The Derivative - Turning the Tables: Trading Pits and Dip Spits with RCM’s Jeff Malec

Episode Date: April 29, 2021

Today’s guest is one you’ve heard many times before if you’ve listened to The Derivative,  but may not necessarily know all that well. He’s and alts/managed futures veteran, having started his career in Chicago’s famed trading pits, founded a futures investment firm, and continued on to become a partner at RCM Alternatives. ,And, of course, when not doing his day job, steps in as the dynamic host of our podcast. We’re talking Jeff Malec. We thought today’s podcast would be a great opportunity to get him from behind the host side of the mic to the guest side to get a little more familiar with his background, have a chance for him to share some of his own knowledge, and for all our listeners to see a different side. It is his birthday afterall – so what better episode? Jeff is interviewed by the team at Mutiny Fund in today’s episode where they’re talking about the differences between the New York traditional equity-based markets and Chicago’s futures markets and the pros and cons for investors, why Chicago’s approach did much better in 2008 and what investors can learn from that to apply to their own portfolios as well as the cash efficiency of futures, how investors should think about correlations, the common traits of the most successful investors, and why low volatility often means hidden risk and how to spot it in your portfolio. *Please note - this was previously recorded and reposted for this episode* Chapters: 00:00-01:50=Intro 01:51-16:16=Harley Davidson & Philosophy 16:17-39:07=Chicago Futures vs New York Stocks 39:08-47:54=RCM Alternatives 47:55-01:03:17=Portfolio Construction 01:03:18-01:13:39=Gold What is it Good For Follow Jeff on Twitter at @AttainCap2. And last but not least, don't forget to subscribe to The Derivative, and follow us on Twitter, or LinkedIn, and Facebook, and sign-up for our blog digest. Disclaimer: This podcast is provided for informational purposes only and should not be relied upon as legal, business, or tax advice. All opinions expressed by podcast participants are solely their own opinions and do not necessarily reflect the opinions of RCM Alternatives, their affiliates, or companies featured. Due to industry regulations, participants on this podcast are instructed not to make specific trade recommendations, nor reference past or potential profits. And listeners are reminded that managed futures, commodity trading, and other alternative investments are complex and carry a risk of substantial losses. As such, they are not suitable for all investors. For more information, visit www.rcmalternatives.com/disclaimer

Thanks for listening to The Derivative. This podcast is provided for informational purposes only and should not be relied upon as legal, business, investment, or tax advice. All opinions expressed by podcast participants are solely their own opinions and do not necessarily reflect the opinions of RCM Alternatives, their affiliates, or companies featured. Due to industry regulations, participants on this podcast are instructed not to make specific trade recommendations nor reference past or potential profits, and listeners are reminded that managed futures, commodity trading, and other alternative investments are complex and carry a risk

of substantial losses. As such, they are not suitable for all investors. Welcome to The Derivative by RCM Alternatives, where we dive into what makes alternative investments go, analyze the strategies of unique hedge fund managers, and chat with interesting guests from across the investment world. Hi everyone, this is Allie, the behind-the-scenes producer of The Derivative. We're doing something a little different today by flipping the script on our host Jeff Malek and sharing a podcast where he was the guest, giving you the chance to learn a little bit more about the man behind the questions. And today is his birthday after all, so what better opportunity?

While I've got you, I'd also like to give a quick shout out to Jeff Berger, our graphic designer and audio wizard who cuts up the podcast each week. So, today's conversation is going to be moderated by the team over at Mutiny Fund, talking about Jeff's humble start on the trading floors in Chicago, trend following, common threads between successful investors, and much more. Thanks for listening and enjoy. So I'm Taylor Pearson. I'm here with Jason Buck and Jeff Malek. We're going to be talking with Jeff today about his background and the futures industry. I want to just kind of jump in. Jeff, how do you feel about Harley-Davidson? I love Harley-Davidson. I'm the great-grandson of Walter S. Davidson, who is my mother's grandfather. So we're very proud of the heritage, but I've never been a bike rider.

The, my mom's father worked in the factory. He died when he was 40 something, uh, mostly of asbestos and can't lung cancer. Uh, but through their life, they never let the girls,

he had three girls and they were never allowed to ride bikes. So a, I appreciate that you called it Harley Davidson. Cause we're the Davidson side. A lot of people just say, oh, you're Harley? Yeah, Harley's a little more memorable, I guess, Davidson's guy. Yeah, and then the Fletch 2 movie, Chevy Chase went into that one bar and said he was Ed Harley,

the grandson of Harley Davidson. So sometimes I get that. But yeah, we're proud. I'm not talking to you from my private island, so it hasn't been a financial windfall, but a lot of proud. We go to the 100-year reunion. Every five years, they have the 105, 110 up in Milwaukee,

so we go to that and participate in the activities. My uncle's a member of the Iron Butts Club. I don't know if you're familiar. I don't know that one. You have to ride 1,000 miles in like three days or something nice yeah it is cool when you go to those reunions they have the parade and there's like the brazilian hog is the big thing harley owners group so there's the like from any country any city you can imagine and they ship their bikes over there and they're coming through downtown milwaukee proud as can be great brand passionate yeah it's cool it's in some trouble these days with

millennials don't aren't buying into it but it's always the millennials always uh you're a philosophy major in in college um what what was the thing you know i guess why were you a philosophy major first of all and then what what do you feel like had the biggest impact on you of what you read, what you were studying? Well, the why is a little bit embarrassing, but I wasn't very good at getting to, you had to sign up for classes, which seemed weird. Just let me sign up for whatever class I want. So you had to get there in time and basically put your names in to get to the classes. Philosophy was not a big demand, so I'd miss the economics classes.

I wouldn't get in time to sign up for a lot of those classes. I had a big theory of the first week and the last week of any school year are kind of wasted, so I would show up a week late and leave a week early, like as soon as my tests were done. But it came to turn out that that impacted which classes i could take so long story short the philosophy classes were the only ones left and this was freshman sophomore

year until i figured it out and got to take the classes i wanted but by that time i'd had all these philosophy credits built up um so i said hey i like it and it taught me how to write taught me how to think uh so i don't really view it as, what was the second part of the question? What was the thing you read that had the biggest impact on you? Yeah, I don't think there was any big thing like that. To me, it was just more learning how to think and being challenged.

I'd have to say, if I had to pick one, probably be Thomas Hobbes, who's the life is nasty poor brutish and short uh that was my thesis was the irrationality of human cooperation so kind of went into that's our natural state and then we naturally also figure out that we have to cooperate or else we'll all run each other over in the streets and whatnot so yeah i'd say that one a bunch of other random weird stuff nichi fun uh but yeah i never really looked at it that way they're kind of like all old dead mostly white guys yeah i feel like you sort of dodged it but my theory is like you either want

to go like hard math and sciences or like history or philosophy it's like the social sciences in the middle where you think you're doing science and you're really just like making stuff up. Yeah. At least with philosophy or the history, at least, you know, you're making stuff up.

Like, yeah, exactly. I'm just like picking random data points and telling stories about it. Like, let's, let's not like, and it's actually interesting.

