We Study Billionaires - The Investor’s Podcast Network - TIP308: Trend Following Investing w/ Niels Kaastrup-Larsen (Business Podcast)

Starting point is 00:00:00 You're listening to TIP. On today's show, we have a veteran of the finance industry, Mr. Nealz-Kostrip Larson. Nealz has been part of the hedge fund industry for more than 25 years, and throughout that period of time, he's implemented a trend-following approach to investing. Through this episode, we discussed the specifics of this style of investing and how it's so different than all the other styles we've ever covered in the past. So without further ado, here's our interview with Nealz. You are listening to The Investors Podcast.

Starting point is 00:00:31 where we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. Welcome to The Investors Podcast. I'm your host, Dick Bruterson, and as always, I'm here with my co-host, Preston Pesh. Today, we also have Niels Kostrop Larsen with us. Niels, thank you so much for joining us today. Thanks for having me. It's great to be here.

Starting point is 00:01:05 So, Nils, I wanted to start the episode off with a story that I think is very telling whenever it comes to today's topic of trading and trend following. You're one of the few people who has interviewed the famous commodities trader, Richard Dennis. And to set this scene for the interview, could you please tell the audience more about who Richard Dennis is and specifically the legendary story of his turtles? So Richard Dennis is a legendary futures trader who worked in the pits of Chicago back in the 1970s, 1980s, and who reportedly turned a few thousand dollars into 200 million dollars over a decade

Starting point is 00:01:45 or so. But what's really fascinating about Dennis is that despite his own trading success, he actually believed that what he did could be taught. Now, so as you mentioned, Dennis is a trend follower. his approach to investing, which really means that he's looking for big breakouts or momentum in the price of the market. And in his case, he was trading futures to identify a potential big move-up or big move down. And not only that, he was a systematic trend follower, meaning that he had rules for what would essentially constitute an entry point as well as an exit

Starting point is 00:02:23 point of any of the trades. Now, so he was also a firm believer that emotions are investors, worst enemy. And I think many of us will know that to be true. And because he had overcome this fact by using a rules-based approach, he believed that you could teach you to other people and that you did not need to have any special background or skill in order to be successful, as long as you could do one thing, and that was follow the rules. So in 1984, he established the first of two classes of students. I think there were like 15 or 20 in each of these classes. And they're the ones that became known as the turtles. And essentially, he taught them for two or three weeks, I think, some simple rules before he would let them trade his capital.

Starting point is 00:03:13 Initially using those rules and then later on, they adapted and improved upon these rules. But to make a long story short, I mean, the turtle project was a big success. And over the four years or so that it ran. My understanding is that the turtles did really well for Richard Dennis. And actually early on in my own career, I worked for perhaps the most successful turtle, namely Jerry Parker. And for those who listened today who are familiar with my own podcast, they will know that I've done many episodes with Jerry. But also, as you say, you know, I've been one of few people who have had Richard Dennis on the podcast, but I think what made it really special was that he was joined by two of his original turtles.

Starting point is 00:03:53 I'll finish this little turtle story by saying that there has been a lot of speculation surrounding the story because Richard Dennis had a business partner back then called Bill Eckhart and allegedly they had different opinions about whether you were born a good trader or whether it could be taught, kind of this nature versus nurture experiment. So for decades a lot of people talked about how they had made a bet and actually that this whole bet was inspired by the movie that came out, I think, around the same time called Trading Places with Eddie Murphy. But at least Rich told me when I spoke with him that there never was a bet. And certainly it had nothing to do with any movie. And in fact, he shared that

Starting point is 00:04:38 he thought of the experiment on a Sunday afternoon whilst drinking some Johnny Walker Black. So, Niles, you are talking about rules-based in that this could be taught. Could you talk about whether the most successful trend followers change the rules, if yes, how often? Talk to us about this idea of kind of changing the rule set, because I would think that that's probably something you don't want to tinker with if you get something that's working. I mean, I think the best way of talking about this is maybe using a concrete example from the firm that I work for, because at Dun Capital, we're actually one of the oldest trend following firms in the world having been around since 1974.

