The Derivative - Engineering, Exponentials, Enigmas, and Equations with Breaking the Market’s Matt Hollerbach

Episode Date: July 8, 2021

What is it about engineers and seeing the world through a quant lens?  We’ve talked to plenty of quants who have an engineering mindset; but this episode’s guest is an actual engineer – doing his mechanical engineering work by day and dishing on portfolio construction at night via his excellent Breaking the Market blog and @breakingthemark twitter handle. Whether it is diving deep, real deep on arithmetic versus geometric returns, comparing performance measurements to Tiger Woods major’s performances, or calling Trend hot air, Matt Hollerbach puts his thought processes for all to see on the web. He does it to not only document his journey to quantlightenment, but also to get called out by pros who are increasingly finding a familiar voice in his writings, and teach those coming into the space. Jeff and Matt talk golf, the DC area, being anonymous versus having a name, LMGTFY, mechanical engineering, rebalancing, Gold, rebalancing, expecting a miss in your portfolio construction, Bryson DeChambeau, why its never as easy as it seems to write a great blog post, a library of quant research, Renaissance, Claude Shannon, rebalancing, and more. Enjoy! Chapters: 00:00-02:05=Intro 02:06-11:26=Tweeting while Engineering 11:27-22:48=Meeting End Goals & Golf Specs 22:49-34:45=Breaking the Market 34:46-50:23=Arithmetic vs Geometric  / Trend is Hot Air 50:24-58:43=Rebalancing, it’s All About Rebalancing 58:44-01:15:52=The Strategy 01:15:53-01:24:35=Favorites Follow along with Matt on Twitter @breakingthemark and visit the blog at breakingthemarket.com. Check out his Pronghorn strategy at https://pronghornanalytics.com/ Don't forget to subscribe to The Derivative, and follow us on Twitter @rcmAlts, and our host Jeff at @attainCap2, or LinkedIn, and Facebook, and sign-up for our blog digest. And visit our sponsor, the CME Group at www.cmegroup.com to learn more about futures and options. 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 the 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. So much discussion about portfolio construction just assumes accuracy. People say you're going to get 10% return and you're going to get, you know, 15% volatility in the investment. But those are just guesses. Nobody has an idea what the future is going to get 15% volatility in the investment. But those are just guesses.

Nobody has an idea what the future is going to be. And so if you construct a portfolio kind of trying to target and maximizing returns around a point estimate, you may feel comfortable about what's going on. But it's very important that you actually understand how far you're how good your estimate is because if your estimate's very poor you might be putting the other portfolio that you think is great but you're actually going to give yourself a portfolio that has got crazy amounts of volatility and because it's so volatile it's not going to actually give Hello, everybody. Welcome back. They say to get smarter, hang around smarter people, read what the smart people read, and so on. And many of our guests on here surely read

Cliff Asness or Nassim Tald's papers. But a growing number of people I talked to in the quantum space are also starting to read the works of today's guest. We've got Matt Hollerback, creator, researcher, and writer for the Breaking the Market blog, which dives into the nitty-gritty of portfolio construction, risk-adjusted ratios, rebalancing, and more. So I'm excited to see just what Matt is up to lately and dig into some of his recent works and thoughts on how he approaches everything. Yeah. Hi, Jeff. Glad to be here. Good to talk to you. Did I get the last name correct? You did. Yeah. It was good. So I'll start with like a year ago or so you were on Just Don't Use podcast, the Resolve Guys podcast anonymously right yes yeah yeah i

didn't have a i didn't have my name out there at the time yeah so what um what was that all but now you've got your name out there and sort of planning your flag is it a little a little bit um i mean the main difference is i started an actual company um and so i figured if i'm going to have an actual company trying to uh do business in in the investing world then uh i should have my name out there too it made more sense to not be anonymous so and then curiously i saw your one tweet that since you put your name on your twitter handle the engagement's gone down right yeah that was that was partially a joke i don't think it had to do with my name i think twitter's just changed their rules on some stuff as the way that they post things.

It just coincided with a couple posts that I did linking to my blog that were lower. I think that's because Twitter is not promoting links to outside sources like they used to. Oh, really? A gremlin in the algorithm. We can talk another time about what twitter should do to

monetize their whole thing their stocks like basically disaster when it's such a great tool oh i have i have no idea what their stock's doing i don't pay any attention to that one but yeah i just use the product yeah galloway's always like they should charge by followers right so like have britney spears or this is how out of touch i am with that space but but have someone who has two million followers charge them 20 grand a month or something right yeah well they're getting the most benefit probably yeah and someone who has you know a thousand followers maybe they'll pay a dollar a month or two dollars whatever so we'll fix that another time well i hope they don't change it too much because i like it it's uh it's fun to interact with people i'd rather not have to think about paying to

get on there and have people like my stuff but uh right and the fin twit as we call it space in particular seems particularly suited right of just people sharing ideas sharing thoughts yeah i mean i'd lurked there for a while before i started a blog just reading people's stuff um it's a good community because people share a lot and there's a lot of people being open. I mean, there's some extremely accomplished people out there that you can just message them and they'll talk to you about things. I also like using it because I can just throw out ideas on there that maybe I'm

not a hundred percent sold on, but you can get people to tell you you're wrong real fast and figure out if there's a flaw in your thinking. And if your view or your ideas actually make sense. Which I find surprising not to age you, but you look about my age or so. So a lot of these like, right, I'm a little hesitant to do things like that. I think older generation, not even old, but just a non-millennial generation is a little hesitant to be like, is this right or wrong? Like they don't want to be told wrong where these younger generations just throws it out there willy nilly and is happy for the whole world to correct them. Yeah, I'm right on the cusp between millennial and Generation X.

And I'm OK to a point. I definitely some people take it to an extreme. But I don't just say something that I haven't thought through. But it's hard to think through all things in your own mind because other people have different perspectives, and I'll hash it through as much as I can myself. And then if I think I got an idea of it, I'll just throw it out there. And sometimes I'm dead wrong, and that's a faster way to figure it out than it is to keep going down the path of thinking you know something.

There's a great tool. Let me Google that for you passive aggressive way so when someone asks something dumb i've been known to like you go on this site and you type in like where is maybe peer in chicago or something right right type that into this site that pulls up a google browser types that in records it and then the person that link and it basically just types this question for them and like yeah that's good it's good we'll put that in, records it, and then you send the person that link. And it basically just types this question in for them. That's good. That's good. We'll put that in the show notes. And so give us your background. You're an engineer by day and sort of quant blog writer by night? Yeah, that's a good way of putting it. So I'm a mechanical engineer. I do HVAC work with my base,

but at this point, I've got a team of people doing a bunch of different things inside buildings, planning, designing buildings, and working on, I guess, strategies of how to maintain them. Got any thoughts on the Miami building? Yeah, that's awful sounding. I don't know too much of the details. I mean, I know that I guess the ground may have been sinking out from underneath it, but, you know, I feel I'm not a of the details. I mean, I know that I guess the ground may have been sinking out from underneath it. But, you know, I feel I'm not a structural engineer, but I think that's probably the most stressful of all engineering because this stuff doesn't happen a lot, but it happens every now and then. And they have to put their stamp and seal on everything they do, effectively saying that this won't happen. I mean, I think this one's a little bit more inspection and the fact that it's changed over time. But even then, you know, inspectors have to go and look at wells,

look at connections. I've had teams of people do that in government, in buildings before. And it's a different animal because the failure is big. Like in the HVAC world, if you fail, people get hot, and that's annoying. But it's not necessarily the end of the world. If you're doing data centers, it can be a little bit more problematic, obviously, but it's still not necessarily the end of the world if you're doing the data

centers it can be a little bit more problematic obviously but it's still not anything the same as the kind of engineering failure we saw down there so right that's interesting i feel like today's world it's moving towards right structural engineer of course if the bridge fails people die the building collapses people die but in today's, who knows how close we are to automated cars and planes that land themselves and all that. There's that increasing link to non-structural has to be bang on too. And then you just mentioned the data centers. Tell me how crazy have those gotten? Is that some of what you did?