The, uh, the far edge of philosophy and you get into logic and it gets very mathematical. So that was some of my favorite classes actually were the uh the logic classes and some of these guys who were with words and and whatnot proving some mathematical theories that's gets in the my buddy the old santiago george saunders purse was the american philosopher that was like the founder of logic

and they so they say he's kind of the inventor of binary digits which lead to computers and everything because it comes from you know logic background but i think the most interesting part that you said is like it taught you how to think in the way like maybe or or how to question your thinking because like everything in school is always additive here memorize this memorize this and they're we're teaching you something we're trying to pour information into your head where then you get in philosophy class and they're like wait why do you think that what's the definition of that word like what's your priors to that and so it forces you to be a much more uh disciplined thinker in a way for sure and if right there's probably a lot of banks that would have loved for their uh analysts and risk managers to have questioned var and

things like that of like no don't just take this for, for what it's worth. So yeah. What does explain VAR for the listeners? Uh, VAR is value at risk. It's a, uh, standard deviation based risk measure of you'll never lose more than 1%,

99% of the time. So it's kind of based on the normal bell curve, but as we know, we don't live in normal bell curve land so right was the anchorman quote works 80 of the time every time yeah or my favorite one 96 of statistics are misleading right yeah and then how did you end up um in the bond futures pits how did you sort of end up in finance and in the chicago school and all that well as a philosophy major i went to live in aspen colorado for a year and a half after school top destination for philosophy majors

and was slopping chili on the mountain there and you know living the dream but you're looking across the place of the people you're serving the chili you're like maybe i want to be that guy he seems to have it pretty good uh so moved back to chicago i was born in chicago raised down in vero beach florida but uh moved back to chicago where my dad was uh his wife at the time which is a whole another podcast but his wife at the time put um made a connection with a guy she knew on the trading floor. So started there as a clerk. Didn't last terribly long down there. It didn't fit with my personality.

It was kind of loud, crazy. And I was always asking, like, you know, and I was in the bond pit at the time, which was they had just built the new room at the Board of Trade. I think you could fit a 747 plane inside the room uh there were multiple pits the 30-year bond pit was the largest pit and uh you know i we'd rally i think that was the time of the asian uh bond crisis like 99 ish and would be you know millions of dollars changing hands i'm like why why did we rally? What's going on? And they'd be like, because Billy's buying.

So for someone that's never seen, what set the stage? What was a typical day in the Bond pit? What was the, it was a big room, just a big open room. You could park a 747 in there. Bunch of dudes holding up pieces of paper, yelling at each other.

Yeah, so it's very three-dimensional, too. So the pits are all raised. It's kind of a ring, an octagon. The middle, I don't even remember what the middle is for. There's no one really in the middle. Then there's the first ring, the second ring. The best guys have either the third or fourth step up, so they can see over and do everything.

And then everyone looking into the pit is trading with each other and it was all go watch ferris bueller's day off that scene where they're looking through the thing and cameron's doing all the hand signals pretending to do them that was the that was called arbing so you know fate if your hand palms facing out you're selling if your palms facing in, you're buying. And it was 1, 2, 3, 4, 5 normally. Then you turn your hand sideways, 6, 7, 8, 9. Then a finger on your head, 10, 20, 30, 40. Fingers on your arm, 100, 200, 300, 400.

I don't remember what thousands are, but it was that whole code. And so they're screaming at each other because you can't hear. There's thousands of people in this huge room. remember what thousands are but it was that whole code and so they're screaming at each other because you can't hear there's thousands of people in this huge room there's probably 200 people in the bond pit itself and they're trading with each other and then they just have a little sheet of paper so i'd look over at you taylor 200 200 and you say 200 sold and then my badge would be jef and yours would be tay and they'd just scribble in the most unintelligible way possible tay 200 at 28 40 whatever the price was and then rip that off

and they had a hard card that they'd put in their pocket rip off the carbon copy hand it to the clerk uh the clerk at the end of the day would go find your clerk and they'd match up the trade. So in today's world of Globex and, you know, digital automatic trade matching, that's crazy, right? Right. But it wasn't that long. It was 20 years ago.

I mean, it wasn't that long ago. Yeah. Yeah. And so then my job was I've, the brokers are all looking inside trading amongst each other. Then I would be back to back withback with him looking into the option, bond option pit. So the option guys are doing their options,

and then they need to delta hedge. So as the market's moving, they're in real time looking at me saying, buy 200 buys. And I'd turn around and tell my guys to buy, and then they'd do the trade with the other guys. So just the sheer amount of paper is would be blow your mind like there's no way it could exist today just from the you know environmentalists would be like this paper's gotta go like there'd be literally an

inch to two inches of paper on the floor at the end of every day can you explain uh delta hedging real quick for the audience? Yeah, so if you have an option position, as the position gets closer to the strike price, so in the bond, say I was short a 106 call or something, and the prices are at 102, the delta of that 106 call is the amount the option moves in relation to the underlying market move. So as prices get closer to that strike price of the option, if it goes in the money, the delta is one.

It basically just becomes the underlying then. So these guys would have all these complex option positions on. And in those days, they had another piece of paper in their pocket, and they'd constantly be looking down at the sheet to see, okay, if we move this much, my delta's changed by this much, and I need to add futures. Is that their market making? So they're just trying to stay delta neutral,

so they don't care which direction the market moves there? Probably not market making. Most were trading their own money or whatnot, but they wanted to be delta neutral. So they're just trying to scalp the volatility of the option or have some other concept inside of options of what they wanted to do. But, yeah, they didn't want to be directional. So they're selling.

They think they get a good price on the option. They sell it. They want to hedge out the directional movement as quickly as possible. And then do you think it's a bygone era of like, like you said, these guys are a lot of more trading their own money. And it was a unique era in Chicago times where like these guys would go down the pit,

they'd trade for those few hours in the day, you know, and they'd, and they'd walk away and they were buying houses cash or whatever. Or they, you know, their P and L would, you know,

fluctuate tremendously throughout the year, but it was all eat what you kill. And we don't really have that physical sense of eat what you kill in the markets anymore yeah i'd say the closest thing these days is probably the crypto space so people who could just get in for next to nothing and made millions of dollars like and it was a huge and chicago was proud of that because it was very differentiated from new york where you had to go to the right schools and get the right internship and get onto the training floors. Chicago was like, if you were an aggressive guy

and push your way onto the floor, you could make a killing. And a lot of guys did without any education, without anything. So for sure, it's a bygone era of nowadays, that's all computers talking to each other and when you said the bond pit wasn't for you is that because you're a philosophy major and you're not an enormous dude i mean you played football and everything but like typical bond pit guys were like big dudes and they're spitting on you elbowing you as like it's a very physical job in a way too oh my god yeah so two things one there were a lot of guys who, they're all big guys. There were fist fights, you know, once a week probably.

