The Derivative - Trends, Inflation Protection, & Getting Investors to the Finish Line with Eric Crittenden of Standpoint

Episode Date: September 15, 2022

In the chaotic world we’ve endured since 2020, it turns out all you needed was an outlier-loving strategy to get you through the storm. We’re talking managed futures and trend following in particular, which tend to thrive in periods of turmoil. But how can you effectively prepare for a wide range of market environments while still producing returns that allow for the investor to stick with the investment.  Eric Crittenden, Founder and Chief Investment Officer of Standpoint, sits down with Jeff to discuss the ever-changing trends and providing the right formula for surviving the chaos. In this episode, Eric and Jeff take a closer look into what has changed since they last chatted on the pod in 2020; needing a healthy investor/advisor/asset manager triangle, the sweet sound of directional volatility, Trend as an inflation hedge, being short bonds(good or bad), the thankless job of a trend follower, if trend following’s long grain positions were war profiteering, and so much more! Plus, get Eric's hot take on the LME; did they do the right thing? Find out here — SEND IT! Chapters: 00:00-01:58 = Intro 01:59-07:54 = What's changed since 2020 07:55-28:10 = Wants vs Needs, a Healthy Triangle & Directional volatility 28:11-38:17 = Trend as inflation protection, not a hedge & an All-weather video walkthrough 38:18-57:19 = Being short bonds: good or bad, the Nat Gas widow maker & the Max capacity program 57:20-01:17:21 = Foreign equities, the Nickel Mess & Trend followers are not evil 01:17:22-01:23:27 = Hot take: LME did the right thing From the Episode: Check out: A Story: Standpoint vs. Equities - June 2022 Eric's previous episode on the Derivative: BLNDX(ING) Trend Following and Global Equity with Standpoint's Eric Crittenden See Eric featured in our latest Trend Following Guide Follow along with Standpoint on Twitter @StandpointFunds and for more information on Eric and his team at Standpoint visit their website at standpointfunds.com Don't forget to subscribe to The Derivative, follow us on Twitter at @rcmAlts and our host Jeff at @AttainCap2, or LinkedIn , and Facebook, and sign-up for our blog digest. Disclaimer: This podcast is provided for informational purposes only and should not be relied upon as legal, business, or tax advice. All opinions expressed by podcast participants are solely their own opinions and do not necessarily reflect the opinions of RCM Alternatives, their affiliates, or companies featured. Due to industry regulations, participants on this podcast are instructed not to make specific trade recommendations, nor reference past or potential profits. And listeners are reminded that managed futures, commodity trading, and other alternative investments are complex and carry a risk of substantial losses. As such, they are not suitable for all investors. For more information, visit www.rcmalternatives.com/disclaimer

Welcome to The Derivative by RCM Alternatives, where we dive into what makes alternative investments go, analyze the strategies of unique hedge fund managers, and chat with interesting guests from across the investment world. I blew it last week, sorry. It was Star Trek Day, and I went and wished you a happy ampersand day. So not sure what I was doing, but happy one-week belated Star Trek Day. And yes, I am the rare bird who likes both Star Wars and Star Trek. It's okay. It's not like being a fan of the Bears and the Packers.

Gross. Speaking of fans, we're a big fan of Chris Abdomacia and his Party at the Moon Tower writings. So we've got Chris coming on next week with his former colleague, Tina Lindstrom, and a guy called Steiner, who taught them both how to trade. So that should be fun. On to this episode, where we're back in my wheelhouse talking trend following with one of the best in the biz. We've got the founder and CIO of Standpoint Funds, Mr. Eric Crittenden.

We dive into a bunch of interesting topics like the trade-off between an investment program's optimal profile and the profile that investor can actually stick with, why trend is better viewed as an inflation protection instead of an inflation hedge, and whether the LME actually did the right thing big picture wise in the nickel debacle. Send it. This episode is brought to you by RCM's Managed Futures Group and their Guide to Trend Following white paper. Eric on the pod today is featured in that doc along with how trend works, why it works, when it works, and all sorts of good stuff. Go to rcmalts.com slash education slash white papers, download the paper today. And now back to the show.

All right, Eric, welcome back. You were with us way back in July of 2020. The world sure changed since then, right? Yeah, it's been nonstop chaos for years now. So thanks for having me. Yeah, that's generally good for people in our line of work, right? Yeah, I have that conversation a lot with people. We built something that we hope will thrive in periods of chaos because we expect them from time to time. And so far, that's been the case. I don't wish chaos on the world, but we definitely want to be prepared for it. And we've benefited from quite a bit of the chaos so far in our short life.

I know it makes me always. It got me thinking like trend followings, 10X more popular than back in July of 2020. You're probably 10 times more popular, people, inbound marketing requests and stuff like that. But trend following hasn't changed. You haven't changed. So it's like a commentary on investor behavior that they're chasing the new shiny thing, but that is also not new. Well, I was going to ask you about that. Have you noticed an uptick in interest in trend following and alternative investments from your perspective? Definitely. Yeah. But it's weird. It's different than a no wait. I feel like you're coming from

zero to one and people are like, oh, trend following is this new thing, even though it wasn't new, but okay, I'm into it. I want to get access to it. Now I feel like people are like oh trend following is this new thing even though it wasn't new but okay i'm into it i want to get access to it now i feel like people are like okay trend following but hold on am i gonna get burned like i got burned last time and what about the drawdowns and so they come with a bit of baggage with their interests uh versus before they were showing up with with fresh eyes and and uh dreams and now they're coming with a little damaged outlook. Well, that's to be expected based upon their experience from 2012 to about three years ago. It was a very challenging environment. But are the incentives different

this time? Meaning like the interest in alternatives and trend-based approaches back in 2012, are they different than, are the motivations different this time around? Jason Lowery I don't think so. What's your thoughts on that? I mean, I think they still want to think they're diversifying, but yeah, maybe the nuance there is back then they thought this is going to go up when market goes down. And now maybe they're saying, hey, this might go up if commodities go up. This might go up if rates go up. So yeah, it's probably a little bit more nuanced in terms of this can do a few more things than just making money when stocks go down. Yeah, I can't figure it out.

Part of the challenge for me is I was mainly in the hedge fund world prior to 2012. And those investors were looking for alternative investments for a different reason than financial advisors and everyday investors, retail investors and whatnot. So I'm trying to figure out, have their motivations or incentives changed? Some of the evidence I see suggests that they have, that they're actually looking for long-term hold and effective diversification. They're not necessarily looking for what we call crisis alpha, something that definitely goes up when the stock market goes down. That seems to have changed, but I'm not sure if I'm just talking to people now that have more realistic expectations versus back then. I'm not sure about that. Good question.

I wanted you to launch into, yeah, the investors are same as always. They're stupid. They're chasing returns, right? And they've seen trend following go up. Okay, I'm picking up the phone. I want to get me some trend following. And then in two years' time, they're going to see trend following goes down, and they're picking up the phone and saying, get me out of this. Now I'm seeing a lot less of that this time around. Um, I think hasn't gone down yet. Fair, fair point. Um, but I am seeing a lot less of the symptoms of that

than I've seen in decades past. And I'm hopeful that people, uh, can see the benefit of just casting your net wider and giving yourself access to all the different kinds of commodities, whether it's grains, energies, metals, things that are inflation sensitive. Not just on the upside, but on the downside too, because deflation is actually still a credible threat going forward. So I'm hopeful that that's the evidence I'm seeing right now. So that's why I asked you that question. And sometimes it'll work every one out of every two years, sometimes one of every three, sometimes one out of every 10. And the power of it really is in those ones that it's not working. It's on average a positive carry. Or is it best for an investor to just think, okay, this is going to hit one out of X times and I just got to survive through the other periods where it's not working?

I think you can think of it both ways. The trend following, the results from trend following really aren't that different from any other asset class. They move different. But after the fact, just like any other asset class, the returns from trend following can go out of favor and stay out of favor for three, five, eight years. So I'm not sure why it's so much more difficult for people to hold on to trend following type returns when they go out of favor. I think it's because they're uncorrelated with stocks and bonds, which is weird because that's the reason you want it in the portfolio, but it's also the reason that people feel like they have to give up on it when it's out of favor. And as you know, at Standpoint, that's why we do what we do

by pulling everything into one portfolio to kind of give people the ability to stick with it long-term rather than just giving them pure trend-following approach, which feels like a boom-bust cycle to them where they have to get the timing right. We're trying to remove the cyclicality from the experience. And so far, that's worked really well for us and our investors, and they can see why we did what we did.

