The Derivative - Uncovering the Known Unknowns of the Pandemic with Chief Economist Blu Putnam, ReSolve's Rodrigo Gordillo, and Teza's Dan Deering

Episode Date: May 14, 2020

In today’s episode, we have a little different structure and three unique guests to bring a fresh twist on The Derivative podcast. Blu Putnam of the CME Group, Rodrigo Gordillo of ReSolve Asset Management, and Dan Deering of Teza Technologies join us to discuss the economic & strategy impacts of the COVID-19 pandemic. Listening today you’ll hear some of the craziest economic stats since the Great Depression, how markets and physics share phase shifts, oil going negative, rallying gold now vs 2007/08, ski shops selling bicycles, AI in the investment process, asset allocation & pricing, quant vs human advantages, and strategy pivots in the world of COIVD-19. Follow along with our guests: Blu Putnam on LinkedIn & Twitter. Dan Deering on LinkedIn and the Teza Technologies website. Rodrigo Gordillo on LinkedIn & Twitter and the ReSolve Asset Management website, along with some docs mentioned in the pod: ReSolve Pandemic Portfolio, Adaptive Asset Allocation Global Risk Parity with Macro Factors.pdf, The Pandemic Portfolio Podcast, & 12 Days of Wisdom Podcast.  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. Please note that due to COVID-19, we are recording The Derivative remotely. We apologize in advance for the possibility of lower quality audio, but we hope that you can enjoy our podcast just the same. 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 name. 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. And so there's a lot of path dependency right now with what's going to happen in the economy. Are we going to find a vaccine?

Is it going to be hyperinflationary? Is it going to be deflationary? We don't really know. And therefore, your only choice is first to diversify across asset classes and then to diversified cross strategy. I'm your host for the day, Jeff Malek, and excited to have three real pros here with us today. The CMEs Blue Putnam, Rodrigo Gordillo of Resolve,

and Dan Deering of Tezza Technologies. Welcome, guys. Thank you. Thank you for having us. Hope everyone's happy, healthy and safe during the lockdown. I'm here in the upstairs guest bedroom of our house, and I think we'll see everyone in a similar situation as we go to their views today. So, Blue, I wanted to start out with you. Blue is a renowned economist and is responsible for leading global economic analysis and monitoring developments in price patterns, volatility, and correlations of futures and options markets. Blue holds a PhD in economics from Tulane, has authored five books on international finance,

and has been published in American Economic Review and the Journal of Finance, among many others. Quite the resume. We're excited to have you on today. Oh, it's very nice. Thank you. How was Tulane? Did you know, who was our Bears running back that was at Tulane? I don't remember. I'm forgetting the name now. Yeah, Matt Forte. Ah, yes, right. He was a good one. So quick, let's start a little background on you,

Blue. So let's start with the name Blue. That wasn't you in the old school movie, was it? No, it wasn't me. My full name is Bluford and it came from my great-great-grandfather. He was the fifth or sixth of a bunch of boys and I guess they all the other kids are named William and Thomas and typical names and somehow another he got Blueford and he gave it to my dad and my grandfather who gave it to my dad and gave it to me and that's the way it goes I prefer blue I like it um and so how did you get from Tulane and a PhD into the CME? How did that all work out? It's a winding path.

When I graduated, the best jobs for economists were actually in the Fed. So I went to the New York Fed for my first job, which is kind of strange, actually, as to why they would hire fresh PhDs who have no real-world experience at all. But nevertheless, it was a great first job. I moved into the strategy part of the world as a global bond strategist with Morgan Stanley, managed some money, got tired of giving advice and went to the asset management for Bankers Trust, running the equity shop there. And then I decided that I really liked running my own businesses. So I became a consultant and had a great run at that. But after 2008, a lot of my clients weren't around anymore. And so I looked around and I thought, wow, you know, the CME is a great company. It's a great exchange. And it turns out they were looking for an economist to put that position. They hadn't had one for a long time. And anyway, I lucked out and the timing was perfect. And as timing is always everything in the market, you know, so it's been a great run.

But CME is just a great place to work. I appreciate that. Their stock has done pretty well over the years as well. Only a game in town. So what is your day-to-day a week, but it isn't. They get, you know, in the spring and the fall are much more intense. I do at least one video every week. I usually write a report of some sign every week. I've got a lot of internal responsibilities. I work with our finance and budgeting departments, things like that, a lot of work with our sales force. So it's a variety of things that occur during the week. What I read, I read a lot of short articles. I read Science Magazine every week because I think I learn more outside of my field than reading other economists.

Sorry about that. But anyway, that's my week. We'll get into how economists can be like the weathermen in a bit. So I'd like to start with, you know, we've just come through a rather historical period and just ask you what some of the craziest economic stats you're seeing during this crisis and the resulting, I don't know if you're ready to call it recession or what, but what are some of the craziest stats you've seen during this whole period? Well, I guess the one that hits me the hardest is the weekly new unemployment claims. We had another 3.8 million people that filed last week for unemployment over the last since March 15th.

We've lost 26 million jobs. Every 1.6 million in the United States is a percentage point on the unemployment rate about. So you know if you kind of do the numbers we're pushing up at 20% unemployed and it's obviously going to go a little higher. Next week, Friday May 8th, we'll get the unemployment number for April but that doesn't include some of this weekly data because they do that survey on the 12th of the month around then. So you know we may not hit 20 on the data next friday a week from friday but you know when they produce the june the may data released in june uh we'll probably be at over 20 and in 1933 the peak unemployment

was a little bit above 24 percent uh it also took from 1929 to 1933 to get there. So it took four years to do what we've done in six weeks. So those are the crazy statistics that, you know, and, you know, people just underestimate how many folks are hurting and how bad this really is. It's tough. And then what do you see a lot of talk before this was uh that the employment numbers were even unaccounted not entirely accurate because people were removing themselves from the workforce so is it even perhaps worse than those numbers are showing oh not really I mean we all we have issues with how we calculate the workforce. And basically what the Labor Department does is they do a survey.

And are you working? Yes. You're in the workforce. Are you looking for a job? Yes. If you're not working, are you looking for a job? Yes. You're in the workforce.

And nobody else is in. I mean, those numbers bounce around a lot. But I don't think that's where the issue is the the issue is that when 26 million people lose their jobs in five weeks that's that's the issue yeah that's a big number to be sure and do you think we're gonna see a quick snapback of that no unfortunately a lot of very large companies are realizing their financial condition is so impaired that they're going to start back slowly. They're also seeing that they won't have the consumers won't be there right away. It's not like you flip a switch. Consumers have been damaged financially.