Two, they all had some sort of vice, at least one vice. So a lot of them, to keep going during the day, would dip, you know, have chewing tobacco. And so where are they going to spit it? So they have their dip cup that they're spitting in inside their jacket. And so to complete the picture everyone has you the rules are you had to have a sport coat essentially so that became super loose and they're all like mesh custom and then you want to it's like being a peacock you got to stand out so if everyone's trying to sell you 500 you want to be the guy in the big loud coat that the eye catches

so like our uniforms were these red and white candy striper kind of coats other guys had purple or yellow or or whatever color but uh yeah many times i'm in the in the thick of it there and a guy gets bumped and his dip cup gets pushed out of the jacket onto my arm or leg or whatever yeah that's so some of that was like what am i doing but for me it was it was less the physical side was more the mathematical like no one could tell me why bonds are rallying and they're finally they're like oh because goldman came in they're buying them from upstairs i'm like well i need to find out what's upstairs and so that started my progression of like all right i'm getting off the floor i'm gonna see what's going on upstairs and upstairs was managed money and big firms hedging and things like that so let's get into that what

you know you mentioned for like the new york York versus Chicago school. How do you, like, explain that difference? Like, how are they distinct? Well, my favorite thing to say in that regard is New York doesn't have alleys. So they pile up all those trash bags outside their $30 million condos, and Chicago has alleys. So we're much better in that regard, much cleaner. But, well, the main thing right is new york is stocks new york stocks change chicago's futures uh so chicago grew up on the

agriculture futures chicago board of trade 100 and whatever years old and that guy chicago was sort of like the center of like agricultural trade it was like in the middle of the country and where the railroads came in and so so you were like, farmers were shipping in soybeans or whatever, and they were doing trading futures on them. Exactly. And, I always tell people new to futures, like it's not what you think the price is going to be in the future.

It's agreeing on a price today for future delivery. Right. It's like I'm growing some corn and like, I want to hedge out, you know, right now the price of corn is $18 a bushel, but like it could go to 25 or it could go to 12 and so okay i'm gonna sell some today at 18 and lock it in if corn prices are at 18 a bushel you'd have billionaire farmers it's like four dollars yeah okay there you go um but yeah so a farmer would be like okay

i'm gonna come to Chicago and someone's going to agree to buy my corn that I haven't even planted yet for $4 a bushel. And so you're like, great. I know I can plant it, harvest it, get it all out of the ground for 360. So I can immediately lock in that 40 cents profit. Right.

And walk us through, how did you get, how did Chicago, sort of how did you get, how did Chicago, sort of how did that grow into, you know, what it is today? What is sort of, you know, I've heard it sometimes CTAs,

managed futures, futures, you know, how did that, what is that sort of industry? How do you think about that? How did that grow out of? So there was the agriculture futures,

corn, wheat, all that stuff, grown in the ground, commodities. And then, all that stuff grown in the ground commodities. And then the, uh, that was all Chicago board of trade. Then Chicago mercantile exchange launched in the seventies something and, uh,

came up with the idea of we're going to trade currency futures, um, Swiss franc yen, things like that, which exploded. And then they started adding stock index and a lot of other stuff. And then you had New York Board of Trade, cotton, sugar, all these things. So managed futures, CTAs.

John Henry was actually one of the first ones who's the Boston Red Sox owner. So he was out of Boston. But essentially he was trading all those different futures markets the classic example is trend following or the classic approach to that was trend following and this ties back to turtle traders too which some people have heard of so in the merc pit uh sometime in the 80s bill eckhart and william dennis uh william eckhart and Bill Dennis, had a bet straight out of trading places. I bet they were arguing, I think you could teach people to be great traders.

You have to give them these rules. And those rules were essentially kind of a trend-following approach. Only risk a set amount per trade. And they taught many people, some of which are CTAs today, that have continued on and been very successful so the managed future space was born out of these out of this futures trading which was highly right the futures contracts are internally leveraged so the back to the corn contract i can control

call it twenty five thousand dollars worth of corn for putting $800 margin in my account. So, right, that's inherently risky. And people were trying to do that on their own, whether in the pit or calling a broker or whatnot and losing a lot of money. So managed futures came along and said, hey, we're going to put some rules around this. I'm not going to only put in $800 to control that corn. Maybe I'd put in $50,000 to control $25,000 worth of corn. So kind of institutionalized it, controlled it, put a model around it, and started to become a big asset class. Was that like a regulatory framework, or that was just investors starting to say,

like, I'm not going to do this highly leveraged thing? Yeah, I think it ties back with the turtle trader kind of concept of just, you know, yeah, people are like, there's a lot of money being made there. I don't need 80% volatility. Like, can we get 10% volatility and make 20%? That'd be great. I don't need to be back to Jason's things. People are buying houses and cash and i

have friends whose parents were traders back in those days and they'd be like we had a new car the car got taken away we had a piano the piano got taken away so there was constantly like all this volatility not just in their pnl but in their lives right we got a new vacation house in michigan oh now we're back to Indiana. So it was just controlling that volatility and attracting outside investor capital. So the CTA is Commodity Trading Advisor, and so what's happening is that you have the corn, the cotton,

the whatever futures in there, and these guys are coming in and they're setting up these trend-following rules. Well, you don just explaining like trend following in in general and then like how it applies to cta's like what what's an example of like a trend following cta strategy sure and i you know they're known for they did great in 2008 made like 18 while stocks were down everything else was down um and i'd say it's not magic they didn't predict the crash they didn't do anything they're participating you know imagine a a band of you know one standard deviation above one standard deviation below prices on any chart they're just putting that on a chart when prices

break above the upper band they're going to buy hoping it's a breakout and it's going to continue for weeks or months or when prices break below that band they're going to sell and hope that it keeps selling off for so there's no magic there they're just doing that every time it breaks above or below those bands and it's not a very efficient trade but they're doing that every time to ensure that when it is the big move that they catch it and then they control their risk by saying i'm only going to risk one half of one percent of my equity or one percent of my equity uh on each of those trades knowing they're probably only going to be 30 40 percent uh profitable so on the on the ones that do hit though they're huge outliers and they're capping the downside because once it drops below one center deviation or whatever, they're out of the market and they're sitting in cash.

Right, and it's kind of synthetic put buying. So you're controlling how much you risk. You're kind of buying, or not put buying, but option buying. So you're controlling your risk. You're only spending a little bit of money of your capital to participate in all those moves hoping that the uh the final outlier move happens and they you know it's counterintuitive to most people but they tend to they joke about they buy high and sell even higher or they buy there they sell low and sell even lower where it's the opposite of most people

want to do especially when they think about like investing. They're trying to buy low and sell high. That's why it's called trend, because they believe that humans are very emotional and rational, and we tend to herd. So if prices spike higher, they're trying to get in thinking that that's going to run along, or if prices crash down, they want to ride those trends as we get emotional

and overshoot the target, so to speak. For sure, and it was one of the first quant models, right? It was one of the first people to use computers to trade markets. And it's essentially a strategy where you're plotting all the, and some of these early guys were doing this by hand, of taking in the data every day, putting it on charts, actually drawing charts and saying, okay, we've broken above the one standard deviation of average prices.

Now I'm going to buy. And today, right, that can all be done in two seconds on any number of platforms. But I was one of the first to put an automated systematic model onto markets. And then what, like talk through, you know know you could get exposure to the s&p index through an etf or you could do it through the futures industry you could trade options on s&p futures like what what are the pertinent differences between like why would an investor choose to use futures as opposed to equities or equities opposed to futures like what are the what are the trade offs and differences sure uh i'll back a second and say part of that managed futures

classic portfolio also is broad global exposure. So I'm going to have about a quarter of my risk in fixed income futures, which is 30-year, U.S. 30-year bonds, German boons, Japanese bonds. Then I'm going to have about a quarter in currencies, yen, franc, British pound, Aussie dollar. Then I'm going to have a quarter in row crops or grown in the ground commodities. So corn, wheat, gold, crude oil. I guess I don't know if we'd say crude oil is grown in the ground, but comes out of the ground. And I pulled a Rick Perry there. I can't remember my fourth one. And sorry, equities.