Dig into that a little more. So you've been on top of that for a long time. A lot of other groups have jumped into that space more recently. Listen, Corey Hofstein was talking about the other day of like, hey, it's not enough to just create the best product, but you also have to be able to get your investors from year one to year 10 in order to see the benefits of that best product. So get into the calculus of like, what's this kind of best product versus product investors are likely to stick with? And is there a trade-off there of, right, if the best product is X percent return, X percent drawdown, but the one investors are going to stick with is Y and Y and it's less, how do you do that calculus of like, okay, I understand this isn't the best thing for you, but it's the best thing you're going to stick with and thus it's the best thing for you. Yeah. You're talking about wants versus needs. So every decision in life is a trade-off.

You may not know, you may not understand it, you may not be analyzing it correctly, but every decision in life is a trade-off. So if we just look at it from a purely mathematical perspective, people would benefit from adding quite a bit of trend following exposure into their portfolio. In my experience, my research conclusively has convinced me that trend following returns are the best diversifier

out there, better than bonds, better than gold, better than MLPs, tips, you name it, if you're looking at five decades of data. However, in real life, when you get people to allocate a meaningful portion of their portfolio to peer trend following, call it CTAs, call it macro, call it commodity trading advisors, whatever you want to call it, it's all basically the same thing. They struggle. They struggle because an effective diversifier necessarily needs to be uncorrelated with the rest of the assets in your portfolio. And because they benchmark it to say the US stock market or the US bond market, there will come a time where trend following underperforms the rest of the assets in your

portfolio. And if you're in a financial advisor and you've got 400 clients, if that underperformance results in 300 phone calls every time it happens, the risk reward for you as a business is not suitable. So what I've found is that if you combine trend following with risk assets into a more all-weather format, advisors and their clients complain less and they're able to hold on to it. So my philosophy is that if you can't get people to hold on to it. So, and my philosophy is that if you can't get people to hold onto something and actually experience the benefit, you're not helping anyone. So some people look at that and say, well, it's diluted. And I say, well, we dilute the, you know, the fluoride and the chlorine that we put into the water for a reason, you know,

and we put a separate tap with just pure chlorine and you mix it yourself in the sink and you can do that. Um, but you're going to get bad results. Yeah. But that part that you said to me is the crazy part, right? Of like, you'd think at this point, the advisors, not to pick on them, but be like, yeah, I'm willing to do the 300 phone calls because I know this is good for them long-term. Um, so that's the little bit that I'm curious of this, that human behavioral issue of like, we can't take the medicine as is we have to like concoct this thing where we have to wrap it up in some cheese or pour some sugar with the medicine to get it down our throat when it should be plain as can see of like, no, just, just take

the medicine. Well, I don't want to get too philosophical on you, but yeah, that's no, I like, I like it. I like it. Um, I've, I've studied cognitive psychology and behavioral finance for several decades now. Um, and what I've learned is that even people that have gone through all of the training and they understand right from wrong, if they're separated from that discussion and those books for six weeks, they revert right back to the same hardwired emotional behaviors. You can play the Monty Hall three-door switching game with people and explain the math to them and then come back a year later and they'll revert right back to not switching doors,

which is the optimal thing to do. And I've read countless experiments where you can just tweak something a certain way and it goes from being 30% effective to 80% effective. But mathematically, it's the exact same thing. So it's our decision whether we want to fight that uphill battle, which is a losing battle, and we want to fight the way the human brain is hardwired. Or if we want to be business people and say, look, we've got what people need. If we can deliver it in a format they want, everyone wins. Yeah. Yeah. And I'm kind of setting up a false equivalency

here of like, oh, you have to choose between getting something that sucks a little bit, but you can stick with it for 10 years or getting the full, full fuel for all 10 years. Right. But in your case, you're saying, no, I don't, you don't have to give anything up. Really. I'm just giving it to you in a better, a better, uh, package that you can digest that you can swallow. Yeah. The analogy we used to use early on was the gummy vitamin analogy. Um, and that's like, you know, remember back in the eighties, uh, parents trying to get their kids to take their vitamin in the morning and those nasty, big horse pill size, chalky vitamins. And it was a war with your kids every morning.

And then some genius figured out a way to put the vitamins into a gummy bear. Yeah. Um, and now you got to making it look like a Flintstone. That was right. Oh, okay. This looks like a Flintstone. It's still. Oh, okay. This looks like a Flintstone. It's still chalky and like a milk bone, but yeah. But put it in a tasty gummy bear that's sugar-free. And all of a sudden you got to hide those vitamins from the kids in the morning because they'll eat them all. So who's the genius?

Is it the molecular biologist that created the perfect mix of vitamins? Or is it the guy that stuffed him into a gummy bear and revolutionized the entire industry? Right. Probably the gummy bear guy. But I guess, so that would be the follow-up question. Is there a trade-off? Are you able to do everything you would want to do in terms of the trend or alternatives bucket in this product? Yes. If there were no limitations, would you have way more bells and whistles or markets or whatever? Yeah. See, that was the thing I struggled with early on. When I sat down to build the program for Standpoint is, you know, I was worried about that trade-off, that decision. You know, I didn't want to be one of those people that has to sell my soul

and dilute something down to a point where it's not meaningful, but all of a sudden now I can make money with it. So what I found through my research is that the optimal combination of trend and risk assets was about equal risk contribution. And after a year and a half of analyzing the data every conceivable way that I could come up with, I zeroed in on a portfolio that combined global

equities with a global trend. And then I looked at my personal portfolio and said, that's almost identical. And then I thought, well, why do I have my personal portfolio that way? And it's the same reason that other investors want it there is I want a compounding machine that's as consistent and anti-cyclical as possible. And using all the available data from all the different asset classes going back to 1970, the optimal combination from my perspective was equal risk contribution from global trend and global equities. And it's also was as tax

efficient as I could make it, as scalable as I could make it. So it just kind of fell on my lap that, well, that is the optimal Sharpe ratio portfolio. It's the optimal Sortino ratio portfolio. And it happens to be something that I think investors can actually hold onto. So the financial advisors aren't going to hate me. They're not going to be calling me 10 times a year, demanding an explanation. So I kind of got the best of both worlds. And when, you know, in life, if something like that falls into your lap,

you take it and run with it. And that's what I did. Right. And my brain goes to like, okay, if it weren't, and we're playing hypothetical games here, but right, if it were, I can get 80% of the way there of the optimal, but you'll stick with it 10 years still worth it. Right. That's like, there's some calculus in there

where it's like, even if I can only get some percentage of the optimal, if it allows me to stick with it for the 10 years to see the long-term effect, then it's, then it's better than not doing it because it's not optimal. Yeah. So that's the second order risk reward cost benefit analysis. And that is, it's a triangle, right? So there's us, there's the advisor, and then there's the end investor and the triangle has to be healthy. So you have to satisfy all three and that's not the easiest thing to do. But I think I found a formula that is able to satisfy it for a decent chunk of the population and the opportunity set.