They're actually going to save at a higher savings rate than they used to to repair their balance sheets. So it's going to to repair their balance sheets. So it's going to be a pretty slow rebuild. I hear you. So I've heard you speak recently on what you call phase transitions, what I would call phase shifts. I think we're talking the same thing. Can you unpack what you mean by that a little bit and ties in with what you were saying earlier, if you like to read stuff outside of economics, how's your brain working on the phase shifts? Yeah, I mean, a lot of times when economists, you know, can't do the math really most of the time. And then when we see something really unusual, we walk down the hall if we're in an academic institution and go to the physics department first, and then maybe the biologist

a little later on to find out what's really happening. The physics of these phase transitions is kind of neat. It's like, you know, if you take water and you boil it, it turns into a gas. We know a lot about the liquid water and we know a lot about the gas, but all the real action is at the borderline, is at the boundary. That's where the turbulence is when you're going through these transitions from one state to another. And we're in a place where we're in one that's most similarly called a cascading network collapse. That's like an electric grid having a power failure in one place and then it dominoes through five or six states around the country. It happens every couple

of decades or less. But that's what's happened to the economy. We're a myriad of interconnected parts. The dominoes are falling. I have a rule in economics that the indirect effects can be two, three, and four times the size of the direct effects. And that's just because we're in a complex system. So we're in the cascading collapse phase.

We're about to move into what we call a financial distress, where we're trying to figure out where we landed. That's a pretty short phase. And then we start rebuilding from there. So we'll be in the rebuilding the network phase. But that is not going back to the regular growth rate. That is trying to put the supply chains back together, companies figuring out what they can and can't do it's a it's a pretty difficult phase and it'll last a couple of years and so but then could it possibly just phase shift right back or it seems odd to me that you're saying okay you're gonna phase shift to this lower new reality but then it's gonna have you know it's kind of

like an exponential move down and then a linear move back up. It seems they should, could be mirrored, not should be. No, it's not a mirror. It's basically you're on a steady state upward path. That was prior to the pandemic. Then you fall off a cliff and it happened very rapidly. So that's the unemployment story, the cascading network part. You land somewhere, that's a valley. You take stock of, you know, I hit bottom, where am I? And then you start to get up and rebuild. And that typically is, the rebuilding is typically slower.

So, you know, in an economy, we go up the steps and we take the elevator down. So we'll be back on the step process in this thing. So it's a, I don't know if you've ever studied chaos theory. It came out around 1990 as a fad. A friend of mine told me it was way better to write about it than actually use it. But, you know, we're at the situation where, you know, if you're a skier, you're at the top of an expert slope and you're really deciding whether to go down or not, or go take the bunny slope or whatever. But once you start down that expert slope,

you are not going back up, okay? It's gonna be a whole different path. So that's where we are here in kind of the physics of complex systems. We've fallen off a cliff, we're gonna get back on our feet, but it's not going to be a V shape. And then while I have you, I'd be criminal if not asking you on this phase shift the prime example of that has been in the energy

markets with you know oil prices just falling off a cliff way more so than it seems the economy or the stock market. So what are your views on what's going on there? It's pure supply-demand issue or what do you see in the oil sector? Well, the oil sector is very interesting. It's got two conflicting narratives going on that are working kind of against each other. So in the short run, we have this huge drop in demand. It started, you know, in China, and then it spread around the world. And so you've got this amazing drop in demand. Seventy five percent of oil is used as a transportation fuel in a refined state. We're not going anywhere. We're not flying. We're not driving as much.

So when oil gets pumped out of the ground, you actually have two choices. You can use it or you can store it. So we're in a situation where the fast, abrupt decline in demand is really putting the stresses on the storage facilities. Now, that will ease because if you look down the road, the shale oil producers in the U.S., they're not drilling any new wells, but they are still producing from the old wells they drill. Now, a shale well only has about an 18-month life, give or take, and it maxes out after four or five months and just starts to diminish. So in several months, we're going to see a fairly precipitous drop in U.S. shale oil production. We know that Russia is going to cut their oil production in May. We know Saudi Arabia is going to cut in May. So what you see in the futures market, the spot market, the nearby futures are trading under $20.

And then about three, four, five months out, you're over $20. A year out, you're over $30. So that's this competing narrative going at each other between the storage issues right now and then eventually the production cuts that we know are going to come down the road to help balance supply and demand again. And do you see any of it coming from global warming and alternative energy and is there, right, that change in demand is not big enough to make this kind of shift? But I've been hearing some people think of like, okay, let's just put the final stake in fossil fuels while it's down here.

Is that realistic or no way we can achieve that? No, that's not realistic. But I do think that a lot of people that were focused on alternative energy are going to actually stay very focused on that. There'll be some growth. But when the price of oil drops like this and when the gasoline price and the petrol price for your car is down you know it will have an impact but we think that the alternative fuels are going to

be a fast-growing area for the next decade but right now in this situation they're not large enough to make a dent. Right. It seems to me if you're going to go drill a new well or spend that money, now you're going to have trouble getting financing. Plus, you have this kind of PR issue of nobody wants you polluting the earth like that. So you've got another piece to the puzzle here of that's trouble for the oil patch. So moving on here, what's, you know, you can tell us how much money has been pumped in by the U.S. government and by, I guess, world governments? Well, it's a huge,

yeah, it's a huge amount of money. We have, the U.S. government has promised a little, well over two trillion dollars of fiscal activity now that really hasn't started up very much yet some of its gotten started but the big part of that will come later in the next couple of months and the rest of the year and then they'll probably do more programs I don't think we've seen the last most of the programs they've done so far on the fiscal side around the world not just in the US or what I call support programs. They get you to the other side of the crisis, but they are not the type of program

that will increase the pace of the rebuilding. The pace of the rebuilding are kind of the programs like infrastructure programs, things like that, where you actually spend money that puts people to work doing something that they otherwise wouldn't have been doing. And so that's why I think we'll see some more rounds. On the central bank side, they are committed to all kinds of asset purchases. Just to take the Fed, they've never bought municipal bonds before. They're going to do that. They've never bought corporate debt or

high-yield structures, high-yield debt structures before. They're going to do that. And they have done a lot of other things in terms of make sure the money markets function properly, and a lot of that came from the 2008. But the Federal Reserve is on new turf. Now, I would again say that everything the Federal Reserve is doing largely makes our markets function well, but it doesn't increase the pace of the recovery. So we're still in a support method. And by the way, central banks really don't have a lot they can do other than support. Fiscal policy is the one where we're going to have these, what I call, regenerative policies. And they're yet to come, but I'm sure they will.