Thank you. Yeah. And then equity indices and global. So S&P, Hang Seng, Aussie, German, DAX. So at any one time, and you're not trying to catch any specific trend you're just trying to spread it across or if the whole model is markets cluster and then they break out or break down to new highs or to no lows they phase shift to these new things so the whole concept if i just did that on the s&p

i could go years and years and years waiting for that phase shift. If I'm on five different global equity indices, there's a better chance that one of them is going to break out. If I'm on five different market sectors now, energies, currencies, interest rates, even better chance. If inside each of those buckets, I have 50 different things. So the whole concept is I want as much exposure as possible. I'm going to be playing 600 hands at the blackjack table and i know risking only a little amount and knowing that at any one time

i'm going to go on a big run on one of those hands so going back almost to the start of taylor's question what he was actually you know asking about in a way is like you know he brings up futures managed futures ctas now at r, you guys are calling them alternative investments. This is a marketing problem that I know makes you want to rip your hair out. But it's like now everybody gets told by their RIA that they need to have a global portfolio and they're trying to implement it through ETFs. But the guys that were trend following CTAs have been doing this for decades in the most global portfolio you could possibly imagine that you just laid out.

Like literally everything in the world they're trading yet almost nobody knows about it so how do you like i don't know if you if you could you'd be a billionaire but how do you overcome that marketing problem with futures options and yeah and it's compounded by the the thing we're talking about one slice this trend following that we've been covering but then there's discretionary ag traders there's professional energy traders that are doing different things so you and that all comes under this managed futures umbrella so yeah i don't have a good answer for that just the way i my understanding because you think about futures and equities like there's there's difference like you know one of the things we talked about is like counterparty risk, right?

So if you're doing a big options trade that's over the counter in the equities market with Goldman Sachs, Goldman is your counterparty. And if they blow up or whatever, you know, you have that counterparty risk. Futures is more like mark to markets, cash based. You don't have the same counterparty risk. Are there other sort of like pertinent differences like that that you think like investors should be aware of yeah so the classic ones are excuse me the uh futures get 60 40 tax treatment which actually comes back to there was no difference in tax treatment and a bunch of

the chicago traders would at the end of every year year basically buy new stuff to they did like a tax spread on the calendar and the feds came in they were going to like take all these guys down and they somehow lobbied and got this thing put in for 60 40 tax treatment so no matter if you trade every second of every day, 60% of your gains get treated as long-term capital gains. 40% is short-term. So that's a huge, huge benefit, especially the more active you are as a trader. The other thing, as you mentioned, there's no counterparty risk.

So the exchange backs every trade, which is how the whole futures market works. If you had to worry about, you know, I buy this corn future, I have no idea if the guy who sold it to me is going to be able to deliver, the whole thing would fall apart pretty quickly. It's sort of an issue in the crypto space is there isn't a centralized thing by design,

but people have a problem trusting who's on the other side. So the futures markets fix that by each exchange, which was CME, CBOT, NYMEX, has a guarantee fund. So in the case that the counterpart, if you are JP Morgan, I'm Wells Fargo, whatever, we do the trade, say one of those banks goes bust, the CME will step in with their guarantee fund and say, I'll make you good on that trade. So you got the tax difference, the whatever I just said, difference. Counterparty risk. Counterparty difference.

And then the leverage difference. So as we talked about before, the leverage is built into a futures contract. If I want to buy, so I can control, you know, $150,000 worth of s&p by buying one e-mini and putting up six thousand dollars worth of uh margin or whatever i don't know what an e-mini is e-mini s&p is the uh electronic small version of the s&p futures which gives exposure to the s&p 500 so it's a easy way to get trade S&P, a little cheaper. And then they actually came out with micro minis, which allows you to do it for even cheaper and less money. But so that leverage is built in. If I want that same exposure in stocks without putting up as

much capital in a stock account, they're going to charge me 50% margin. They're actually going to charge me for borrowing money from the bank to buy that full nominal amount. Whereas in futures, it's embedded in the contract. And I think this is a good place to point out that typically when people hear leverage and especially leverage in futures and options market, that usually scares people away right away. Understandably so, because you should be afraid of leverage.

But leverage is a two-headed beast it cuts both ways so going back to what you pointed out earlier if going into futures i can trade 60 global markets and i can have on hundreds of bets at the same time well then using that cash efficiency of that margin and leverage now makes me much safer so not only can you know leverage be used hurt you, it can be used to help you. And that's kind of the beauty of the futures market that most people don't understand is it allows me to put on a broader diversification of bets across global markets, which makes a more robust, safer portfolio than I could ever possibly attain with equities because I have the cash efficiencies of being able to cross margin those different markets.

Yeah, for sure. And that's, I agree 100% of that. That's, it's got a bad connotation of leverage, where in the futures markets, anyone who's knows what they're doing, it's like, that's the main, main reason they use futures versus an equity component, because they, they don't have to put up all the cash, right? So if I have to put up 100 grand to control 100 grand that's gone if i have to put up 10 grand to control 100 guess what i can do something else with my 90 which in a in a anyone's futures account you can buy t bills that count as collateral so right there you can get an extra whatever two percent a year uh to just do what you were going to be doing anyway but then the the more sophisticated, and as Jason's saying, okay, I'm going to take that 90, now I'm going to buy a few more things, which if you're doing that poorly could be over-levering.

If you're doing it into non-correlated things, it's additive and can grow. And I'll also add, so people like our clients at RCM who trade multiple professional managers, multiple CTAs, they prefer futures and managed accounts because they can put up a million dollars and have it traded as $5 million. How? Because of this embedded leverage. So each manager might say their minimum investment is $1 million,

and that gives you this fake numbers here. That gives you a 15% return with 12% volatility. Okay, if I'm willing to have a 20% volatility, I can put in a little less cash, and they still trade it as $1 million, which is notional funding. We're getting a little off the rails here, but the whole concept is they can trade

all five of those managers with just the one investment uh which you can't do anywhere else besides futures accounts without borrowing actual money and paying a yield to borrow that money yeah the key thing as i understand it right is the uh yeah you get paid you get paid to take leverage as opposed to paying to take leverage so that's nice and then what the ctas are trying to do is like, well, if you're using that leverage to buy things that are diversified, you know, if you have two assets and you know when one goes up, the other's going to go down, and when the other goes up, the other's going to go down, and they're offsetting each other, you can use that leverage safely, right?

And that's what the CTAs were kind of trying to replicate with their global trend following, right, is that we have a big diversified basket? Be careful saying safely, because people can for sure do it. Right, we don't know the correlations you're going to hold into the future. Yeah, exactly. So I think it's less about that and more about,

so if a trend following CTA has a $1 million minimum, they only actually need to put their strategy on, their average margin to equity, what they actually need to put their strategy on their average margin equity, what they actually have to have in the account per the exchange and in the rules is probably on average $120,000. So 12%. So why then don't they say their minimum is 120,000? Because a their volatility would be like 50%. And no investors would sign up. So one, it's just a bit of window dressing of, hey, I can't put it at the minimum I need

because it looks too volatile. So I'm going to say I need a little bit more and that's back to what we said a little earlier. Instead of trading $25,000 worth of corn for $800, I'm going to trade $25,000 of corn for $50,000. So one, it's a bit of window dressing. Yeah, so basically you can leverage or deleverage is what you're saying too. Yeah. So essentially the CTAs build their model, see what it is, and then they deleverage it and make it look, okay, what kind of return stream

would attract investors? And in the first days, like John Henry, when he launched, he was doing 40, 50, 60% with with 30 volatility and people were into that these days you go much over 10 12 15 you're going to spook a lot of people you have the million dollar guy all he needs is 120 he's going to window dress it up but the investor still only needs that 120. so instead of putting up all the million dollars they can only put up and there's rules around it usually most ctas don't want you to they can only put up, and there's rules around it. Usually most CTAs don't want you to put in the bare minimum because if there's one week of losses, then they need to ask you, hey, send in more money. So typically they'll only allow two to one or three to one.

