The Derivative - Volatility as an Asset Class with Jason Buck, Zed Francis, Rodrigo Gordillo, and Luke Rahbari

Episode Date: February 23, 2023

We’re back this week bringing you the second half of our Miami event - sharing the open discussion and panel portion that focused on volatility as an asset class. The panel was quite the collective of talent, with Luke Rahbari, CEO of Equity Armor Investments, Zed Francis, CIO and co-founder of Convexitas, Rodrigo Gordillo, president of Resolve Asset Management and Jason Buck, CIO and co-founder of Mutiny Funds. In this packed VOL episode these four stir up an interesting discussion on volatility as an asset class, why we should care about volatility, and why it's necessary to have protection in your portfolios. How volatility comes in waves, and we need to be ready to react to its movements. Defining volatility vs risk, rebalancing your portfolio, offense + defense, low volatility, long volatility, these are just a few topics that are being dissected in this episode and it’s a conversation you don’t want to miss! Chapters: 00:00-01:43 = Intro 01:44-29:23= Volatility as an asset class, Why should we care, offense + defense, the world & diversification 29:24-43:02 = Defining Volatility vs risk, the importance of rebalancing your portfolio, & how volatility performed in 2022 43:03-01:02:08 = Role of players in the market, Options, Liquidity & Overlaying strategies for low Volatility 01:02:09-01:21:47= Key Q&A’s on Volatility Follow along with our panelists on Twitter @RodGordilloP, @jasoncbuck, @convexitas, & @luke_rahbari Don't forget to subscribe to The Derivative, follow us on Twitter at @rcmAlts and our host Jeff at @AttainCap2, or LinkedIn , and Facebook, and sign-up for our blog digest. Disclaimer: This podcast is provided for informational purposes only and should not be relied upon as legal, business, or tax advice. All opinions expressed by podcast participants are solely their own opinions and do not necessarily reflect the opinions of RCM Alternatives, their affiliates, or companies featured. Due to industry regulations, participants on this podcast are instructed not to make specific trade recommendations, nor reference past or potential profits. And listeners are reminded that managed futures, commodity trading, and other alternative investments are complex and carry a risk of substantial losses. As such, they are not suitable for all investors. For more information, visit www.rcmalternatives.com/disclaimer

Welcome to the Derivative by RCM Alternatives, where we dive into what makes alternative investments go, analyze the strategies of unique hedge fund managers, and chat with interesting guests from across the investment world. Hello there, and happy Thursday, everyone. You're back, we're back, and volatility is back. Maybe a little bit. Maybe it never left. I think that's what we're going to talk about today. I gave you a little soliloquy last episode talking trend and the misconceptions out there.

And the guy who spurred those thoughts, Meb Faber, is going to come on the pod next week, so don't miss that. I'm going to have to think of a good baseball hat to wear. On to this episode, we shared the first part of our Miami event with Kevin Davitt last week. And this week, we really get into the nitty gritty, sharing the panel portion of that event focused on volatility as an asset class. We've got yours truly moderating a panel with quite a collective. Luke Ribari, CEO of Equity Armor Investments. Zed Francis, CIO and co-founder of Convexitas. Rodrigo Gordillo, president of Resolve Asset Management.

And last but certainly not least, Jason Buck, CIO and co-founder of Mutiny Funds. Nothing much more to say except send it. This episode is brought to you by Arsene's VIX and volatility specialists and its managed futures group. We've been helping investors access volatility traders for years and can help you make sense of this volatile space and intro you to guys like we had on the pod today. Check out the newly updated VIX and volatility white paper at rcmalts.com slash white papers. That's rcmalts.com slash white papers. And now back to the show all right thanks everyone thanks to kevin for that lovely talk um we're gonna also try and keep it high level but probably fail miserably at that and dive into some deep alternatives uh

lingo so if anything is unclear just just raise your hand, ask a question. Introduce our panelists here. First up, we got Luke Rabari, CEO of Equity Armor Investments, which sub-advises on the Rational Equity Armor Mutual Fund, as well as run managed accounts for investors, blending long equity exposure with their own volatility index. Luke, was that good? Pretty good. Did I miss anything? Pretty good. All right.

Next up, Zed Francis, CIO and co-founder of Convexitas, which run unique tail and convexity option overlay strategies in equity accounts, as well as offer two programs in the futures-based managed account space. After that, we've got Rodrigo Gordillo. If you want to see me murder that name, go back. What was that? That was pretty good. Three years ago, we did a podcast, and it took me about five minutes to get it correct. Why do that in Miami?

Yeah, exactly. Rodrigo's the president of Resolve Asset Management Global. I've learned to add the global. Where they sub-advise on the rational, resolved, adaptive asset allocation mutual fund, as well as run some private hedge funds and deeply involved with the return stacking index, which I'm sure some of you have heard of. And last but not least, to my left, Jason Buck, CIO and co-founder of Mutiny Funds, which run a multi-manager ensemble approach long volatility fund and the fund whose name goes least

well with your food today, the Cockroach Fund so named because you can't kill it anyone have anything they want to add on the bios there? yeah, I'm frequently seen on Resolved Risks with Rodrigo Gormio may have seen me on YouTube yes, and I'll throw a pitch in, Jason does a I'm frequently seen on Resolve Riffs with Rodrigo Gormio. Yes. You may have seen me on YouTube.

Yes, and I'll throw a pitch in. Jason does a fantastic podcast called The Mutiny Investing Podcast. Rodrigo and his group do Resolve Riffs every Friday with some great guests from across the financial world. Myself have the derivative podcast. So if you like all that content, go sign up, subscribe, learn as much as you can. We have guests like this on all the time. So I want to start. Kevin was mentioning volatility is endemic. Change is constant. You need to be proactive. All those good thoughts. These guys have been proactive, have created programs that try and harness volatility, try to look at volatility as an asset class. So I want to start with Luke and just ask, how do you think about vol as an asset class

and as a portfolio allocation in the constructs of your model? Well, vol is definitely an asset class, but I'm going to give away the secret here. There's three things about volatility. There's yesterday, there's today, and tomorrow. And how many people think that which day is important? Yesterday? Let me see you raise your hands. Today or tomorrow when it comes to volatility? Tomorrow. Well, what's the least important? Yesterday.

No. Today. And that's why I'm the expert and I'm up here. It's today that's the least important. Because if I told you if the VIX or VolQ or Spikes are trading at 90, you would say, wow, that's really high. But it's not really high if it was trading 150 yesterday, right? Or maybe it was trading 30 yesterday and is high. So volatility, as Kevin said, it comes in waves.

You have to take a look at it not only on an asset class basis, but also on a time continuum. And I don't mean to sound Star Trek, right? But there's some events coming up where volatility goes up. There's some events coming that happen. Volatility might go higher, it might go lower. Last year, we had a lot of anomalies with volatility when the market went down and volatility went down. And it's bad for people like us. If you're long risk assets, meaning stocks, and you're long volatility to hedge that. And at the end of the day, you look at the market and it's lower, so your stocks are lower.

And the hedge that you bought, which is volatility, is also lower. And so are your spirits and your AUM. And your number of calls from clients go higher. So there's a relationship in volatility. And before taking too much time, the other thing I'll say is volatility has changed over the years. You cannot just look at volatility in the asset class that you're trading or managing. And I'll coin this phrase. Volatility from every asset class will bleed into other asset classes. The only question is how fast and how much.

If you're just trading equities and you don't care about FX volatility, if you don't care about fixed income volatility, you're going to get kicked in the face. Okay? So you have to keep that in mind when you're investing in a particular asset class or managing what you're doing. Jason, same question. when you're investing in a particular asset class or managing what you're doing. Love it. Jason, same question. Yeah, how do you think in terms of your portfolio

construction of vol as an asset class? Yeah, sort of like a higher level, whether it's vol as an asset class or vol as the only asset class, we can have that debate endlessly. At a high level though, we think that the world or portfolio construction breaks down to implicitly short vol or or long-vol trades.