So yes. But to answer your question specifically, if you've exhausted all avenues and the best you can do is 80% of the benefit, but now people will do it. If you multiply through, yes, that's worth doing. Sometimes a number meaningfully lower than 80 is still worth doing. Yeah. Yeah. And then that triangle is an interesting thing because I feel like in the eighties, right, the triangle was focused on the advisor. So it was make a product,

pay the guy at Morgan Stanley 4%, right? Like John Henry made his name in trend following, but they were paying, I think it was five to 8% load to get into his fund. So every time you're rooting for the Red Sox, thank those Morgan Stanley brokers that were funneling money to him. So it used to be focused just on the advisor. Basically, where it's going to build a product that they will sell and why are they going to sell it? Because they make money. And then I feel like it switched a little bit more to the investor of, okay, we're going to do it, or excuse me, to the advisor of like, hey, I'm building the best product. I don't care basically how you access it, but I'm just building the best

mathematical sort of product. And then in the last 10 years, it feels like it shifted more to the investor of this behavioral thing of like, okay, it's not good enough to be the best product. It's not good enough for the advisor to want to sell it, but it has to fit all sides of that triangle, as you say. Yeah. And I would say that back in the eighties, you know, they had a tailwind of really, you know, performance was easy. It was easy to make money from, from trends in the eighties for the most part. So you can't just pay people eight if your fund's returning three because the investor's getting a negative net 5%. So that doesn't work. So you need, there's a different triangle over there. It's performance incentives, and you can't do that

anymore. I mean, we don't pay the advisors anything. The advisors pay us, so they have to charge their clients. So the transparency increased. So costs became an issue. Performance is always an issue. So I would say that it wasn't a triangle back then. It was more just like there were two dots. Is the hedge fund manager getting paid? And is the advisor getting paid? And that only works if the performance is high enough to offset all the leakage along the way of people getting paid. When that disappears, the whole thing collapses. I think now we've zeroed in on what the true triangle is because the transparency is there. So there needs to be value at each node on the triangle. Then diagram with triangles instead of circles. And so speaking of the 80s, are we back? Were we

back shortly in a 80s type directional volatility environment? It certainly felt like that. I was going to ask you how you felt about bonds yielding three and inflation being nine, giving you a negative six real return for bond investors. I haven't seen that since World War II. You kind of almost saw it in the 70s, but really you got to go back to World War II to see something that out of sync. What do you think that means? And is that ushering in an era of macro trends?

Ooh, I love it. I think it means you're going to have a lot more dispersion between the central banks, between currencies, between all this stuff that has to react to those realities, right? Of like, okay, if I'm only getting, if I'm getting 9% real over here, maybe I'm going to go play around with Australian yields or Argentinian yields or something where I can perhaps get, or vice versa, get some actual by crude oil or by metals, by actual physical commodities where I'm getting a real yield. So yeah, I think it'll drive different incentives is basically what we're saying, right? Create different investor behavior. I think so. I mean, it's very rare to find. I mean, if you go back to 1925 and you just look, if you compound inflation through time and you compound

risk-free and say three months T-bills through time, you'll see that most of the time, those T-bills get you back what you're losing from inflation, which is kind of to be expected, right? It's very rare for inflation to spike to nine and then, you know, the risk-free rate not to adjust and reciprocate. So a lot of people look at that and say, well, that's debt monetization. That's the government essentially printing money, but holding the interest rates, their own borrowing rate at an artificially low number in order to relieve the balance sheet. and creates pressure. And what you were just talking about earlier, people going elsewhere to find yield, arbitraging differentials, going into other foreign currencies. Like now you're seeing the volatility come into the currency space,

into the metals space, into the energy space. And that's to be expected. How it all plays out, we don't know. But definitely it makes sense that we're starting to see big trends. And to me, it's not just the, and we could do do the math on this maybe we'll do a blog post on it i don't believe the like take your metric average true ranges are much bigger than they were in 08

say um or 2014 when energy was going i think the volatility itself is in line with historical standards but it's the fact that it's bonds going down, energy going up, right? There's different moves at the same time. We'd been so used to for so long, it's one big trade, one big correlated trade. And now we have back to 15 to 20 different trades where trend can do well on any one of those trades. Yeah, I would say that's correct. So the spreads, the differentials are starting to trend. The other thing is, I think I agree with you that the statistical volatility is not meaningfully higher than it's been in the past.

However, the directional volatility has been quite a bit higher. And that's why you see CTAs and managed futures funds making money is that the auto correlation and the tendency to trend has definitely woken up from its slumber. So it depends on what volatility you're talking about. Statistically, yeah, I would say those ATRs aren't meaningfully higher than they were, you know, times in the past. to measure that directional volatility. I always kind of use it as a word without a definition, without a meaning of like what we need in the CTA space is directional volatility. Yeah, it would just be tendency to trend, auto-correlation, stuff like that. I don't even bother measuring it because you only see it in hindsight.

It doesn't really, because the tendency to trend itself doesn't really trend that doesn't mean anything so let's not go down that rabbit hole but um i mean it means something but it would take a week to unpack all that well that was going to be my next question so if we're if you're in one of these environments where there is directional volatility does directional volatility beget more directional volatility, right? So, or said in a more mathematical way, is there proof in your research of persistence of returns once trend starts moving, or is it big reversion of the mean?

And we're going to see a big pullback. It's a little of both. Yeah. You know, it's a, it's a little of both and there's just not enough historical data for me to come to any conclusions. You know, it's a little of both. And there's just not enough historical data for me to come to any conclusions. You know, the best we can do is prepare for directional volatility by having the discipline to take those trades and to be on the right side of big trends and to not be on the wrong side of big trends and know, have faith that they will happen at some point. That's why markets exist. You know, if they never happen, then there's really no point to these hedging markets.

So I can't give you a... Yeah. And if they never reverted, no one would ever revert. You would just, right? No one would sell. You'd just buy and keep going up. Yeah. The data says that the tendency to trend versus the tendency to revert is pretty close to random.

That doesn't mean that... That's not an argument against trend following. It just means that there are no additional rules that I could throw into the pot to say, hey, I'm only going to trend follow when trend following is working and then sidestep it when it's not. That's a very seductive idea. I don't think it works in practice though. Yeah. Right. I was getting into it on, I can't remember where, a pod, I think, but someone was saying, well, if you identify this trend followers as smart money, institutional money, when they get into a trend and you could get into that trend. And I was kind of saying, well, hold on, they might only be successful 35% of the time, right? They'll get into lots of trends, but their strength isn't

identifying which trend is which. Their strength is getting into all of them and grabbing the one that ends up working and not losing the whole book on the ones that don't work. Yeah, that's an astute observation that falls flat in a lot of conversations, but there's an old quote. I think it's from Charlie Munger more important than the will to win is the will to prepare and being prepared to, to, to buy every breakout and short sell every breakdown, regardless of whether the last two or three or four worked is absolutely essential in this business. Um, just like being short energy during COVID, you know, we took all those trades. Was it

fun? No. Was it popular? Absolutely not. Did a lot of our peers skip those trades? Yes, they did because they were politically and socially uncomfortable to put on. No one wanted to shoot short crude oil at $65 a barrel. They thought it was too low. That turned out to be the trade of the decade. And that's a reoccurring theme. You can go all the way back into the seventies and look at newspaper headlines and get a feel for what the sentiment was and realize that those big trades that make your career are the hardest ones psychologically and socially to put on in real time when you have to put them on. So being prepared and never breaking discipline is a prerequisite, in my opinion, for success in this business. And that's, I don't even know of any

trend followers who can't figure that out of like, right. Hey, you got to be able to manage your losses. Like that's just baked into the DNA of a trend follower, right? Of like, I'm only, what's your risk per trade on a percent basis? Probably less than 50 bps? Yeah, I'd say it's about 50 basis points, which is half. I have a 1% typically. We don't look at it that way because our portfolio, I mean, we could be in 30 markets or we could be in 80 at any given time. So that number is going to move around. But on average, yeah, it's about 50 basis points. Right. So the general concept is, hey, I'm only going to lose. When I lose, I'm only losing one half of 1% of my whole book. And when I win, I could win four, five, six, 10X. Or eight or 10 in the case of the energy trade, which was just a massive

trade. And then also the bond trade this year. I'll admit I'm a human being like everyone else. I didn't want to short bonds, but as a trend follower, I have to. And that being short bonds over the last 18 months has been, eight, 10 months or so, has been the real big winning trade. But was it politically and socially comfortable? Absolutely not. And do you shout that from the rooftops? Because a lot of trend is saying, hey, we caught inflation, we're here. But the reality is it's been mainly, right? The commodities helped in the beginning of the year, but the whole maybe since March, it's been mainly the bond trade, right? Yeah, being long the dollar and short bonds. How do you feel about trends as an inflation hedge?