And then you pointed out three of the biggest benefits to futures markets. And a fourth that I always loved is that depending on the manager you invest in and depending on what you structure and negotiate with them, you can have what we call the SMAs or separately managed accounts. And what I love about that is it almost eliminates the possibility of like Bernie Madoff scenario of him like falsifying trades, because on a daily basis, you get almost a window into what your manager is trading. And, you know, given the cash settled markets, that's the other, I guess, benefit A and B to this idea is that it's cash liquid market. So not only are you able to kind of see the trades to make sure they're not going off the rails or using excessive leverage or anything, but you can also go to cash on a daily, weekly or monthly basis. So you can,

you know, there's no lockups like you would see in like a hedge fund space where they you know they're down 10 they lock up your money for two years no these things are cash held markets we can go to cash right away we can also see what our managers are trading so that way you know they're they're sticking to their knitting so to speak um and these are things that i think that are not talked about enough is the benefits of how do we mitigate any sort of even like bernie madoff risk with an individual manager this can take care of 99 of that risk yeah that's a great point so in practice how it works so you're going to sign up with cta super duper cta one how you've been tracking you like all the performance uh he or she let's say she let's be progressive. So she's going to send you an advisory agreement.

You're going to open a futures account with someone great like RCM. They're going to put it at a FCM, a lot of Ms, but that's just the firm that owns the exchange membership and you do your trades and clear your trades through that firm. So it's called a clearing firm. So you open an account there. It's your account. It's in your name.

You can call tomorrow and say, send me my money. Then you give our super-duper XYZ CTA, power of attorney, to place trades in that account. But also they have to follow a disclosure document. They have to follow the rules. They have guidelines. So they can't just willy-nilly do whatever they want. So they have to do their program in your account.

So they're placing the trades with that account number. And then there's several additional layers of risk there as well. So say they mess up and hit, you know, by 1,000 instead of by 100. That'll go through that clearing firm to the exchange. There might be gates there of, hey, this CTA for that account don't allow any orders that are more than 10 contracts. So there's some, like, fat finger protection there. But also they can't, the manager can't call and say, send me $100,000 out of that account.

So the money in that account can only go back to the person who funded the account. Versus a fund or Madoff, you were sending the money and it was all commingled and he had control and he could write himself checks or do whatever he wanted with that. And then you mentioned RCM, which you work with. Tell us a little bit about RCM and how you all fit into the futures CTA space.

Sure. So I'll back up. So after the training floor, I came upstairs. I bounced around a few different uh brokerages one had an owner that drove a Lamborghini and wore leather pants so that almost spooked me out of the business but uh left there ended up uh starting my own firm in 2002 attained capital management uh we launched our own CTA in 2004 ran that up to about 75 million bucks, had a few industry issues. MF Global went bankrupt. PFG guys stole some money. We had exposure to both those. So eventually shut down the CTA, took a bit of a hit in our business,

built it back up. That was 2012. Built it back up through 2015. And the industry was consolidating. Regulation was getting more expensive. You had to have tech. You had to have websites. So merged in with RCM in 2015. And both of our models were complementary. But the essential thing we do is help investors find and access these professional managers. So we have a database of thousands of managers. I came up with a proprietary ranking methodology where we rank those managers

across several different metrics. And then also not just these different metrics, but across timeframes. So in seeing all these things you always had a there was an old trader called rosetta capital who made like 80 in their first year and then like five percent every year after that or something and but their compounded rate of return was off the charts but i kept looking at i'm like well nobody wants that though that's not so it came up with this model that time-weighted the returns across 1, 3, 5, 10 in all time and kind of averages those and then gives a score to each one. And that happens across all the metrics too. So it's a way to compare apples to oranges

and compare across all these different metrics that are important to people. So we have that database. You can build portfolios you can blend different managers you can see all the statistics there and then we're doing the actual physical face-to-face due diligence on these managers also in understanding what they do and my personal feeling is you can run all the math you want, but if you end up with some guys that on paper are non-correlated, but they're all doing a similar type of trade, at some point in the

future, they're going to be very correlated and it's going to hurt your portfolio. So kind of RCM's MO and my personal MO is you got to put managers that are fundamentally non-correlated together as well. And by that, I mean doing different things and having different return drivers. And what do you mean by fundamentally non? What is a non-fundamental correlation as opposed to a fundamental correlation? Well, so I could just, in the database,

be playing around all day and come up with this great portfolio and all the managers have 0.04 correlation with one another but if i dig deeper i see that manager one is doing volatility breakout on a daily bars and manager two is doing it on 15 minute bars so maybe statistically they've been uncorrelated but they're sort of doing the same thing they need volatility they need breakouts to new. So it's just a little bit of me personally not trusting the math, or Jason probably has some fancy word for it, but like that it won't, it just hasn't happened yet. So in my view, if they're doing something similar,

they're going to be correlated. It just hasn't happened yet, and it's not showing up in the math. So I have a distrust of the math based on that what fundamental non-correlation i want if i've got that guy doing this volatility breakout i want a discretionary ag trader who trades hogs based on calling around you know 500 pig farms and seeing what demand and supply is so they're just fundamentally different in what they're doing and another way to look at it to almost simplify is like statistical versus fundamental correlation is the science versus the art or the math versus the art so you guys have the ability and you guys are pretty much the only one in this game that has

an amazing platform where all the math is there for you to look up but then you have all of the personal experience and the art from the 30,000 foot view to say, you know, decades ago, this happened and these things were fundamentally correlated versus uncorrelated. Or you go, look, I've been in the game for years, you know, decades. I know that hogs are actually correlated with the Swiss franc, whether people, whether statistical correlation has not been there for a few years over the long run, these things are fundamentally uncorrelated. So it's, it's this combination of math and art that is very rare to find in any financial space. And that's what you personally embody. And that's what you guys are trying to do at RCM.

