. They're trying to figure out a way to reduce supply or reduce demand. Because they're probably not going to change their menu prices, are they? That's so interesting. uh last question i wrote down here i never got to have going back a little bit like you never mentioned risk parity in talking about bridgewater which was kind of synonymous with them in the

Starting point is 01:03:10 past and you don't have a risk parity et f what any reasons for that uh i mean risk parity in a lot of ways is just a uh uh it's a somewhat smarter way to build a passive portfolio um it's uh in this in this world, like, you know, I think when it comes to diversification, and, you know, I talk to a lot of advisors that are out there, you know, most of them have 60, 40 or the equivalent. And when you're thinking about what are the most important ways in which you could build diversification into your portfolio, the highest bang for the buck, you know, it's not really shifting all the way to a risk parity portfolio. It's really doing simple things like maybe you add. some gold into your portfolio, or, you know, adding long short strategies, like tactical, long short strategies at a reasonable fee, that those are the sorts of things that will move the needle for advisors. And, you know, risk parity is a, is a fine theoretical concept, but it's not. And I think it's one of the first replication ETFs, right, R par or something like that didn't do very well from my recollection.

Starting point is 01:04:25 Um, it, it's just, uh, it, there's a challenge with the, um, the distance between that strategy and, you know, where most advisors benchmark themselves. And that's, you know, line item risk or peer risk is a practical reality that exists for any manager. Uh, and you're, you're better off recognizing that that's, that's, uh, that's the reality than trying to think that it doesn't exist. Love it. Get yourself some managed futures and global macro instead. Exactly.

Starting point is 01:05:01 Awesome. I think we'll leave it there. Got any other thoughts? Leave us with? No, no. Thanks so much for having me. It was great to catch up. Agreed.

Starting point is 01:05:10 Next time, I'll try and find you at Future Proof. We missed each other, but there's 5,000 people running around. And we'll look you up next time we're in New York. Yeah, for sure. It was great chatting. and let's definitely do it again sometime. Awesome. Love it, Bob.

Starting point is 01:05:28 Thanks. Talk to you later. 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 RCMaltz and visit our website to read our blog or subscribe to our newsletter at RCMaltz.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.

Starting point is 01:05:53 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 paths or potential profits, and listeners are reminded that manage 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.

The Derivative - Bridgewater, Botany & Breaking the 2&20 mold with Unlimited ETFs Bob Elliott

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