The Derivative - Long/Short Commodities with Emil van Essen & Bryan Kiernan of Katonah/EVE

Starting point is 00:00:00 Welcome to The Derivative by RCM Alternatives, where we dive into what makes alternative investments go, analyze the strategies of unique hedge fund managers, and chat with interesting guests from across the investment world. Hello there. Welcome back from the world between worlds, for those of you who have been watching the Ahsoka series. If not, well, you won't get it. Check it out.

Starting point is 00:00:28 We were going to bring you the Russ Colitis interview this week, but the good folks in compliance took a bit longer to review that. So that's on tap for next week with Russ talking through option income strategies, downside protection, and even capturing S&P upside. And then we're recording our live event in Philly for the pod. So go subscribe on your favorite pod platform today to get those new episodes dropped into you automatically. On to this episode where I got to sit down with two old friends in this business, Brian Kiernan and Emil Van Essen of Katona Eve. We talked through their journey from spread broker

Starting point is 00:01:02 to spread trader to spread head fund and what it's like being big, what it's like being small, and then dig into their long short commodity program, which tackles commodity trading in a unique way using the term structure to identify coming market moves. Oh, and we also chat energy, crypto, and China. Send it. This episode is brought to you by RCM's China division, where we help Western asset managers access Chinese assets using Chinese futures markets. That's discussed a bit in this pod. Visit rcmalts.com slash China for more information on how all that works. And now, back to the show. Welcome guys. How are you guys? Fantastic. Great. Uh, Brian, I got asked

Starting point is 00:02:00 what happened to the wing there? Well, uh I started a new career in mountain bike racing and blew a tire last week and broke my hand. Whoa. Actual racing? You weren't just riding for fun? Well, I've been riding for fun, and I've started to take it to the next level. Nice. Yeah. And with that, I'm learning.

Starting point is 00:02:24 And when you learn, well, your new career lasted as long as Aaron Rodgers. Yeah, about the same. Right. A little longer. Did you make it around at least? How does it work? Is it laps? Yeah, they they it's lap times. And so I've been out of the races i've been doing i've been about 100 riders and uh i'm about i'm about middle of the pack uh it's my first season and uh but i'm only going to be out for they think uh you know unlike aaron rogers maybe maybe uh six weeks so not season ending and uh so yeah i hope to be back out on the trail soon wait is aaron rogers out for the season he had four snaps last night yeah uh and then his achilles blew so listeners and we're recording this on tuesday september 12th the day after that game um yeah

Starting point is 00:03:21 that's i don't know what they paid him 100 million or something for four plays yeah zero zero completions whoops um anyway and emil you're here in chicago for now yes i am until mid october um and and where do you do those you brian you moved down to kentucky right yeah so just uh the hills of Kentucky. Yeah. Northern Kentucky, just outside of Cincinnati. Awesome. So people probably didn't come here to talk about mountain biking.

Starting point is 00:03:56 So even though it's interesting, Peter Sagan, do you know? No. Tour de France guy. And then he tries to compete in the Olympics in the mountain bike race. Okay. So that's all we'll say about that. We've known each other forever. It seems like been in this business for a long time.

Starting point is 00:04:23 So just wanted to kind of have you guys give the Clip Notes version of how it got started. Kind of ran it up big hired some institutional people came back downsized into the smaller group launched some new programs merged with another group so you've kind of been all shapes and sizes and pieces of this puzzle for what's it been 20 plus years um so that's right yeah so someone's starting we'll we'll dig into that journey that you've been on yeah so we we um we started really as a as a brokerage firm uh ib and uh started developing programs i mean that was sort of my my thing. I'd come over as a bank trader a long time ago, Bank of Montreal, and started developing programs and eventually developed a spread program in 2006 to trade commodity spreads. And that looked pretty exciting. It was a time at which commodities were growing dramatically.

Starting point is 00:05:28 And that program really took off. We averaged over 30% a year for five years. And the assets grew as commodities became more popular. So we built that to almost $500 million over the course until 2012. Then the people, the long-only commodity funds, started changing their behavior a little bit, started trying to make it hard for us to make money off of their backs. And so the space started shrinking. A lot of the big institutions started pulling back on their commodity allocations.