Yeah, I would call it math and philosophy. Full circle. Full circle, right. But yeah, and so then RCM, so we're helping investors in that manner, we're building these portfolios. And then we help the, as we said, you open an account, the manager advises, manages that account. So we actually clear like 13 different clearing firms from small Chicago-based guys up to, you know,

JP Morgan and Wells Fargo and whatnot. So depending on what kind of client you are, if you're a high net worth guy with $500,000, we'll get you to this clearing firm that'll accept individuals. If you're a $50 million family office and have to build a fund to one and do all this, you know, sophisticated stuff,

you're going to probably go to a bank FCM. So in addition to building the portfolios, we're introducing accounts to all those FCMs. Then on the manager side, we help managers by matchmaking with the other side, with the investor clients, and helping them structure funds, helping them with their clearing, with their execution. execution uh then we also have a algorithmic execution uh division which is super complicated and kind of cutting edge stuff but essentially there's as everything's gone digital there's bad actors out there prop firms who are trying to scalp and take advantage of people naively buying and crossing the spread these execution algorithms computerize have anti-gaming theory all sorts of things that kind of help you not cross the spread and not get preyed on by those uh high frequency guys on the

other side uh then lastly we're doing uh some interesting stuff in china now where we've set up a chinese wuffy they call it holy foreign-owned enterprise, and bringing signals, bringing Western CTA signals through our Chinese partners there to trade Chinese money on Chinese futures markets. So Western people aren't allowed to put their own money into trade Chinese futures markets, but they're highly volatile.

They're kind of like the markets, Western markets in the 80s, highly volatile, directional volatility. So some of these classic trend following and classic models are working really well there. But you can't get Western money in there yet, but the Chinese money has a big desire to have it traded. So we're working on facilitating some of that.

Just what you said about directional volatility in China being like 70s and 80s in our markets. And obviously, the next question for our audience is how do you view even like the cryptocurrency markets using like classical trend following? Yeah, just was here down at a conference talking about that with someone of why don't more managers have it in their portfolios? Because it's Yeah, it's the same thing. Like, hey, why go through all that trouble to get into China do that you have it right there. And, you know, there's only one futures market right now, Bitcoin futures. But for sure, that's the same. That's the kind of volatility that people like. And there are managers who have outright crypto Bitcoin futures programs

managing and kind of probably more volatility breakout shorter term than classic trend following. But yeah, to me, every CTA should have Bitcoin as one of the markets they're tracking and trying to catch those trends. The issues are there. The clearing firms were spooked from the beginning. So our corn example, you have to put up $800 to control 25 grand in corn. Most FCMs are saying Bitcoin, you have to put up $25,000 to control 25,000 worth of corn. So it kind of removes a lot of the benefits we were talking about earlier with all that embedded leverage. But still, if it's going to be one market out of your

85, I think it should be added. So we kind of started working together because, as you said, you all have this big database of managers, and we were trying to do the due diligence, and you're managing billions of dollars across all the CTAs and have the infrastructure and stuff set up to do that. But I'm curious, like, in terms of, you know, you work with a fairly sophisticated investor base. Like, if you were sort curious, like in terms of, you know, you work with a fairly sophisticated investor base, like if you were sort of like looking at, you know, the median

retail investor that's got a job running a business and like managing their own account in the background versus the people you're working with, like what are the, what are the big differences? Like what, what, what do you feel like the lessons are that you've taken from that, that investor base? To tell you the truth, I don't think there's that much of a sophistication gap. It's kind of crazy like the, and I hope not to offend any of our clients who are listening to this,

but some, I'll say in the far past, I've run across clients who you're like, you must have found your money in a bag in an alley because there's no sophistication there. So a big part, I don't know if there's that big of a sophistication gap. They chase performance just like retail. They panic and get out at the wrong times

just like smaller guys. Yeah, I think the biggest difference is the smaller investor can only, you know, it's a minimum game. So the larger investor can see a lot more things, things that have five, $10 million minimums. But there's also a flip side. I'd rather be the smaller guy and be more nimble because the sophisticated institutional investors, they end up only being able to invest in this super small sliver of managers because they have their check boxes of, okay, you have to have such and such business structure.

You have to have all this cybersecurity stuff. You have to have this, this. And as you go down and have to check all those boxes, you might end up with, you know, six managers across the world that qualify. I know IPERS, Iowa's pension, like four years ago, put out a, uh, RFP basically saying, we're going to put a hundred million to work in the CTA space requests, you know, submit your things. And I should have at the time,

but I was going to write a blog post of just like, Hey, Iper save your time. Here's the six managers you're going to end up with. Don't go through this whole stupid process and interview all these thousands of managers when there's only six that check your boxes. And this might be, to Taylor's point, and this might be just subjective to me, but I always had the gut feeling or inclination that the future traders, like you're saying,

in the bond pits or those pit traders who are very entrepreneurial, they're trading their their own money a lot of times the people that are going to invest in futures are high net worth individuals that actually are the the first generation wealth they're the citizen maker they're an entrepreneur so it to me it always felt a really alignment as an entrepreneur dealing with chicago guys that are entrepreneurs and then then creating trading systems or trading global markets in a very uh statistical entrepreneurial way it just seemed like alignment of entrepreneur upon you know like it just it's a almost a perfect alignment do you see that a lot with your clients a lot of entrepreneurs first time definitely and a big uh common denominator

across our clients we tend to have these engineering type whether outright engineers or just that kind of a mindset and the entrepreneurial mindset i'd say is a lot of them are engineering type there's a problem i'm going to figure out a way to fix that problem uh you know even if it's not i'm not saying like mechanical engineering but just the process of like i need i need to have a process i'm going to go through that process and get to the result so you definitely have a lot of the clients who have that mindset of not just blind trust, of like, no, I want to understand how this guy's applying a model to a market.

And the better I understand that, I'm more willing to invest instead of 80% of the rest of the world's just like, well, I golf with Jim and he says, this is a good thing, I'm going to invest in it. I've been interested, like the people that i've found that have known the most about the cta space in like my circle has been poker players and

i guess you know something about like the way they they obviously they understand risk in like a more sophisticated way than than most people but like that the global asset allocation the trend following like that that seems more intuitive to to that crowd like every kind of poker player i've hung out with has always been like cta for sure and get super deep in the weeds here but it's all probability based right the best poker players are saying okay i've got i think there's a 20 chance jason's on a flush draw i've got a straight already like and they're just doing the math and then okay there's that much in the pot if i risk x i know i'm going to get y so they're just doing the math. And then, okay, there's that much in the pot. If I risk X, I know I'm going to get Y. So they're doing that math in real time in their head, which is impressive.

But that's essentially what the advanced CTAs are doing, right? Okay, here's the market setup. The pot is, I think it could move this much. I'm going to risk X. So it's a similar mindset for sure of, okay, I've got probabilities and I'm going to risk certain amounts based on those probabilities with an expected return. And by the way, I can backtest all that and see how it would have done in the past across many different markets. And before, I mean, I'll try to keep it short without going

on a rant that'll start a whole nother podcast. But we know the my favorite part um about the cta in future space is we talk about your return to drawdown is your risk you know where a lot of other spaces now are talking about you know volatility as a measure measure of risk and you know you know i love that line like why did we let a 22 year old university chicago define what risk is where for entrepreneurs it's about did you lose my money or not that's your drawdown not how volatile are the cross-asset correlations it's like what is my return and what is my drawdown at the end of the year did i make money or lose money and the managed future space has been pounding the table about return versus drawdown since the start so they always understood that from the entrepreneur's perspective it's like it's about what i can eat

at the end of the day and i can't eat a sharp ratio or my volatility i can eat returns and and i can not eat with drawdowns explain what you mean by who's the 22 year old that we're talking shit about and then what's that yeah give give the give the unpack the sharp ratio return to drawdown um so jeff actually probably knows the history better than i do but the the idea of bill sharp coming up with the sharp ratio is that um it's based on volatility and volatility is based on a look back and uh and the look back is your standard deviation over time so you know based on you know your gaussian curve of one standard deviation two standard deviations it's basically um you know how volatile is this asset over time but as you would assume you're