Yeah, I've delved into a little bit of data center stuff with some of my clients. I mean, they keep getting bigger and bigger and denser and denser. And more power and more reliability. They just can't go down, which makes the engineering side of things a lot more complicated. But they throw off a tremendous, unthinkable amount of heat? Or have they gotten them pretty good at figuring out how to? There's no real way to escape the amount of heat they throw off, because if they're computing, if they're taking in more electricity and computing more information, that almost all gets converted into heat. So you can't really, you can't get rid

of that. You can make better ways to get rid of the heat and more efficient ways to move the heat out of the building. But the heat, the heat's there. I mean, there's not a whole lot you can do about that. So is that all, that's the whole game? Like cool, move the heat? Yeah, cool it, move the heat. Most people think you get rid of heat, but you really more just move it to somewhere else. You can't really get rid of it. But right. And the data racks, they get dense. People want just more and more and more stuff. And that just makes it more challenging. I mean, a lot of stuff now is becoming more like water cooled or interact cooling. As opposed to the old, I mean, you can I've walked into some

old data centers that are abysmal, they just kind of dump heat in one side or air and cold air in one end and suck it out the other. And they think that that doesn't create hotspots. But if you really get deep into it it there's all sorts of airflow modeling like it shows how all you you map the expected pass of air throughout the entire building and you can effectively model where the temperature should be in every location based off the heat sources i mean people take it to some very high you can like adjust the flow to keep it all yeah exactly and then you just you go into your model and you move a air register to one place to another and it'll, it'll recalculate the whole thing.

And you can have enormous changes from just like, you know, one return grill moves 10 feet and the whole, the whole room will adjust and the hot spot will disappear. But another one will pop up somewhere else on the other side. That, what was that? I have the nest, but there was like echo B. Yeah. That's what I've got. It's thing was like was like oh it has the sensor in the farthest away but then i read into i'm like well

all it's going to do is run the fan for longer to make sure that far sensor cool yeah so that's what i've actually picked i i like that one but it's got multiple sensors and you can actually get in there and if you're nerdy in this you can program how it responds to which sensor at which time of day so it can ignore certain ones that you can program how it responds to which sensor at which time of day. So it can ignore certain ones that you don't want it to. Nice. All right. We got to have you out to Chicago one time and consult on my home.

Yeah. My wife's house was like, this stupidness doesn't work. I'm like, well, you do actually have to turn it sometimes. It's not, you know, it's not intelligent, supposedly intelligent, but it's not sentient. Doesn't hear you say I'm hot or cold. Hopefully not. You never know. know yeah this is too far so many of our clients and even some of our guests as we've talked about are engineers so what do you think what's the link there between like wanting to figure out the markets and and being an engineering mindset well i think a lot of people wanting to figure out the markets and and being an engineering

mindset well i think a lot of people want to figure out the markets i don't know if there's a link in that perspective but i i do think engineers take a certain tact to it um we're taught to think about problems in a certain way like you know define the define the boundary conditions define the goals goals up front. And I think you see a lot of engineers attack these kind of things from a very systematic standpoint. And the systematic idea, the structured nature of the way we try to invest, I think comes from our training. I mean, I do think investing is a gigantic problem,

and it can be modeled in very similar ideas to the way engineering works where you're, you've got an end goal, you know, you want returns. And then there's all sorts of constraints on those returns, you know, you have volatility constraints, you've got your different tools you can apply. And so you're trying to figure out how to apply, you know, bonds or stocks or golds or tail hedges or trend following or factors or all sorts of different things in different quantities and mixes and ways to meet those end goals. And then, you know, like from an HVAC engineering problem, you know, you want to stay the right temperature, but what that is, is it's a lot more complicated than that. You know, there's ranges and what's

an okay temperature. It's nothing's precise in that front. And then there's ranges in what's an okay temperature. Nothing's precise in that front. And then there's different ways to accomplish it from like an energy efficiency standpoint. You can spend more money to get there or not. So, you know, that can kind of relate to how fees work with investing. So it's a bunch of inputs with a handful of outputs and that kind of systematic thinking. Engineers have had to do that on a lot of different challenges in the past. and so I've approached it, I think, similar-ish in that front, and I assume most others because we go through such rigorous training in college to think differently. They go at it, you know, we go at it the same way. I mean, you know, I know that there are just stock picking engineers out

there. I've had some discussions with some of them, but I feel like a lot of the famous ones have more systematic approaches. And how do you view it? I think we went into this with Howard, Sal, yeah. Of like, what if the market's not solvable, right?

Like, so if you're working on some of these engineering problems, yes, there's a solution, but what if there is no solution? It's getting close good enough how close can you get yeah i mean it depends on how you define success in a way i mean obviously you can't sit here and say that i want 50 returns for the next 10 years at least i don't think you can

maybe maybe jim simons can but i don't think anybody else can um so you you have to put something out there that's reasonable as a goal um and then understand it's it's not precise i mean like when you're planning for a building there's always a there's always a base budget early on you envision that you need to build a new building for some purpose some mission and you you say it's going to cost 100 million dollars um but that number is not fixed in stone and so like as you work forward and design and come up with the solutions for the building it's going to adjust and change over time so um never go down it doesn't seem too much no i it doesn't it certainly doesn't unless somebody starts removing scope that never seems to happen but um yeah that's just always in the back of my mind of like and i know the answer is no it to me it's

like no it doesn't need to be solvable just be the approach the systematic approach is going to yield results well and so the good thing about investing is at a base level i think there's two there's two goals but technically there's no end goal i mean you really won't you probably find making as much money nobody goes I made too much last year. The only reason they do that is because that implies that maybe they took too much risk. And that's the other side of the coin. The risk goal, I guess, is essentially zero, but that's probably never obtainable. I mean, I don't think it's probably, it's not obtainable if you're going for anything more than the risk-free return.

So because of that, you've kind of always got pie-in in the sky goals anyway you want you theoretically want more return and you want less risk and the perfect world is beyond what we're going to get to i mean you're like i said we're not going to get 50 returns with with very low volatility um we would so there's always kind of an obtainable you know shoot for the moon how you know keep improving continuous improvement kind of mindset in that in that front we we used to have on an old website like 10 15 years ago was when investors fill out a form and they would it was like a slider they can choose their return and their risk except they weren't linked anyway so they'd always be like 22 percent return right yeah yeah drawdown right

it was never so then finally we linked them and there was like people are like what's going on here right and then they weren't happy probably with anything you put in front of them yeah exactly it was like how do you link them two to one that's great it's probably right the reality might be half to one or even one to one they're like oh i don't want 30 returns with 30 drawdown are you crazy like well that could be the reality right and you're a big golfer you told me so what sort of handicap are we talking about uh i'm i'm about scratch right now i i might be tripping just slightly under it but roughly scratch slightly under meaning like a plus something yeah yeah i think i'm a plus 0.4 or something at the moment oh that's awesome um and you played collegially i did i played uh i played

at virginia tech i used to play a ton um which is why i'm a plus still because you get enough i mean the handicap system doesn't average your scores it just takes your good ones and so i get enough good ones around that i still look like i've got I know what I'm doing most of the time. So who did you play with? Anyone famous in the ACC there? Who was at ACC? So we weren't in the ACC. I'm old enough that it was before that time.