Starting point is 00:06:14 And so that program kind of shrank and we shut it down a couple of years ago because we weren't seeing the kind of alpha that we used to see way back when. So that was the history. Was it as simple as the Goldman roll trade? I know it wasn't, but that was the genesis of it? Yeah. So the start was looking at all the long-only funds, which totaled a couple hundred billion, were rolling from one month to the next. And they were doing it in a very consistent way.

Starting point is 00:06:51 So we could easily get in front of how they were moving their money. And we knew everybody else who was front-running it. And we essentially were front- the front runners. But through all the trades we did in spreads, we started doing a lot of testing and developing systems to trade spreads as well. So we started merging the two, the, you know, front running the Goldman role, as they say, and then just trading spreads. So we found a lot of unique opportunities in spread, commodity spread trading. And that's what we did for a number of years. And Brian, were you guys using the spread price, its own data set or using looking at each market separate and then calculating

Starting point is 00:07:35 you wanted to be long this market, you wanted to be short this market and it created a spread. Well, I mean, at that time, data wasn't as readily available as it is now. So we were pulling in data from a variety of different sources, creating our own proprietary spread databases, building our own contracts. You know, now it's a little easier to get that data. But, you know, I feel at that time, one of the things that gave us a competitive advantage was being at the advent of electronic spread trading, you know, being able to have the forethought to realize that that was the direction that markets as a whole were moving to, that being electronic trading. And that was probably a

Starting point is 00:08:20 byproduct of being in the brokerage business and being in the financial technology business. And so, you know, many of the tools that we were building for the CTA, you know, were part of that data aggregation process that we were using within brokerage and the financial technology business. And it all was kind of fitting together that we were finding that nobody else was doing that at the time. And we found ourselves with a set of data that nobody had. And that allowed us to develop different strategies beyond the role trade on spread data. And I think that that really allowed us to stay ahead of folks that were trying to gain entry to term structure trading. And we've always tried to kind of just stay ahead of the game as it relates to term structure trading. And that's part of data construction. Were any of the banks who had those long-only programs front-running themselves, front-running their product team?

Starting point is 00:09:31 Off the record, even though we're recording. You know, I wouldn't be surprised if Goldman's trading group was front running their own GFCI. But I don't know firsthand. I know that the guys who are running the long only commodity funds were pretty afraid of us front running them. And they would ask to talk to me. And then newsweek wrote an article about it and uh that that was kind of stupid on my part to actually you went on say in the article i went on record as saying you know we try we try to get get in front of the dumb money and um they made it they made a big point of that so that we'll show you who's dumb. Yeah, exactly.

Starting point is 00:10:28 They kind of changed their strategy. It seemed like they had to change anyway, right? Because these ETFs were poorly constructed, just the constant roll, and they were losing the quote-unquote roll yield. So it seems they kind of had to move to an average of three months or six months or whatever. Yeah, but don't forget, like in the mid-2000s, everybody wanted into commodities. And everybody wanted, so people came up with these formulas and they came up with a standard way of rolling. So eventually then people evolved and changed. The institutions changed their strategy, but in the early stages, they just wanted the exposure and they wanted it to be well-defined.

Starting point is 00:11:12 So that's what they got. And that created an opportunity for us to make money off of. And then we evolved too. So we evolved from just front running the rolls to trading spreads. And that was profitable. And let's clear up, there was nothing illegal about front running, right? Because you didn't know the orders. You're assuming the orders or assuming the rolls, right? It has a negative connotation front running, but.

Starting point is 00:11:39 Yeah, and I don't think there wasn't any inside information involved. I mean, we basically mapped out where the market was when it was shifting from one contract to the next. And by the way, they published it too. They published the dates at which they were rolling. Well, firms do this now and like someone gets added to the S&P and they believe it's going to be this group, right? And they start to buy up that stock and sell the one that's going to get dropped. And that hasn't worked so well over the last few years, running the S&P inclusions. And then why commodities? Just that was your

Starting point is 00:12:17 background. That's what you knew well. No, I would say that was the whole development in the mid-2000s was commodities started getting big and people started using it as an investment vehicle. So it used to be something for producers and consumers, the commodities. But then all of a sudden in the mid-2000s, commodities became like an investment tool, which is kind of strange in a way. And it really made commodity prices go higher than they should have. Because all of a sudden, you had hundreds of billions of dollars worth of investment capital going into these commodities as an investment and basically driving up the price. And so we were just going with the flow, like following the money. And that made sense at the time.