saying over what look back period so if i look back over a week i'll have a certain volatility i look back a year certain volatility 10 years volatility you know it changes over time so when people are talking about a sharp ratio they're taking their return divided by the volatility over the timeframe they're looking at. And that's how, that's what we call the efficient frontier portfolio construction. And that's what everybody uses to kind of match up their portfolio based on volatility. Now, volatility doesn't necessarily correlate to your drawdown. And so you can have a low volatility, but a high drawdown and drawdown means from peak to trough. If I'm, you know, I'm at a hundred dollars. If I, if I go down to $70, that's a drawdown of $30. So I've lost $30 and my volatility might not have changed very much

over that timeframe. So the, this goes back to the, actually the idea of math and art or math and philosophy is you can work out the math of your return to volatility and you can line up your portfolio to be very efficient to have the best return to the volatility, but you could still have, your drawdown could be massive. And so I don't... Mortgage-backed securities is the example I always give, right? The volatility of mortgage-backed securities in early 2007

was extremely low, right? Exactly. of mortgage-backed securities in like early 2007 was like extremely low, right? So using Sharpe ratio and like the historical volatility as a measure of risk, it's like, oh, this is an extremely safe investment, which is what everyone was doing. And then, you know, that's how the whole thing blew up. And that's why, you know, everybody's actually searching for, you know,

high Sharpe ratio, which means low vol. I think that's what you should be searching for. But almost to Taylor's point, you should be looking for the opposite. If somebody has low vol and a high Sharpe ratio, you should be searching for but almost to taylor's point you should be looking for the opposite if somebody has low vol and a high sharp ratio you should be looking for how do i lose all my money because that's most likely what's going to happen is because they have a barrier point where you lose every risk there's an embedded risk that you're not seeing and you're going to lose everything yeah my natural knee-jerk reaction when i see

low vol is there's you have hidden risk you just't found it yet. You haven't hit it yet. But back to your question on drawdown. And yeah, the CTAs, I think it probably comes from a place of they were known for rather large drawdowns. And they're sort of exact opposite of the stock market. So the stock market, you're taking in little consistent gains, little consistent gains, and then you have a huge loss. So they say it takes the stairs up and the elevator down. taking in little consistent gains, little consistent gains, and then you have a huge loss, right? So they say it takes the stairs up and the elevator down.

CTA space traditionally has been the opposite of that. You're taking little loss, little loss, little loss, and then have an outlier gain. But those little losses can add up and be, you know, the death of a thousand cuts, and that is what gets reflected in the drawdown. But you see them much more frequently because that's kind of the natural state of them, of their losing, losing, losing until the big outlier move.

So yeah, you have the drawdown. We've actually run some stats on doing an efficient frontier, which is usually done with return and volatility. We did a return and drawdown. Yeah, and the managed futures asset class is like way better than stocks than anything else it makes me think of like you were talking about earlier your proprietary metrics that you developed at rcm which i always liked about them is you risk weight based on per unit of risk what's your return per unit of risk and you're using like

drawdown for per unit of risk and that's very unique instead of using volatility yeah and so it to me it's all like you're saying the i need to see the investment through the biggest thing to right if it's if i'm down 10 and then back up the next day that's volatile but i'm fine right like i didn't feel it if i'm down for 23 months in a row and sitting down negative 22%, that's a big problem. You're going to, somewhere along the line, you're going to be like, this isn't working, I'm going to get out. And invariably, you'll get out right before it goes on to make new highs.

So it's two parts of the drawdown. One is the magnitude, and the other is the duration, which is part of our risk metrics as well. So you can have something has a super low drawdown but if the duration is three years like you're never going to stick with that yeah i like that you always had that is like yeah if i'm in drawdown for three yeah there's no chance like i'm not i'm not getting back to even so what does it matter is like it doesn't matter at all and then the other thing we didn't point out about sharp is that the volatility is standardized both up and down and so do we really care about upside volatility no

we care about downside volatility and sharp doesn't take that into account so you could have a manager that they have extreme volatility to the upside so they're making huge gains or small gains huge gains or small gains but then their volatility on a sharper they're going to look terrible based on a sharp ratio but it's's not accounting for that volatility is only to the upside, and they're mitigating the volatility to the downside. For sure, and that was the birth of the Sortino ratio, which is returns over downside deviation, not just upside deviation. The proponents of the sharp would say,

hey, but large upside volatility portends large downside volatility. You just haven't seen it yet. Because they're saying there's no free launch. You can't get that large upside volatility without risking low downside volatility, which I'd say is patently false. You can set up asymmetric return profiles and say, no, I'm risking very little and waiting for the outlier move.

And that's how I get the high volatility. I'm not getting the high upside volatility by risking a lot. I'm getting it by structuring the trade in a proper way. Would this be oversimplification? If you can think about Chicago versus New York is like future commodities versus stocks is CTAs commodities will take a lot of small losses and take large asymmetric gains where new york and stocks will take a lot of small gains and large asymmetric losses is that too much more simplification no that's i love that that's perfect i i wanted to start a twitter

account that was like five years ago when uh i can't remember someone in new york was talking smack about chicago and like you are the second city and so i just have a twitter account that every day was like we have alleys you have trash yeah i can't that was as far as i came up i had to come up with 365 more stuff there but then yeah and then uh as as right we have futures you have stocks yeah as we talked about a million times and what always boggles my mind is like, so if you take those two dichotomies of like Chicago versus New York, commodities versus stocks is if they have these two different return profiles, it's like, why wouldn't you combine both of them?

And if you combine both of them, they might offset each other and you might end up with a better portfolio overall. And that's what we're always working towards is like if you combine, you know, these short volatility and long volatility assets, you upgrade to a better holistic portfolio that you can hold for a lifetime. Yeah, and that was 2008, right? And people get confused, I think, with diversification.

Oh, I wouldn't have lost money. No, if you had managed futures and you had significant, not significant, maybe you had 10%, 15% allocated to managed futures, your drawdown was less because it was making money. The long ball was making money as the short ball stocks was losing money. And your duration was much less. So it's back to that concept of, okay, I'm adding this to make my worst period less painful and less long, which drastically, you know, non symmetrically increases your odds of sticking with the investment. And that's the biggest thing to me, like if you once you get out,

you're done. So it's like, how can I structure things to make sure I don't get out of equities? I'm saying like, and how many people, you know, they say this is the most hated rally of all time. Cause people just got totally spooked and moved to the sidelines in oh nine and 10. When, if you'd had something that kept you in the game there, you were, you're going to be way better off. And just to keep reiterating what you said, because you're one of the people I hear speak about it the most. And it's such a rare thing about the duration of the drawdown. You would love to harp on that that and i appreciate how much you harp on that because for example in equities you can go an entire decade without getting back to even yeah or let's

look at the nikai in japan they went i think 30 years uh until there was a new high so yeah that's that's the the whole game that's the painful part of it. Can I make it to new highs? Um, yeah, that's all I got to say about that. Jason was telling me earlier that, uh, gold once took your mother out to a nice seafood dinner and never called her again. I want to see, is that correct? Leave my mother out of it. How do you feel about gold? Tell us about your thoughts on gold as an asset class.