I hesitate to aggressively talk about inflation hedges and crisis alpha. What I can say is that historically, a disciplined trend-based approach has been able to latch onto inflation and benefit for most of the inflationary periods and also latch onto deflation and benefit. But I can also create a market scenario that's inflationary where trend following doesn't work, one that has really deeper tracements and then source the new highs and then deeper tracements and whatnot. So trend following isn't guaranteed to make a fortune during highly inflationary periods of time, but the research suggests that it's a great diversifier and generally can be counted on to participate in inflation when it's going up. Yeah. It's a nuanced thing, but it's, I think, important for investors to hear of like, yes, I can't think of a better inflation hedge, but similarly, I'm not going to tell you it's

an inflation hedge. There's tons of basis risks for lack of a better word, right? Yeah. And anytime you're talking about a hedge, you're talking about something that loses money. Yeah. Hedgers lose money on their hedge because a hedge is basically insurance so you don't get paid to insure yourself against loss so having diversification casting your net wide to participate in trends that are unrelated to stocks and bonds both up and down you know long and short is a great way to increase the diversification your portfolio and that looks and feels like a hedge but that's really just the diversification benefit. If you want a hedge that's guaranteed to work, then you need to use options or dedicated positions and you're probably going to lose money on the hedge. That's just the way the algebra of

the markets work. Right. Or you'd go to a bank and say, hey, I want to buy this inflation swap at X, right? And it's an outlay of money. And if inflation prints that, you get paid back. Why? And dig into that for a second. You're saying if you could map out a market that loses money during inflation, like use crude oil, I guess everyone would be familiar with. It would something like crude goes up to 100, then down to 60, then up to 180, then down to 120. So kind of big retracements like that, you're saying? Yeah, it'd be like an expanding megaphone where it just becomes more directionally volatile. And you're not diversified in your systems meeting. If you're just using medium-term

trend following, it's possible for the market to move in a way where it hits a new high, you go long, it immediately collapses. You stop out and then it immediately goes up, hits a new high. You go long again, then it immediately collapses. And you just get whipsawed three, four, five, six times in a row. This actually happened to me in the Euro. I think had eight losing trades in a row back in the 2012 to 2018, something like that. It's pretty painful. But like you mentioned before, if you limit your risk to say 50 basis points per trade, even after all that disaster, the total losses you're nursing are pretty manageable. But you can solve this issue somewhat by diversifying your approach. You can have short-term trend following, medium-term and long-term. It's really hard

to whipsaw all three at the same time. meaning like now you really have to create a special permutation or market environment that that smokes all three of those approaches at the same time but it is possible um for sure possible and felt like march of 2020 was a little bit of that right of like the quick down the quick up but the long terms in those scenarios didn't even react probably long term long term trend lookbacks, right? Might not have even reacted to some of the sharp down moves. No, I would say ours, we definitely, so we made a lot of money being short energy

and long certain currencies and long bonds, but we got absolutely smoked in equities and a bunch of other risk assets. So we didn't actually make money during COVID. We just held strong and didn't get annihilated like most traditional portfolios. And that's because on the trend side, it was pretty effective at being short energy and long bonds. On the risk asset side, we got taken down just like everyone else.

But when you net those two together, you get what I talked about earlier, that kind of anti-cyclical smooth ride. Have you been seeing Cliff Asness get in a war on Twitter over his volatility laundering tagline? No, I avoid Twitter as much as humanly possible. I don't use any social media other than LinkedIn and I just post one thing a month. That's it. And I just stay away from the comments. So my coworkers probably know all about it, but I don't have an interest in the artificial wars that people are creating with one another.

Well, he's getting into it because he's called private equity volatility laundering, right? They basically hide the volatility. I like that. Yeah, that's clever. And then another guy came on and said, well, this private credit fund hasn't had any volatility. And he's like, yes, you're proving my point. And he's like, no, the prices haven't moved. He's like, again, proving my point. But a little bit of what you're doing is, I don't want to call it laundering, but it's dampening that volatility by putting these two things together. Yeah, but that's real. That's not just hiding it. You've actually got uncorrelated assets. So you can't hide it in a mutual fund. The accountants print a daily nav and the

accountants don't listen to me. They look at the settlement values and they calculate the nav and they broadcast it to the world. So that's real. What Cliff's talking about is those assets in the fund are incredibly volatile and incredibly illiquid, but they just don't print a nav for you at a daily frequency. So you don't know how volatile. So I had this conversation with my dad a long time ago when he was trying to convince me that real estate is the greatest investment ever and never goes down. And I said, well, if you had a real-time feed and you got a daily nav on your Silicon Valley house, you'd lose your mind. But you don't. You basically get an appraisal once every five years or when you

refinance or whatever. And it's like, hey, it's gone up another 22%. And then you factor in the cost of carry and the property taxes and you do all the math and look at it. It's not that great of an investment, even when you were in the best performing zip code in America for 30 years. But are we kind of too clever by half to say like, oh, you're not marking to market. And they're like, yeah, that's the point. Right.

So I can see both sides of it. I intellectually, I get it. I'm like, no, there's volatility there. You're just not seeing it. But on the flip side, I can also see it similarly to how we're putting these two assets together. Over here, we're just investing in things that don't print the volatility in order to not get the volatility. Yeah. So symptoms are similar, right? But what's actually happening under the hood is not similar at all. But if it lets you get to that 10-year

endpoint, like we talked about, does it really matter? Probably not. You remind me of that old study about the best performing 401ks in the world are the ones that were forgotten about. Yeah, or the people that died and they just kept rolling. Yeah, or either they forgot about it

or the people died. Those 401ks had like 300 basis points of alpha over all the other 401ks. And it's because people didn't see the assets. So they weren't in there screwing it up. Yeah. So yeah, I'm torn on that debate of like, intellectually, I get it. Philosophically, I'm like, maybe they're the smarter ones. I was like, no, the whole point is not to print the volatility so that you can stick with it. Well, those guys are the smartest in the world. I mean, they still got the carried interest, right? So they're basically, they're winning on every possible front. True, true. So let's talk, we'll put it in the show

notes, but you guys did a video a few weeks ago or a month ago. I can't remember when it was, but it was kind of a cool look that I hadn't seen anyone do before. You kind of sped up the equity curve and then overlaying it on the stock's equity curve at the same time, right? Which we can all say like, look at the Sharpe ratio versus 60-40. Look at the return, look at the drawdowns. And it kind of a lot of times falls on deaf ears, but I feel like that presentation really lets you walk through

what it would have been like to be in this product for two and a half years. So not sure if there was a question there, but how'd you guys come up with that? What'd you think it presented well? I wasn't a part of that. I didn't even know. I just saw it online. Have you seen it? Who did this? And then I talked to my coworkers and they said, yeah, we've been working on that. We told you I was just too busy running the fund. But yeah, my coworker will put that together. And yeah, when I watched it first, I thought, oh, don't don't brag.

But he basically was showing that, you know, you walk forward and you can just and you can associate the experience of those declines because people were living it. And then they're looking at an all weather style multi asset fund and saying, huh, well, that's different. And then they see the risk assets soar and the multi-asset all weather fund just kind of gently that doesn't soar, you know? And so they, it helps you intuitively wrap your head around that counter cyclical approach so you can see the good times and the bad times and say,

and then make a decision whether, yeah, I could, our philosophy is we want to bore you to success, not bore you to death, but bore you to success. And I think that that illustration did a good job of giving people the ability to kind of walk through it. You know, like you said, it's a speeded up, sped up equity curve so yeah and it made a point if it had been down and you're not it would have been the same concept the same proof of concept right of like here this both went down ours is down a lot or even flat or down a lot less but it would be the same concept of you've shortened the shorten the drawdown you've reduced the um absolute loss so i don't know. I thought it was great and really helped people understand what it would have been like to have been through that fund. Back to trend.

You mentioned the bonds. I think we talked about this on our last pod. Have you seen yet any problems with being short the bonds in terms of cost of carry uh in terms of right i don't think our if we trend down for 30 years just like we trended up for 30 years the performance might be half of what it was because of that roll yield roll cost yeah so that's been it's been a very, very interesting couple of years.