Starting point is 00:13:06 How much do you think that's come off of? You'd still come across investors who have like a stated 3% allocation of commodities or 5% just along only commodities? It still exists, right? Yeah, it still exists. What happened is a lot of pension funds, I think, moved to actual hard commodities or commodity assets like land or even equities and stuff like that. I think there was a big decline in the amount of money sitting in futures in a long-only program. And then somewhere along the way there, you guys started bringing in some other traders, doing some different types of trading in-house. What was that evolution? Brian, you want to take that one? Or sorry, go ahead. I mean. No, I mean, we expanded what we were doing. I mean, we were doing well and we were kind of a force in commodities. So we started doing market making and calendar spread options.

Starting point is 00:14:10 We started hiring people with fundamental knowledge of, let's say, the energy market. You know, we were just building as a company. Yeah. I mean, I think that one of the one of the big things that we had going for us at the time was, you know, not only a good stable strategies, but, you know, operationally we were, I think, you know, we, we were best in class, you know, we were institutionally digestible. And with that we could provide infrastructure to incubate other managers and then add that as a diversification to the business. And, you know, for that, it made a lot of sense because it's, as we know, it's not cheap to operate a business. And we had the infrastructure to do it. And so we wanted to incubate these

Starting point is 00:15:01 managers and bring them to market. And some were complementary to two existing strategies and others were uncorrelated and could provide our investors with other uncorrelated asset streams. It's like a pod shop before it became known as a pod shop. A bit. Essentially. Yeah. yeah so on the screen behind you katona eve right so the firm was for a long time emil van essen i don't know where you came up with that name um and now katona eve so how did that go down what was the uh logic behind that merger is it fair to say merger or joining whatever it was

Starting point is 00:15:49 yeah so so i had uh i had been uh in touch with uh alex larrero for a number of years at katona capital partners and uh you know they had a rip rip roaring, you know, track record for a number of years and and had seen massive asset growth, you know, quickly to 600, much like we did. And so we had been sharing notes operationally as to, you know, how to avoid certain pitfalls with that type of rapid asset growth and became friends. And, you know, at some point in time, back in 2020, 2021, you know, we started talking about maybe it had, you know, would make sense to get together and do something. And, and, and so the conversation started, you know, and I think that the first conversation that, you know, Emil and Vivian had, Vivian Oberoi, that was kind of where we thought that it really made a lot of sense because, you know, those guys are the, the, you know, I, I tend to lend myself more to the business development and ops side of things. And Emil is always kind of the mad scientist, if you will, and strategy guy. And Vivian is,

Starting point is 00:17:13 you know, the guy that is able to implement these ideas via research. And so the ability for Meehl and Viven to play in the sandbox together well made a lot of sense for the firms to get together. Well, they lost, Katona Capital Partners lost one of their partners. He was having medical problems and bowed out. So they were down to two partners and they thought it was necessary to expand a little bit by joining us. Then when we saw the synergies,

Starting point is 00:17:53 we did it. We just put it together. Love it. It's been good so far? Yeah. You get to play in that sandbox? How do you like the sandbox? For me, I like it because, you know, Vivian is really good at doing all the depth work, the quant work. And I come up with the ideas and he does the coding. And, you know, it's very productive that way.

Starting point is 00:18:20 There's no cat dirt in the sandbox. Every now and then you leave some behind right um but that leads me into well first yeah i'll go there first right leads me into i've always known you guys right emile we're talking at a cocktail event you're like well i'm trying this thing in crypto and oh i'm doing this thing in the energies and And so some of those ideas, you're not just testing, but you're putting your own money into. So I've always kind of admired how you're, right, you're running this business, you're trading client money, but at the same time, you're running your own money and trying new things with your own money.

Starting point is 00:18:56 So kind of how do you view that evolution of, right, it's hard to get rid of the trader in you and the piece that wants to make money on your own with your own ideas, these new ideas, kind of before you put clients at risk with it. Yeah, so there's a constant search for alpha. I mean, I'm kind of an alpha junkie. I'm always looking for stuff that's sort of outside the box that generates a lot of alpha. So when you're trading oil, you tend to look at, oh, what are oil producers doing? Oil infrastructure.