I played in the Atlantic 10 in the Big East. We actually switched conferences midway through. But no, two of my teammates were on the PGA Tour, Johnson Wagner and Brendan DeYoung. And so what's your best ever my best score ever yeah 65 65 nice about 30 maybe i had 82 once was about i i i kind of i i played golf a bit like how i try to invest i didn't have a lot of volatility in my scores i never made like nine birdies in a round or anything like that i i was mainly just a few birdies and mostly parses roughly when i was playing well how it would work

which if you rolled a few in have a good score right um and what do you think about bryson trying to like quant engineer his way to champion yeah i actually i like it i like watching it um i mean i don't know i don't exactly like the way he plays, but I very much appreciate the way he's thought through the whole process and the way he attacks it. And I mean, I think golf's already been changing a lot over the last 20 years because of distance. And I think he just took it to a whole nother level. It's pretty amazing. He was able to do that. There have been some people that have tried to get bigger and it almost always backfires so the fact he even pulled that off and stayed flexible enough to still uh still play um and i mean his putting approach is kind of crazy too i don't know if everyday people know that he putts really strangely um explain it if you would yeah i've read a little bit about it

but yeah it's cool well i mean he so like he tries to take out all variability like there's no wrist hinges i mean like most people putt with a little bit of like hinge in the wrist there's feel involved and he definitely has feel but he tries to putt essentially like a straight line off of his off of his shoulder but he does it i mean so he's he's very locked he's very angular and um it makes the the um the club just move very piston like um most people rotate and of course rotation means that like you're not always aiming at the the the club's not always pointing back at the hole and he doesn't try and rotate anything away from the hole he just tries it's honestly mechanically it's about the simplest way you could possibly put and then doesn't he do just pure math of like as you said oh yeah oh and then so then you get into

his green reading stuff i mean he he effectively just solves everything before he goes on the golf course where he knows the slope of every single point of the green and he's got a book that he's able to he just looks at the book he effectively doesn't have to people, when they play golf, for those that don't play golf, have to bend down and look at the slope and see how it's tilted. And then you kind of guess, and you say it's tilted this much, so I'm going to try and hit it six inches to the side of the hole, expecting it to roll down the hill. Bryson has mapped all of that out on the greens

so that he essentially can just look at his green, not look at the hole and go, okay, my ball's here, and and the flag's here and i'm going to aim a foot to the right and it's as long as the green is smooth it's right like he he doesn't really have to think about it um and the distance too does he like it's eight feet i mean i need to go back six inches and forward four inches so i think he does that a little bit but i i i don't i have trouble thinking that actually works i don't know how you get rid of that like yeah from a field perspective um but from a line perspective absolutely and um but i think that tor just said they're banning those books so he's gonna have to which i mean push back against him right

but he won the u.s amateur before he was doing that, so it's not like he can't play world-class golf just putting normally. I think he'll still be fine. All right. I don't know how big a fan I am, but it is interesting. We'll leave it at that. Yeah. I mean, I just appreciate the different way he attacked it. I think it's – most people just – they go the same.

They approach things the same way. They look at what people did before, and Bryson said, I'm going to reevaluate this thing from scratch. And it's working reasonably well. I mean, obviously he's not the best player in the world right now, but he's doing very well. The cool thing was that last US Open, right? When he added the game theory component to it, right? So he's like, I can drive it a ton.

Everyone else wants to put it in the fairway. So they're not using driver. I'm going to steal driver because I'd rather have a wedge out of the rough than a four iron. Yeah. I mean, he went through the stats of the whole thing, essentially, and said that if I'm 30 yards closer from you, it's OK if I'm in the rough. It doesn't make that much difference statistically. And he's just he's playing the math. I mean, and that's what's interesting about it is he, he knows sometimes it's going to backfire, but he knows that when he does hit it 30 yards farther and in the fairway, he's going to destroy people. Right. It's like money ball for golf, essentially with his own body.

Like instead of building this team of stats, I'm just going to build it with money ball thing is exactly right. And, and I don't think he can be what tiger woods was with that because tiger woods won like you know i mean he had a stretch where i think he was winning every other round and statistically i don't think he could pull that off but i think he can win a lot because when the you know when the odds go in his favor um yeah he's gonna win and it's gonna be very hard for people to beat him when he gets the luck going his way i'm trying to get a theo epstein on the pod still lives here in chicago so nice thing please come on yeah um but to talk

through all that he he's doing some interesting stuff with all the overall baseball analytics so moving on uh the blog is fantastic i don't know where you find time to write all that stuff you've got a family you got a job but um yeah you must not sleep very much or you're a very fast writer no i'm not it takes me forever i wish i was much faster but it's all the data in there too it's impressive well so some of that is i did well before. Like I've I've I've been a fan of investing for a long time. I mean, I kind of started dabbling with it in grad school. I mean, two years going on, I guess it's 18 years ago. But but mostly that was just picking stocks. And, you know, you learn about discounting cash and and that kind of stuff in an academic environment and I that's where I started kind of paying attention to investing and then I

got a real job and got out in the world and I dropped off a little bit but I really got it back into it a lot when during the financial crisis and during the housing boom I lived not too far at wash outside Washington DC and we had a pretty decent participation in that housing boom and it was just it got me back into learning a lot about finance and how money works and those kinds of things. And so I would spend a lot of time just in the evenings after work, just reading articles about it. You know, I was trying to find a home, but trying to figure out, okay, this is, these are crazy expensive. Why are they so expensive? Should I really buy it? And then of course, seeing my 401k drop, I wanted to know what was happening with that. And so I started digging into it. And like I said, applying the engineering mindset, trying to figure out how to approach it.

So a huge percentage of the stuff that I've pointed put out, at least from a math perspective, I did like over the last decade, like I like pulled together the data. Now, I did have to learn that it may be good enough for me, but to present it, I do have to go back and refine a lot of it, which has been a little bit of a pain, but, and I'm also starting to run out of those things, which is why my posting repetition starting to come down a little bit because I don't, I can't just go, okay, go pull this topic. I've already got the data.

I just have to go massage it and write about it. So, I mean, a lot of, you know, that's where the blog kind of started was just my idea to start sharing the things that I'd been studying and come up with my approaches and my methods and how they evolved over the years. But yeah, you're right. Some of the data stuff can take, can take a long time to pull together because some of the charts I've gained a lot of appreciation from people that share stuff online because you think

certain, you know, three page articles took someone like two hours to write and that's, that's not even close to true. Yeah, exactly. And it's a, it, that, that aspect of it is a huge disadvantage. If you're at a big firm, they have the data warehouse and the, right. They can kind of just type it up and run the model. Right. One, two man shops are doing an Excel. You're doing all this stuff.

I'm waiting for google or some company to get bought by google that's just like hey right if you could just type plain language like show me the volatility on a stock plus bond portfolio over the last 25 years right or plain language it seems like that shouldn't be too far off no i agree that annoys me too i data floating but i always i was like why is the 60 40 portfolio not just published somewhere yeah easily accessible and it's it's not like there's no i mean some of it's i don't think everybody agrees with what the 40 is exactly so that maybe causes a problem as to what the duration and the type of the bonds are but i that's not just

floating out there to just snatch and that's's always found, I found that strange. So when I feel like we've gone backwards, cause now there's so many ETFs that people are like, no, you just use as that data point, but well, the ETF only goes back such and such. Right. Right. Yeah. So when you, once you get past the mid 2000s, you're probably torched and you have to recreate it. We use VBINX.

Mutual funds are good. 60, 40 60 40 yeah that's what i've benchmarked against to us but like you said that's uh you're if you're trying to compare yourself back into the 90s you got a problem so let's get into some of my favorite posts you can tell me whether yours or not but we put out on the rsam blog a little summary of your post on Tiger Woodsying back to golf Tiger Woodsying is that woodsifying Woodsying you didn't say that language but we use it anyway of Tiger Woodsying your portfolio so talk to us a little bit about what you were talking about there so what I was talking about there was um it was based around the concept of errors and that um in golf obviously you aim for a point but nobody ever hits it literally on that point you know except for one in a million shots

so you have to be extremely conscious of the fact that you're not going to hit it there so how far to the left how far to the right how far long how far short am i likely to hit it if you think there's a decent chance you're going to hit it so far to the right that it's gonna go in the water you probably shouldn't aim there and so the post was around the idea of tiger woods if anybody watched his master's win in 2008 um like half the field around him hit the ball in the water on on the 12th hole because the flag was right up against the water and and tiger didn't didn't hit it anywhere near the near the flag he hit it i think i looked this up and i think he hit it further from the flag than anybody in the field all day long because

there was wind out there it was swirling he tiger was smart enough and he played that enough he knew that it was very uncertain what the what the outcome of that shot was going to be so he played as far away from the water as he really could um as an eight or 18 18 you're correct 18 yeah yeah two two years ago or three actually it was at 19 i'm getting lost with covid i get lost at dates now yeah golf tournaments got skipped and moved around but um his last major his last major went from just a few years ago um and so i related that to portfolios so much discussion about portfolio construction just assumes accuracy. People say you're going to get 10% return and you're going to get 15% volatility in the investment. But those are