You remember that bond video I did in the summer of 2020, where I did the Monte Carlo simulation and basically said that it's possible to make money in bonds, but it's just extremely unlikely going forward and all the hate mail I got back from that video. But then to walk forward and see, and I'll say for the record, I wasn't predicting that interest rates would soar, that bonds would go down. I was just simply pointing out the math. It's just such an uphill battle with the yields where they're at. Any inflation comes along and your real return is going to be negative. And then we got what we got. And the arguments back then were that CTAs will struggle in a rising interest rate environment

because they made all their money from being long bonds over the last 30, 40 years because interest rates went down. That was one argument. The other one was, well, they can't make any money being short, even if they do go short because of the cost to carry. They're on the wrong side of the coupon yield. So now fast forward to today, any CTAs that have had a good track record over the last three years, if you decompose their returns, you'll see that a big healthy chunk came from

being short bonds. So people are scratching their heads and saying, wow. And the CTAs have done phenomenally well over the last couple of years. And it's primarily been from being short bonds. So all the people that were writing those papers saying CTAs can't make money in a declining bond environment or yields are going up, they've all gone silent. But their core thesis was actually correct that you can't make as much being short as you could make being long because you're on the wrong side of those coupon payments. So I think what they missed though, is that when interest rates rise, bonds can go down a lot and fast, and that's what we've seen. So bonds are not symmetrical, the same way stocks are not symmetrical, meaning that on the way down, the descriptive statistics can look quite

a bit different. It can be a lot faster, more volatile, and you can make higher returns in a shorter period of time, but you can't keep it up forever. And that's where we're at now. And yes, we're short bonds, much less so than we were, say, three, four months ago. But now I see everyone piling in on the inflation bandwagon and everyone's confident that inflation's going higher and that the Fed's going to raise. And I'm looking at it going, I'm glad I'm not as short bonds as I was before. Because as soon as you get a crowd all on one side, really confident, sometimes they're right. But more often than not, you're very close to the end of that trend. Market likes to inflict the max pain to the max number of people. Certain types of people, overconfident,

emotional people. The market really likes to lure them in and then rip their heads off. But do you think there's more opportunity, whether rates go up or down with rates off the zero bound a bit? Is there more opportunity to trade? Just by definition, there should be more up and down availability and trades on the bonds and rates. There's more potential. But also you are going to see that if things stagnate and bonds just basically become kind of dead money for five years and with rates range bound where they're at. So I don't make predictions like that. I just look at risk reward. Right now we're modestly short bonds because that's where the trend is, but not heavily short like we were before. And whatever

happens, happens. I mean, I won't be shocked at all if we get a bout of deflation and we end up being long bonds in a few months. That won't shock me at all. You can go back and look historically after World War II and in the 1970s, it's not just a one-way street for 10 years. There are trend reversals and sometimes you go the other way. So there's a lot of inflationary pressures out there, but there's also policy responses that could lead to a one-year deflationary run that could happen. And then I always love that about trend. You'll get these brilliant macro guys on CNBC, on Twitter, wherever talking about the curve and here's how we're positioning for flattening or steepening and all this stuff. And it sounds great. And you're like, yeah,

that's what the trend portfolio has been long two years and short 30 years for two months. So like built into trend following, I don't know, accidentally or on purpose is this concept of you can be trading the curve without actually trading the curve, right? You're just, each market signals its trade independently, right? And then as it happens, you all of a sudden get into a curve trade because you might be long the short end and short the back end or vice versa. Yeah, I remember back a year and a half ago where we started getting into an inflationary posture. And it's because of what you said, certain trades entered the portfolio.

Certain markets had an increase in open interest, so position sizing went higher. Other markets were kind of like the short end of the curve was trading very different from the medium and the long end of the curve. So you end up having a bet on that was all systematic and you just let the market basically tell you where to go. And then if you step back and look at the big picture and say, oh, we've got a steepener on, that's interesting. But the trend following portfolio actually implemented that thematic trade. Yeah. Which is cool. And then the same thing, I mean seeing the same thing in energy prices, you don't doesn't necessarily work that way cause you're not trading each market, right? But you can have nat gas versus crude or different parts of the energy curve

or the energy complex. Yeah. To a lesser degree, you'll see it. I mean, nat gas is its own beast. That thing doesn't care what crude's doing. It doesn't care what anything's doing in the world. I was talking with someone the other day because we're long natural gas and that was a very profitable market in the last quarter. I said, if Bitcoin and Ethereum and I don't know, some other crazy market had a baby, it would be mad gas. I mean, really, I mean, that's the market that can keep you up at night. It can do anything it wants.

It is really just an epically volatile and unpredictable market. The widow maker, right? Yeah, like the yen used to be back in the uh in the 90s but curiously both of those not as much back in when there was no volatility in like 17 18 both of those seem to be flights to quality when i would uh right when they were both so low that i feel like people when risk was off they would park some money in that gas and yen um i think we did a blog post about that at the time of like this super volatile thing has become less so but now it's snapped back into its natural natural order um quick thing you mentioned there in terms of the open interest if you could dig into that a

little have you seen so tell us what you do with the open interest helps you select which markets you're trading? Well, we start by selecting about the 80 most liquid markets in the world. And we do that by looking at their open interest multiplied by the contract multiplier, the size of the contract, and then dividing by the FX rate to get it back into us dollar terms and then rank and sort them and i just did that analysis a couple days ago i like to do it a couple times a year who's number one uh the s&p 500 is the number one then brent crude um and i don't know the euro stocks 50s in their stock indexes are pretty liquid um a lot of the energies are at the top. And then you come down, you get into the golds of the world and the corn and the nat gas and stuff like that.

So that's one thing we do with open interest is treat it like it's the float of a stock in order to get a feel for what's out there, what's tradable, how many contracts are actually out there floating around, able to be traded. So not the market cap of a stock, but the float. Essentially. Yeah. But if you multiply the float by the price, you get the market cap. Yeah. Yeah. Right. And so that, so it's, we're, we're doing that and then normalizing it into us dollars beyond that. That's how we select our potential universe. And I, we've been talking with you guys about looking at some of these other Asian commodity markets that have become more liquid recently and adding them into the portfolio, which is a normal thing that you need to do every couple of years is add stuff and delete things out of the portfolio. Beyond that,

though, when we go to size of position, we want our program to be able to scale. In other words, let's say we're fortunate enough to get a couple of billion dollars in AUM in three years. I don't want to have to tell my investors that this is a different program than what they invested into back in 2020. And that's a conversation that always comes up is as you've gotten bigger and successful, how different is this from what you were doing? Because I can't trust your track record if it's not representative of what you're doing. And that'd be something like, oh, corn just quadrupled. Why didn't you win it? Like, oh, we're too big now. We can't access corn in a meaningful way. Exactly. So the way we built this program, we call it the max capacity program. It believes it has $12 billion in it. The model believes it has 12 billion and it trades

accordingly. And it creates a model portfolio. And then we simply ratio that down to whatever asset base we actually have. So back when we had $10 million, we were trading it like it's a $12 billion program. We're just doing it with $10 million. So everything's deleveraged down to the same volatility for $10 million. Now that we're ataged down to the same volatility for $10 million. Now that we're at 475 million, we ratio down to that number. But what it means is that I can go up to 12 billion, but the program's the same. It doesn't mean that we won't be impacting those markets. If I'm sending you guys orders to do 20,000 soybeans, it's going to affect the market. But the model is consistent. It would be just like if somebody created the S&P 500 50 years ago, but they only had 10 million bucks. You can invest just a market

cap weighted. And then when you have 20 billion, invest the same way. So it goes a long way towards removing the need to change your program and kick out the illiquid markets as you get bigger. So I have some experience in that, that those bigger guys tend to not be able to access these unique markets that make trend following what it is. So the whole goal of that is to be able to keep the corns and the kind of niche markets that are in there. No, I'd actually argue the other way. And I would say that when you look at the big blue chip trend followers over in London and some in the US that these guys have been managing 20 billion for a few years, 40 billion in some cases, they can't treat palladium the same way they treat Brent crude. So we want to be successful and manage a lot of money. So we're not going to make that mistake either by treating the small markets as if we could access them the same way we do the large markets. So our program has always been designed from day one to mimic that of a large manager. So what that means though, and where I disagreeing with

you a little bit is that I don't care about palladium and Japanese platinum and tiny canola, although we do trade canola, but just not, not a lot. I don't think they matter as much as a lot of people think they do, you know, creating all these synthetic spreads and whatnot, what we're doing is just simple, old school, plain vanilla trend following on the 80 most liquid markets in the world on a liquidity weighted basis. And that's what all of our research going back to 1970 did too. And what it told us and was very convincing to me is that you don't need obscure small markets in order to have a good program. So in theory, that lessens the diversification benefit? Yes. In theory, it lessens the diversification benefit. But when I measured it, because I built the one with the bells and whistles too, that treated all markets the same, did a beta neutral, full risk parity,

overweighted markets that had the least correlation with others. I did it every way I could conceivably think of. And when you go the full distance to maximize diversification, your risk adjusted returns are a tiny bit higher, tiny bit higher, but your capacity is 94% lower. And if you just strip away all that complexity and you just use the raw, simple stuff on the most liquid markets, your capacity is enormous. You don't have to change your program. But here's the most important part, Jeff. Which one of those do you think blended better in with global equities? The max diversification trend program or the raw power trend program? I would think the max diversification, but I know the answer would be the other one.