Starting point is 00:05:20 So you could say for sure that we've been through a number of different market cycles. The challenge you have as a rules-based manager is, as you allude to, I mean, every time you make a change, there is the risk that you are going to get it wrong. So first and foremost, I would say in our own case, we very rarely make meaningful changes to the system. And in fact, I would go on to say that from 1974 to about 2006, we didn't really make any major changes at all. Returns were strong, and let's call it that they came with a healthy dose of volatility,

Starting point is 00:05:58 but our clients were okay with that. So there's very little reason to change something, as you say, that was already working. If it ain't broke, don't fix it. But what has led us to start evolving the strategy in the past 20 years or so was really the recognition that trend following is a really hard strategy for most investors to hold on to because returns are lumpy, which means that we tend to make money in very few months of the year and we tend to have more losing months than winning months. But of course, the reason why it works is that when we do have strong performance, it's typically much

Starting point is 00:06:33 more than the typical sort of losing month that we have. Now, most investors, frankly, they prefer the steady return stream like Bernie Maita's produced. until it was clear that it wasn't real return. So I think there is a saying something along the lines that the seduction of safety is often more dangerous than the perception of uncertainty. And I think that's really true when it comes to investing. But to answer your question, we've made about three or four major changes when we come across some really important discoveries.

Starting point is 00:07:07 And a lot of it has been to do with how we manage risk and how we get out of trade. because actually identifying a trend, and I'm sure many of your listeners will know this, identifying a trend is not that hard. Frankly, you could almost do it with the naked eye looking at a chart. It's much harder to figure out how much to risk on a trade and also during the lifetime of a trade should you change your exposure and also, you know, when is the trend coming to an end? So those two things, in my opinion at least, has always been the weakness of trend falling.

Starting point is 00:07:40 our losses tend to happen when there are either no trends and when there are big reversals in the markets. So we work very hard to find ways to improve that because if we can improve on this, what you'll end up with is better risk-adjusted returns. And you could say that the journey we've been on at least is really to try and deliver trend following in a better package. I think a lot of people forget actually that investing in stocks,

Starting point is 00:08:09 for example, is a kind of an 8% return strategy, but with 50% plus drawdowns from time to time. And we really want to do better than that. But let me also stress that we're very humble about the markets and we're still students of a trend following. There's always ways to improve what we do. And I think it was a Leonardo da Vinci that at least he's quoted for saying that simplicity is the ultimate sophistication. And that's really what we're trying to do.

Starting point is 00:08:41 Create something that is simple, but not too simple, but that can handle the complexity of global markets. It sounds to me like you somehow figured out a way to apply the Kelly criterion to the way that you're looking at the trends and saying, hey, this is one that we need to put more money on or more position size on because the trend is so strong relative to these,

Starting point is 00:09:07 other investments. Is that an accurate characterization? I think that's a pretty good characterization, absolutely. And I think the challenge is that, as you say, you want to build confidence in your position to those things that turns out to be a really strong and long-lasting trend. At the same time, you want to be able to get out of those positions that, obviously, one, don't work from the beginning, but actually also when you have been in a trend for a while and suddenly things change, you want to get out quickly. And I think the challenge we've had as trend followers is that the old style of trend following or the original style of trend following was to get in slowly and get out slowly. That's kind of how it worked. And so going back to my initial point about why we didn't

Starting point is 00:09:53 change a lot from 1974 to the early 2000s was the trends were pretty long. And so that kind of timeframe worked really well. In fact, we've done a study on our side where we go back to 1990 and we look at what would have been the absolute perfect time frame in terms of what we call the look back period for our trend model. And we look at each year to see whether that would be 20 days or 200 days or 300 days, really a wide range of possibilities. And what you see is that it changes dramatically from year to year. So just from recollection, in 1990, I think the best look back period was only 20 days, like three weeks, which is very short term. Then the next year, it was 40 days, which is twice. And then in 1992, it was 260 days, right? So you get this