just guesses. Nobody has an idea what the future is going to be. And so if you construct a portfolio kind of trying to target and maximizing returns around a point estimate you may feel comfortable about what's going on but it's very important that you actually understand how far you're how good your estimate is because if your estimate is very poor you might be putting the other portfolio that you think is great but you're actually going to give yourself a portfolio that has got crazy amounts of volatility and because because it's so volatile, it's not going to actually give you very much return. I built the post was built around the idea of the geometric frontier, which is going to show you your compound growth rate versus volatility. And that always goes up and it rolls over and it always rolls over. Like, you know,

it could be out there, but at some point it's going to roll over. And if you start getting out near the peak of that frontier and you really do not, if you think you're investing near the peak of that frontier, but you have a very poor idea of how accurate your return is going to be and how your standard deviation is going to be, you can kind of view the path, the peak is a big water hazard. And if you start aiming at that point, you're making the mistake that everybody else in the field did, because you could end up going in the water and your portfolio gets disaster, you know, if if you try to do something like that what it is, you need to become much safer and you need to you need to not necessarily aim for the optimal best results. But then we're talking efficient frontier. You call it geometric frontier. Yeah, it's a geometric efficient frontier.

I leave efficient off every time for some reason when I bring that up. But yeah, it's the geometric efficient frontier. I leave efficient off every time for some reason when I bring that up. But yeah, it's the geometric efficient frontier. My issue with the efficient frontier was always like, and this is big in managed futures, right? The CME and others ourselves always put this out because it's a great data point of like, hey, if you put 30% managed futures with stocks, you get the highest return with the lowest volatility. Right.

Right. And then it curves back. But like, if you dig into the numbers, the volatility goes from like the standard deviation of like 9.8% to 9.6%. Right. I was a little like, does anyone really feel the two 20 basis, whatever that is,

two hundredths of a basis point of the volatility. So it's similar to you. Like you could miss out on tons of upside trying to just shorten that downside a little, the volatility. And then a whole nother question of whether volatility is even the risk you care about. But that's right. Yeah, that's a whole that's a whole nother discussion. But then you're talking about it. And then is the concept like add errors into it or just be cognizant of theirs? Because it's... Yeah, and it's a whole nother discussion into how you figure out how accurate your estimates really are. And I didn't really try and get into that in the post, partially because I'm not entirely

sure I'm an expert on that answer yet either. But the point was, is if you look at something, you can mathematically pick a point and then realize that you're not accurate. So if I think I'm going to say a 20% volatility, but in reality, I should be honest and say it's a range and 10% to 30% volatility, you can go and calculate what your returns would be at those other percentages if that's what the realized future is. And then you can compare to, you know, and so that should be more of what your estimate of your future is. And then you can compare to, you know, and then you can, and so that should be more of what your estimate of your portfolio is. And the interesting thing is, is

because of that, because you're not going to get a precise answer in the future, you can actually get a better return if you don't aim as if the precise was correct. If you, if you recognize that like 30% is way more, volatility is way more painful than 10% volatility. So acknowledge that and say, okay, if I know I'm going to make a mistake, let's aim a little bit to the left, be a little more cautious. And then when I get, let's say, I'm just going to make this up, but let's say 6% and 26%, that portfolio is way better than the 10 and the 30 portfolio was. Yeah. I view that issue as like we have client putting together a multi-manager portfolio, right? Five CTAs.

You put it in the portfolio. Historically, their correlations are great and they dig when the other zags and everything is a smooth line up. Then we say, hold on. What if each went into their max drawdown in the future at the same time? Yeah, right. And that's exactly right. I mean, that's a different way of approaching it because it's drawdown and not volatility. But it's the same concept of effectively, how wrong can I be?

And if you think all five can do that, and you think that's plausible, you need to account for that in your future calculation. And I think most people think that the effects of that are linear. They're like, well, there's some opposite form of that. Like that's like a good version of missing, but that's not really the case in investing. Like, right. You think like, oh, it could be one and a half times worse than this drawdown that I'm seeing on the test. Right. Well, no, it could be six times worse. Right.

Well, there are like, you know, investments that have crazy outside gains and you can, you can get things that go up, you know, 10 times in a year. In bigger, more liquid things, I feel like it's far more common and like effectively I'm leading into like a left skew situation where like the S&P 500 is left skewed. Like you're probably I mean, even though I think the S&P 500, I mean, it's gone up a crazy amount in the last 12 months. But generally speaking, it doesn't double in a year, but it could easily half in a year. And it's done that many times. Like it's way more common for it to go down a crazy amount than it is to go up a crazy amount.

That's a fun topic right there. Have we flipped the script on equities? Is it now right skewed and the the risk is all to the right side yeah yeah i don't i don't think so but uh you're right this past year has been something else and in the returns that have passed rolling year at least and so that leads to my next one the. A lot of your stuff's on arithmetic versus geometric return. So talk through some of that, what you've done. I think, I hope, most managers understand this concept.

I've talked a lot on this pod with COVID of like, most people we had on were early worriers about COVID because they understood geometric growth, right? And the other people who didn't were like, there's only 17 cases. What's the worry? Right. Well, that doubles every day. That's a thousand in a couple of weeks. It'll be out of control real soon.

So anyway, talk through what you, some of your findings there. So where to start? So the big matzo ball. Yeah. Well, I mean, that's a lot of what I've written, so there's a lot to discuss on that front. So for those that don't know, the arithmetic return is the average return we think of if you just take all the returns and just average them. The problem is that's not the same as what the investor experiences over time. Because essentially, if you go up 10% and then down 10%, you're not flat because you multiplied by 10% up and multiplied by 10% down. You're actually 1% down.

You lost money. Even though our first gut feeling is 10% up, 10% down. That's zero. I got nothing. But in the math of the way the market works you lose and so um you had a hundred dollars you made 10 now you have 110 when you lose 10 now you've lost 11 right because you lost 11 and um that volatility drag which is like the i guess the official term it eats away at your portfolio. And so I believe that you have to pay deep, deep attention to what that is and how it plays out. Like when we talked about last March, volatility obviously

got very high. So if you followed my blog, you would have seen that it got started getting scared of a lot of assets and started reducing positions because that kind of volatility implies, it implies that the risk return situation is nowhere near in your favor and it implies that quite frankly the market's got a decent chance of going down now not necessarily because it's not going to return well you know you know plus 10 9 minus 10 perspective but because if you just repeat that you lose a dollar every single time and it'll just it'll just you know fall off um so that's got that's that's in very quick summary, the basis of a lot of what I try and write about. The thing is, is it's not that it's not intuitive, because our minds ultimately

very quickly go to the addition part of it. But so much is affected off of the up and down or off of the multiplicative side of the geometric return. So I ended up doing a post over the winter, effectively saying that the arithmetic return doesn't exist. It was from an investing perspective. But because we invest every day, and we're invested every day, I mean, I guess you could be pulling up and most people invest every day. You know, I'm getting up there in age, but I've still got a lot of time left in my investing horizon, hopefully. I'm going to have thousands of days left. I'm going to have, you know, hundreds of months left in my time. I've got a lot of compounding to go through.

And when you compound returns over and over and over again in large quantities of compounding, you get a wider and wider spread between the arithmetic return and the geometric return. So when you see somebody say, you know, I think you can get 10% a year for the next 50 years of your life, and you put that in there, that number is probably just a fantasy. Like your chances of getting that number are, I'm making this up. The blog will actually probably explain it in the post, but you got maybe a 2%, 3% chance of actually getting 10% every single year if you're told that that's the arithmetic return.

Because if you then have, say, 20% volatility on it, your geometric return is going to be 8%. And so when people talk about the arithmetic return, and they pretend like it's something you can actually obtain, and that it's something that you can get in your portfolio, if you look mathematically, I mean, it is technically possible, but the chances of it happening are so low that why anybody would ever plan for it or try and go after it, just, it doesn't end up making any sense. Are you talking like when I'm reading a mutual fund tear sheet and it says like this had an 8% average annual return? Or are you talking like when a pension is like we're targeting a 8% annual return? Or both?