And what are your thoughts? So, Ray, we're just talking about oil, and that seems massively deflationary. Then we're talking about trillions of dollars in fiscal stimulus that people would assume is going to be inflationary. How do you square those two competing forces, and who do you think is going to win between the two, or do we go into a stagflationary period? Well, I think in the short run, yeah, the short run between the six to nine months, I think we're going to see price decreases on net. That doesn't mean some prices may rise. You may find that you pay a little more for a steak because we've really destroyed restaurants. Cattle, by the way, can produce steak or ground meat. The steak goes to the restaurant, so that's not selling. And the ground meat goes to the grocery stores. So there are going to be disruptions where certain products become in very short supply. But on the whole,

prices overall, the consumer price level, I think we're going to print six, seven, nine, 10 months in a row of declines from the previous month and over the previous year. And then we'll start to see a little bit of stabilization in prices and a slow recovery. And then the real question is, what happens about seven to ten years down the road? Now we're back, the economy's growing. Have the policymakers unwound some of the stimulus or are they still addicted to stimulus? If they stay addicted to stimulus, that's when you see the serious inflation. So this is a little theory that they call modern monetary theory or MMT. And the issue for MMT is it says you can spend as much money as you want until you

see inflation. And we, a lot of us don't believe that the policymakers will stop when they see the inflation. We think they'll say it's temporary or whatever, and they'll just keep spending. But that's going to be in the 2030s. Inflation is very hard to stop. It's very hard to start. And we're starting, I believe, from a period of modest deflation. So we'll have a long time before we have this problem. But when it comes, it might be pretty severe. And I keep thinking back to 07, 08. These were the same arguments, right? Of all this stimulus is going to cause massive inflation and here we are 12 years later and we're having deflation so there's obviously this big shock to the system

but even a year ago we weren't seeing the massive inflation by those trillions of dollars yeah that's a little different the uh the 2008 was massively uh monetary stimulus so So it did create inflation. It was just in bond and equity prices, wasn't in goods prices. And then we had a trillion dollars of fiscal stimulus, which we immediately started to unwind. So the budget deficit did skyrocket to a trillion. And then under the next seven or eight years, it wound down to about half that so we took fiscal stimulus out of the equation for me fiscal stimulus is far and away the most important inflation generator in the long run because monetary policy is a more asset price situation and where where are we at now with the budget deficit after or assuming they put in all these stimulus packages where are we at now with the budget deficit after, or assuming they put in all these stimulus packages, where are we going to be as compared with that trillion after the financial?

Approximately by the end of this year, we'll be over $2 trillion. And by the end of 2021, we'll be at $4 trillion or so. So we'll be up at 30%, 35% of our GDP, a pretty massive expansion of debt. Now, at the same time, I don't really look at just government debt. I look at government plus private and corporate debt. And we believe that corporations and private citizens are actually going to pay down a lot of debt over the next five years while the government debt goes up. But the government debt is, the rising debt is going to swamp it. We're going to be way more indebted,

which, and by the way, the more indebted a country is, the less likely a central bank is to raise interest rates because it can cause way bigger problems when you've got way more debt and you're way more fragile. I hear you. All right.

I think we're going to move on to talking with Rodrigo and Dan now. But thank you, Blue. Thank you. Very insightful. I'll let you with the last comment of anything that keeps you up at night or scares the bejesus out of you already hit it. The debt scares me down the road. And I think a lot of people are underestimating the depth of the crisis even still. So those two things do scare me. And even, I'll follow up on that quickly, just even without, a lot of people I'm hearing, they're worried about a second wave that will cause another crash or another leg down lower in the markets. But you're saying maybe even without a second wave of the virus, just the pure monetary environment may be problematic.

Yeah, that's correct. I'm worried about the economics. I'm not an epidemiologist. None of us are. That's the problem. All right. Thanks, Blue. That was fun. Now I want to move over to the guys who unpack all that data day in and day out and turn it into actual trades. We have two talented asset managers with us today. Dan Deering of Tezza Technologies and the Catalyst Tezza Algorithmic Allocation Income Mutual Fund. And Rodrigo Gordillo of Resolve Asset Management and the Rational Resolve Adaptive Asset Allocation Mutual Fund. Welcome, guys. Thank you.

Thank you. How's everyone surviving quarantine? Physically fantastic. For sure. Yeah. Emotionally, with the children, trying to homeschool them is probably possibly the most draining thing I've ever done in my entire existence. And then I'm assuming I'll go with you first, Rodrigo, just you guys were trading wise and your firm wise, there's been no dislocation or anything. It's all.

No, we were we went remote a couple years back. And in fact, every one of our employees are work from home two to three days a week for years. We have a decentralized workforce as well. So it forced us to use everything that everybody's using, Zoom, GoToMeeting, a lot of asynchronous work being done already. Employees in Germany and in Montreal and Cayman and all over the place. So this is a part for the course for us, didn't miss a beat. It's been pretty fantastic, actually. Got it. And Dan, how about you guys? Yeah, certainly no displacement on our side. We're used to working across three different locations with pretty evenly spread from our employees. So we've continuously worked either from home or kind of a distance

relationship anyhow. So I think the transition was quite easy for us. I think the biggest issues that we've had and probably others have had as well as just, I think, I don't know that the internet has been, was particularly made to take on the type of traffic, or at least in certain congestion areas. And that's always a little bit painful but I think that's otherwise everything else has been good yeah and we saw it here in Chicago Dan you're in the Chicago area along with me but we saw it was it two weeks ago when the public schools finally figured out their e-learning and online learning and then there was this wave of new internet users and a lot of people saw things slow down. So Dan, I'm going to stick with you here. So you're a CFO at Tezza,

a global quantitative investment firm, uh, based on talent, science, and innovation. That's in the process of making the transition from a prop firm trading your own capital to an institutional asset manager, trading client funds. And your unique strategy you're doing in the mutual fund is a systematic global macro type model with a high focus on AI and machine learning and order book management with the symbols T-E-Z-I-X. So can you give us the elevator pitch on what you guys are doing in that strategy? Sure, absolutely. Why don't I take a second, I'll help paint the picture a little bit and talk a little bit about the company itself and where we came from.

Please do. So Tesla was started in 2009 by Misha Malyshev after he had built out Citadel's high-frequency business. And there we spent several years building out the research and technology platforms that we deploy today and in running our proprietary trading business. In 2014, we actually expanded into the advisory business in the form of a hedge fund and managed accounts. And it's here now in 2020 where we're taking that goodness and moving it over to the 40X space. As I mentioned before, Tezza has 57 employees across three different locations here in the U.S.