Starting point is 00:10:48 massive, wide range of possibilities. And one of the things we've done in our firm, which is really hard to do, I think, but something we cracked in around 2006 is to completely systematize how we select these time frames inside the model. So that, I would say, is one of the game changes for us, because we don't want to have any kind of discretion into the system. As soon as you do that, you can forget about all your research and backtest. You have to trade what you test and test what you trade. There's no in between. But it is definitely a challenge. And as you, both of you know well and your audience, markets keep evolving. I think this year we've seen that we've had the quickest sell-off in history. So yeah, it's a continued process to evolve.

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Starting point is 00:15:56 multiple times on the podcast about the holy grail of investing, which is having 15 uncorrelated assets because the idea is that it will provide the best risk to return ratio. So having you on this show now, I think, is very interesting. interesting because we haven't really been covering trend falling like that before. So how does trend fall into this thesis? So first let me say that I actually really like the way Ray Dalio explains the benefit of diversification and how this can really be a game changer for a portfolio. If, as you said, Steeke, you can find truly uncorrelated assets. And this is where the trouble start, right? Because many of the so-called alternative investment strategies that people have been

Starting point is 00:16:39 toll can be a hedge, quote unquote, when equities go down, have shown to be much more correlated and especially during their time of crisis. So to answer your question, the reason why trend following on a diversified portfolio of markets, meaning both financials and commodities, is so powerful to include in a portfolio of stocks and bonds, is because generally it's not correlated at all with stocks and bonds in the long run. So again, if I think of our own experience, so since 1974, our correlation to the S&P is minus 0.05, which is essentially zero. And that's ideally what you want.

Starting point is 00:17:23 But what is important to understand is that it doesn't mean that we have zero correlation all the time. We can be positively correlated when stocks grow up. we can be negatively correlated when they go down. So it's not a fixed correlation. And the other thing that I have come to appreciate over the years is that the key thing to understand is that non-correlation is probably more important than excess return, meaning that if you can find an asset that gives you a slightly better

Starting point is 00:17:54 return than your stock portfolio but is highly correlated, it won't do as well as picking a non-correlated asset even if it gives you a slightly lower return. And I think this is quite counterintuitive to people. Speaking of this, I came across a study a few years ago where the author had essentially created like a million random portfolios with different weights to traditional assets, but also including trend following. And one of the things they had tried was to across these one million-inch, was to see if an allocation to trend following of 30% would increase the overall portfolio

Starting point is 00:18:35 risk-adjusted return. And can you guess in how many cases a 30% allocation to trend-folling improve the risk-adjusted return in all 1 million portfolios? So this is obviously really interesting to me, and also at least from my experience, I've never come across a white paper that suggests that adding trend-following to a portfolio of stocks and bonds won't be beneficial in the long run. So then to answer your other part of your question, and that is, you know, so you have diversification in your portfolio, which is really important, but what about the diversification inside

Starting point is 00:19:11 the trend following portfolio? How does that play into it? And I would say that that is equally important. In fact, I would say it's vital because a lot of people think that the secret source to trend following is the rules, where to buy, where to sell. But frankly, a lot of people unfortunately end up saying, okay. okay, I'll just do trend following on my stock portfolio. But trend following on a single sector or a single market may not work for a long period of time.

Starting point is 00:19:36 The secret is that you trade it on many truly different markets. So in our case, we have commodities like grains and energies and metals and meats and softs in order to deliver these attractive returns. Now, here's the downside to this, and that is the challenge many managers come across. and that is, if you want to grow your business really big, then at some point, these smaller markets, these commodity markets, which are the least correlated in your portfolio, become too small for you to have a meaningful allocation to them. And if you're tempted to kind of overstate your capacity to build your assets, then actually your returns most likely will be lower over time.