Starting point is 00:19:29 And I was like, oh, look at some of these companies look pretty interesting. So you start looking at the companies and then maybe buy some and do something. Or, you know, in the case of crypto, I just saw a lot of opportunities and just dove in. And eventually you see more and more opportunities and you say, okay, I want to try something here. So it's just investigative. And it's the idea of just trying to find avenues that have superior alpha generation. With the goal of getting that into client portfolios eventually? Yeah.

Starting point is 00:20:08 So what you're trying to do is, is the alpha real? Is it sustainable? And is it scalable? And if it is, if it is all those three things, then you want to bring it to investors. And so does it take a special mindset to be like, I'm fine risking my, because you don't know the answers to those three questions, but you're putting your money to work, right? So I don't know if a lot of managers would do that or they'd just test it to death and then bring it out to clients to risk, right? You're doing the other method of like,

Starting point is 00:20:40 I want to see it with my own money first yeah so i think you've got to test it out and you you have to vet it out and um i mean how do you know how it really works unless you put your own money in first and um and i'm i'm perfectly comfortable with that so and what helps to have your own money first right yeah well some guys starting out might not have that luxury yeah yeah so maybe then you use other people's money right um you know but i think it's kind of always been that way right i mean i think that it's even even maybe from the very onset right when when there maybe there wasn't that much money i mean i don don't I think it's kind of tough to sell something if you don't believe in it and you don't have enough conviction in it to kind of eat your own cooking. And I think Emil has always, you know, had that philosophy.

Starting point is 00:21:35 And that's kind of way he the way that he's built the brand. And I think that that, you know, certainly from a business dev side certainly makes it easy for me to pick up the phone and be like, well, you know, we're we're trading it. Right. And, you know, I don't I don't think that I don't think that we've ever done it any other way, you know, and I don't know how you can't I don't know how you can't really test something unless you're really trading it. So, um, I think that our investors that have been with us for a long time, understand that. And that's, that's kind of always been the ethos for us. Yeah. Which I like, it's not just that you're eating your own cooking, you're eating like junk you're coming up with in the kitchen that gets burned too. So it's like, uh, there must be enough good stuff in there that you didn't just burn all your fingers off and, and your mouth is rotted out. Right. That you're finding enough good stuff in all that process to make it through

Starting point is 00:22:35 and, and not blow through all the money that you're using to test. Yeah. I mean, obviously you got to use some caution in the early stages, and then you build it over time. You guys have had a newer program, long, short commodity program that I wanted to talk about. We talked about commodities being big back in 07. They kind of got big again here in 22 with the inflation specter coming around. So tell me what you're doing with that newer program and kind of what the philosophy is, and then we'll dig into how it works. Long short, commodities was actually developed almost 10 years ago. And when we were doing all this work on commodity term structure, we realized that there's this really critical relationship in commodities between term structure and the outright price movement. And that you could use the term structure to really predict what outright prices

Starting point is 00:23:46 were going to do. So if you wanted to predict where crude oil is going, just look at the crude oil spreads. And so we had developed this 10 years ago and we had traded it for some customers. It had a bit of a drawdown in 2019, 2020. But I've traded it like I do with my own money since inception. And it really shot the lights out. It was making all kinds of money 2021, 2022, even in 2023, we're now at high watermarks. But it's a very unique way of approaching the market that I don't see other people using. And yet it's systematic. So, you know, a lot of times commodity traders are discretionary fundamental and they trade one market and it's kind of boom or bust. But this

Starting point is 00:24:45 is sort of a diversified approach of trading many markets systematically using this sort of unique predictor of term structure. I'll throw in a quick past performance. It's not necessarily indicative of future results disclaimer there. Explain the difference between it and a normal trend following program that goes long and short, different commodities. Well, we go long and short, but most people use trends. So if the market's going up, they get long. If the market's going down, they get short. But we actually mostly look at the term structure behavior. So there's certain patterns of the spreads which tell you. So like tell you if a market's going to go up or it's going to go down. And those predictors are much better than trend.