And we think about pairing those up. We like to say offense plus defense wins investing championships. You need both to survive and thrive in any environment. The other thing I like to think about vol, as Luke was referencing, is time. And it's very different from all the other asset classes due to time, tenors, durations, and expirations. But at the same time, I'm repeating myself there with time there is uh it's the last bastion of active management um maybe i'm a weirdo i like looking at all surfaces through time and watch how they undulate and move and it reminds me you know the ocean that we have

out of our windows here um but it's a really tough difficult environment when sort of somebody's long ball short ball relative value of all um we allocate to 15 ball managers and we probably track another 30 in the space we follow everybody um And we think it's a very dynamic space. And like Luke's saying, the markets are constantly changing. The hardest thing in the world is everybody wants to see a backtest. You can't really backtest long vol or tail risk. It's impossibility. The markets change way too much. And a lot of these instruments haven't been around for long enough. So you have to make a lot of guesses when you're backtesting, which I go back to. We view it as the last bastion of active management.

It's a really interesting and complex space, and then we try to just seek and talk out with the best managers in the world. And the defense is the vol piece? Yes. Zen? I was going to say, I don't think it matters. Like, why does it matter if it's an asset class or not? And volatility can mean a lot of different things.

There's an infinity amount of tenors, infinity amount of strikes. They all mean different things. They're all different decisions. So there's not really, like, a blanket statement, in my view. It's a tool, and you can use that tool in many, many different ways. And the simplest, unique thing about volatility instruments is a convexity component it's

the only kind of thing out there that you can invest a dollar to make way more than a dollar or vice versa you can you know potentially receive a dollar and risk a lot more than a dollar so how we think of volatility at convexitas as a tool is to utilize it within your portfolio to create liquidity during nasty events and they give you the opportunity to utilize that liquidity to accumulate additional assets for the long haul. That's our view of utilizing the tool.

But again, there's a lot of different flavors of how to construct and utilize that tool. Yeah, I'm the only manager here that's mostly terrified of volatility. I don't primarily, we don't primarily focus, my partners that are in the back, on long volatility strategies, though I have used it my whole career because born and raised in Latin America and Peru, my family lost all their money in a 7,000% inflation regime that creates all types of volatility. Happened again in Toronto when the housing market went down 50% and happened again in NASDAQ with all my family's money in 1999. So when I looked at how people thought about portfolios, what I saw was people had their asset allocations

and would let volatility happen to them. And what I wanted to do is I wanted to set my volatility profile and allow my asset classes to happen, right? So we are dynamic, long, short futures managers that we have an active mandate, we have a passive mandate, and all throughout my career, understanding that gap risk, that volatility risk, that thing that terrifies me the most, have always employed a long volatility portion that all comes together to create something that has steady volatility throughout. I don't want to have 80% volatility happen to me like in 08. That was always fascinating to me to see people at the bottom of a crash saying this is an opportunity of a lifetime,

as if it was, you know, they just lost 50%, now they want to buy hand over fist, but they don't have any money. It's not an opportunity of a lifetime. You're going to see 80 vol gone the way up. You're going to see the equivalent of levering up five to six times. You can always lever up. It's always an opportunity of a lifetime if you like 80 vol. For us, it's always, I don't want 80 of all ever. I want to have steady, pick your target, whether it's eight, 12, 15, you choose your target, we'll deliver

that consistently. That to me is harnessing my fear was the goal here, and that's what I'm here to talk about, I guess. How did your family keep replenishing the coffers to go through all those debauchery? Yeah, so my father, luckily, is a brilliant, brilliant man. He was a mathematician, professor at the University of Lima, did his master's in operations research in Monterey, California. He worked for the Army. He was the man who brought the first computer to Peru,

was lucky enough to be using computers when nobody in Peru had computers, and that kind of was a thing that my dad kept doing, just plowing in money, losing it in the financial markets, then building it back up again with a business. So four boys he managed to get through all that. We learned a lot of lessons. And emulate him as an academic, don't emulate him as an investor.

And we'll stick on this for a minute and whoever wants to jump on it like how do you think of vol then as a portfolio allocations we've talked about some of its characteristics and I misspeaking here when I'm saying Vaughn talking about long volatility right we're thinking Jason saying offensive side of the assets the risk assets are short volatility, so you want to pair long volatility. Let's talk a little bit about how you view that as an allocation, how you view that sizing together. Who wants that grenade? Pass it over.

I'll take it. Luke, you want to start it? Go ahead. The way we think about it is pretty simply, like I was saying, we break out the world into implicit short vol, long vol trades. Another way to think about it that Zed was starting to reference is linear versus convex. So if you think about your implicit short-volume trades like stocks and bonds, those are very linear instruments. And we like to pair those pretty equally with long volatility, tail risk, commodity trend advisors

because you have that convexity. And you get this nice portfolio effect, the emergent property, when you're pairing linear with convex instruments. So during risk-on times that can last a decade, you're riding that linear wave, and you're bleeding out a little bit of that convexity to try to offset that portfolio. And then you get that huge pops and convexity when a risk-off event happens that really ballasts the rest of the portfolio. So a lot of people think they would negate each other, but when we're talking about linear

versus convex instruments, you get very unique emergent portfolio effects. Yeah. Much simpler and maybe more apropos for you guys is why should you care about volatility? Well, it depends on the asset class you have, right? So if you're long stocks for a lot of your clients, what kind of volatility do those asset classes or do those stocks have and how are you going to hedge it, right? You're not going to hedge NASDAQ volatility, which all of you have more than you know, as so did I, because 80% of the market gains came from 11 stocks. Everybody knows what those 11 stocks were. If you have five or six or seven different ETFs and they match the market, then they all have the same stock in there. Or one of those guys is a super, super great stock picker, right? Because he didn't have Apple, he didn't have

Google, he didn't have Tesla, he didn't have whatever, Netflix and all the rest of it, right? So first you got to look at the asset class you're investing in what is the volatility of this asset class what is the correlation to the overall index like the nasdaq right kevin was making fun of me earlier how old i am and because i talk in dow terms even when i call the office or whatever people you, oh market's down 18 handles. That doesn't, what is the Dow? Because I'm old, right? Not spruce. Last few years, S&P, Nasdaq, and Dow have all become the same. 50% of the S&P is Nasdaq. So which volatility are you hedging? You've got a S&P manager and you've got a Nasdaq manager, oh I'm diversified. Well, they all own the same

thing, right? So knowing the volatility that you own, knowing the risks that you have, and then how do you find the correlations and what instrument do you use to hedge that? That's super important. And understanding that, understanding your exposure, right? As Rodrigo said, if it goes down 50 50 percent how much am I gonna go down is it more than 50 percent because if you thought you were diversified turns out with a lot of managers they all own the same thing and you're not that before I pass it oh I just reminded me like you know I hate on these like things with a lot of times we have generic answers so I was mad at myself

so I want to just be more specific and I'll talk our own book this is how we think about the world is if in Rodrigoo can speak a little bit differently about this, is if you think about Harry Brown's permanent portfolio, it was a quarter each stocks, bonds, cash and gold. It came up that in 1972. But these ideas go all the way back to Talmud of having proper portfolio diversification. So we just think about what we do as a modern example of that. That's why I wanted to give you a kind of percentages instead of just giving you kind of grandiose projections. It's like we break down the bonds instead of cash we use long volatility instead of gold we use ctas because we just think it has a higher beta over time to inflationary environments so you said

uh trend followers cta trend followers so commodity traders that trend follow because then if you're trading those 80 commodity markets you have a better idea of capturing a little bit of that beta to inflation then you have a pure gold. Because gold is great for thousands of years, but any intervening year, gold might not do well. So it's about trying to capture that beta. So the idea is you're pairing the axes of growth and inflation. That's the four quadrant model that Harry Brown came up with, Dalio copied, everybody uses. But that's the idea is you want to worry about what happens in global macro environments of growth and inflation and kind of pair those things in equal proportion.

And then whether you use a little bit of implicit leverage, that's up to everybody on how they run their portfolios. But I just wanted to be clear, like we use equal amounts, stocks, bonds, long volatility, commodity trend. That's the way we look at the world. Maybe you'll answer my question. These guys. How much? I'll even add a little bit to it. Like why should these people care?

Right? Like, you're saying, okay, how much volatility do you have? What are you going to hedge? Why should they hedge? Right? I think we might just assume it's evident, but give it. So, those are two different questions. So, you know, do we think folks should utilize a hedge within their portfolio?