It was the other one. It blends in better. And I'm not sure if that's causal or just spurious, but it actually blended it better with global market. I would guess it'd be causal because it's going to keep you in stocks and currencies and rates and things that are more tied to equities, right? I would think. That's one theory because that is what happens, right? It forces you into energy and bonds and more liquid grains and whatnot. There's also the transaction cost issue. So when you build your transaction cost estimation rules, if you factor in that, you're just going to pay a lot more slippage in canola than you are in corn, which is reality.

Yeah, it hurts. And that comes full circle back to our, right? So you've built over here, what'd you call it? Max power. Max power can get to the 10-year finish line. Whereas max diversification, maybe it's great, but now you've hit capacity constraints. It's a different type of finish line. But if you can't get to the capacity finish line, why start at that point to begin with, you're saying? I think that's fair. The small, the boutique, generally capped out at like six, 700 million bucks.

Yeah. You know, you could kind of get to a billion, but beyond that, you had all kinds of problems. The max capacity approach, you know, we run it like it's got 12 billion in it. And I think that's a reasonably conservative number. Can't go meaningfully higher than 20. Um, you'd have to start building your own spreads and bringing in the Chinese markets and some of the other stuff, then you could do it. But we want to manage a lot of money. We want to actually be a core holding in people's portfolios. I think when people get comfortable with a multi

asset all weather approach, they're going to look at it and say, why isn't that 20, 25% of my portfolio? It really does solve a lot of problems for me. I think that's what's going to happen. And we want to be able to actually meet that demand. And if I'm running some boutique program that's capped out at 700 million, why am I bothering these people with an opportunity that doesn't exist? Yeah. If you're an RA with 7 billion, it's not worth his time to get into you if he could fill up your whole capacity, he or she. So talk a little bit about that in terms of the,

what are you seeing from advisors that are investing in the fund? Is it still 5%, 10%? Is it being treated like an alt or like a core holding? Like an equity replacement or something? The transition, I believe, is beginning. In the beginning, early on, obviously, we're a young company, three years old now, and we didn't

have a lot of AUM in the beginning. So people treated it like a pure alt, 2%, 3% allocation. Those have grown over time. Most people have added to their positions. Now the conversations we're having are quite a bit different. Now people are talking to their positions. Now the conversations we're having are quite a bit different and how people are talking about how much greater than 10 should it be. I'm not saying everyone's doing it yet, but that's where the conversation has gone. And we haven't aggressively pushed that, but that is where it's kind of navigated to. And compliance hell, because my natural answer is that is a hundred percent this is a good blend you get the equity you get the diversifier right of like some number large number and the

compliance will be like well you can't say you can't recommend they put that much into it like and we don't and we don't i tell them look the only person that puts a hundred percent of their money in the fund is me because i built it to basically be my personal long-term investment um or at least it matched what i was already doing so i just got rid of what i was doing and put everything into the fund um so i think people are looking at it you know 10 to 15 percent as the idea of a core holding with a few people looking at 20. going north at 20 usually causes more problems than it solves from a compliance perspective so i don't see too many people doing that. Some do, but I tell them like, you got to handle that compliance stuff on your own.

But to me, if it's like, okay, I was doing 60-40 with whatever, some fee banks, mutual fund or an ETF or whatever that was mimicking 60-40, I can get the 60% stock profile from this. I can get the 40% bond profile, which. I can get the 40% bond profile, which maybe we can dig into that, whether that's the actual profile, but essentially I can get the same risk reward profile from this. So why would I limit it to just 20%? Compliance reasons. You answered your own question. I know, but that comes back to like, okay, we're just artificially limiting this because we know it's, that's just stupid.

That's like, you want the medicine, you want to take the medicine, but we're not going to let you take it because you can't take too much medicine. That's like putting the pill limit on the bottles. Maybe that's a good thing, though. Well, like we mentioned earlier, the gummy bears, you got to hide them from the kids, right? So they get the gummy vitamins. So, well, they look at other funds. Like you mentioned earlier in this podcast, there's other people entering the space and some of them are high quality. Um, so they've got an opportunity, um, to not just, you know, use standpoint, but there's other firms out there that have

quote unquote, seen the light and said, you know, this actually makes sense and would solve problems for everyone in the triangle, the advisor, the end client, and us ourselves. Which I guess you're fine with. Cool. Do 20% to five of us and everyone's happy. Foreign equities was my last piece. So a little different than most, you're doing not just S&P, not just US, but what is it? 50-50 split, US and foreign, or remind me of the split. It's a 60-40 split. So of our dedicated long equity exposure, which we get through ETFs, we really want to be tax efficient on the equity side. So we use the ETFs to get that exposure and we do not trade them. I mean, it's very rare that we have to liquidate some of the ETFs.

We have to buy more all the time when there's inflows, but as far as liquidating them, it's just very rare that when there are liquidations are usually very small. So it's 60% US total stock market exposure, which is going to be market capital weighted. So it's mostly just large cap, some mid cap. And then 40% is global developed. So you could break that 40% down to about half of it is developed Europe and the other half is developed Asia. Okay. And it's all going to be not GDP weighted, weighted but similar to that it's market cap weighted um and that sounds like it wasn't mathematically based but fundamentally based that'd be fair to say i want to split 60 40

u.s foreign or was it no no it was capacity based, meaning I don't have any edge when it comes to is Chile going to outperform Argentina or is Italy going to outperform Ireland? Honestly, just don't believe that those edges exist anymore. And if they do, they're outside of my area of interest. The idea here was to capture the global equity market risk premia in the most tax efficient and fee efficient manner possible and pull that into our macro program so that we have a more all weather multi-asset approach that people can stick with. So, and that's what we do. So you can think of it as it's similar to the MSCI world index or the, the, every FTSE has got their own version. Everyone's got their can think of it as it's similar to the MSCI World Index or every

FTSE has got their own version. Everyone's got their version of it. And it's the maximum capacity global equity approach. But I guess why global versus just US? Well, the futures program is global. So why would I restrict the equity portion to just US? That's what I struggled with. The other thing I looked at is historically, if you look at the returns of global markets versus the US on a rolling basis, there are many times where the foreign markets significantly outperform the US. I know the US has outperformed over the whole period of time, but that's not always the case. And we don't know what the future is going to bring. I mean, trust me, I wish I had put all the money in the US because they've dramatically outperformed the foreign equities since we've been live. The returns

would be a lot higher, but the outcome doesn't tell you a lot about the quality of the decision. The process was we want the maximum capacity portfolio. The macro program is global in nature, so therefore the equity program should be global in nature. So therefore the equity program should be global in nature. And there are periods of time where you're really going to appreciate having those international stocks in there. Cause the U S can be dead money for a decade or more. Right. Which was, that was, that was the answer I was looking for. Right. I'm Meb Faber. Everyone's pounding the table. Like what,

why is everyone ignoring foreign had these huge periods of outperformance?performance yes it hasn't performed lately but i feel like many if you took 10 people who created the same program i feel like eight of them probably would have said no we're doing us only just and they would have benefited they would have benefited from that u.s stocks have definitely done a lot better but was it the right decision i don don't think so. Yeah. I jotted down here when we were talking, when you mentioned gold, were you involved in silver at all? Or when I mentioned Cliff Asness as well, were you guys in silver and get caught up in the LME canceling those trades or anything? Are you talking about nickel? Nickel, sorry. Yeah. The other side. Yes. We were nickel nickel sorry yeah the other yes yeah yes we were definitely um caught up in that we had a not sizable nickel's a small market yeah uh but it was you know millions of dollars in

pnl moving around yeah right so we were we were definitely long nickel when it went crazy um and held it you know while they suspended trading for a week. And then we liquidated it when they resumed trading after a couple of days and haven't revisited that market since then. The LME is different than other futures exchanges. Preaching to the choir here, you know all about it, right? And then the nickel market in particular, kind of like some of the other smaller metals like tin and zinc, they've got their own reality under the hood where big producers may not have the right type of metal to deliver against short positions if they're in China or somewhere else. So that was a giant mess.