I was golfing once at Band and Dunes, the lovely Oregon resort. And this was back at Gold had made some moves higher in the caddy. He's like, what are you doing? I was like, I'm kind of hedge funds, commodities, things. He's like,

what do you think about gold? He's like, my mom owns some bars. I was like the total magazine indicator. I'm like, all right, a caddy is telling me his mom owns gold bars. I think I'm going to sell tomorrow.

Um, but I told him, I say, you know, I'm in Warren Buffett's camp, which is rare. But, and this one thing, like he says, if aliens were watching and we dig up gold out of the ground,

we try and buy and sell it to someone else. And then whoever buys it, sticks it back in the ground with a guard. Like they'd think we were insane, right? Like, what are we doing? So just, and it has limited economical use, right? Maybe on some stereo equipment or whatnot. Jewelry. Okay.

But so to me, I just don't see the economic purpose of it, which you could argue same with Bitcoin or anything like it's just valuable because people think it's valuable. But more importantly for me is you have, right, we have an infographic, we'll put it in the show notes, of five different crisis periods, which was like long-term capital management meltdown, surprise Fed rate hike in 91, 9-11, internet bubble burst, financial crisis, 08-09. So five big market-mo uh crisis periods in stocks gold averaged a gain of less than one percent across those five crisis periods so right it's it's not doing it for me as a

diversifying a crisis period there then people say no well you need it as an inflation hedge and i looked up some stats here from 1980 to 2000, it lost 80% on an inflation adjusted basis. So since then it's done pretty well since 2000, whatever, but I don't know. I just don't understand the, I understand why people like it. I just personally don't like it as either a diversifier or an inflation

hedge. Well, that's what Artemis would argue that even since like 2000, like you pointed out, it's actually gold has done better on a purchase power parity than even the stock market since 2000 so it's like and to your point to to back up what you're saying is like we think about a purchase power parity but people go with the 5000 year history is like over the large spans of time you get that purchase power parity but is it is it really going to keep up with inflation

when you need it to or is it going to be during a risk off event is it going to keep up with inflation when you need it to, or is it going to be during a risk-off event, is it going to provide you with those returns? It's hard to really know, so I'm not a defense. But also, as you know, this is a hotly debated issue, and after 20 years of studying gold, I still am uncertain. I just don't know. Like you're saying, is it a barbarous relic, or is it currency? Yeah. I mean, yeah.

If I had a, you know, the Italian job, if I had a big safe full of gold bars like that, that'd be great. But I'm not going to seek it out or steal it. But to me, and we've debated before, like inflation to me is a amorphous thing and I don't really know what it means. Like to me, I i have kids i have

medical bill like it's education inflation and medical inflation those are my two biggest inflation uh levers and personally so does gold solve those problems right there's things in your personal life that can see super inflation like private tuition in Chicago, taxes in Chicago, no matter the amount of gold I own, it's not going to solve the tax increases on my properties in Chicago. So it's an imperfect hedge at best for inflation. But do you think what we do agree is that if we think about probabilistic bets across global markets, and we think about the uncorrelated nature of gold trading versus maybe other commodities or stock indices or fixed income is it's it's important to include it in a portfolio for an uncorrelated trading vehicle whether you believe in the value of gold or not based on

inflation or purchase power parity i yeah i love having it in a trend following portfolio i don't necessarily want to buy and hold yeah yeah so for sure it's a trend following portfolio i don't necessarily want to buy and hold yeah yeah so for sure it's a it's a tradable asset and should be part of any tradable portfolio and that's why i think what's great about um portfolio construction is we can debate the fundamental merits of gold all day but who really cares if it helps our portfolio just put it in there and we trade it yeah and back to my other thing, right? If the math works out, which from a non-correlated standpoint, it pretty much does, and the fundamental reasons work out, sort of, right? Yeah, both those things, I can put it in a portfolio

because it checks both those boxes, even if I don't wholly believe that it's the end all. And I'm curious whether, you know taylor could speak better to this but if bitcoin kind of surpasses gold as the which they would love and that's the part of their theory right of the holders but that it would surpass gold as the de facto like this is what you want to own in case global currency, government controlled currencies go bananas. Right. I guess my working thesis is it's a,

it's a bad inflation hedge, but probably a good hyperinflation hedge, right? Like in, I don't know, Weimar, Germany, you pick some scenario,

you know, one in a hundred scenario, one in a hundred year scenario of hyperinflation. Bitcoin or gold? Well, either that's the argument for both, right? Which is the stock to flow ratio is low. You can't, you know, of hyperinflation. Bitcoin or gold? That's the argument for both. The stock-to-flow ratio is low. You can only dig up so much more gold out of the ground every year.

Historically, it's like 1.7% more a year over the last 100 years. You can only inflate it at 2% a year. There's that tweet that circles around every six months of that asteroid that has all the gold and if we could just capture it and i i was i'm like it's true i'm like then gold prices would go to zero like if there's 50 times the amount of gold ever put on the earth is now we just grabbed it off this asteroid but to your point though if you

have trend following you would ride that down to zero and you'd make money shorting gold yes right yes and so that's that's kind of of the point overall that I've always, at least felt an affinity for trend following CTAs is they come at it from the perspective of like your fundamental narrative arguments don't matter. Yeah. I'm going to be invested in 60 markets, both long and short. And I'm just going to follow my probabilistic trend strategy and I don't have a view on markets. My view is only going to hurt me. So like, for example, let's take fixed income as, you know, bonds are going zero to negative in Europe. Everybody that has a fundamental perspective is screaming their heads off like this is irrational. They're killing the economy.

Like they have all these reasons why this cannot happen, negative interest rates. Meanwhile, the CTA trend followers are just riding the trend. Yeah, and they actually did. That was their best market last year. Right. And they actually bought German bonds, boons. Right. And you buy bonds.

If bonds prices go up, rates go down. So they were actually buying bonds as their negative. So they were implicitly betting on rates going more negative, which any other economist is like, are you crazy? This is unsustainable. And they don't, yeah, it's pure math. They don't care one way or the other what the narrative is. It's just, and that's the all-time example of like,

why are you going to buy high and sell higher right this is you're buying negative yields and selling more negative yields which is insane to anyone who studies that kind of stuff and that's why their discipline is impressive because you know personally they might have a personal opinion that this is insane but their their formulas and their math are telling them no you need to be in this trade and they just get in the trade and they don't let their personal opinion override and i think direction back to something you said whatever 20 minutes ago of like why can't people wrap their heads around all this managed futures ctas and stuff is because of that the narrative is hard to explain um you know if you're just saying i i know you heard 23 hours of junk on tv about why negative rates are

bad or whatever. And I just say, well, we just bought it because that's what the model did. Like it doesn't sit well with a lot of investors. They need a narrative built around the trade. And by definition, you know, most managed futures CTAs don't have a narrative. Like they can try and make one up, which is what other people are doing,

but it's just making it up around what the math told them to do. On that note, wrap it up. Jeff, people want to get in touch with you. What's the best way to do that? You can follow us on Twitter at RCM alts. Check out our blog, rcm alts.com slash blog, maybe we'll put it into show notes. And then we're launching our own podcast, The Derivative, hosted by yours truly. So check out that as well on all your favorite podcast places. The most underrated blogger in finance, Jeff Malek.

Yes, thank you. Good times. All right, thanks everyone. Thanks guys. 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.

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