And I think the answer to that is yes. Do we think long volatility is the right hedge? From our universe, the answer is no. And the reason for that is we don't think adding correlation risk to your portfolio is a good decision. So our means of adding diversification to your portfolio is something that's targeting essentially the assets you own. Most of the assets that you own in relation to our relationship with investors are long equities. Our returns are negatively correlated to equities which is very different from being long volatility because long volatility may or may not perform in a negatively

correlated way to all of your equities and we don't think adding an additional correlation risk that's meant to be the main fulcrum of, you know, kind of positive carrier delivery to your portfolio during the drawdown events should rely upon correlation to actually achieve the designed purpose of it being within the portfolio. The why hedge, really it has to do with, like I will say, construction of that hedge is almost more important than the actual investment efficacy of that hedge. Construction from our seat is if you are adding something to your portfolio, what is its job during that drawdown event? And we don't believe something that just has a warm and fuzzy mark to market is actually that useful of a tool. It needs to be cash liquidity in your portfolio that you can utilize to service lifestyle expense, real money, or be an opportunistic reinvestor. Because those are the real wealth

creation moments over the long haul is the ability to actually deploy assets during the drawdown event. So a lot of strategies that may be negatively correlated look like a decent return during the nasty events. If you can't actually use that capital, what is it really doing for you? So without getting in like, you know, specific option speak and all that, we're just firm believers,

don't add additional correlation risk to your portfolio. Make sure what you're doing is negatively correlated to what you actually hold. And then make sure the delivery of that allocation is liquid during those events so you can utilize those proceeds. Let's dig in on this a little bit because I think you all do a flavor of this. You're saying, hey, even though you said you're not long volatility, but you, in essence, you are sometimes.

Or you're long gamma instead of ulti. But regardless, in a down market, you are up 25%, let's say. For sake of an example, you're not waiting for the investor to call and say like, hey, I want to redeem that because I'm going to now put that into stocks that are underwater. It's automatically getting taken out, and that liquidity is there for the investor to use, right? Yeah, I mean, how we work with folks is directly in your account, separately managed account. So essentially we're placing trades directly into where your assets currently are sitting. So if the market is going down and we're hopefully doing our job, those are instantaneous cash returns sitting in your account for you to use that day.

There's no process of redeem and wait for the check and then we'll see where the market is in two months when you receive that check. That's your money unencumbered. Please use it. That's the whole point of being involved in the portfolio is to allow you to use that money to accumulate additional assets. Like that is the value creation is on the operational side. You know we think we're obviously decent on the investment side too but the operational construct is what we think is the most important identifier and what makes us unique in their ability to help people's portfolios during drawdown events. And then Rod, you guys tackled a little bit different way of like in the same portfolio that can get redeployed some of those volatility assets. Yeah, again, going back

to why I invest like an 80 year old, I do it because of what happened in my formative years, right? What happened, I dealt with inflation early on in my life. Then I dealt with a real estate bear market. Then we dealt with a tech bear market. And it all affected us by the fact that we were highly focused on a single asset class every time. We were 100% in cash in Peru. We were 100% in real estate when we landed in Canada, and then we're very, very heavily invested in tech. So the common denominator is to diversify. So how do you protect against those big events? The vast majority of people here I would imagine is long U.S. growth assets, whether it's equities, real estate,

I would imagine. Like what percentage of people here have over 50% in equities, real estate, I would imagine. What percentage of people here have over 50% in equities, private real estate, private equity right now, if you raise your hands? That's pretty much everybody. I don't get that. I never did, but I didn't get why my dad did that. So the way you tackle it is similar to what Jason's talking about. You want a portion of your portfolio to be good for growth environments. So low inflation, high growth, high liquidity, that's your equity portfolio, your private

real estate, private equity. You want something that's going to be there to protect you against non-inflationary bear markets, and that's going to be your sovereign global bonds. They make money in bad periods. In 08, buying a simple iShares TLT was up 35%. That's a 20 to 30 year U.S. Treasury. That's better than most hedge funds did in that year. And then you want something that nobody's thought about except for Latin Americans, which is something that can protect you against inflation.

So you want your base to have some commodities in there that include gold, right? And so now you have your three-legged stool. That should be your do-no-harm portfolio. That's the base of half of what we do with the RDM IX mutual fund it's if you don't know anything how do you create a balanced portfolio that has thin left tails in the distribution you don't have these blow-up events and then what's the problem there how can I hedge myself against the risk of just being long

everything well we're seeing it now quantitative tightening is a problem right so liquidity long secular liquidity events where the Fed is pulling out liquidity is going to affect commodities it's going to affect equities and affect bonds I need somebody that something that can short in case that happens to me whatever it is whether it's commodities gold equities or bonds and that is the CTA space, the managed futures, that we run a systematic global macro space that does more than trend and can short things to fill in the gaps of that risk parity.

And then sometimes those systematic macro players are net long everything because everything's been going up for 12 months. And there's an event like COVID where volatility just spikes and everything is offside. How do you fill in that last gap? A long volatility strategy just in case, right? And there's an event like COVID where volatility just spikes and everything is offside. How do you fill in that last gap? A long volatility strategy just in case.

Right? So those are the major pillars of how I think about my portfolio. The rebalancing across these asset classes. A pillar of a solid long only globally diversified portfolio with inflation protection, long short global macro, and then a tail protection just in case. That's what we call the all-terrain portfolio. And that's how I thought about the world since I started in the business. Is this the first time you... Is this the public unveiling of all-terrain? You trademarked that? Right. This is the first all-terrain. That's the first time I heard you say that. We got to see that CFA article recently that Adam wrote about the all-terrain. And Luke, if you could talk a little bit about you're doing

this rebouncing daily, right? Yeah. Yeah. So, but I just, you know, I also have a little bit of a similar background from Rodrigo. I've been through a life event where we lost everything and had to start over, but either I'm cursed or these life events happen to people more than you realize. So for people who are here, 87 crash, 91 mini crash, 1998, 99, whatever internet bubble, global pandemic, 2008. There's some other stuff I'm missing. So these once-in-a-lifetime events seem to happen a lot, right? So maybe that's why you should invest in volatility and have some hedge, right? Because remember, when you start at $100 and you lose 10%, you're at 90. When you go back up 10%, you're at 99.

Controlling losses are a lot more important than trying to catch all the upside all the time. That's the first thing. Secondly, you know, I think everyone here looks at the world differently. What you have to find out is how it fits you and your clients. In our OCIO models, we were really negative bonds last year, really scared of bonds because of how far they'd gone down and how a small move was such a big percentage move in bonds right when the 10 years at two and it goes up to three right that's a 50 percent move well we couldn't handle that for our oci model so we changed some stuff around we did

some structured products and in our in our funds what we do is we're long risk assets which are stocks and we're long volatility and we rebalance every day so if we start out 85 15 and let's say the market goes up I'm just using big numbers 10% our stocks have gone down we sell some of that our vol I'm sorry the stocks have gone up we sell some of that our vol has, I'm sorry, the stocks have gone up. We sell some of that. Our vol has gone down. We buy more vol. And then we're 85-15 again tomorrow. And we found that, as you said, there's no good back test.

But over the long term, that's a more efficient way of holding risk assets than just being butt long, right? And the other thing for a benefit is you guys run a business or you run a family office, you manage money. If you're managing other people, you need parts of your portfolio that are that are risk where they can hit home runs. You can buy the I don't know, NVIDIA's of the world, which we actually we actually like. But you also need a place in a portfolio where you can point to, hey, I know the market's down, but this thing's holding steady. You don't need to liquidate. You don't need to get out of the market. You don't need to time the market.

We're going to be okay for a little while. Let's run this out. It might not return as the market is doing, or it might not give you huge returns. But this is what keeps you in the game, and it doesn't force you to liquidate at a bad time. Because over the long term, we all know the market tends to look like this, right? But it's those things in between that can slap you around. If you've got something to add, I was going to jump in. You're a good one for this.