Starting point is 00:25:36 So while everybody's using trend, we think trend is actually kind of a poor predictor. If you look at the tops and bottoms of the market in 2008, when crude hit its top, the spreads were telling you there was going to be a turnaround like a month before the turnaround actually happened. And this is what we believe that the spread actually is a good indicator of the supply demand in the market. And so it's the best way of really getting a handle on what the supply demand conditions are. And then you use that to trade. So it's something we worked on for years. We really believe in it. It's making money. It's holding on to the gains that it makes. And so we think it's the best way of trading commodities.

Starting point is 00:26:26 And by term structure, are you saying when it shifts from contango to backwardation or you don't really care about the shape of the curve, but specific time points on the curve? Well, we're looking at the shape of the curve and also the direction of where it's going. So we look at the trend of the curve, how it's moving. So there's shapes of curves that when there's a real shortage of commodities that show up in the term structure or the spreads.

Starting point is 00:26:58 And then there's a different type of shape when a market's about to collapse so we have mom you came on our uh when crude oil went negative you came on the pod we'll put that in the show notes that was a good listen but right that's an extreme example of like this supply demand is so out of whack that the front month is actually going negative uh in crude oil right so so you you had you know an extreme contango in in that market and it was telling and and you had it long before that so it was telling you that there was going to be a problem in that market and uh and there was a massive oversupply they couldn't get rid of the oil and that showed itself in the term structure. What's the risk profile look like?

Starting point is 00:27:48 It's similar to a trend follower? Is it going to necessarily, do you expect it to capture trends like in 08 and 22? Even if it gets there a different way, do you expect it to kind of have the same profile that investors expect out of managed features and more specifically trend following so like for example in in in 08 it was amazing at predicting the turn in the market so trend followers kind of got their face ripped off when the market reversed but this kind of model picked it up exactly in 22 you see a lot of people made money with the war in Ukraine and everything that happened. There was a lot of bull markets and people made money, but when they reversed, they gave it all back. But I think the term structure was able to predict

Starting point is 00:28:39 that there was going to be a turn before it happened, and therefore was able to hold on to the gains. So very good returns in 21 and 22 when there was a lot of two-way action in the markets. And Brian, is it just commodities? Yes. There's no bonds or currencies, so that is a differentiator between your classic trend follower. Yeah, we've had investors that like that return profile. And so we've kept it that way. And we're starting to see increased demand and people looking for commodity only products. And so we want to see that continue

Starting point is 00:29:20 to grow. We feel that this product is going to be best in class for commodity only. And is it always in the position or no? It could be long, short, or flat. Correct. Yeah. So it has to have the right setup to have a position. So it can be long, short, or flat. So probably it's about a third, a third, a third. And if I had to summarize it in one paragraph, would it be fair to say it's about a third, a third, a third. And if I had to summarize it in one paragraph, would it be fair to say it's most likely going to give you most of a trend following exposure when there's trending markets, but capture those turning points a little more effectively? Yeah, it'll capture the turning points um but it'll capture the trend as well yeah and so you don't necessarily have if if the market does a quick reversal you don't necessarily give it all back you know you can actually catch it right at the turning point

Starting point is 00:30:19 not not always obviously it's still the markets but but it's much better at doing that than other programs. The bad scenario is you kind of get these, it reverses down, then back up, reverses down, then back up, right? That you'd get whipsawed in that kind of scenario. Right. So to give an example, I believe in June, crude oil was heading down and a lot of people thought, you know, we're going into a recession and crude is going to go lower, lower, lower. And all of a sudden there was a big reversal in July and it was a big up move. And a lot of people in the energy space got hurt badly in July.

Starting point is 00:31:00 And we picked up on that and actually made a new high water mark, had a big up month in July, caught the move while a lot of people were getting hurt. So it's actually a good diversifier for sort of a lot of traditional players in the commodity space because it behaves so much differently. We'd say that it's a great complement to traditional trend. Yeah. So put it in the portfolio, have it be a diversifier, cover those sharp moves on the other trend followers. The weird part in 22, right, for trend followers, you're saying they gave it all back. Yes, in commodities.