Starting point is 00:20:22 And that, I think, has hurt our industry to some extent. The other thing, which is super interesting, which is something that I also came across recently because of what's happened this year, when you go back and you look at crisis periods, and you look at your portfolios, and you look at the various different sectors that you have in your portfolio, and we all think about crisis as equity market crisis. And I think it's very tempting for people to believe that because trend followers can go long and short, that we can make a lot of money from the short side in equities when they have like a 35% drawdown. But actually, what you find is that the most consistent performing sector going through

Starting point is 00:21:04 all of the crisis we've had in the last 40 or 50 years is commodities. And this is, of course, because there are a lot of things happening when you go into a crisis, right? So that kind of diversification is really interesting. and just to maybe take one step aside from this and something that I noticed just in the news this week and I know this is obviously near and dear to your hearts and that's someone like Warren Buffett,

Starting point is 00:21:30 I'm not an expert in Warren Buffett, but to me he's always stood of someone who kind of argued for diversification, he invests in many different businesses, et cetera, et cetera. But I noticed because of the success of Apple recently that right now he has like a 43% experience, in his portfolio to Apple. So I think it's just an interesting point because you do need to find the sweet spot

Starting point is 00:21:54 between diversification and conviction. So I'm not saying that you can't end up with, from time to time, you know, a large exposure in a certain sector, for sure. But it also is so, you know, for example, when I meet investors who come up to me and say, oh, great, you know, I have an allocation to trend following in a portfolio.

Starting point is 00:22:13 And of course, I say, that's fantastic. But then you learn later on that it's like, two or three percent. And that kind of, you know, it kind of sinks your heart because you know that it's not enough to make a meaningful impact on the portfolio as a whole. So it's a lot of different things to take into account. So Niles, you had mentioned earlier that Dunn Capital was founded back in 1974. So what I find interesting is many younger generations are pulling data from the past and trying to develop whatever their model is. You've been doing it with real data. So what does your data show about trend following since 1974?

Starting point is 00:22:50 And I'm very curious what your thoughts are on about the last three or four years compared to the 1974 to now time period. Because I think what we're seeing in the last couple years just from a performance standpoint seems like it's kind of a standout. You're absolutely right. I mean, there's definitely benefits of having a 45-year track record. There are some drawbacks as well because we tend to have had drawdowns along the way, which people who just look at back-tested performance never show. But the most important thing I find from having been around that long is that you have this real experience and experience from really some hard-learn lessons

Starting point is 00:23:32 that you can use in your research. One of the things you learn when you go through difficult times is, of course, back to one of your earlier points, you know, the temptation of changing your model when you're losing money is very high, but it could be devastating if you did. So I think real experience is important. Now, so to answer your question, the type of trend following that we do have stood our clients very well, I would say. And actually, I just want to add one thing, which I think is important for a context point of view. And that is, when we talk about our clients, we really look at them as partners in this journey and we demonstrate

Starting point is 00:24:10 that by never having charged a management fee for our services. So we actually only make money when we make money for our clients. And we think that's the fairest way to treat investors. But this is important because it informs us in terms of how our research should be done. But let me be a little bit vague here because of regulation. I'm not really allowed to say how well we've done, unfortunately. But of course, if your listeners would go to our website and accredit themselves, they can see all the data. But what I can say, and I think this is relevant to answer your question, we have made three really big improvements or two major improvements,

Starting point is 00:24:49 I would say, over this period. So in 2006, we made a big improvement, and in 2013 we made a big improvement. And so what I often like to do when we think about, you know, have returns changed, because everybody remember the 70s and the 80s and the 90s and think about certainly in our world, those being much, much better than in the last 10 years or so. So when I look at those three different periods, so you have 35 year, you have a 14-year period,

Starting point is 00:25:17 and you have a 7-year period. If I look at our annualized returns, they're almost identical. And so this is important for two reasons. One is that, as mentioned, a lot of people have complained about performance in the last decade or so because of the central banks and how they have manipulated the markets and trying to control the markets.