Do you think it's more a mathematical advantage or a behavioral advantage of adding this defense, of adding long volatility? Behavior, I was actually going to piggyback more on what Luke was saying. I also want to just clearly define terms because I know Zed was about to take umbrage with long volatility versus tail risk. We're all kind of talking about the same thing. You want structurally negatively correlated assets that have convexity in your portfolio. Is that fair? Yeah. back city in your portfolio. Is that fair? And the idea, but also what Rodrigo is saying is like, if you do that in your portfolio, a lot of times proper diversification means there's part of your

portfolio you absolutely hate. And that CNBC is telling you is the worst thing ever. Everybody's telling you get rid of it. And that's proper portfolio. Just, you know, if a part of your portfolio doesn't want to make you throw up, then you don't have proper diversification. And most of the time it is long volatility tail risk that makes you want to throw up is that negative line item, but it's there when you need it most. Cause like, as, as Luke was saying, it's like, you know, we've all been through it, whether we're Peruvian, American, whatever, like we've all been through crashes and devastation within our own portfolios or our families. And what that structurally negatively correlated asset class can do for you

is keep you from doing anything stupid. Because how many of us is like, I think, is it Jason Zweig says, you know, I can show you a picture of a snake, but if I throw a snake in your lap, you're gonna have a very different reaction. And everybody likes to think. What's that? Yeah, everybody likes to think that when the market sells off, they're gonna get out,

you know, they're gonna be calm, they're gonna add to their position, they're gonna buy at the lows, but none of that ever happens. We've all lived through 2007, 2008. And so having these structurally in your portfolio that can provide you with these convex cash positions, more importantly, behaviorally, it keeps you from doing anything stupid at an inopportune moment.

And then more importantly, it can force you to rebalance at a lower NAV point with those other asset classes. And that's what helps you compound more effectively and efficiently over time. You're reducing that volatility tax. But in any quarter a year, you're going to hate that diversification. But it's about your terminus wealth. Where are you going to end up? How are you going to outpace inflation? Are your savings going to be there when you need them most? You need a properly diversified portfolio and you need things that can provide cash when you need it most so you don't do anything stupid. Let's talk a little bit about Kevin's up here saying buy NASDAQ options. Yes.

Why not just buy puts on the NASDAQ and call it a day? Like why if people are like, this is all too fancy. I'm just going to go home and buy some puts and that will be my hedge. I think the biggest problem with something like that is what's your monetization plan? If you were to go out there and buy a put because your exposure is mostly in technology, maybe that makes sense

for your portfolio. The question is when the NASDAQ goes down 10, 15, 30, when are you actually going to monetize that position? Because that is the more difficult piece almost of the entire decision is not when to get in, but when the heck do you actually get out of this thing and actually utilize those proceeds to go do something proactive. So we believe that active management smooths that out, that you're constantly monetizing that position as the markets moving keeping that risk exposure pretty you know in a defined area thus you know

when the market moves we're doing something when the market moves again we're doing something else but if you were gonna go home and and just go buy a put before you do that have your sheet of paper on the post-it note next to the computer when you're gonna actually sell this thing and even when things seem really distraught and you probably feel like you need it to be there, you got to stick to the plan because that is the harder piece, in my opinion, of the equation. It made me think like some of that Rodrigo said too, is like, I don't want to be the one to quote Taleb up here, but he did say if you don't have portfolio insurance, you don't have a portfolio. So this is about going back to the behavioral aspects of it. And we're sitting here in beautiful South Florida. I don't know

anybody that builds coastal real estate without home insurance. I mean, it's really that simple, but everybody goes around without any form of portfolio insurance. But I want to get more to the cost of that, right? So is there at some point it's prohibitively expensive to like, I don't want to build this coastal home and the hurricane insurance is $10 million a year, right? So at what point does it become prohibitively expensive to just buy the puts? Well, two things. Sorry, I want to piggyback your earlier question. One, you know, we don't complain about house insurance, car insurance, or life insurance, right?

We just keep paying those premiums. But for some reason, we hate portfolio insurance. The other one is I would bet everybody in this room has tried to trade options themselves. And I bet everybody in the room has the same experience I have where it didn't work out too well. I'll give you the worst example in history. I was a commercial real estate developer going into 2007, 2008. I saw who were the worst mortgage providers on the planet, the worst banks on the planet. I started shorting all of them in 2007, 2008 using put options. But because I wasn't a professional options trader,

I thought it was all about delta. If I was directionally correct, I would be correct. But I fucked up my vega, I fucked up my theta, I fucked up everything you could possibly do. And I managed to lose money shorting the mortgage and housing buzzer of the worst players. So as- So put your money with him.

Yeah, so as Zed was saying, it's really, it's really, it's, it throws people off. It's very easy to put on options trades to your point, but what is your monetization heuristics? You know, how do you roll? When are you taking it off? Are you then naked to any protection beyond that? That is incredibly difficult. And that's why I say it's the last bastion of active management. Yeah. I mean, I agree. I agree. I don't tell you how to get clients or how to manage clients, right? I don't know how to do it. But I think everyone here, maybe some more than others, we've traded options for a long time, right? You go to a doctor, you go to a mechanic, whatever. Just make sure that they're aligned with what you want to do.

If their portfolio analytics or thoughts are the same as yours, and then you'll be comfortable with what they do, right? Because insurance is going to cost you and sometimes it's going to cost you a little more than other times. But if you're comfortable with their philosophy, then you'll be comfortable with the manager. And then you'll have a total portfolio allocation that really works for you. But if you're uncomfortable with the risk that you have on and you want to go buy insurance, and I'm going to get killed for saying this, maybe the first thing you should do is just reduce your risk or move into something else. Then rethink it, right? And then get back in in a more risk-aware format. Not buy options? No, use a manager that's going to lower your risk. Use a manager that isn't just long apple. As I say, the only, you know, my comment is everybody's really bearish up here. Like this is all about like protection

and like, you know, world ending. Like, you know, my whole view of utilizing these types of strategies is that redeployment. It's like, that's what's exciting. Like, you know, in 30 years time, do we think most assets are gonna be higher? Like I think pretty much globally, we'd all think that's the most likely outcome.

So it's utilizing these strategies to actually accumulate additional assets during those drawdown events. So in 30 years, you have more things. Yes, being able to ride out nasty times is important. But to me, the exciting bit is accumulating additional things, to end up with more things in 30 years than you would otherwise.

Look, the last thing I'll say about doing it yourself is that we're all kind of specialized in the areas that we do. You can't be all things to all people. If you're an advisor, your job is to grow a solid business and have a relationship, be smart enough about choosing how you want to invest, and if you can pull it off easily with passive investing, that's great. But to take it a step further, you actually need to find good partners to do it for you.

We attract a very unique set of people. We call them TOPS, technically oriented people. Those are the only people that come to us. And they're almost always ex-traders that knew just as much as we did, but somehow were on a plane, couldn't put the trade in, blew up for this or that, just got busy, and it doesn't work out for their private accounts. Same thing for advisors. We're having client events, couldn't do this, couldn't do that, and missed this opportunity. If it hasn't happened to you yet, it likely will.

You want to out-sort. You want to focus on the business and what you want to do in your life the most and then have an ensemble of managers that what I consider will be the decade of active management again to help you through this event. I think we all have slightly different ways of skinning the same cat and you just want to outsource to the first set of managers that know what they're doing. Jason, I know you'll have thoughts on this, piggybacking on what Zed said. You can view the protection as the ability to lever up more, to increase your offensive exposure.

Yeah, I was also thinking about what Zed said. Breaking down, are we bearish or bullish is kind of irrelevant, right? It's like we're both, right? The offense plus defense is the way to think about the world, and it's just acknowledging that bad shit can happen. So you want to protect yourself against that. But then the other question is like, you can either take out on your exposure,

which probably most people need to do if they're uncomfortable with their position. Or if you have structurally negatively correlated assets that have complexity to them, maybe you can run your equity a little bit hotter. It's about the combination of those. And if you have that true structural negative correlation, it enters into a very interesting conundrum, right? You don't have to necessarily lower, let's say, a long

equity position. You could run a little bit hotter than most people do because you're truncating that left tail. And then more importantly, you have that convex cash position to redeploy at those lower NAB points that helped your compounding over time that both Zed and Luke have been hitting on. What does that look like in terms of daily rebalancing, monthly rebalancing, quarterly rebalancing? I know your friend, your friend Corey Hofstein's written a lot on rebalancing luck. Anyone have any thoughts on that? I'll tee these guys up in a way.