It was very profitable for us. Trend followers more often than not tend to be on the right side of these disasters, but we don't enjoy it because that nickel market became quite fragile and a lot of trust was lost between traders and the LME based upon the way they handled that. I personally kind of agree.

I agree with how they handled it. I don't agree with how prepared they were for it. But once you get into that disaster, it's better to do what they did. I don't agree with Cliff that they should have stuck it to the guy and given him the profit because those prices weren't real. It was just pure supply and demand for the, for the derivative had nothing to do with the underlying market. And,

and that would have caused more damage to the market long-term if, if you bankrupted producers. Now they need to fix that and bring trust back into the market. My opinion until then, I don't trade, we don't trade nickel anymore. So I didn't expect you to say that. So you think they should, right?

I'm on Cliff's side of saying, hey, that guy's got to pony up. He's got to pay. If the LME goes bust, I can see both sides. Because if the LME went bust, then they got to grab all those members and grab two, three, five billion

from each member to make everyone whole. And if that didn't go well, then you have a potentially a crisis that expands over into CME world and other exchanges, right? So maybe it was best for the entire ecosystem. That's what I'm arguing for. I don't dispute you and Cliff's moral position. You're right on that. I'm looking more of the long-term, like the cost benefit. You really just need to own up, say, look, we screwed up. He screwed up. We're not going to allow this. Here's how we're going to fix it. But we're also not going to give you these

fake profits that aren't a function of your... It's not because Cliff's a genius or anyone else who's long is a genius. It was a structural flaw in the market that led to you know three four hundred percent moves um and then legally speaking a cliff has i mean everyone who was long has an argument legally speaking i'm just saying in the best interest of having this market be around going forward to trade you shouldn't be going down that road so it's a moral versus practical argument in the flash crash they they canceled, right? People were buying IBM at one penny and stuff, right? There were some bad prints. What was that, 2010 or something?

Yeah, May of 10. So there were bad prints down there and they re-canceled all those trades. So there's a little bit of precedence. But yeah, it just seemed wrong of our whole lives of like, no, if I trade at a price on an exchange, that's a valid price, right? That's just ingrained in everyone's head that ever traded a futures market. So it was just odd to be like, wait, what do you mean you can cancel those trades? Yeah, and I think TransTran has some strong opinions about this too, and that I don't really fully understand their argument. They're always complaining about the Canadian, I think it's the Montreal exchange and the way pricing works there.

And they trade something like 800 futures markets. So a lot, a lot of those are synthetic. They're, they're creating spreads or a lot of those were listed by the marketing department. Perhaps. Yeah,

could be. I mean, those guys, those guys definitely know what they're doing. So I'm not criticizing them. They've been around forever and doing well. I personally don't see the need to trade 500 different futures markets. I don't even see more than 80 that have the liquidity to trade.

So you're either synthetically creating them or you're doing some stuff on Clearport, off-exchange stuff that is interesting, but just not necessary in my opinion. And just to wrap up the nickel thing, my thing was telling people like, yeah, there's going to be a class action suit and you're going to get back a nickel. You had 2 million in paper profits and you're going to settle for a nickel. Well, here's the thing though. So I'll play devil's advocate and take the opposite side of my argument about practical. What if the trades were the other way around? Would they be letting us off the hook? Or would they be sending us a bill? I'd like to know that one. If trend followers were the ones nursing those enormous losses and making the case that this isn't

right or fair or whatever, would they be bailing us out? I'm not sure about that. Yeah, I don't think so. Maybe, maybe, Cliff, maybe some of the big ones, but which I put that out on Twitter a while ago. Have you ever gotten a thank you note for when oil goes down or commodity prices go down, gold is right? Everyone blames the trend followers when all this stuff goes up. The trend following, the hedge funds are pushing prices up, but I never get a thank you note. I get blamed,

but I never get a thank you note when it goes down. Well, there's two things I'll say about that. One, yeah, you're not on their radar when prices are going down, right? The second one is when I get this argument that you guys are bad and evil because you're pushing up food prices, corn and wheat, and that poor people struggle because you push up food prices. I've never understood why people feel that way because it just tells me they don't understand the mechanics of the market. So when I buy a corn futures contract, it's a futures contract. It's not corn itself. I'm not trading spot cash itself. I'm not trading spot cash corn. I'm not pushing up the price of corn. I'm pushing up the future price and I'm

trading against a hedger and I'm giving them the liquidity that they need to expand production to push those prices down. Without that price certainty, then they would stand back and let prices go higher before they would be willing because their margins need to go higher to build in a buffer. And they'll say, all right, now I'll plant more. But if I step up and buy it now, the futures contract, not the corn, the contract for nine months out, they say, oh, well, if someone's willing to pay this price, I'll go ahead and lock it in, hire these guys, and we'll go out and we'll produce more, which has the effect of pushing the price down when it becomes the cash market nine months from now. So when I explain that to people,

and usually I use a graphic to show how it works, they're like, oh, I always thought you were pushing up the prices, but you're basically transacting almost like an insurance contract with the hedger. And then they're going to go produce more because you pushed up the price of the contract. Okay. You're not evil. And I'm like, I wish, I don't know, understand why that's so hard for people. And even I could argue they're trying to sell that hedge aggressively, which is pushing prices down.

And then you come in and provide a floor. So I don't even agree with pushing prices. That's kind of semantics. But I was arguing the other day, we should have called them deliverables instead of futures. Because futures, right, people are like, oh, you're predicting what's happening in the future. Like, no, if I buy these corn futures today, really what I'm buying is the, I'm agreeing to have corn delivered to me in the future. Right. It's nothing about what the price is going to be in the future. It's the price I'm agreeing to have corn delivered to me in the future. It's nothing about what the price is going to be in the future.

It's the price I'm willing to pay today for delivery in the future. So yeah, it's nothing to do with the price in the future. It's the price today. Yeah, I've had that debate with academics for decades now, and it gets heated. It's so weird to me, but I look at that price as being exactly what you just described. It's whatever we can, it's the price that clears the market today for future delivery of corn at some date in the future. So that's what brings buyers and sellers together today.

You know, that's, it's a price at which sellers are willing to transact, but also buyers. And then there's three things that I think get factored into that price. And one is expectations. That's a small one. The other one is the carrying cost, the financing charges, meaning if you do this, you don't have to hold the wheat in a storage facility and pay them. It's just basically the components of term structure, and those things get factored in. That's what keeps the market coherent and stable through time so that you have a place to go get rid of risk or collect risk. I mean, the reason these markets exist is for risk transfer. That's why they were designed. They weren't designed for traders. They were designed for the market participants to actually have a place to go manage their risk. Now you need traders to give you the liquidity to do so. And the markets work very well at doing that. I don't know why more people don't talk about that.

We started right here. So hopefully they do. Well, we were, that was 07, right when Congress was having hearings and everyone's pushing the price of commodities up and then inflation, and then it quickly all unraveled and that all went away. But yeah, we got a little bit of that. A few investors during the first stages of the Ukraine war were like, I don't want to get into trend following. If it's war profiteering, they're making money off wheat prices. Those are only up because of the war. Energy's up because of the war.