We do have a presence in China as well. And really, you know, we have about 80% of our workforce is focused specifically on quantitative research and technology development. So that's a little bit about Teza. It gives a little bit, paints the picture a little bit about who we are, you know, going to the fund and what the fund's all about. So the fund is managed completely quantitatively and systematically, as you imagine the core of the strategy is utilizes 100% futures contracts that's kind of our bread and butter you know when we look at it the fund we think of it as a combination of a top-down asset allocation approach

combined with kind of a bottoms-up signal generation that adjusts daily for market conditions and so when we when we think about it we kind of start from the balance asset balance asset allocation perspective you know here we're allocating based on risk so in many ways the fund is similar to a risk parity approach to start with and then you know this allocation from a balanced perspective we do so across two different dimensions we look at geographic and so we're looking at investing in and allocating to North America Europe and Asia and then also by product class and so by product class we're looking at stock indices government bonds and commodities really with the starting point of around 40 40 20 on a risk allocation basis the

one thing I'll note is that the stock and bonds those particular classes we keep a long biased on those products we expect those to appreciate or produce income over the long haul meanwhile on, on the commodity side, we are long short as we just don't have that same expectation. We'll be an example of one of those. The next step is kind of I think what helps differentiate us a little bit from others is that we look and we rebalance and reallocate on a daily basis. And we're doing so to kind of manage different market conditions you know it's here is where we look to apply information and research really at various levels of granularity we'll look at market macroeconomic information in our research all the way down to pre trade

exchange exchange level detail and so And so essentially we're then using information from this data and from these forecasts to kind of reallocate to different buckets, in between the buckets. Here I'll mention our history is really high frequency, and so we're strongly rooted in the principles of kind of the supply and demand dynamics kind of at the micro level on the market. And we use a lot of that information, both real time, intraday information in our research to really kind of help us drive these forecasts and asset allocations. Great. So, Rodrigo, you're the President and Portfolio Manager of Resolve Asset Management, who do private funds, manage accounts, and sub-advise on mutual funds all around systematic asset allocation modeling. We'll be focusing on the Rational Resolve Adaptive Asset Allocation Mutual Fund, RDMIX is the ticker, strategy today. So, similarly, give us the elevator pitch on what's going on inside of the fund.

Sure. Yeah, I mean, this is a strategy designed to we almost we we've kind of renamed it over the last couple of weeks as the pandemic portfolio. We recently did a podcast on that because it is framed from the perspective of kind of everything that has been outlined today by blue dealing with having an ability to deal with phase shifts across global economic dynamics right you the when you're dealing with a complex universe that that has a lot of patients you want to make sure that first and foremost you have an asset class universe that can deal with different economic regimes. And so we'll get into the specific details there. But the first thing that we do is make sure that we get exposures or have the ability to get exposures to asset classes in the equity space,

in the commodity space, in the sovereign bond space, because they're going to react differently to different economic regimes. And we also start with this idea of a do-no-harm portfolio, right, where if you don't have a view as to where these markets are going to go, then you want to make sure that you're allocating to these asset classes an equal risk contribution to start as a starting point. And then how you decide to overweight or underweight or eliminate asset classes from that do no harm portfolio is where we add our quantitative, you know, macro factor based views.

And we're not looking, unlike Tezza, which is looking at the micro factors, we're looking from the top down. We are really identifying global macro factors everybody talks about factors in the security selection space like you know momentum uh small cap value etc um we don't deal in that space whatsoever we deal in the factor on the macro level uh which we can get into why we believe that to be much more robust in the long term and the alpha that you can extract from there is likely to provide solid returns in the future but the factors that we look at a wide variety of factors and we keep adding to them but you're looking at things like momentum trend carry mean reversion skewness mean reversion to carry conditional

conditionalities that we are we're looking into from the machine learning perspective and identifying as many different factors as possible to help us decide at any given point what asset classes should be overweight underweight or eliminated and from that perspective you're able to really navigate called market surf across different dynamics whether it's growth a high growth, low growth dynamics, or high inflation, low inflation dynamics. So in a nutshell, it's designed to be, we like to mention that it is a completion portfolio. More often than not, the vast majority of investors and advisors have a very plain 60, 40 domestic home country buys portfolio.

And you're missing some of these key elements of gold and commodities and sovereign global sovereign bonds and so on, because they're tough to trade. People don't know how to trade those things. And they recognize the value in diversification, but they also recognize the complexity in trying to put that in a portfolio and explain it to clients. And the idea would be to have a portion of your portfolio to be completed by methodologies such as Tesla's and ours to help investors maximize that diversification and navigate markets a bit better. And so you guys did a nice white paper a few years ago on a ski shop needing to diversify their revenues and add selling bikes in the summertime.

So it was a pretty easy thing to understand. So essentially the fund is adding many different types of bikes and even paddle boards and ATVs and a lot of different things to basically diversify that revenue and make sure you don't go bust. Precisely right. In a way that adding 2,500 U.S. equities in a portfolio don't do. Right. Those are just adding more bikes to your portfolio. That's why the asset allocation level is so much more important. I mean, if we talk about this inflation story of my background, why% in six months, right? And that impacted me. I saw the macro impact to a portfolio, but not everybody lost in the same way. You had the people that had savings, like my grandfather, who had roughly the equivalent of a million dollars in cash, had recently retired. His savings went to zero because it was in Peruvian soles. And my next door neighbor, who was literally about to be evicted from his house because he couldn't pay his mortgage,

was able to pay down his mortgage with a couple hundred dollars in US dollars that he had under his mattress, right? So these phase shifts, these really macro level events are what matters the most to survival. And they do act very, very differently. Gold will act very differently from equities will act very differently from

bonds in, in economic scenarios that, that will vary. So, and we can get into that a little bit later. And just to follow up on that theme real quick, then we'll come back to Dan, your recent podcast. I listened to the other day was quite good. As you said, the pandemic portfolio. So, again, that concept is we don't know what's going to happen in this thing. Just make sure you have what you call do no harm.

I would just say a base, you know, just be in your football terms, be in your base defense. We don't know what the offense is going to come out with. They might run. They might throw. Instead of betting the farm on what they're going to do, they're to run right right over here let's just be in our base defense and yeah don't get sucked into any particular narrative that feeds your bias right um start with if you don't have an edge just do no harm just do equal risk contribution across a wide variety of asset classes that we know act differently depending on what's gonna happen next.

And from there, if you feel like you have a long-term edge, then you can start tilting, whether it's an order book style prop trading like Tezza or a factor-based like we do here at Resolve, there's ways to start tilting thoughtfully. And you also wanna diversify that, right? Don't also buy into all of my narrative about my strategy, diversify my strategy with others.