We think about this often. Corey's a good friend. And we talk about how many at-bats do you get, right? And this is one of the problems if we're fair about tail risk. Like if you think about typical buying puts, deep out-of-the-money puts, and rolling them, and really trying to capture that one every 10-year event, going back to Zed's point, the monetization is key to that. And so if you only have one at-bat every 10 years, you better monetize that perfectly.

Better hit the home run. Right. And can you trust a manager to monetize that perfectly? Maybe they've done it the last two times, but is two a good enough sample size? Better hit the home run. Right. And can you trust a manager to monetize that perfectly? Maybe they've done it the last two times, but is two a good enough sample size? No, it's not.

But if you can find managers like these two sitting up here that are rebalancing on a daily basis, you can have some more statistically significant, you know, exposures that you can

more reliably count on and that can improve your compounding over time. But I'll let them touch on that better than I could. Yeah. I mean,

seriously, nobody knows where the market's going or where vol is going. Okay. You can only work in generalities in the long term. I agree that the era of stock picking, asset picking is definitely back. Okay. It's back for sure. But again, you have to construct a portfolio and you have to look at, and a lot of times your clients or the people that invest with you end up having the same kind of thoughts as Rodrigo was saying, as you do. A lot of our clients or people that come to us don't believe the Federal Reserve.

You know, every time I hear someone talk about rates, here's another big clue. Rates don't matter. It's the balance sheet. Is he reducing the balance sheet or not? That's the only thing that matters. Because if he takes rates to 10% and he buys $90 trillion a week, okay, right, it's a whole different relationship. So you've just got to be aligned with what your

expectations are for your investments and find a manager that's going to deliver that for you. We believe that the best way to hold risk assets is with some volatility and to rebalance. Get back to that point because another big important point is that assets, risk assets, are not mean reverting. They're trend. They either go up, they go down, but volatility is mean reverting. You're marrying two different types of things together for a better total return than just total return, meaning less risk, you're trying to get the return. Then just being long or just being short or whatever, right? I think Zed might disagree that rates don't matter. Do you want to get into that?

I was just going to say rebalancing. I think the answer is you do it way more often than you think. If your diversifier within your portfolio generates 3%, 4% portfolio-level cash, that's probably time to go buy more things. Because, again, you have no idea where the bottom is going to be. And even probably more importantly is there's a lot of 10%, 15% draws during bull markets. Those are opportunities to add additional investments. Before we have three consecutive years of 30% rallies,

take significant more bites at the apple and rebalance more often than not. The other piece with the rebalancing side that we focus on is doing things in separately managed accounts allows it to be tax-efficient rebalancing. So the buys and the sells of what you actually own in your portfolio are stuff that you and your advisor, you yourself, are doing to go ahead and increase potentially taxless harvesting,

make sure that the assets that you have are efficiently being rebalanced. Because all this stuff is really nice, but if all of a sudden you're paying a 45% tax bill on it at the end of the year, it's a lot of movement for not a lot of rewards. If you can do this in a tax-efficient manner, then it becomes incredibly attractive within your portfolio. So more often than you think, and then also with a tax-conscious mindset, I think is very important. And you don't want to get sideways on rates, don't matter?

Oh, my God, we're going global macro now? We wrote a paper called The Rebalancing Premium. And one of the things that people don't understand with regards to rebalance more often is how much money you can make out of nothing. As long as you are invested in things that move differently from each other. So we're talking about a lot of what we're talking about here comes across as you got your equities and you got your convexity trade, long vol trade, whatever these guys are doing, you have two unique bets, two completely non-correlated bets

where you can grab from the winner. Maybe it's long volatility that's mean reverting and buying the loser. And over time, that creates what's, we have a piece called Shannon's Demon, but you can really have mathematically two asset classes that are losing money, but if they're non-correlated and highly volatile,

you can make a positive sloping equity line. So how does that look like in the real world? In the paper we wrote, we show across 80 different futures contracts, you roughly have long-term 13 unique bets. If you're able to rebalance across those as often as possible this is across commodities equities bonds the whole gamut you can actually if you assume that all of them make zero over time simply by rebalancing you can make as much as a 4% excess rate of return so this is this is volatility harvesting diversification harvest there's a lot of names for this

but not rebalancing is a bad idea, just broadly speaking. And there's different frequencies that you can look at, but it is useful to understand the value of it and the value of being diverse, having different assets, and rebalancing as often as you can. So a lot of this sounds too good to be true. So I'm going to bring it back and say last year was a difficult year for quote unquote long volatility. What are the reasons? Why was that?

You put it on me? Oh, man. You told all 30 of them. Yeah. This is a difficult question because we were talking about defined know, whether it's long volatility, tail risk. And like we said, we allocate to 15 managers. We follow 30. The idea is there's so many path dependencies to volatility in a sell-off. And that's why we believe in ensemble approaches, especially if it is a one every five, one every 10-year event.

We can argue what it is. You want to make sure you capture the meat of that move as much as possible. So we've heard, you've heard people banging the drum that long volatility or tail risk or none of those things worked in 2022. Well, it really matters what strategy you have. If you're rebalancing more frequently, you probably did just fine in 2022.

And your clients did even better because of tax loss harvesting. And then if you did cross asset vol, if you're a European manager trading vol around the world, across FX, commodities, everything, you did exceedingly well in 2022. The hard part in 2022 was for the deep out-of-the-money, tail risk, long vega funds. Understandably so, though. They did what they said they were going to do on the 10. And we always knew this was coming, and it always surprised me when people are surprised by it.

It's like, if you have a slow, protracted drawdown, you are not going to get a pop in volatility it's just not this is the way it's mathematically works i mean we've been in a medium ball environment let's say the average of all last year i believe was 25.5 on the vix index what that means in general is about a 1.6 expected move up or down on a daily basis on the s p all those moves were pretty much within there and it's just like that slow grind down. So it's that slow bleed to death is really going to affect your long Vegas strategies. So it's understandable when those managers get hurt. But if you have different managers

who are trading long gamma, people are doing dispersions tradings that were working great in the first quarter of the first half of 2022 and then kind of faded off a little bit. It really depends on what volatility we're talking about. And this is where we get into deep amounts of nuance. It's horses for courses. And this is where we get into like deep amounts of nuance for different, it's horses for courses.

And this is why we believe in ensemble approaches. What worked great in 2008, didn't work very well, maybe in 2020 or vice versa. And then what's not working well or working well in 2022, it's gonna have different effects. If you have liquidity cascades that happen sharply, you need certain strategies that work for those. And if you have these long protracted drawdowns,

you're gonna need other strategies that work for that. So it's really impossible to know a priority what that drawdown is going to look like. And so we try to manage accordingly across a broad swath of volatility or tail risk strategies. And Kevin, I'm going to put you on the spot. If you bought the NASDAQ like $11,750 put at the Jan of 22, right? Or a straddle at that point. Like, what was the, it was probably at the same price at the end of the year? Or down some? Even though the NASDAQ was down 20% or whatever?

Right, but isn't that just coming back to the post-it note of, here's why I have it, here's my plan and the behavioral element of when you're uh mid april or just before the election are you at that point and are you able to actually follow through on your plan that's why people stop exercising we're just i was just making sure you're paying attention and if what we're talking about is like path versus terminus we all, everybody and most of finance only talks about terminus, and we don't talk about path. And we're talking about managing the path to get there. And we work in a non-ergotic system.

Give me my red flag now. And so your life expectancy versus everybody else's is very different. And so we really have to manage the path, not just the terminus. I have a general question that everybody, I've been observing this. I'm sure everybody here has observed it, that the environment, the nature of the players in the sandbox may have changed over the last couple of years with zero-dated expiration options, et cetera. Has that influenced the trading and volatility?

And like you were talking about, muted volatility, slow grind down. Have those products, have they played a role in that? Is that going to be a continuing factor? And if so, how have you adjusted? Maybe. Well, it's, so the amount of players that are in the market and whether they push a product down like volatility or sell a lot of premium, et cetera, can have an effect. I don't think it can have a long-term effect,

or I don't think you can keep it that muted for that long. I think a part of the reason it was so muted is everyone, it's still the Fed's game, right? Oh, the market's going to go down a lot more, so then he'll stop raising this, that. That's a part of it. We've looked at a lot of stuff. High yield never really broke down. If you look at a high yield ETF, HYG, it never really broke like it should have if credit is going that badly. The P-E ratios and S&P, long-term P-E ratios and S&P is 15.5.