So there was a few investors who kind of had moral issues with it. And I was, yeah, it's a tough conversation. I don't know how to precisely answer it to say like, well, you didn't want the war to happen. You're not profiteering off the war happening. You're right. I say you're like a fly on the bull or bears, but just wherever it goes, you're going to follow. You're not making it go one way or the other. So I've won that argument with everyone I've ever had it with in the past. I mean, if they were willing to see the argument through, and I would just simply ask them, do you want wheat prices to go lower in the future? And they say, yes. And I say, well,

how do you get them to go lower? And they say, well, you got to cut the prices. And I'm like, how do the prices go down? And they're like, well, the supply needs to go up. And I'm like, all right, so you need the farmers to plant more, right? How else do you get the supply to go up? It doesn't come from Mars. And they say, yeah, they need to plant more. And I said, all right, well, if I buy weed futures, those farmers are on the other side of the trade. Why do you think they're doing the trade? It's so they can go plant more. without the trade then planting more is scary for them and it's risky i'm giving them money today to deliver me going in the future we in the future yeah and i'm giving them price certainty right now which gives them the ability to lock in their margins and then go spend the money to expand

production and then they're like oh i didn't realize that so you're not pushing up the i'm pushing the price of the futures contract right now, but that's not what your people and you are paying for wheat. And it's not what you're going to be paying for wheat nine months from now. And then you and I don't, I need to have that argument in electricity pricing because I don't quite understand how the power markets work and all of that. And traders that do all that stuff and the traders are making billions of dollars when Texas prices shot up 400 X. So those are, those are a one and two day forward markets and that's completely different ecosystem.

So I, you ever traded them? No, but I studied them for a long time and i know people that have back in the midwest when i lived in kansas um you know and then that some people that would trade them over i think it's nordpool over in northern europe um it's just a completely different ecosystem and it's it's like pay to play meaning it's it's it's there's no exchange right it's just all these kind of oligarch type institutions that get around and they have a kind of a, what do you call that? A regulatory capture relationship with the regulators. And then they basically trade these power forwards between each other to try to offset demand from the utilities and whatnot. But it's all like quasi heavily regulated utilities. And then these kind of almost parasitic entities that not parasitic in a negative way, but

really just, they just make money from doing one thing. And if you're not in that group with the economies of scale to do that one thing, you can't make money. So when I look at it, I say, that's nothing I would ever want to participate in. I've always wanted to just own in like one of these tail hedge funds just own calls on the power but probably the carry is insanely expensive but you think you could own a way way out of the money call it seems like at one every three years these these spikes happen and you could capture that right you couldn't trend follow it it jumps too quickly yeah i was somebody asked me recently if i trade a

european or uk natural gas um i told them no we don't it's not one of the more liquid markets in the world and they were under the impression that it's just an incredible market for trend following and i went and pulled up a total return stream of the whole curve like that market's been a nightmare you know it's up 700 but then it's actually negative three months later and then it's up 700%, but then it's actually negative three months later, and then it's up 800% and then negative. I mean, it trades like Bitcoin did back in 2011. But that's not indicative of a true hedging market. There's something else going on there. Yeah, and I was tweeting a while ago, there's a bunch of the pricing isn't what's actually happening.

Yeah, there's some trading mechanism that posts those prices. But as you mentioned it, Bitcoin in the portfolio ever going in there? Is it one of those 80 markets? It almost made the cut, but still it's not up there yet. Got it. And how about carbon? Carbon's in there, carbon emission credits. We just had a position a while back in that market. It made a new, I think, multi-year high and then immediately collapsed. So that was not a profitable trade for us. But it's been one of the biggest winners for us over the past three years. I think you should do a YouTube channel because that always happens, right?

Oh, here we go into carbon, all-time highs. This is going to be a loser. I'd probably be the only one who'd watch it, but that would be funny. Well, I thought it was going to be a loser the first time we put a trade on, which was in 2020 and ended up being our biggest winning position over a two-year window. Yeah. Yeah. That whole period was unbelievable. But that happens to me all the time. Why in the world would we be going short bonds right here? These are going to bounce back. But that's probably why we're both systematic instead of discretionary traders. Yeah. I was just having a conversation. Somebody suggested to me, you would have been a good discretionary trader. You were right on bonds.

You were right on this, that. And I said, no, I, I, I wasn't right. I wasn't, I didn't even make that prediction. I never would have had the courage to put that trade on, on a discretionary basis. I don't want to live that way. I like being able to sleep at night. I am not here to entertain myself or create excitement. The systematic discipline prepared approach is a perfect pairing with my personality and everyone else that works at standpoint. And I think it works better. Yeah. Well, and it has, well, and there it gets you to that 10 year thing, right? Who knows how you would, that's a whole nother conversation, but to be able to exist over a 10 year period, having to put on each trade through your own mental process, God, that'd be exhausting. i'm gonna ask you your hottest take but i think you already gave it that this that the lme did the right thing i they did the right thing by putting themselves into the wrong position

so they put themselves in the wrong position and then they did the right thing that's very unpopular, but necessary to keep the ecosystem alive. So what do they call that when you bad incentives and you have to keep doing the wrong thing to keep it from blowing up or whatever. So yeah, I'm not happy with them and a lot of people aren't. And I've even kicked around the idea of just not trading LME markets anymore based upon that and in the end said well they add enough value to keep them but i'm watching them like a hawk i don't want to see any more crap like we saw with nickel but given that it did happen i i for like for think about this if they had marked a market i mean our profits would have been a lot higher right um a lot and i but i didn't feel entitled to those profits i don't think my shareholders were entitled to those profits um even though legally speaking someone could make a case that

you were but at the end they had they did what they did they're the exchange the regulators evidently signed off on it and it is what it is and we did make money in that market but it could have been a lot more um and i remember looking at it thinking i kind of hope they don't do this because it's going to destroy that marketplace in my opinion um and it's more important to just take our modest profits and keep the market alive yeah i'm talking about more about the LME, not nickel. I don't care about nickel one way or the other, but the LME as a whole. I'd like for them to get their stuff together and do a good job going forward. And that's more important than making an extra million bucks on one particular trade.

Yeah. The smell test for me was when you pulled up your screen that day and saw the nickel trade was up, right? Yesterday had been up 42,000 per contract or 4,000 per contract, and now it's up 420,000 per contract, right? Did you think in your brain, this must be a bad price, right? That's the first thing that went into my brain of like, oh, there's a bad tick in here. Well, I knew something was up with the market because there were rumblings that something was up um and then i thought well either they're gonna have to bust all these trades um or you're gonna have a year

of litigation and absolute chaos and you're gonna have litigation either way yeah both right they bust the trades and years of litigation right um but i don't who do you think is gonna win the litigation probably them i think it'll settle for some, right. Like some small amount, but yeah, I think in their bylaws and in all the fine print, they can do whatever they want basically. Yeah. Well, you know,

they actually do have a case when you, because a certain amount of volatility, if it gets to a certain level, it'll break a margin, a margining process. Oh yeah. Right. And they have a margining process and it's not the greatest exchange in the world. They don't do the best job out there, but still it's the fact it's been

effective. They've been around for hundreds of years. But the margining process got broke because the volatility was so high. And when that happens, you got to figure out what to do. And they could have split the middle, but they chose the side of the hedger over the speculator. And I, in their shoes, I would have done the same thing they did. That's all I can say. All right. Tell everyone where to find you, standpointfunds.com. Yeah. If you want to learn more about standpoint, the best way to do that is go to our website

right there on the front page, scroll down to the bottom and just sign up for our monthly updates. We don't spam you with junk. It's just what we did, what happened, how we compared to the others and any of the other good stuff that we think would be worthwhile. So just put in your email address, hit enter, and you'll be good to go, standpointfunds.com. Can you do, I keep wanting to, trying to get people to do this. I wanted AI bot to write a fake narrative over the systematic trades just right for comedy's sake just be like well we really liked the that uh india was flooding and so we bought corn futures or right some some fake narrative would be fun i'll get sean my my

my uh quant guy here to start working on that right now, because that would be pretty entertaining. Click here for the facts and then click here for the onion version of what happened. Oh, that's a good idea. Yeah. No, I think we'll just stick with what we're doing, though. All right. Well, thanks, Eric. This has been fun.

We'll talk to you soon. We'll visit you next time we're out there in Phoenix. Awesome. Yeah. Thanks for having me on. Appreciate it. All right. We'll talk to you soon. We'll visit you next time we're out there in Phoenix. Awesome. Yeah. Thanks for having me on. Appreciate it. All right. We'll talk soon.

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