Starting point is 00:31:43 But right at that same point, they started making money in currencies and bonds. So as a portfolio level, it was kind of a smooth upward climb the entire year for quote unquote trend followers. But yeah, if you look under the hood, it was commodities first, then commodities reverse, and then bonds kind of carried the baton from there, which was a unique type of year. Usually you get it all reverses at the same time and they give back all the gains. But talking specifically about commodities, the issue is there's not very many good commodity systematic programs. And what you see in commodities is you get discretionary fundamental guys. So somebody trades nat gas, or they trade grains, or they trade crude oil. And that is kind of a feast or famine approach. Like, sometimes

Starting point is 00:32:31 they just hit the ball out of the park, and they make a fortune. And sometimes they blow up and are never heard from again. And it's a tricky proposition to get this mix of discretionary fundamental guys. And it's sort of a certain type of approach. So it doesn't capture everything. So we feel like this is, hey, a very different approach with very different results and often more diversified and hopefully better results than you'll see with discretionary fundamental. And you just can't get that. It just doesn't seem like it really exists in a strictly commodity sense to have a systematic program that works. investors who wanted to own those long commodities in those products, right? Because it was a simple premise. There's inflation, super cycle in China, blah, blah, blah. I want the commodity exposure as part of the portfolio, ignoring that commodities has huge drawdowns and tons of volatility.

Starting point is 00:33:38 So I think all the investors would get, hey, this is a better way to access commodities, way less drawdown, way less volatility. The question is, can I still capture that if there's a super cycle, if there's an inflation move, am I still going to capture the upside in commodities? That's the trick with investors. Like, okay, I get it. If I put it in my commodity bucket, am I actually getting commodity exposure or is it just an alpha source that uses commodities? Yeah, well, I think it's like, you know, drawing the analogy to cryptos, right? If the market has a huge bull market, you're going to profit from that. And that's probably where you're going to make the most money. But if the market falls apart,

Starting point is 00:34:26 you actually can make money as well. But not by mandate. There's not 20% of the portfolio is long only. It's right by chance is the wrong word, but by... The profile is it should capture those commodity moves. And on average over time, it will. And so that's the idea, that you make money in both directions, that you're not simply limited. Like some people might say in certain asset classes, you're better off just being only long.

Starting point is 00:34:58 But I'm not sure that applies to commodities because you do get these boom and bust cycles. Or you see a lot of these long flat in commodities. Like, okay, I don't want to try and make money when it goes down, but I want the exposure, right? Instead of my 3%, 5% commodity bucket, I'm going to have 3% to 5% of the long side. But that's difficult too, right?

Starting point is 00:35:20 You might be flat at the wrong time. You might give up money when you should have been short. Obviously, you're going to see all different styles. And the idea is to get the combination of managers that produces the best Sharpe ratio over time. And we just think that this is differentiated enough that it improves almost every portfolio so there was actually um somebody wrote a report on this that um right i don't know if you recall the name of the report but they they looked at the how additive what i said was it me yeah no they they they wrote about how additive programs are to a managed futures portfolio. So that really goes to correlation and alpha, the combination.

Starting point is 00:36:14 And this program was listed as the second highest in terms of being additive to the typical CTA portfolio. Yeah. CWARP. Oh, Chris Cole. Right. CWARP. Yeah. the typical cta portfolio yeah c-warp oh chris cole right c-warp yeah um our c-warp for this program is is a 27 nice and i would argue right it's improved the mar ratio instead of the sharp ratio right that is more especially for managed futures and that kind of, right? Like, I don't think people care as much about reducing the volatility. They want when there's a big upswing, when there's a big market crash, truncate my drawdown, right? So if you improve that MAR ratio, return over drawdown.

Starting point is 00:36:59 But I'll argue that all day and not get a lot of takers because everyone still cares about SHARP the most. But I'm planting my flag in Mar. Right. But Sharp, usually you look at it on a manager by manager basis. But the idea is to create an efficient frontier that combines the right non-correlated managers to give you the maximum return and the lowest drawdown. Those programs. Sharp would be the lowest volatility, not the lowest drawdown and um those programs would be the lowest volatility not the lowest drawdown right right right so that's what i'm saying i want to do the efficient frontier with with drawdown yeah sortina instead of uh instead of ball i always kind of think of you as an energy guy i don't know if that's fair or not

Starting point is 00:37:49 um so just quick side note what are you seeing energy prices the energy environment right everyone seems to think this move to uh greenflation right that it's actually causing energy prices to go up to get to where we need to be for all that stuff. Got any thoughts there quickly before we move on? Well, I do think that, you know, oil prices have been going up here. So we're at the $90 area.