Right. Agreed. No offense, but agree. Yeah. Yeah. So, Dan, coming back to you, I cut you out before. Did you want to finish your your thought on that or want me to jump into the next question? You're good. So the I think that just the last... Go ahead. I was just going to say the last thing that we do as a part of our portfolio construction is we do bring all of that back to a centralized target for our volatility, which just allows us to manage the volatility regimes within the markets a little bit better. And that has obviously been very important over the last several months. And so how do you square and do you get comments from investors and whatnot of like HFT has gotten a rather bloody nose or right it's kind of been looked at as the evil in the U.S. that they're taking advantage of small investors or whatnot. What's your thoughts on that? Can you clear up any misconceptions on that? Well I don't think we've had many responses recently from investors that have that have a particular view on on HFT I think we try

to explain kind of what the advantages of the system are and what we're what we try to do and I think once people start to understand the value that is provided in some of the liquidity that's provided from the HFT firms, they start to understand a little bit better. But it's easy to point fingers at someone who's been successful. So we kind of take that with a little bit of a grain of salt. I hear you. And you'll see here, like using some of those concepts to in a mutual fund that retail investors can get into. So you're kind of bridging the gap between those two worlds and showing that, hey, this isn't all some evil mathematician up in his ivory tower. So let's get into that a little bit of you both use you're both heavily quant focused shops.

You both use different flavors of A. of AI and machine learning in your processes. Dan, coming back to you, can you talk a bit how firms like yours use AI and machine learning in your process? Sure. So just to kind of be straightforward, just to make sure everyone understands, in the fund itself, we don't use any high frequency trading. So it's definitely it rebalances on a daily basis but what we do do is we use information that we've learned from the high frequency space in the way that we've done our research and applied it here to the fund you know generally speaking and just I'll just ask a quick question does that a simplistic example of that would be hey I know if I'm gonna go buy a hundred shares of IBM that's

not what you do in your share but just for sake of example if I'm gonna buy a hundred shares of IBM I'm not not what you do in your share, but just for sake of example, if I'm going to buy 100 shares of IBM, I'm not going to naively cross the spread and pay an extra five cents more for that if my HFT background and my models say like, no, you can wait and buy it at this better price. Is that similar how the HFT experience has bleeded over into the mutual fund? Well, you know, that specifically is looking at really kind of your benefit that you're going to get on your pure execution, which is kind of one level down really from where we bring it here into the fund. What we do do is we bring

information from that granular level. We compile it together and understand how these, you know, whether it's relationships with other assets how those are changing over time and really use that granular level data that's that can be you know can be pre-order but you know can be order books so pre trade or can be post trade as well to help us identify signals of where we think market conditions are going so we're not necessarily using it to take advantage on the pure execution piece, but it's that information that bubbles up. Got it. And then back to the machine learning question. So how is that being worked into the process? Sure. Across the board at TESA, we use AI and machine learning in different facets. We specifically have a team dedicated to researching and providing tools

around deep learning and neural nets, but that's still a pretty new area that we focus and that sits mostly in our hedge fund product. But here what we're doing is we're taking and we're using machine learning in ways to really optimize whenever there's multi-dimensions that we need to be optimizing against, whether it's for the construction, some risk aversion, when we're looking at fitting the models themselves, you know, from the alphas and the signals that we build from the ground up, we're using them within those processes to kind of optimize what the forecast is going to be. Got it.

And Rodrigo, I'll come back to you quickly how you guys look at AI and machine learning and what you think are some of the biggest misconceptions out there about it. So, I mean, the thing about machine learning is that it's very multifaceted, as you can see from this graph, right? And when it comes to investing, you can apply machine learning to very different areas. And I think that a lot of investors don't really internalize or understand. I mean, the idea of machine learning tends to be seen as something that can predict prices better. So find me a system that can make me a lot of money by telling me where a market is going to go over the next day. And that is definitely part of it. But at Resolve for the last 10 years, you can see in the red area top left there, there

is a ton of value in the portfolio construction level. So clustering, you're dealing with 70 different futures markets. They're all very multicolinear. There is complexity and the highly correlated nature of those asset classes are there ways to use unsupervised machine learning to find better clustering systems and create better waiting schemes so that's an area that is not about predicting the P&L future P&L of an asset class but rather in creating a more robust balance for the portfolio then there's supervised

learning right this idea idea that you're not just sticking this machine learning algorithm to the markets and asking it to give you something back. It's more using old tools, old technical analysis tools or, you know, momentum driven tools or mean reversion tools that you feed into the system and say, look, here's some structure to the market. And I want you to find me conditionality between these structured elements to find me something that might be a bit predictive. So we're looking at regression, we're looking at classification. And then there is the reinforcement learning, which is more like gamifying machine learning, which is really the what you hear in the news today with chess masters, go poker players, where you're really saying, I want you to try to beat yourself

or play this game and learn from playing yourself iteratively until you find something that does better than everything else. And so machine learning is a why it's very vast. It's quite varied. There are many ways you can benefit from it, and we apply, we use all of those dimensions that resolve. And of course, the toughest one is always going to be that reinforcement learning side, where you go from our hedge fund can apply some supervised learning and reinforcement learning. When you go retail, it's going to be tough to really make that widely accepted because it requires a level of explanation that you may not be getting in reinforcement learning.

So, Al, if you go to the next slide, the biggest problem and obstacle with just using, you know, here's a machine learning technique that I cannot explain. And let me know when you see that next slide, because my punchline won't work otherwise. Is that if you can't explain it and it goes wrong, you know, maybe it goes wrong momentarily in a way that you've seen it before on your back test, you're still going to lose all your money from investors, right? So a key aspect of all this machine learning stuff is creating the systems behind it to be able to understand what's going on and explain it. And that is a big, big process for the ML people out there. And then my two cents on that. Right. Yeah, I totally agree with that. The narrative, people have gotten so used to having a narrative around why things go up and down, regardless of whether it's true, that they're still going to want that narrative, regardless of whether it's true or false. And Dan, coming back to you, so

what would you say some of the problems of investors getting this asset allocation mix right? Do they need to be right, the perfect allocation of the perfect percentages in each thing, or is it more important to be right the perfect allocation of the perfect percentages in each thing or is it more important to be consistent yeah you know I think it's I think that's a good question and I'll maybe sidestep it a little bit from the standpoint of you know the way that we've looked at that problem is is you know we tried to address it at the same time because really you know the relationship of getting it right and being well diversified, those two kind of go hand in hand. And so, you know, I think the way that we've looked at it is, you know, you want to make sure you have a good process that understands these relationships under the timeframe that you're trying to to match up the aloe you know the particular allocation if you're