You thought it's still, I don't know what it is today, but it never got down to, if the long-term is 15, maybe you want to buy at 15. But at 12, you're really excited. It never really got down there right um there could be a lot of factors you you don't know so and it takes a lot of time to kind of recycle through so it's hard to say if i knew why it didn't maybe i you know i'd be the king of the world but it's hard to say you just got got to manage it the best way you can. My first thought, and I'll pass to Zed, is like, yes and yes. All those factors matter.

We're talking about complex adaptive systems, interacting with complex adaptive systems, and all those things matter. But at the same time, I don't care because I can't predict the future, so I try to find an ensemble approach that can cover as many path dependencies as possible. But Zed and I were just talking about the zero DTE the other day, so I'll let him answer that. And for zero DT, zero days to expiration options.

So what do you got? You release those daily is the whole point? Yeah. So for whatever reason, someone wants to trade that option that expires that day. Yeah, don't get distracted by that. It's not important. You're going to get a lot of articles and stuff written. Obviously, the volume is really big.

But essentially, it's just one-day jump risk. The people that are servicing those flows are very good risk managers and understand what they need to do to take the other side if needed. If that wasn't the case, those options would be very expensive. They're not. So I think that's a lot of headlines, one-day options, but they're one day. They don't adjust meaningful risk out the curve in any format. So a lot of headlines, I wouldn't really focus too much on that and focus your attention

elsewhere. A little more color. Who's trading those, in your opinion? I think it's all over the place. I think we have a lot of eventy things on the calendar. So I think there's a decent amount of retail, but I also think there's a decent amount of institutional that are doing one-day type of things for what's going on. And there's plenty of market makers that are willing to service a lot of trading volume at a fair price for them. How much do you think, like we were talking about the other day, especially in Q4 this last year, is like everything is around CPI and FOMC meetings and like everything's been really event driven and so that's why maybe 0GT is part of that too as well. Yeah I would say like institutional style players are probably using them for one-off events in their portfolio and then there's a decent amount of other folks that you know are using them for other-off events in their portfolio. And then there's a decent amount of other folks that are using them for other reasons. I think more importantly than that is last year, 2022, for equity volatility was not weird. It was exactly what should be expected and has happened ever since 2008. A lot of markets have changed'm going to exchange post-great financial crisis, but essentially the common theme since then is in the first move lower in equity markets, volatility is stagnant or potentially even compresses. We've seen that in basically every draw since GFC.

Now, when you get to the potentially second leg lower in equity markets, then you see a volatility explosion. We never really got a second leg at any point last year. You didn't get it in December 2018. We had volatility down in a pretty not happy month for equity markets in a pretty volatile fashion. You didn't really get it February 2020 into the first week of March 2020. Volatility did not expand. It needed that second leg to actually have that inflection point and accelerate. So I think there's a lot of headlines that last year was weird. It was exactly what's taken place the 14 years prior. And I think it's because the market dynamics that create that didn't change in 2022. They've remained the same.

Real quick. Was it Bill? I have a question here because it kind of correlates to what you were saying before. There's a very old saying on Wall Street, never fight the Fed. Okay? Now, M2 right now is contracting at the greatest level it ever has since World War II in the last six to eight months. If M2 continues, the Fed reading the straight topic, do you believe we'll have increased volatility going forward? So it's about the fact that the M2 money supply has collapsed in ways that we haven't seen in a long, long time and whether that collapsing of liquidity is going to have effects, long-term effects in the market and whether it's going to sustain asset levels. Again, I think that question is again part of the noise, right?

It's part of, it's like Warren Buffett says, you know, the market in short term is a waiting machine and the long term is a voting machine. If you think about the dynamics that affect markets long term, the way bear markets generally work, right, the traditional bear markets are ones where you have these long term, multi-year bear markets, whether it's due to a lack of liquidity or it's due to a valuation compression. There are, the waiting machine is what we need to focus on. And to do that, you have to go back 100 years to understand what drives all markets that we're talking about. We're not just talking about the S&P. What drives equity markets? What drives bond markets? How does liquidity affect both of these markets? How does it affect commodities? How do interest rates affect us in our lifetime, our investing lifetime?

And that is a bit more clear, right? In periods of abundant liquidity, persistent positive growth, and low inflation, you're going to have 40 years of domestic equities and bonds do amazingly well. And what has happened is that we've built our intuition to be like, my long-only portfolio equity heavy is going to do really, really well in this environment, right? Well, what happened in the 70s was the complete opposite right you saw equities and bonds do poorly while inflation was up but we haven't experienced that in forever now we're starting to see a bit more of uh liquidity compression whether it's through m2 i think there's a that that whole liquidity conversation is much more complex in the money

supply but there might be a liquidity extraction coming and it may continue and that'll create inflation volatility inflation volatility leads to an environment that our intuitions whatever we thought our lived experience taught us is gonna be dead wrong right you are we are not going to feel the same way we felt in most of the last 40 years. And if that's the case, you don't want to confuse your own experience with the expertise of understanding how these asset classes evolve over time. Right. So broadly speaking, what does a lack of liquidity do? It increases volatility at times, spurts of volatility. So we call it inflation volatility, lots of volatility, collapse of volatility. We can see, spurts of volatility. So we call it inflation volatility.

Lots of volatility, collapse of volatility. We can see a lot more of that. You're going to need to manage across of that. You can manage it by being diversified across inflation assets, growth assets, and bear market assets. You can manage it with volatility assets. But you're going to have to be more thoughtful than the easy markets of the last 40 years

of just investing in whatever you throw money at makes money. That's, I think, is going to be over. So yes, I think liquidity or lack of liquidity is going to play a big role, and you're just going to have to figure out how to manage it by diversifying and being more active. I could argue that the whole system is set up to not let that happen, to make the next 40 years repeat the last 40 years, right? You could argue that. The Fed and the banks. And I also wanted to bring up, which I was like, sorry about that.

Everyone will say, well, your experience in Peru, that couldn't happen here. So I don't know if there's a question in there but. No, I mean like we say that but then the markets as we know it don't function, right? In the 70s it happened in the United States, it wasn't hyperinflation, okay? So there's a different, when you have the most liquid market in the world that has the currency of the world, you're gonna have a different dynamic. But we saw what rising rates have done to both bonds and equities. I hear all the time, well, I can't wait for bonds and equities to go back to normal.

And the answer is no, that is normal for a rising rate environment. So people prior to 2022 said the Fed can never raise rates beyond 2%. It's just we're going to go bankrupt. Here we are. We have inflation at 8%. That could have never happened before. So it's not possible to have a properly working financial capitalist system without inflation being a lever.

Now, the Fed has not had to deal with that third dimension. They've been kind of been balancing on a two-dimensional scale forever, right? For the last 40 years, where if it's a bear market, they add liquidity without care for inflation. If it's a bull market, they take away liquidity. Now they're trying to balance on a bull

because inflation has become a third axis that they need to handle. We've had to deal with inflation for 100 years with the exception of the last 40 years, right? So now the Fed can't play that game. They can't control the economy the way that people have experienced in their lifetime. They no longer have full control. It's not an easy game to play and inflation is going to be a problem. Volatility is going to be a central tenet of the next decade and whatever volatility, inflation volatility leads to

all types of volatilities that are going on. You want to get on your macro horse there? No, no, no, I was gonna just do something like, where the liquidity comes from is people wandering in a situation when there's forced liquidations, essentially, right? Whether it's a group of people owning the same asset that have to sell for whatever reason. I think people probably got fixated on banks because obviously what happened in 0789, they're in an okay spot because essentially they don't house much risk anymore. So you're like, okay, everything's fine from that seat. I actually think where the greater illiquidity risk is comes from just investors in general more broadly, because I think everybody over the last 20 years has greatly reduced the liquidity in their portfolios from investment choice, going to more and more illiquid investment

vehicles from kind of traditional listed equities, bonds, so on and so forth. So the stampede event that causes massive illiquidity probably comes from issues with having an illiquid portfolio as a more general investor, in my view. But because of that, it's rather than 10 people that are the source of illiquidity, it's hundreds of millions of people, it can be tamped down for a long time. But when there's a consortium across all those people for a needed reason, whether it's, oh, geez, I can't afford my house anymore, so I need to go find assets elsewhere to service things. Whatever it happens to be the fulcrum, it can be a more dramatic

illiquidity event, but it's harder to achieve with the amount of people involved to cause it. Do you think Wall Street slash pension slash institutional investors have figured that out by going into private equity and private credit where they don't have to mark it down and so can keep it inflated and then there isn't the liquidity crunch just almost by definition because there isn't liquidity. Right. So it can starve it off longer.