Starting point is 00:25:38 Now, I would say that it has not been easy, and I will say the last five years has not been great, but, you know, again, if we go back seven years, actually our returns are pretty much the same as we've seen in the last 35 years. So that's one thing that's important. But the other thing that's from our point of view that we focus on is, okay,

Starting point is 00:26:00 so if we've delivered the same level of return since 2013, have we done that through research with better drawdowns, with less volatility? And the fact is yes. So the journey we started in trying to deliver this in a more appetizing way by making these improvements is really turning out to being delivered to the investors, but not in terms of more performance, but actually in terms of same performance, but less volatility, which is something that people generally tend to like. One thing that's also interesting about the track record that you have, Nils, is that very few people,

Starting point is 00:26:36 on contrary, have been doing trend following when interest rate have been going up. And we're in this interesting point in the interest exile today, but let's not forget that they were going up until 1981 and then actually been going down since. That's a long-term trend. So how is trend following different types of interest rate cycles? When you look at trend following returns, you know, as you say, most firms haven't been around that long, so they have generally all of them been trading through a period of falling interest rates. And there is no doubt if you look at the attribution of return from the CTAs in general, a lot of

Starting point is 00:27:13 it in recent years have come from the fixed income sector, short-term interest rates and bonds. But as you rightly said, I mean, we have actually traded through a period of rising interest rate. I think it was like 1976 to 1981 in particular where we saw quite a long period of significant rise in interest rates. And when we look at our track record, we did really well during that period. Of course, that's not a guarantee about any future returns and what they will look like. But what I will say is that since we can be short as easily as we can be long in a market, My belief is that trend following is one of those strategies that can do well when we do see a return to higher interest rates. This is actually also interesting in another way because in the last 20 years or so, we've had this perfect correlation between stocks and bonds, right?

Starting point is 00:28:09 The 60-40 portfolio type approach has looked safe. But if you go back more than 50 years, you'll actually find that more than more than 50 years, you'll actually find that more than often than not. So I think it's around 66% of the time thereabouts. Stocks and bonds are positively correlated, which means they go up and down together. And so when that starts to happen again and we get into sort of more normalcy in terms of correlations, there's going to be very little or no protection to be had inside the 6040 portfolio. And then you also asked about, you know, the various sectors and how they perform. Interestingly enough, for example, equity sectors, of course, when you have slow upward moves in equity markets,

Starting point is 00:28:53 as we have seen from time to time in the last 10 years for sure, equities is a great place to be from a trend following point of view. The challenge what we've seen in recent periods with the equity sector is that on several occasions now, it has gone into deep bear market territory straight from an all-time high. And trend following, of course, you have to be long as long as the market goes up. That means that typically we as trend followers will have the largest long exposure right before the market turns. So we saw that in February of 2018.

Starting point is 00:29:29 We've seen that in February of 2020. You know, when you go through a crisis, equities actually, as I said earlier, not the place where we make a lot of money. We tend to make it in other places. And yeah, so, but this is why you have to be diversified, frankly, not just, you know, in your own overall portfolio, but certainly also from a trend following point of view. So Niles, here at the Investors podcast, I would say our roots of our audience, and I know Stig and myself included, it's all about Warren Buffett-style value investing. So for many of us not familiar with trend following,

Starting point is 00:30:08 what are the first few important steps to take us as we learn about this and to help us understand just the methodology and the approach? First of all, I mean, if you look at just any market really, a value investor would be looking to buy a market that is moving down, right? The cheaper it gets, the more value you can get from it. So that's kind of the first main difference. We as trend followers would never be buying in a falling market. So when it's cheap enough, value investors would get into the market and as the market moves