Well, both. It depends on the words they're using and what they're targeting. Actually, this is a pet peeve of mine. I think the investment world. I pay straight. Every time I look at an, prospectus or brochure, I'm always looking to try and figure out what they're talking about because people's often just say returns and they, and it's,

it's not always blatantly clear what they're, what they're discussing. And, um, that, that, this, that disappoints me, but, um, the NFA and the futures world made us long ago right on arm or tears has say and we say compound annual rate of return and then you know the definition is the rate of return the annual rate of return which if compounded over the listed time period would equal the listed total return so there's a lot of moving parts there of like, okay, that, that those only exist in relation to how long you've been invested in the, the return on those years. Right. Right. Moving on trend is hot air,

which kind of tied in with this concept, right. Yeah, it did actually that, that post I wrote about the arithmetic return didn't exist. It used to be part of that post and I had to, I had to break it out to make it consumable for people. Yeah. So.

A lot of eyes in my space, right? Like, trend is hot air. What's he saying? Trend sucks or what? Yeah, no, and I was saying the opposite, but it was a little bit of a clickbaity title to get people to think they were going to violently disagree with me. And maybe some people still did.

But so that idea, and this one plays off of engineering. When you look at hot gases, literally hot air, the position of any individual molecule is a guess. Like it's pretty much impossible for us to know where they are and where it's headed with, you know, its velocity. But if you look at the whole thing, if you look at the whole, you know, whole ball of gas, the whole, all the air and on air balloon, you can know pretty well what the properties are. You know what the temperature is. You can know what the pressures is. It's exerting on the side of a canister that it's in. Like it's not, it's not really a guess at that

point once you've collected all the molecules together. and so the point of of this post was to say that i think stocks work similarly in that individual stocks are kind of like molecules of air we really don't know what they're going to do maybe they're going to go up maybe they're going to go down who knows um but when you collect them together the properties change and the reason they change is essentially because of the or the arithmetic return not not existing and that all of a sudden what really drives the behavior of the whole group of them is the geometric return um and that is dependent on how concentrated the stocks are essentially in the, in the portfolio. So, so what I did is I took a rant in that post is I took a random, essentially I made a made up index with random coin flips and said,

there's a hundred coin flip stocks that are just going to work through time. And we're going to start. They stopped where we can be talking assets. Yeah, sure. In anything. Right. And, you know, essentially that the fake stock, I don't remember what I use, but I think I said maybe 30% up if it's heads and 25% down or so if it's tails. And then I had a portfolio of those together, though. So I was internally, I was tracking every individual one's return, but I just reported and showed the trajectory of that, of that, you know,

imaginary random, perfectly random stock index. And I set the parameters up to emphasize this. So, you know, you could, you could see every time you ran this randomness, it went up and it flattened out and then it rolled over and then it fell off to nothing. And it does that every time. And that of course is very unusual to wrap your heads it does that every time. And that, of course, is very unusual to wrap your heads around because you think randomness with a positive arithmetic return should continue to work up.

It could be crazy, but it should continue to work up. And this doesn't do that. If you look at the portfolio, it rises up, flattens out, and goes down. And by definition, each component was set up to be positive expectancy,

right? 30%. Yeah, right, right, right. Each one should have made money over time. Now, they all had a negative geometric return, which is what made it iPOP and actually roll over. But because of the volatility drag, we thought because of the volatility drag, that's why it rolled over. And so what that meant was, and then I put a second indicator underneath the chart that explained how concentrated the wealth was in the portfolio of coin stocks. But the point of that was to kind of actually show where the internal portfolio was from a geometric perspective. So if the portfolio was concentrated in just a couple of stocks without trying to get too much into the math, what that meant is, is it was going to behave more like the geometric

return. Whereas if the portfolio was very spread out in wealth amongst a bunch of them, it was going to behave like the arithmetic return. And it was predictable. Like you could go look and if you saw the portfolio get concentrated, the next couple phases, you would be pretty certain that my fake random portfolio was going to go down. And if you saw it become diversified, you could be pretty certain that it would climb upwards. So back to the stock world, obviously stocks aren't coins. They're a little bit more complicated than that.

But stocks have correlations with each other. They also have concentrations. Interestingly, if you look at times when like the S&P 500 gets highly concentrated in a few stocks, it is more likely to go down. Or like financials before 07-08 or energy. Yeah, exactly. And then they have internal correlations to them as well so that um if stocks become very correlated to each other right if and you know you can't have correlations and coin flips but if you if we if stocks are very

correlated to each other then that would imply that the return should should flatten out but if stock correlations become very uncorrelated from a pure randomness perspective, that implies that return should come back upwards. And so because correlations and volatility in stocks show a tendency to cluster, to effectively stay similar issue over time. What that means is, is from a pure randomness perspective, if a stock market index is kind of in a certain world where it's got a low correlation and a little bit of return, you should expect the index to probably stay in that state of climbing. Whereas if the index is in a high correlation world and maybe going downwards some, until the correlation snaps out of it and changes,

you should expect it to continue to generally stay in that state and continue to work in that position until something happens. Like in my coin flip scenario, you could see when it flipped because it might be overly correlated, sorry, it might be concentrated in a couple stocks. But then if those two stocks had a bunch of really bad returns, and some of the stocks that were farther down had good returns, all of a sudden it became diversified and it changed the whole internal compilation. And so if you're tracking that, you could all of a sudden go, okay, different world now, it's going to turn up. And so theoretically, the same kind of thing can

happen in the stock market where you see something very, all the stocks correlated and then things change and then they all of a sudden become uncorrelated and you can kind of think, okay, things are going to flatten out or turn around. And so tie that back with the trend, the clickbait. So you're just saying. Right. essentially saying is that when it comes to assets trending, that there's this general idea that that shouldn't be possible in financial markets, that it's not a thing. The efficient market theory kind of says that shouldn't be possible. However, if you look at the physical world, like I said, with molecules and hot air, the properties of the collective don't behave the same as the individual. So the idea that, you know, you can believe in an efficient market at a stock level and believe that stocks trend and that's actually still or sorry, and believe that stock indexes can trend or collection of essentially collection of assets.

You can do the same thing with commodities as well. And it's still it all jives like the math still plays and you you can it's not inefficient to believe that something trends like that if if you're just saying that the individual components are purely random the the the big higher level indexes or collection of those groups can can show those trending and it can still be all efficient and then i'll take it a step further like you can have inside an individual market like coco or something like the players are all random yeah right and i've i didn't talk about this in the post but i started trying to run through this in my head and said all right does this should this make me question some stocks like if you have like a conglomerate stock that has a bunch of different companies all over the place in different sectors that aren't related to each other, should that work the same way?

And in theory, maybe it should. Well, you could say Apple versus GE. GE had 16,000 products and things and turned over. I mean, there's a lot. Yeah, and obviously that's not the best example there. I, I didn't write about that cause I'm not sold that that works that way. But, but I mean your commodities point is dead on. And I think being coming from, you know, not being in the financial world for a while,

commodities are a little bit, they're a little bit scarier for the average investor to get into and touch on. But when you look at the environment... Not in this podcast. No, I know you guys are. And I'm just saying that your everyday average engineer that doesn't love finances is probably not talking about the cocoa market. But I do wonder about commodities index.

And if we go back to like commodities index trending especially back when they did a lot in the you know 70s and 80s uh how much this played into it i don't have the data to evaluate that myself but um you know because they are for the most part generally uncorrelated except for really big times of stress um yeah how much that uh that would have played into some of those new posts that would have played into some of those things. There you go. New post. Next on the list, and this might even be harder than arithmetic and geometric, is rebalancing.

Big enchilada there, but you've written a lot about rebalancing. Just start high level, or what's your favorite thing you found there um well so i think the easiest way to talk about it is to talk about shannon's demon um which those that don't know claude shannon was a professor at mit uh he developed information theory and a lot of the ideas that we have for communication between computers and how they work with each other and talk to each other.