investing over over a shorter period it's going to give you a different output is as if you're investing over a longer period and how you're going to manage you know the particular allocation and so and so what we do is when we're looking at on a daily basis we're looking at relatively short short time periods that allows us to modulate our positions quite heavily from one to the next. And we think that there's an advantage in doing so. And I think, you know, some of the reasons why we do it, maybe others don't, is that one is whenever you are moving, whenever you're moving parts, you do take on a different risk. And so you have to address different risks during that short period of time. And so it's a balance between the allocation and, you know, kind of taking a particular view. That's a place where it's a difficult thing to kind of give up what we would say, you know, around the offices,

the free lunch of a balanced portfolio, right? I mean, that's what Markowitz came out with and was that the 50s or 60s and and and so you really got to be good with taking that risk and I think the other is You know, a lot of people are in products That you know try to be well balanced, but they're in products that they just can't rebalance in very quickly Especially if they're not in an exchange market. But even if you are in certain products, you're going to have heavy costs if you rebalance all the time trying to manage that relationship. And so, you know, doing so in the futures market, it allows us to manage that risk well and manage the costs of it as well.

And so can you give us an example? I would I'll throw out an example. Tell me if I'm off base or close of, right? Someone might say, if I'm looking at it over a hundred years, I definitely want gold in the portfolio. But you're kind of saying your approach is, hey, I don't need gold this week, or I don't need gold today. I know I want that type of exposure over the longterm,

but in the short term, based on our micro level looking up, we can say gold shouldn't be in the portfolio or or should be a small percentage this week or this day yeah so I think so that's that's right and and I think you know from that perspective you may not necessarily want to get completely out of gold at any point in time because your forecasts if you could forecast correctly 100% of the time you just take a bet every single day so So you want to manage that dynamic between the two. Got it. And Rodrigo, back over to you, what are your thoughts on why it's so difficult for people to get this asset allocation piece correct? Well, because everybody has very strong opinions and they follow a narrative and they want

to be in one single asset class at any given time, right? It's just human nature to believe strongly in things. And as Peter Bernstein said, that the truth is that diversification is an explicit recognition of our ignorance. And a lot of people don't like to claim ignorance. So you have to balance your hubris and what you believe to be your predictive value versus your attack in the market from a place of humility and balancing those two as markets evolve. Right. So if you, Ali, if you put up the slide five in the main presentation, this is just the framework that we live on at Resolve, which is this idea that you want to be, again, diversified shocks or phase shifts, as Blue said earlier on, whether it's rising inflation or slowing inflation, and growth shocks, whether it's slowing growth and accelerating growth. And depending on what the cross section of those

two dynamics is, we can predictably say what asset classes are going to do, right? And so the truth is that if you look at the next slide and we look at real life examples of secular trends, you know, periods of inflationary boom like we saw in in 1999 and 2007. Well, we can predictably say that if you have high inflation shocks and high growth, you're going to have these big winners in asset classes, which is commodities, gold, real estate, and so on. In deflation, accelerating growth and following inflation like 1982 to 87, you have developed equities and bonds do really well. In deflationary busts like today, you're going to have gold and commodities do really well. And in periods like the 70s, you're going to have, sorry, sorry, in deflation is gold and bonds and sovereign bonds do well in the deflationary bust, which is what we've seen this year. And then inflationary stagnation, you're going to see gold and commodities really outstrip everything else.

So we can predictively know how things are going to react in different regimes. What's tough to do is know what regime we're in at any given time. Right. And so that's where you need to infuse a little bit of humility. If you go to the next slide by this is the idea of preparation over prediction, all right? Preparation is the fact that had you come into 2020 with a balanced portfolio of global asset classes, then predictively, now that we know that it was a deflationary shock, predictively, we saw, sorry, this slide after after that we saw that the two big winners in 2020 have been everybody's talking about this bear market there's

two bull markets out there and it's sovereign bonds in gold right as as explained by the model so this is this is where preparation is important and then you can infuse a little bit of prediction right every year that there's there's these secular periods where we know markets you know ebb and flow then there's a micro cycle which is every year there's big winners and big losers across asset classes because in the year in the in the quarter in the year different inflation and growth dynamics change through time so even having a balanced portfolio is great a risk parity strategies across the board have done fantastically well,

with the exception of one big blow up, which took the headlines. But the vast majority of these risk parity approaches have done well. And then if you infuse a little bit of hubris, and you put your own twist to how much you want to overweight and underweight, you might be able to do a little bit better, right? So again, you don't want to go full hog, you want to overweight and underweight, you might be able to do a little bit better, right? So again, you don't want to go full hog. You want to have a balance between the two and understanding how markets work, especially on the asset and allocation level. Love it. Switching gears a little bit, Dan and Rodrigo, we'll start with you, Dan.

What sticks out most with you guys about some of the stats blew through around and just how hard it is for a fundamental approach to asset pricing right now given the wild swings in these economic metrics and basically how happy are you to be a quant manager where you don't have to sort out what's noise and what signal? Although I'll argue you actually do have to sort that out, but in a different way. You know, I think the biggest numbers that are just really amazing is the speed and the acceleration that has happened in unemployment. And I think what makes things difficult here is really seeing, you know, what is that going to mean?

And, you know, looking back over history, you know, there's very few instances where we have good information of when unemployment's moved this quickly and how it will respond over time. his belief is that it'll take a while for that rebound to happen, just as the natural forces of business and economics is going to require time to do so. And so I think on a pure absolute basis, being able to put valuations on assets today is really very, very difficult. I think, you know, we're still in a period of, certainly within the stock market, where most of the movements are based upon news and sentiment rather than economic information, because economic information just doesn't add a lot of value right now. You know, once we get to a point, if we have a vaccine, if we have levels of new cases declining considerably, we'll start to look back at the economic news and that'll start to help drive some of the valuations. But for the time being, on an absolute basis, it's hard.

Now, if you look at it on a relative basis, there's definitely opportunity. And that was very easy to see with, you know, you probably within the first 24 hours could have picked out a handful of stocks, put those relative to other groups and definitely found ways to be successful in managing a portfolio during this period of time. But on an absolute basis, I think it's really difficult. From a quantitative perspective, you know, I think it kind of echoes those sentiments from a grand economic perspective. I think it's hard at this point in time. So saying diversified is important.