Starting point is 00:38:18 So when you get above 70, 80, up to 90, $100, essentially you're getting incentivizing a lot of development in shale and what have you. And so it tends to breed a lot of overproduction in time. And then that causes price to go down. So it's just an endless cycle. Even with rates here and banks' willingness to fund those projects? Yeah, well, investors will fund them. At some number, it makes sense.

Starting point is 00:38:52 The returns are there. Look at Warren Buffett. He's putting his money behind some of these energy drillers. And the oil infrastructure, I think, has very good returns. So all that's getting built. And it slowed down a little bit in this year. But I think with prices now going up, I mean, people are incentivized to do more. And eventually it takes its toll.

Starting point is 00:39:18 And then shale starts taking market share from OPEC. And then OPEC gets upset. And they flood the market with oil to kill shale. And, you know, we go through the cycle again. It goes round and round. That all seems too simple, but basically that's what it is. Yeah. And then you mentioned crypto.

Starting point is 00:39:44 Tell us what you can, what you're kind of doing in crypto real quick. Well, we built a lot of trading strategies in crypto. Tell us what you can, what you're kind of doing in crypto real quick. Well, we built a lot of trading strategies in crypto, but what we found is that there's a lot of managers out there. And with the government sort of declaring war on crypto in the United States, a lot of these guys have lost their assets or a lot of their assets, but there's a lot of good technology and a ton of alpha in crypto. So what I started doing is using my own money to allocate to managers who I thought looked good, doing managed accounts with them so I can observe their trading and trying to get a combination of traders that really produces high sharp ratios for institutions. So you want a combination of short-term directional, which can make a ton of money in the right market conditions,

Starting point is 00:40:34 and then market neutral, which doesn't make a ton of money, but makes consistent money with virtually no drawdowns. So by having that combination, you can get like a five-sharp type of return. The problem is a lot of these guys have no compliance. Their operations are poor. They just have a good strategy. So our idea is to make sure their strategy is good and then try to figure out how to put things together and get them more institutionally vetted out

Starting point is 00:41:08 so we can package it up for a pension fund or a big fund or a big allocator of any kind. So you got to remember, it's early stages in crypto and it's not a mature market yet. And that's what, you know, always in a growing market that's not a mature market yet and that's what you know always in a growing market that's not mature you get a lot of you get a big opportunity set a lot of risks but a big opportunity set you can make a lot of money with people who have the right technology and the right ideas and that's our job to find that and to allocate the money appropriately and make sure that they have the right operations. Do you think there's a half-life to that? We can get these five sharps for the next X years until it matures and it catches up?

Starting point is 00:41:59 I think you're going to get some high sharps. You're going to eventually get a bull market again. And the bull market is going to produce crazy sharps, high sharps. And people are going to make a fortune. And then eventually everybody's going to pile in. We already see BlackRock Fidelity, a lot of big players lining up. And then probably it's going to slip quite a bit so right cause the most pain to the most people and i take a little offense not offense is the wrong word but like it's not that

Starting point is 00:42:33 new of a mark right it's been around for how many or 15 years now more well so i get what you're saying like it hasn't institutional money's not in there and then trading isn't as mature as other markets. But like it seems a little bit weird of like, OK, we're still waiting for all this to happen, but we've been waiting for years and years and years. Well, I think when we look at when we look at the way that the. The infrastructure is set up right, you know, and we compare it to TradFi. Yeah. You know, are there FCMs? Is there banking?