Starting point is 00:30:42 back up to say fair value, you get a lot of the benefit of the trade will come in the initial phase. And of course, if the market moves up and becomes expensive, then this is probably a time where value investors would start thinking about getting out. So again, from my experience, you kind of lift this buying low and selling high mentality. And now I started out as a bond trader, so I'm fully familiar with the benefits of buying low and selling high. But then I came across trend following, which is really the opposite where you buy high, because we're waiting for this breakout to show up,

Starting point is 00:31:18 the momentum to come in, and then hoping you can sell even higher. So from just comparing trend following to value and why I think they're a good match, is that, okay, trend follows won't be buying at the low, for sure. We're going to be weight and we're going to be patient until the market starts to show some sign of upwards move. On the other hand, we don't have this concept

Starting point is 00:31:38 of something being too expensive. So we'll be, quote, unquote, stupid enough to stay in the trend for as long as possible, whereas maybe value investors have already left. And I think maybe just speaking at this moment in time, Tesla is a great example of that, right? Because a lot of people didn't expect Tesla to be able to go this high. Now, we'll say we don't trade single stocks for Tesla, but the concept is very important. And what I found really interesting is that I found this, and I think this ties into a lot of points in terms of our conversation today, also as to why you may want to consider

Starting point is 00:32:17 using rules rather than discretion in your approach, because I think it was Barron's this week came out with an article showing the quote-unquote the analyst's price target for Tesla. And the highest was something like $2,300 and the lowest was $300. It just shows you how difficult it is to assess the price of anything. And of course, both of them are quite far away from where the actual price is. And I think consensus is like half of what the actual price is. So, yeah, I think marrying discretionary type trading with systematic trading that gives you diversification on investment approach, value and trend.

Starting point is 00:32:59 Also, in my view, seems to be going well hand in hand because it's just another form of diversification. Let's take a quick break and hear from today's sponsors. No, it's not your imagination. Risk and regulation are ramping up, and customers now expect proof of security just to do business. That's why VANTA is a game changer. VANTA automates your compliance process and brings compliance, risk, and customer trust together on one AI-powered platform. So whether you're prepping for a SOC 2 or running an enterprise GRC program, VANTA keeps you secure and keeps your deals moving.

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Starting point is 00:36:44 Perhaps that's whenever you really need to stick with your strategy, because we just can't handle that volatility. But I'm curious to hear if you could talk a bit more about how trend following strategies have performed in previous crisis because you have actual data on that, but also how the COVID-19 crisis is different, if it is different. So in our case, we've been through, I would say, four crises that most people remember, right? So we had Black Monday back in 1987, then we had the tech bubble in year 2000, then the great financial crisis in 2008.

Starting point is 00:37:18 Right now, 2020, we have COVID-19. And that probably is still unfolding, right? So these crises are very different. Black Monday was a relatively short crisis, only a few months. The tech bubble was the longest in time. The great financial crisis was the deepest in terms of stock market losses. And then COVID-19, so far at least, has been the quickest, both going down and going back up again.

Starting point is 00:37:45 So all of these things presents a lot of challenge for any investors and, of course, for trend followers as well. What I can say from our actual data, as you said, we've done well in all of these four crises, and perhaps that's because we kind of blend a couple of different types of trend following techniques together. But what I will say, which I think is maybe less talked about, is that in order to be successful through periods like this, you really have to overlay your strategy with a very strict set of risk management rules and framework. So what decides whether you do poorly is not just

Starting point is 00:38:27 based on the signals where to go long and short. It's very much dependent on how well you manage the risk. Because keep in mind that no investor can control the return. You just don't know what kind of return we're going to get from our trades. But what we can control is the risk we take and how we manage the risk. would say we spend a lot of time trying to become the best risk manager that we can. And I'm sure the next crisis is going to be different from the previous one. So I mean, of course, I'm incredibly biased having done this for more than 30 years. But what I truly love about trend following is that it's adaptive, right? So we only look at price and we don't have any preconceived notion as to how those prices should evolve and how they should change. And so

Starting point is 00:39:17 So this is probably why we've been able to handle many types of environments. But let's be fair, we don't do well in all environments. If you have short-term sell-offs that jump back straight away, I mean, I can think of February of 2018 as one of them. That was not a great time for a trend fuller, but it's only one month. And that's what people have to recognize the importance with any investments. And I know you guys believe in that as well. it's really having the patience to stay with the investment for a long period of time.