Right. So you have fewer but likely larger events. Potentially and definitely. Yeah. Potentially and definitely. Which I don't think any of us believe. Sorry. Oh, you guys are still here?

Sorry. Yes. Just real quick, I would say that I don't think, maybe I'm wrong, but I don't think anybody up here would say that you should put 100% of your money with one of our funds. I think what we're really talking about is volatility as an asset class, what it does in a portfolio, what active management does, and what portion of your portfolio should be in that for the actual client. Some clients who are more conservative or some clients who just don't care, right?

Again, it's about an entire portfolio. That's why I'm sure everybody here, including us, when people call us and they want to buy our funder, we talk about the rest of our OCIO. This is how we look at theIO. This is how we look at the world. This is how we are seeing things. This is how infrastructure is going to help some of the infrastructure bill is going to take up some of these stocks. This is how it might hurt them. You know, you can make an argument for anything. I could make an argument that solar power is bad because the sun's going to burst out in two and a half billion years. But as a carbon life form, my time is limited here,

and I got to make hay, right? So it's got to fit what you're doing in the time period that you're in. But I absolutely believe that it should be a part of your portfolio. And it's reducing risk in ways that maybe you hadn't thought about before. Other people, they're telling you they're reducing risk. That's how i look at it young man in the back thank you for the recognition i think there's a lot of advisors who maybe embrace some views that we need a different kind of diversification in the current environment. They're wondering how to increase exposure to alternatives.

How would you recommend advisors strike the balance between the risk of reducing exposure to traditional asset classes? Like, you know, if investors are reducing exposure to 60-40 or whatever the investor thinks is the benchmark in order to put more diversifiers in the portfolio, then the advisor might feel like there's a risk of cracking your regret or advisors complaining if the markets actually do go on and run the same way they

did over the last four years. How do you guys think that maybe trying to fight the balance or efficiently add diversifiers to the portfolio while also trying to preserve the strategic allocations that clients are more used to? That's what we call a plant. Yeah, exactly. I was like, should I just toss it over there?

Do you want to tackle it? Yeah, actually, I have a terrible answer that Adam's not going to like. I don't believe I can convince anyone of anything. And trying to convince people to move away from what they have to what I have, I find a fruitless task. We're just trying to find people that believe in what we believe in, and then we work from there. And I know it's a tough answer, but I just think it's an impossibility. I'm never going to twist anybody's arm to do what we do. Most people hate what we do.

And so I have large allocations along volatility and CTAs, almost more than anybody I ever meet, and that's the way we run portfolios. And if people like it, great, I'll find those other weirdos. But otherwise, I can't convince anybody of anything. All right. I call BS on that. I think you don't give yourself enough credit. I think everybody here that has been speaking about this for decades, I just want to give you some props.

At the margin, we're not going to move everybody wholesale, but at the margin, you have changed minds and you have brought people to a more sane way of investing. So I think you are helping, you are changing, but the average advisor continues to have a hang up with 40 years of something that has actually worked. Again, their experience, their intuitions tell them that doing anything outside of a heavily equity-weighted little bit of bond portfolio is the only way. I keep being proven wrong every time I try to go outside of that. And so believe me, I know I've had these discussions for 15 years. And so I think we can talk a little bit about this, but overlay strategies is a way

that we found help people get their diversification while maintaining the tracking that they need to their benchmark. So in July of 2021, I realized that there was a bunch of ETFs and mutual funds out there that gave you more than a dollar for every dollar you invest with them. So there's an ETF that gives you 90% equities and 60% bonds. Our fund is basically risk parity plus another 100% in systematic global macro. We identified 10 different blocks of stacks between a beta and an alpha or two betas. And what you could do there is you could replicate a 60-40 portfolio by x-raying each one of these mutual funds securities and putting them together

in such a way where you get your 60 or 40, you give the client what they want, and then you tack on trend futures or systematic macro in the case of the paper that we wrote, which is return stacking, strategies for overcoming a low return environment if you guys want to look it up, and then really providing the advisor the opportunity to say to the client, not let's make space, but rather saying, yes, and. Let me give you what you need and something on top that has a zero correlation over time to your traditional exposure. So that's my way. I still am trying to do like the full Monty, which is super diversified, similar to what Mutiny does.

But I've also come to terms where I can help more people by allowing them to overlay on top of the thing that they care most about. And I know that that's something near and dear to your heart as well, right? Yeah, so we understand that that's problematic both from a tracking error and also a disruption of cost basis, you know, even if you wanted to get out of those equity holdings into something else, if they have a cost basis of zero that's a huge problem from a tax situation so we designed our program to only be implemented simply manage accounts by an overlay what does that actually mean and real people speak is your current asset base is non disrupted you don't have to sell anything to have us involved in your

portfolio we just get trading authority in the portfolio, limited power of attorney, and we just drop our trades directly into the account you already hold at whatever custodian your custody assets at. And that way, we don't disrupt any of your current holdings and we're just an additive to that current portfolio construction.

I'll add quickly. While the mic's passing over, that in futures accounts, right, you could argue, hey, client, you're buying T-bills over here to earn that 4% interest. You can own those in the futures account and access any of these programs with that same money that's holding the T-bill as a way to accomplish it. I would answer your question in a non-portfolio way at all,

and I would just say that everyone's a liar, okay? So when you say, I want to do this for my client, this, that, whatever, that's not what they really mean. Drill down further. Get their beta, right? When Netflix was trading 680, right? Every, oh man, if it gets down to 500, I'm going to get in there, right? Until it gets down to 500. And then you're like, wait a minute, there's a problem. And what's the beta of Netflix to the NASDAQ? And when Netflix is at 500,

that's because the rest of NASDAQ is down another 12%, right? And everything's on fire. Ask the client, push the client, what are you comfortable with? If that's what you're comfortable with, maybe they want a lot of risk, maybe they don't, right? There's all sorts of different things you can do, but you kind of have to push them. And you also have to kind of bring them to reality. Over the last 25 years, and this is no exaggeration, the way the U.S. government

calculates inflation has changed at least 25 times, Okay. You cannot, they can't just come into your office and bark out numbers and you say, oh, okay, that sounds right. Yeah, that's, don't believe the numbers. Don't believe what they tell you the risk tolerance is because I used to run an institutional desk and I talked to institutional managers and they did the same thing. If this stock ever gets down, yada, yada, yada. I'm like, well, it's not down there. So what do we do? Well, sell a put. That sell the put, the stock would be down and then the call crime, right? So push them, ask them questions. Say, what are you comfortable with? Oh, I see what your risk profile kind of

looks like to me. This is the bucket you should be in. Maybe you should be a little more of this. Maybe they're willing to take a lot more risk. Maybe a guy who's 30 years old and he's a dentist and he's making a crap load of money should be taking more risk. Ask him why he's not taking more risk. Find out what other problems you might have in his life. What is the flow that you should be in? And then you've got to construct a whole portfolio that's why a lot of our conversations from our fund just always lead into our OCIO well what else do you have because just coming

into our you know our couple of products that's that doesn't make sense right so it's just asking questions really understanding what risk you're comfortable with and then when it happens, all right, I was ready for it. Any other questions? Great question. So this is actually what we try to talk to our clients out, but we something where there is no clear natally related assets? Great question. So this is actually what we try to talk to our clients out, but we never get any traction on this. It's like we started off talking about everything in the world is implicitly short of all

or long ball and people don't take their life holistically into the approach. My partner had to, unfortunately, he coined the term, we use like an entrepreneurial put option, because we're entrepreneurs and we work with entrepreneurs and we think about their global risks right and so like that March 2020 to like 2020 so it happens that you know the pandy-wandy

happens sorry and so what do we do in that scenario right I think you know my my mom owns a single-screen movie theater gone right my dad sells machine tools gone my sister's a surgeon you think that'd be fine gone they can't even come in for elective surgeries so people don't think about their life risks, right? And then your house risk, your car risk. Like, everything in your life is implicitly short volatility. So it always boggles me how, you know, entrepreneurs, if they have anything left over, you know, with their business and their savings, they go out and buy S&P 500. They're just not leveraging up for a risk-on event, right?