He's one of the most important people in the last hundred years or so. And he came up just kind of as a side project, a game, where he said, if I have a coin that would be, let's say, double on a heads and cut in half on tails. So, you know, up twice, but then cut in half, you end up back where you started. So theoretically, if you just keep flipping that coin, you shouldn't really think you're going to make any money. But of course, the average of up 50% or down 50 you know 100 is is positive but if you if you've understood what we talked about the geometric return or you might look at that situation and go well look i'm

just going to go up heads down tails i'm most likely to get an equal number of those and i'm not going to make any money because it's just going to balance cancel it out so the interesting thing is claude shannon realized that if you took that coin and had a pile of cash sitting on the side, and after a win, you took your bet and cut it back in half and put some of the cash over there. And then after a loss, you took cash and added it to your bet. So your bet size stayed equivalent to the amount of cash that you had on the side, and you constantly rebalanced back, no matter if you had heads or tails. He realized that you would make return, you would you would gain money over time it's it's a rebalancing premium from um from just effectively putting yourself back into an equal cash equal um equal bet proposition and that's or it's very intriguing by the lows. Yeah. So it's kind of, I mean, it's similar to buying

at the lowest and selling at the highest because literally you're selling after a win and you're buying after a loss. So, but it's a very strange concept because I've had a lot of people say, well, that's just mean reversion. You're just betting on mean reversion. But I'm talking, my example here is a coin flip. There's no mean reversion in a coin flip. If you have mean reversion, it makes this work all the better, but that's not the root idea of this is essentially you are forcing the portfolio and you're sizing it in the 50-50 ratio that I said here is a sizing mechanism based on the Kelly criteria to size the portfolio so that you harvest out the volatility out of what's happening. And so it's not an intuitive thing that it should work that way, but it does. You can take something that essentially makes no money over time,

but as long as you rebalance it and rebalance it and rebalance it, and the more the better, you end up actually making money off of the situation so on the far edges of that doesn't he when you could you say two losing assets that have enough volatility oh yeah yeah i like yes yes it doesn't have to be the flat you can have two assets that go down and this is where like when people get into the whole tail risks that you know debate about are terrorists getting good and they'll slap up a chart that shows it slowly like maybe bleeding over time and losing money. That is the rebalancing premium that I just talked about on steroids because that's actually kind of inversely correlated. It's like a super coin that will flip exactly the opposite of what your other investments do.

So because of that, it can actually bleed a little bit over time and um it will you can lose that that one asset will look terrible but if you rebalance it back with another asset you can you can end up making a um a lot a lot more you know money and it helps your portfolio the amazing thing about this is if you if you figure out how to size this stuff properly you said earlier that there's a risk return trade-off and your company was like, let's lock it in and more risk is more return. If you really dig into it, the risk return trade-off here flips in that less risk to a portfolio gives you more return. That's actually where the rebalancing premium comes from. And that by holding 50% cash, I'm reducing my risk at the same time increasing my return.

Or holding, you know, 10% tail hedge fund reduces my risk because I don't experience the drawdowns because of the tail hedge, but it increases my return. And essentially, my own strategy that I talk about on the blog um is that very focused on just three uncorrelated you know highly liquid common assets which is the s&p 500 or some form of a stock index uh long-term treasury bonds and gold um kind of a dynamic version of the permanent portfolio a bit if you will oh hold that thought we're gonna get to your strategy so how do you so one i'm going to tell the mutiny funds guys to launch a crypto coin called the super coin and that would be the whole thing the super coin rebalances when the stock market goes down so we can we'll coin that term coin super coin um but two i have this argument with jason buck over

there all the time of like i get it i get the math i get the concept but show me one real life example of two assets going down over time that rebalance into uh positive returns so to me the problem is it's too cute of a toy model and it's like the sawtooth effect um right in real life you never get that perfect sawtooth effect and it never really happens the way it should yeah so the danger i mean i think that there are some that go down over time that we balance in properly but there aren't many and the really big danger is when you start working on the edges of this idea you have to get the you have to get the ratios right. A lot of people take the Shannon's Demon and they see the 50-50 and they think that it's 50-50 for whatever I want to throw in the mix,

equal weight for anything. And that's not true. You have to get the ratios correct based off of the properties of the assets, the volatility of the asset, and the correlation of the assets to the other thing. What you just said is part of the reason why I don't have anything, I think, on my blog that talks about actually an asset going downward and creating that effect. It is probably more visually impressive if you,

when you see something doing that. I'll put that challenge to you. If you can find one and write the blog post on it. Yeah. Well, so here's the, here's the thing though. Like I,

so I wrote most of my blog for non-professionals. I mean, I know that a lot of professionals read it, but that wasn't, I mean, I kind of wrote it for myself like 10 years ago is what my envision my target audience is um and i do think that like you have to be really good there's a reason that professionals i think mostly deal in those kind of worlds where you have something that might go downhill like a tail fund because you really have to be really good at how to size it and how to pair it with something else

and what else to pair it with it's not for the it's not for the um just the amateur to just grab it and slap it together because if you overdo it your portfolio is going to be terrible um so that's why i've generally tried to stick with things that go flat or hopefully trail up and just explain look this effect exists so if you can you can pick something like stocks and bonds and gold that don't correlate with each other or sometimes negatively correlate with each other, you give them enough time, those are making money. At least they have historically. I would like to think they still will. And so therefore, you don't have to worry about if you do mess up, this is where you go back to errors. If you do mess up a little bit, you're messed up saying like, all right, well,

I have too much of this, but it's still making me money a little bit. I just didn't do as good as I wanted. Whereas if you were to mess up with, you know, some of the really fancy instruments out there, you would just, you might lose money in your whole portfolio where everybody else goes up. And it's just purely about position sizing really, really properly, which is, which is difficult. As you said, the blog wasn't just to educate people. It was more documenting your own journey. Yeah, that's both.

I mean, educate people, give people a chance to tell me that I may have messed something up. Like I said on Twitter earlier, I don't know a lot of really, I do now, I know a few, but I don't know a lot of really, you know, I do now I know a few, but I don't know a lot of crazy intelligent finance people that could have told me that I was crazy for thinking some of these things. So it gave some people a chance to give me some feedback. And then to just a document that this is this is real. So I've, it's been a little more than two years now that I've been publishing every single, every single week, the positions that it says to rebalance into, and you can go back and document and see

every week what it was supposed to be. I did it physically for about a year and a half and then I got tired of giving up my Friday evenings to posting. I coded it to automate the whole thing. Tell me the overall strategy. You mentioned the

asset classes. Go back. The overall strategy on the blog is S&P 500. ETFs is the focus because, you know, ETFs are pretty easy for everybody to get their hands on and fairly low in fees. So S&P 500, some kind of long-term treasury bond ETF, which I talk about TLT on the blog, but there's a few others out there that would probably work just as well.

And then gold. And, you know, like I said, they're all uncorrelated. Well, they're mostly uncorrelated with each other. We've, the last six months has tested that theory a little bit with some of these assets, which has been kind of annoying. But so therefore, together, they theoretically work well in tandem with each other. Even when they're correlated with each other, they're only so correlated with each other. They never seem to go through amazing stretches of just one-to-one correlation. And what this allows is if you can get the right asset mix, and then you rebalance it frequently, and you allow

the asset mix to be dynamic so that it can respond to things like, you know, the COVID March drawdown when the market clearly changed and morphed from one market to the other. So you're constantly kind of measuring the market's volatility, measuring the market's correlation, trying to understand what frame it is, and then using that information, you know, acknowledging there's errors and what you've got to to plop in the system and come out with a allocation of those three plus cash because at times as we talked about with shannon steeman at times pure cash helps too um and so the starting point for the to think about it is a quarter in each or third no i i don't you don't think about it so the no i mean i didn't really think about it in that way um if you look at the historical positions it's closer to saying let's say 50 stocks 30 bonds 10 gold 10 cash and i actually posted that somewhere what the historical number was so don't quote me on that you can go so you guys can go look and find it on the blog but

that's roughly what the historical position is um but at times it'll be way way way different than that um there's there's been plenty of times over the last year that you're kind of quarter each thing that's roughly that's popped out um because the volatility has been so high and it's there's been some danger in the market how do you think about so coming back to rebalancing so how do you think about the time frame the look back right if you're dynamic and you have bad timing luck right if you got out at the end of march out of stocks and more into bonds you missed the rally apr, May. Yeah.