Starting point is 00:43:12 Is there, you know, administration? What does custody look like? All these things are different, and it's all being built. And it also is difficult in the sense that when there's unclear regulation, it does hamper the development and pace of development within those areas that I think that help make these infrastructure components mature in a more expeditious fashion. And that is what you need. When we talk about maturity, these are the things that I'm referring to. The markets themselves and the participants within the market, yeah, well, you have liquidity and you have these coins that have been around, or Bitcoin's been around for a long time but in the end you know if you look at the age of the stock market or the age of the futures market and i mean

Starting point is 00:44:12 electronic trading is only 20 years old right so i mean in comparison you know there it's it's i would say that it's still in in, very early days. Yeah, I mean, don't forget, like, crypto probably in 2017, 2018 was still absolutely in its infancy, but most companies were an absolute joke. So the institutional involvement has really only come in the last few years. Right. It's sort of a weird thing to be like oh this decentralized thing is really going to be something when it gets centralized right that's essentially what we're saying like once we put all these centralized pieces on top of this decentralized technology then we'll really have something um i think i think that it's i think

Starting point is 00:45:02 that there there will be a happy medium there yeah Yeah. That's, that's what I think. And I just think that you need to have, you know, some clear guidance, um, you know, on both sides, uh, in order to, to really have it move to the space where we would like to see it, you know, where, where you'd have, where you'd have a little bit less systemic risk. Yeah. Um, and then I'm going to finish my tangent bit less systemic risk. Yeah. And then I'm going to finish my tangent section here with China.

Starting point is 00:45:29 China. I said that very Trumpian there. So you guys are working with our team here at RCM to deploy some models in China. What's your experience been like? What does the data set look like? What do you guys think of those markets any other thoughts yeah you know so um we've we've been looking at china for almost a decade now um i feel like it's you know one of those things where we you know it's another it's another data stream right and it's a another way for us to you to diversify our business and potentially develop another product.

Starting point is 00:46:08 And China is another market 10 years ago that was very immature. Term structure didn't really quite exist. And we've been watching it grow. And now the liquidity in these markets is, is incredible. I mean, it's, it's really something to see. It's now globally, you know, opening it's, you know, the regulation has changed and changed quite a bit within just the last year. So we've got more markets coming online. You know, we've got direct access via RCM, which is, which is pretty incredible. Um, and, uh, you know, we're, we're, we're trying different things, uh, to find different trades, um, within, within a variety

Starting point is 00:47:02 of different markets that are available, both, both just direct to China or via, via RCM. And, um, I don't, you know, I, I see this as, you know, hopefully becoming a very big part of our business and, and, you know, three to five years. It's fun. Some of those markets, right. When you're like building it out and you're like, wait, what is this? Yeah. How do I pronounce this? Pennexpilephaline? Well, like, you know, we've seen, you know, agricultural markets there are huge. The open interest in these markets is, is, is, is, like I said, it's unbelievable. I mean, it's three X what it is in the U S markets. And, you know, some of that is, you know, I'm not sure who the big players are. Uh, a lot of it's prop. A lot of it is what I've been told is retail. A lot of it's, uh, banks, um, you know, maybe some of it's part of the government, but I do know that there's huge liquidity and there's good trend.

Starting point is 00:48:07 And so for guys like us, that's what we want to see. You know, so our our systems have evolved over the past 10 years to start incorporating term structure, which did not exist 10 years ago. Within the last five years, you know. The term structure within the commodity market was only in three months. Now we're starting to see term structure starting to move into something that we're used to seeing within the United States. So the markets are becoming more mature and that should allow our models to work a little bit better as we believe that term structure is the better predictor of flat price movement. So we want to be able to implement those models in China. And we think that that should drive some pretty good returns.

Starting point is 00:49:00 Awesome, guys. Thanks real much. We'll talk to you you soon if i don't see you before you head to uh i wanted to say cartagena but medina medina you told me how to pronounce it i already forgot that's medellin medellin medellin uh have fun thanks for having us. Appreciate it. Thanks, guys. Okay, that's it for the pod. Thanks to Brian. Thanks to Emil. Thanks to RCM China for supporting. Thanks to Jeff Berger for producing. We'll see you next week with Russ Kalaitis, and week after that with our recording of our live Philly event. Peace. You've been listening to The Derivative. Links from this episode will be in the episode description of this channel. Follow us on Twitter at RCM Alts and visit our website to read our blog or subscribe to our newsletter at rcmalts.com. If you liked our show, introduce a friend and show them how to subscribe. And be sure to leave comments. We'd love to hear from you. 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

Starting point is 00:50:13 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.

The Derivative - Long/Short Commodities with Emil van Essen & Bryan Kiernan of Katonah/EVE

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