They're just leveraging up that in that scenario so it's like how do you really hedge your whole life risk is a very difficult assignment of like you're saying you're taking basis risk but part of that basis risk what we find though is especially if we're going from a risk on low volatility environment to then a risk off high volatility environment you're gonna see that manifest in the SP 500 I mean it's the most liquid market in the world so that is going to be for those liquidity cascades. They're going to really get you caught with your pants down. You are taking some basis risk from your own individual life. But when you have liquidity shocks, it's going to manifest right in the S&P 500.

It's the most liquid market in the world. That's the way we think about it. I've had this discussion with my business partners where they're – we're quads, so we're very focused on basis risk. What is it that you're hedging against well if it's a bond market then you should hedge against the bond market if it's a commodity or gold you should hedge against gold but the reality is when it comes to your life that big illiquidity event is you want to you want to get the hedge in the most liquid market that you can and if it's something like the COVID crisis and everybody lost their job and you had a nice convex option there,

you're going to be better off with some extra cash, right? So definitely, I think we bonded over me asking you, like, I got a great idea. Let's go to the VC managers and let's sell, like, long convexity trades because, of course, what are they, nuts? Like, eventually this is all going to end. Maybe down 70%.

It's like you don't understand. Like they are marked. They're competing against each other. They need to beat everybody else. And anything that might suck a little bit of extra return on a given year is 100%. And he was right. Like I could not convince a single private equity person to add convexity to their life. Look at them now, right? I think we've had a pretty spectacular year for tech and VC and growth assets.

I think VC is, right, like a three beta or something to the NASDAQ. If you put the indices together, you could replicate with NASDAQ options. Of course, you could. Behaviorally, though, like you're saying. But even, again, I'm trying to convince people. I'm sure through our conversation we've convinced one or two people to put some, hopefully, fingers crossed. But even a little hedge would have helped. Great panel.

Absolutely. John and Kevin and everybody else. I'm going to throw it to Jason because I actually heard you speak last fall at John's event in Miami, so thanks again. But everybody, I just thought, how do you get beyond the negative connotations? You guys both talked about Buffett, but are we going to be talking about Buffett and

Fink and everybody else in a way talking negatively about doing overlays when, then again, they go ahead and are probably one of the biggest users of it, right? So how do you, through an advisor community, how do you kind of get past that negative connotation that it's like, you know, you should eat healthier

when you go to a gym, you should exercise all the time, we don't always do it, it's like the overweight doctor that tells you to do it. When you're saying like Buffett, like, oh, stay away from those derivatives and those hedges, and then on his left hand, right. Well, back to Luke like Buffett, like, oh, stay away from those derivatives and those hedges. And then on his left hand, right. Well, back to Luke on Buffett. I mean, everybody lies, including Buffett, right?

Like Buffett does, derivatives are, you know, the last thing he'll touch, except he does buy a bunch of derivatives. And he has throughout his career. He'll never touch crypto, and yet he buys a bank that deals exclusively with crypto. Like, it's just, I don't know how to figure out Buffett and his investment style, but I can tell you that, you know, he's certainly focused on American exceptionalism, and that's kind of worked out for him. But Buffett has captured assets through his insurance vehicle. And if I had captured assets,

I'd probably be taking a lot more risk than I am. But again, in a non-ergotic system where you got to take care of yourself and your liquidity over the next three to five, 10, 15 years, you need to focus on safe withdrawal rates. There's no insurance against your assets going kaput. You need to make sure that you are that you have a smooth ride in your lifetime and in the vast majority of advisors and individuals that we

talked to actually do understand the attacks of a high volatility investment. They do understand safe withdrawal rates so I tried to to talk in that language and say how do we make it so that you're not suffering from a sequence of returns risk right that we saw in the 2000s they're like a lot of people live through 2000 to 2010 zero return in the equity market in nominal terms right we had a bit of inflation period there in the middle so kind of just try to pull them back into what is this for it's for a safe withdrawal rate at the end of the day the only way to do that is through through having non-correlated assets and the only way to do that is through having non-correlated

assets and the only way to do that is to be globally diversified outside the United States to diversify against inflation risk and to diversify against bear markets. And then you just explain your solution to them. It's roughly helped over time. Yeah, how we think about it is our services are more of a tool rather than an allocation that tool is meant to be used and for a specific use case ie be negatively correlated to equity exposure and then have the conversation of what are you going to do with the proceeds from that tool and keep everybody on track for that but then on top of that we were kind of just a very vanilla description of what to

expect from that tool from kind of a day-to-day, week-to-week, month-to-month basis. And so nobody does 100% overlay day one, 10%, 25% overlay of their equity exposure. But after they see it do what it says on the tin over and over and over again, that's ultimately how you gain comfortability of utilizing an overlay within the portfolio. And that's why we're focused on more, you know, it's an instantaneous reaction to the market. Market goes down 1%, 2%, 3%, 4%. You should expect us to actually create positive returns in those smaller environments rather than the once a decade.

And we really, you know, there's investment reasons why we do that as well um but having something that has day-to-day reactivity to portfolios in a negatively correlated means and you know quasi does hopefully in a consistent manner when it says in the tin that's how we kind of get folks comfortable with utilizing services in the overlay community can you define what it says on the tin for Tracy? Does anyone do the Smart List podcast? No, they won't get that Tracy joke, but go ahead. What does on the tin mean? That we're negatively correlated. And so, you know, you should see us 90% of days, you know, do the opposite of what the market is doing. And that we're targeting capturing half of the

downside in the S&P 500. So S&P down 10. Hopefully the overlay is up approximately 5. On the other side, there were a 20% drag. S&P up 10. Expect the overlay to be down 2. And we're very clear that this is negatively correlated. Expect it to lose money when the market is up. But we're delivering, hopefully, those positively symmetric returns that are instantly available within your portfolio. And so that's the 10 that we're hoping. All harvesting losses for the tax. Right.

That's the two sides of the coin. You utilize your losses during the up years to raise cost basis within your portfolio, adding value even obviously when we have a negative impact, and then on the way down utilizing those proceeds to accumulate additional assets. All right. I think we're out of time specifically because there's a vocabulary question and unfortunately I was perfect vocabulary question because in the uber right down here said now we're talking about overlays he's like if you ever heard me say overlay because like once again overlays become a pejorative and the hard part is like as what happens whenever we turn mics on

apparently the the letters in our vocabulary increase and we all get more verbose but what I find over time when with clients is that the simpler I can make things the better because you need that emotional buy-in before you get the intellectual buy-in you can follow up with all this fancy quant talk later but I found that we as simpler as like I started the right at the beginning offense plus defense so it's not about like overlays because yet we change everything like what drives me nuts in the Bay Area these days everybody's talking about riff a reduction in force right we used to call it getting fired

getting laid off getting made redundant we're constantly changing our vocabulary to make everybody feel good or somebody blows up an overlay or somebody blows up portable alpha now we got to call it by a different name and so i just like to go for the sake of simplicity get the emotional buy-in just use like a word defense and later on we can talk about very specific definitions of what that means. All right. I think we're going to call it there. We ran a little over. These guys will be up here afterwards. If you have any other questions, I want to talk to them one-on-one. And then I think when everyone registered, we have your email. So we'll send out all their tear sheets and how to follow up with them. Yeah. Thank you all. lunch. Thanks to Jeff Berger, our editor and producer, who took a feed from a crew down there and made it into a pod for you up here. And thanks to Jason, Zed, Rod, and Luke for sharing their

expertise. We'll see you next week. 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 our blog or subscribe to our newsletter at rcmalts.com. If you liked our show, introduce a friend and show them how to subscribe. And be sure to leave comments. We'd love to hear from you. This podcast is provided for informational purposes only and should not be relied upon as legal, business, investment, or tax advice. All opinions expressed by podcast participants are solely their own opinions and do not necessarily reflect the opinions of RCM Alternatives, their affiliates,

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