How does that all work? How do you think about that? So I lean towards being faster with shorter look back periods or look back periods that allow for more recent information to move it reasonably quick. There's a trade-off in there, obviously, in that it can make the portfolio too jumpy, which is something I've been trying to work really hard to smooth out and reduce.

But to me, if you go back and use data from even a full year ago, it doesn't necessarily look very much like the market we're in. And I want data that reflects the world we're in now. And I mean, I've heard people talking about using, you know, five-year, 10-year information and that's fine. But when we talk about the errors, that's very obviously going to be wrong during some markets.

Like if you're trying to use five-year look-back windows and the volatility spikes, your look-back's not going to move much. It's not going to respond dynamically to what's happening. And I feel like that the better miss is to more often respond to the volatility to be prepared to make sure that you're not going to feel the major drawdown of a major event than it is to try and miss the other way and um right seems less dangerous to get whipsaw than to hold for six months yeah and so there's an interesting like there is a whipsaw potential in the way that I deal with this,

but it's very different than when you talk about whipsaws and a trend following idea. I've got no on off switch in anything I'm doing. So it's not that it's going to cross some, some threshold and I'm going to, I'm going to drop it entirely. Like what's going to happen is I'm going to move from like 50% to like 40% or some, you know, something along that front. Whips, you're only lost that incremental.

Yeah. So I don't, it doesn't cause me to just be out of the position. It just caused me to back off of it. And so the thought process is, is I may mess that up a handful of times. And I will mess it up. It's not a may I will, but, but if you look at the whole life, if you look at the whole, let's say my next 20 years, I'm okay messing it up a few times if I'm very right in the right positions when that happens. And will it go to zero at some point? Yeah, it's not.

The official technical version of it will. I'm actually fooling around with some concepts around that idea. But it will. And it did on bonds um two weeks ago which and there's nothing set in stone there right if if bonds and gold go to a correlation of one week after week for years basically that'll become the same asset and in the model and it'll yeah right and it'll only it'll it won. And it'll only, it'll, it won't, yeah, it'll, whether bonds and gold really hold the same place in the asset,

in the, in the portfolio, I'm not, they kind of do, and they kind of don't, but from that perspective, it would treat it essentially the same in terms of it. Yeah. The return stream would be the same. And between the two of them, their place in the pie will go down because they essentially will be acting the same. Right. So they used to each get 40 yeah now they'll each get 20 percenters yeah right yeah each getting 40 is really high but like it would have been they each get 20 and they now each get 10 because they're acting the same and therefore there's not as much benefit

from an overall portfolio reduction perspective um and then you're going to take this out live to investors. So you, that's why you came out of the shadows, put your name out there. Right. So I, I created a company Pronghorn analytics to to start to offer this to investors. It is live. It's a, it's a real company now that has a few early investors in there. What is a pronghorn all about? Well, the name. So a pronghorn is the second fastest animal in the world from a top speed perspective, but

in other ways it's... what's that? Land animal? Yeah, land animal. I'm sorry. Yeah, leave out birds. And actually, I think there may be a dolphin or something that's crazy fast too, but it's the second fastest land animal in the world behind a cheetah as far as top speed. But the difference between a cheetah is a cheetah can only run that way for about half a mile or so, maybe a little more than that. A pronghorn can run 45 miles an hour for for well over 30 minutes. They both, they have extremely fast top speeds and they have crazy, you know, ability to run forever. They've got crazy stamina. And so it's kind of a metaphor for the type of investment that I'm looking for. I'm looking for one that's fast, that gives you really good returns. Maybe not the best in the world for the year. You know, maybe there's still some cheetahs out there but you know bad years and no return for stretches just very

smooth consistent returns is kind of the the goal but you know not not low returns i'm still looking for for some return but uh stuff that compounds a long time over time some peregrine falcon yeah mostly but even they have to land every now and then so so talk through a little bit were you ever like had a financial advisor looked at different hedge funds like how did it go of like you know what i'm gonna do this on my own like i don't trust all this outside advice or outside advisors uh no i've never had a financial advisor um i i don't know I guess I'm just I'm independent I like to do things by myself I've made random pieces of furniture in my house I like to try and see if I can pull stuff off

myself and so that's where this started it's just me poking around and as I started looking at what I thought either back test or what it looked like I could do in my actual live stuff that I was doing myself and I was like this doesn't seem to be that much worse if not probably better than a lot of what other people were publishing out there in the world so and do you ever worry like you're too

clever by half right like you're doing all this work and research and like the guy who just listened to his golfing buddy and bought some Netflix and apple is doing right 80 better yeah um i don't think i worry about that from a long-term perspective um i that's a little bit on the short-term perspective i mean that's obviously true if you look at the last year through like now um there's been a lot of people making a huge amounts of money and i've done fine but fine, but no, I'm not wowing anybody. I liked Twitter back in December when people started posting their annual returns. And there were some eye-popping numbers of people humbly saying what they accomplished for the year in their own personal portfolios. Yeah, unbelievable.

Yeah, I'm always on that front. And you think the other shoe's gonna drive and they're gonna get hurt but yeah oh and some won't i mean i'm sure some of those people are spectacular investors and they'll keep it up but if you haven't seen stuff go through multiple cycles i don't know how you really know i mean you know people can do amazing things through one one phase of a cycle but you but life is repetition. It's compounding. You have to be able to...

If you're worried about the long term, you've got to be able to see how it works through a bunch of different cycles and phases. And so coming back to your model, in that turnover effect, would you think the more assets you add to that, you might have the same turnover effect of the volatility drag

uh you mean like if i added bitcoin or commodities or something like that to the whole thing yeah um yeah i mean on paper that's that's better um there's a bit of a trade-off there too in that um there's more there's more variables so there's more uncertainty. So there's more uncertainty as to what I'm actually putting in there. And I think that if I had, and I've run models with four and five different stuff in there, different assets. I do think turnover would go down a little bit

if I had a little bit more in there. But where things get complicated is when you start having assets that start getting more correlated, you can get some really crazy swings in the allocations. And I don't want that because I don't want to see all of a sudden one day foreign equ want to see one day, all of a sudden one day, you know, foreign equities go from 50, you know, 10% of the portfolio to 60% of the portfolio and then right back. I mean, there's a few times that I already get those kinds of swings and that's, that can, you know, that can be concerning. When it's back to geometric, right? Like a horse wager, right? If I have three horses in my trifecta box versus four horses, right? I have to multiply those together. It's not just one more bet. It's essentially 12. Right. And the way the

math works out, there's diminishing value to adding more and more stuff in there. If we make the assumption that stuff's uncorrelated, you know, the first one you get about a, well, square root of two, which is a 30% reduction or so in your volatility. And then the next asset will kick you down another 30%. But holistically, like not, well, the next one won't be another 30%. It's less than that. But every single time you add an asset it it it's it doesn't give you as much bang for the buck so you know this from having uh three girls right like the the chance of having that boy on the fourth one is half again as much of the yeah and i don't think i'm gonna get a chance to get a chance to figure out what that chance is but that's actually a

really funny thing i i you know i always grew up thinking that like it was always 50 50 but apparently um if you've had three girls the chances of having a fourth is like 58 percent or something like that yeah it's almost the same as what you quoted it like has almost has every time yeah it so yeah and i thought that was interesting i always thought it was a pure random crapshoot but apparently it's not like if you if you if you were you know if you and your wife are consistent in one direction you've actually got a better chance of staying consistent than you are going back the other direction and then it used to be like we try standing up in the shower like the different there were methods you could use to lower those odds but that for sure was just hogwash. Do you have anything else on the model that you want to share,

upcoming posts or research you're doing? I don't think so. Future posts, I'm way behind on posts. I start posts and then I don't finish them because I get the rough idea down and then I hate editing them at the end. But I think two posts away, I'm going to do something on,