I think it is helpful and we've seen that it's much easier to look and understand things at a very short time horizon when we're looking in periods of uncertainty. And so from our perspective, that's been a good thing where we've been able to see a lot of information, especially within the exchange dynamics that have been beneficial. So I think there's advantages. It just depends on how you're – on really the tools that you have and how you're taking those to put your positions on. Rodrigo? Look, I think we've spent a lot of time internally with partners arguing about what's going to happen next from an economic perspective, and we've realized that none of us know or have a clue as to what's going to win out.

There's a lot of great narratives. And the economic narrative might be right, but it might not be reflected in the market. These things, whatever's going to happen, whatever's already part of the narrative today is already priced into the markets. Here's what we know. We know, first of all be you want to have exposure to asset classes that that diversify you against these regimes you also want to have a varied um or a variety of alpha factors because another thing that we did in in our pandemic portfolio

is try to we had an argument internally about which factor was going to do best in this environment when we said clearly it's going to be trend right because it catches the trend it can go short or whatever it wasn't it was Kerry I thought care was gonna be the worst so as we did an examination of not only just an examination of what is likely to do well across these different strategies and looked at mass a lot of bear markets back to 1990 and every bear market gets unique every bear market has different path dependencies bear markets are a series of bull markets and bear markets that take two two years to evolve and depending on how those happen your your portfolio is going to do differently all

right and so there's a lot of path dependency right now with uh with what's going to happen in the economy are we going to find a uh a? Is it going to be hyperinflationary? Is it going to be deflationary? We don't really know. And therefore, your only choice is first to diversify across asset classes and then to diversify across strategies. And the last thing that we'll say is that what is clear is that you can't your bet sizing can't be the same right now right you can't place the same dollar amount in in a conviction trade today as you did in january because the volatility is five times what it was right and and i think a lot of people conflate volatility with opportunity here there's a lot of retail. And I think one of the highest searches

in mid-March was, how do I buy stocks by retail investors? And they're seeing it as opportunity, but all it is is a levered bet on a stock, right? If it's five times more volatile, you're just, six months ago, you should have just bought whatever your commission was,

just lever it up five times, right? So I think a key thing when we don't know is diversification across strategy asset classes diversification across strategies but then make your bet size commensurate with the the current environment and I think there's a I recently read this you know people are starting to feel like we're coming back to normality but the truth is that the S&P 500 just posted the most daily swings of 3% or greater in more than a decade, even a stock market set a five-week high. The S&P also booked its 38th session gain of at least 1% this year, last Tuesday, surpassing this year's total.

So we're not in normal markets. And people think we are, and they're putting money back to work as if it was our view is we much like Tesla We everything that we do is we we bet size we volatility size So our strategies have different volatility targets the adaptive asset allocation strategy targets 12% which is reasonable It's like a balanced portfolio and what that has meant throughout this process is as volatility expanded our Conviction has gone way down right there's more volatility less price discovery and and so you want to make sure that as you deal with this market that you don't get too overconfident you put the right bet sizes in and i think i can kind of one of the

benefits of that is that you eliminate the left tail or you you really reduce the left tail risk of your portfolios if you're vigilant about expanding and decreasing your yeah and I think people some people naively feel oh we just saw the left tail now I can get in and that's right no risk of a left tail but there can always be a left or tail and I think Dan can kind of echo my sentiment here is that the the old saying that there are old traders, there are bold traders, but there are no old bold traders, right? And nobody in the product trading desk is taking big positions right now. Why should retail investors be doing so?

Yeah. And the ones that did got carried out. Some notable busts there. So we're going to wrap up. I'm going to go to a couple of questions we got here. Blue, start with you. I'm going to conflate two questions here. So

one, you mentioned that inflation takes years to catch up after the use of stimulus. Can you touch on why this has has such a lag and then two is sticking with inflation Rodrigo mentioned the 7200 percent inflation in Peru we've seen it in Argentina is there I think talking of home country bias US folks would say no way that could ever happen here so kind of a two-parter, why is there the lag and could we ever see hyperinflation here? Yeah, well, it's no way it could ever happen here. You really don't want to ever say that word.

But anyway, that's not a prediction, by the way. It's just an observation I'm saying that Bernanke wrote an interesting paper and around the 1999 or somewhere telling Japan what to do and the implication was it couldn't happen in the US but then he did people that all the same tools when 2008 happened but anyway inflation and the actual inflation is very much related to inflation expectations, and people are fairly slow to adjust their expectations. We had slowly rising inflation in the 60s and then much faster in the 70s, but it didn't really get absorbed into the narrative as we had a huge inflation problem until OPEC kind of triggered it in 74. And on the way down, we hit 13% inflation in the U.S. in the 1980-82 period. You may remember the long, long bond, the 20-year bond was at like 14% or something. But the inflation expectations, high inflation expectations hung around for all the way from pretty much for 20 years.

I mean, 20 or more years, because that's the rally in the bond market, you know, that just kept on giving. But that was because people were taking a long time to realize that inflation really had been tamed sufficiently. So the feedback loop with expectations versus the reality is exceedingly slow for countries that have very little inflation. Now, once you start having a lot of inflation, then you start indexing everything to it, your behavior changes and how you keep your money, and then it happens a whole lot faster. And then typically when you have a huge amount of inflation, you don't solve it until you reissue the money and rebase everything.

So it's a pretty drastic solution when you get into the hyperinflation situations. Great, thank you. And then had another question here from the audience of whether the two funds go short. So if you had something like the oil going down, could you capture that downtrend? Dan, we'll start with you. Sure.

Yeah, so as I mentioned, we're definitely – we go long and short commodities. We're in the energy sector. We have been negative in the energy sector. So, yeah yeah we definitely will go long and short depending upon you know kind of the conditions that we see have negative meaning you've been short not not negative the P&L correct yeah Rodrigo yeah so we similar to Tezza we flat. Well, maybe Tezza doesn't go flat, but we go long flat financial assets because of that positive carry and positive risk premium that we would expect from equities and bonds. But we have the capabilities to go in long short currencies and long short commodities because they don't have an expected positive risk premium. So, yeah, I mean, and also I will mention that as one of the charts that we put up there

was, is there really a need for shorting in order to be able to thrive in different economic regimes? And I think that chart really shows you don't. The vast, a lot of P&L from trend managers, long short commodity managers come from being long bonds uh i always like to say that drunken miller everybody thinks that he made he made a lot of his wealth in the bear markets and everybody thought he's just a really good timer to shorten the s p or the little markets he self-admits that most of his money was from treasuries and uh and long the euro dollar

right so there's um this belief that in order to have absolute returns and do well in crises you need to go short is just not well-founded. And then there's a question here of Rodrigo, you mentioned risk parity and this kind of goes in with that. Is your fund a flavor of risk parity? There's a piece there that you guys can read that we call risk parity with factors. I think we have a slide we can pull up that you had on risk parity. Yeah, I mean, just the report on it. And you'll see that the idea here is start with preparation and then add your prediction on top of that. Right. So it kind of the same thing that we've done that is kind of we've gone through today in today's podcast and webinar.