not why volatility clusters but just kind of showing that it does that's it's there's it's really important that one that that's true for my method to work because if it's not true it starts to cause problems but it's in it's amazing how many people don't really grasp that it does cluster and what that means. That's been one of... Sorry, I was just going to say, there's other... Some people believe in this like phase shift too, right? So it's like, yes, it clusters, but then it'll phase shift immediately to a new cluster. Yeah, but then it doesn't usually phase doesn't usually face it doesn't phase shift back right away like it usually stays up there for a while and that's why yeah that's a that's a danger

that you get a major jump um the really big problem is if you got a major phase shift for and then like two days and then you went right back to where you were like that that would decimate my strategy if the market started doing that kind of thing but when i hear you like oh i need basically you're saying i need correlations to hold yeah right and they're famous for not holding right so yeah correlations are correlations are much trickier than volatility but volatility it doesn't seem to just i mean it'll change but it generally when it jumps it kind of stays in that in that world and and the interesting thing thing is there's some deep academic papers about this. There's just not a ton out there that's really straightforward and something an everyday person would grab

that's not posted behind an academic server somewhere. And so I've come across a lot of people that said, yeah, but none of that stuff's actually predictable or like it doesn't cluster it's just all pure randomness and i'm like no it's it's not but i i try and stick stay away from like you know throwing a bunch of stochastic equations into the blog because that just causes people's eyes to roll over so i've been working for a while to figure out a way to actually show this to people that doesn't seem and where did you get all the math

knowledge of being the engineer are you like had a mostly math background yeah i mean mostly i had you know i had to take four levels of calculus or so in college um and then i've had to kind of try and teach myself some of the stochastic stuff because we didn't get into that as much but yeah it's impressive and your ability to just kind of break it down into simplistic simplistic terms that every everyday guy can understand or gal awesome moving on to your favorites do some quick fire here favorite you've listened to the pods you know how this goes right favorite investing book um fortunes formula i was gonna i actually had in my next all right give me one that's not my next question was favorite tangential investing book like

fortunes formula oh you mean like because it's not really an investing book right oh no i mean it yeah no it doesn't it's not stories about the mobsters and the yeah oh right that's why i think it's great is because it's half entertaining i mean yeah um all right favorite pure academic investing book oh gosh i don't i don't know I don't read a lot of pure academic investing books. You ever read the – I got that book over here. The Banker, the Professor, and the Suicide King. It's like a poker book, but it's similar to Fortune's formula without the math. So you might not like it as much, but the stories in there are great um favorite pro golfer favorite pro golfer i mean well johnson wagner because i i

know him i guess would be my my answer to that one but he's still out there a little yeah he's not as much i mean but uh no he definitely played a few last year. It's crazy. How crazy. This is always crazy to me. Like you're a plus, but like how far away are you from the pro tour? Oh, it's not even close. Right. That's what's crazy to me. Like you're one of the best, what? 5,000 golfers in the world, 50,000. I don't know what the number is, but. Yeah, that's that. No, I'm probably not in the best 5,000. So I may have, I probably wasn't college, but'm not now um but uh no and i would have said brendan young too but brendan's not really playing anymore um but uh no i i actually caddied for brendan young in the second stage of

q school it's mind-numbing how good those people are like i i mean people i'll play with people i'll play well i'll shoot like even par and people like, did you ever think of going pro? I'm like, no, that's not even close. Like, like you think that was good and it's nothing. Like if there was a pro with me today, they would have shot nine shots better. It's like the precision that they have is just, it's through the roof. They know where they're like mechanical ability, right? It's also.

Oh yeah. They also think well. And you know, as we talked a little bit about Bryson I mean Bryson has taken it to a whole nother level but the idea of when to attack when not to attack pros are brilliant at that I mean they're absolutely brilliant and they they will specifically lay off of all sorts of flags if they're not comfortable with it and then they go to town when they are comfortable with it and they're so good when they are comfortable with it. And they're so good when they're comfortable with it that it's amazing. They're also just unbelievable putters.

I mean, they make everything. Yeah, when you look at those stats of, like, versus yourself, I can't remember. I used an app once, and it was, like, the average pro at eight feet, I think it's, like, 55% or something. Right. And these were, like like mine's like five percent yeah hopefully a little bit so yeah no it's it's i mean you know it it's like other sports like if

you were to watch basketball and how good is lebron come you know tiger woods compared to everybody else i mean you know your average person played pickup basketball it's not even in a the world i mean i you know um i mean when you hear when you hear stories about pros pack practicing putting and making you know a hundred five footers in a row like that that's what they do like they do that for hours and hours and hours and hours and they just sit there and say and they get hot like steph curry making enormous numbers of you know three pointers in a row you've been getting hot or no oh yeah no absolutely i've got a post i've got a post on that too it's that you absolutely they're saying

no there's no no no that that's that i mean that's that's kind of been proven to be actually bad statistics but uh really yeah because that was all the thing for a minute and i'm like it makes total sense in basketball right if you get nervous you kind of shorten your swing like it's not mechanically the same every time yeah and i mean right and it's the same thing in golf you just you feel comfortable and like you feel like you've got it and i don't know if you haven't experienced it i think almost everybody's played golf a little bit knows what i mean like you just got around it starts off good and and you don't feel worried that it's going to go away and uh I think that's that's you know worried it's going to go away I think you're the exception there the rest of us feel like it's going good no no no I think it's

going away all the time now um but sometimes I don't and that you don't know why you feel that way but you just do and yeah it goes good for the rest of the round but um favorite golf course you've played and then favorite golf course you want to play that haven't yet gotten to play uh augusta national and play i played it yeah nice i did as beautiful as you'd expect yeah yeah it's it's pretty spectacular i played it in college and what'd you shoot my buddy is like a five and i have this bet that i'll never get cash that he would on master's weekend wouldn't break a hundred then um is he a good putter if he's a good putter I shot 70. I shot 77. Nice. I think it's such a great course because, like the members,

it's not overly hard if the greens are not rolling 14. Yeah. But it's still very challenging for the best players in the world, obviously. And if you don't know how to putt well you're gonna shoot a million well and i'm like if you just for the first time showed up there and you their championship weekend you might put one into the water or something right yeah yeah you absolutely could i mean i think that happened this year in the masters i think some people put it in

the water and they're the best players in the world so if you're not really good at the short game stuff then you would shoot a billion there, but it's favorite course. You want to play yet to play probably St. Andrews. I've been to Ireland to play golf, but never, never Scotland. And, you know, I'd like to see where, where it all started and yeah. All right. Home of golf. Let's set up a trip. You ever played out abandoned dunes or any of the kaiser

courses no that's that's awesome tory pines is the only place on the west coast i played that was a while ago um awesome last one favorite star wars character uh r2d2 r2d2 he's like a an engineer right a little bit yeah he's kind of mischievous, too. A little mischievous. I didn't like when they threw on the little rocket boosters in the prequels. Like, you can't improve. We went back in time. You can't go backwards and make things better.

Yeah, I think they have a story arc for a reason. That's true. I haven't seen the last two, so I couldn't tell you if R2-D2 is still my favorite based on that. But as far as the first seven or so movies. It still gets the job done. Yeah. You got to go watch them. You do Disney Plus with your kids? Have them watching Mandalorian and Bad Batch and all that?

No, I've not watched Mandalorian. But now we have Disney Plus. So, yeah. I mean, you have kids. You kind of have to, don't you? Yeah. It's all princess movies all the time, pretty much. Favorite princess movie much favorite princess movie

favorite princess movie I don't know Aladdin maybe Little Mermaid for me yeah alright Matt it's been fun thanks to everyone breakingthemarket.com right yep breakingthemarket.com

I always thought it was breaking the mark but that doesn't make any sense no that's because my twitter handles that and i ran out of words all right that's where i got letters they imagined it but breaking the market dot com yeah um we'll put all your other stuff in the show notes and we'll talk to you soon best of luck great thanks the derivative is brought to you by cme group cme group is the world's leading and most diverse futures and options exchange. For more information and educational resources about futures and options, visit cmegroup.com.

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