You can see that the and this is the research report is not exactly what we run in inclined portfolios. It's just the idea of what happens when you add macro factors to risk parity. The yellow is that the kind of P&L from adding the factors in the blue factors to risk parity the yellow is that the uh kind of p l from adding the factors and the blue is just risk parity so a portion of it is risk parity and the rest is tactical bets and if you scroll down a little bit more figure seven you'll see the differential um in terms of what the allocations will be versus the risk parity portfolio so you the idea here being a risk parity believes that there's a positive risk premium for equities and bonds all the time. We believe that there is a positive risk premium in equities and bonds some of the time.

And so you want to act accordingly. So that chart right there shows periods where we differentiate from the risk parity portfolio because it is an interesting thing with rates at bond rates at 50 basis points and whether a risk parity portfolio on its own, it's going to do really, really well. No, a basic risk parity portfolio is likely to do, you know, half of what it has in the last 100 years. And so you want to be a bit more nimble around it while maintaining some humility. I'll throw out a question to all three of you based on negative interest rates and having fixed income as part of the portfolio. So Blue, I think we did touch some negative rates at the depths of the market there in March, right?

But what's your forecast or what are you seeing for the possibility of prolonged negative rates in the U.S.? And then after that, guys, just what would negative seeing for the possibility of prolonged negative rates in the U.S.? And then after that, guys, just what would negative rates do to your trading, to your portfolios, if anything? Well, I don't think the Fed's going to go to negative rates. I mean, negative rates are a tax on the banking system. I don't think this is exactly the time you want to raise taxes. Negative rates...

The Fed for that? Yeah, the Fed. Negative rates, the European Central Bank put them in. It didn't help them at all. In fact, from the time they put them in to the time just before the pandemic, it really no help at all. It may have even hurt. Japan's gotten a lot of pushback on it as well. So, you know, to me, negative rates have already been proven wrong. That doesn't mean some people don't like the idea. They're very linear thinkers. They think if, you know, if three is better than four, if two is better than, you know, whatever, then let's go negative.

That's just linear thinking, and the earth is not flat. But there's still a lot of flat earth people out there. Now, there are people that are doing interesting options strategies that have several legs to them and sometimes one of the legs does have an option in the euro dollar rate futures that implies a negative rate and so we do see some volume trading on the futures on the options on futures exchange but typically those are not outright positions. They are usually part of a more complex structure and, you know, and they're pretty, you know,

and it certainly could happen just because I don't think it's going to happen to me and it happens. Yeah. And guys, how about you? What would that do to your portfolio allocation and performance? If anything, I'll start with you, Dan. Go ahead. Sure, sure. So obviously having lower rates, you know, over the long term, holding that asset is going to give you less return there and less opportunity for return. But in the way that we approach kind of our construction, we're more interested in kind of the volatility and the correlation

of the interest rates to to other products and so um you know you lose some opportunity there in in one aspect but then you you gain some other opportunity as well um you know as it relates to the other products so so you know will it change our approach? It will change the overall construction reasonably. But, you know, the things that we're looking at to take advantage of, it doesn't necessarily change it. Got it. Rodrigo? the same, right? One of the benefits is that we can go zero bonds if we need to. But that's not to say that we can't make money as rates go from one to negative two. If you look at the German bond complex that went to negative rates, if you're buying it for capital appreciation, throughout that ride, people think that if you had known that German bonds would go to negative territory, that you shouldn't own them. In fact, an investor

who owned them over the last 10 years made a lot of money. So you may not want to hold it as a strategic holding because you're going to have lower rates or negative rates, but as a tactical holding, it could provide tons of opportunity. And as Dan said,

you're going to have diversification benefits from it too, right? The zigging and the zagging, when you put two portfolios together, one may be in negative territory, but the other two may be in positive territory. You put them together, your risk reward ratio is higher, even though you include an asset class as losing money, right? And I think in the PowerPoint that we're're going to share i did a webinar called the 90 years of risk parity where we go through a 40-year period where treasuries lost money like

for that whole period a 60 drawdown in treasuries which is the fear for most investors in 60 40 and risk parity but if you have true risk parity you would have had you would have been making money in equities and commodities in an equal risk perspective, right? And so two of the three engines were making money. The combination of the three makes your Sharpe ratio or your return to risk ratio higher. And you actually made a lot of money in a risk parity portfolio. You actually beat equities if you did a risk parity portfolio at the same level of risk as equities without having to predict that equities were the best performing asset class from 1940 to 1980. So just because we're going to have a bear market, may, may, may have a bear market in bonds,

does not mean you wouldn't benefit from owning it in a do no harm portfolio. But it also speaks to the just a naive 60-40 portfolio at zero or negative rates. Oh, yeah. You don't want that. You want some dynamic, adaptive. You want exposure to that asset class, but not just a naive 40%. First of all, yeah. First of all, from the perspective of 60-40, 60% equities actually represents over 90% of the risk of the portfolio.

So that is not a 60% equity, 40% bond portfolio, it is a 90% equity that 10% bond. So in that perspective, that's one thing that you're missing also the third engine, which is inflation protection. This is a key thing that I see around when I talk to every advisor, they just they would they know they should have some inflation protection, there's some goals and commodities, but they have a hard time explaining it to their clients. So you need something that has the ability to do well in an inflationary regime and right now a 60 40

portfolio in an inflationary regime during the 70s annualized at zero in real terms if you don't have that third engine you're in trouble and that's that's going to do okay for you you might need to use a little bit of leverage to increase your return but then the third the third phase is you know getting comfortable with being uncomfortable uncomfortable with a little bit of tactical allocations. Agreed. All right, guys, we're going to wrap it up. We're going to post this out to our new podcast, the derivative. So listeners make sure you go subscribe to that to get more interviews like

this. Any final comments before we drop off guys? Blue, we want to know what that is over your left shoulder. It's a Woodstock poster. Ah, I love it. Got it. Three days for peace and music. Got it. All right. Well, thanks, guys. We'll post all the materials and whatnot out there. And thanks, everyone, for listening. Have a great day. Stay safe. Thanks, Jeff, for putting this together. Thank you. Thanks.

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 alt and visit our website to read our blog or subscribe to our newsletter at rcmalt.com if you liked our show introduce a friend and show them how to subscribe and be sure to leave comments we'd love to hear from you