Starting point is 00:39:52 Now, as you were talking about risk management and whenever I think about trend following, I think it's so important to get something that when the trend changes that you have this sense of it continuing in the direction that you think it's going to go. And so when I'm thinking about how I would manage the risk of something being super volatile and reversing that trend that I'm expecting to continue to go in a certain way, I would think that the market capitalization, the size of the particular pick that you're buying, would have a huge part of managing that risk. Would you agree with that?

Starting point is 00:40:28 Yeah. So the way I would think about the question a little bit differently is maybe to say, so if you were a trend follower and you only had one entry point, right, and one exit point, yeah, I mean, this becomes incredibly important, but that's not how we do it in real life. Essentially, we want to build up confidence in a market. market right. So we do it across different time frames, we do it across different levels of momentum indicators in order to have this gradual move in to a position. And as I said, sometimes it's a gradual move out, sometimes it's a quick move out if markets really change. So I do think

Starting point is 00:41:02 this is what makes it challenging, certainly for individual investors to try and do it themselves. I'm not actually a big proponent of kind of DIY trend following, simply for the reason that you need a fair amount of capital to get enough diversification across markets, across timeframes, because otherwise you end up becoming incredibly reliant on, as you say, on one specific price, one specific correction, and therefore the returns may look very different to what you expect it. So that's another challenge for sure. I'm really trying to wrap my head around this combination of value investment and trend following. And it's sort of like connection to Preston's question before about like where should you go from here.

Starting point is 00:41:45 Because I guess what I'm as so many other investors are looking for is whenever my normal value investing portfolio is not performing, then what will it perform? And so you were talking about February of 2018 before, for instance, and you said, well, trend following didn't do too well. Value investing, it wasn't like value investing did do well compared to the rest of the market, but like everything just fell at the same time. So how does trend following play into this? I think the answer is that investors are deep down looking for something that can make the money when equities go down. You can come with all sorts of reasons why people would consider trend following. But I think it all comes down to that one point. You want to find something that can make you money when the rest of your portfolio is going down.

Starting point is 00:42:31 And this is what became known about 10 years ago as crisis alpha, right? So when there's a crisis, then can we produce some alpha? And when I heard that concept initially, I was really excited because I thought, wow, this is something that a lot of investors can hold on to because it makes sense and it's easy to understand. The challenge is that over the years, the definition of a crisis have changed. So before 2011, we thought about these crises as I mentioned, the dot-com bubble and the debt crisis or the great financial crisis, and they were like a year and a half, two-year crisis periods.

Starting point is 00:43:11 Then come something like February of 18, and it's like one month. In fact, I think it was 12 days, the markets went down and then they went straight up again. For us, that's not a crisis. So you have to look at these things in a much longer time horizon in order to see the benefit of combining these things like you have to really with all types of investments.

Starting point is 00:43:33 Now, what I can say is that leading into, February of 18 from a trend following point of view, most trend followers had made significant amount of money, especially in equities. So frankly, what happened in February of 18 was we gave back about half the profits from the previous four months, which is okay. Over a five-month period, trend followers were still doing well. But it's just not to say that it's a hedge. And I think this is the danger. And this is also why I think hedge funds have become a little bit of a sole point with many investors because they use the word hedge in the name. We're not a hedge. We're an uncorrelated return stream and there's a huge difference between being a negatively correlated, are you

Starting point is 00:44:15 a hedge or a non-correlated? As we talked about earlier, sometimes we will be highly correlated to equities because if equities go up, we'll be long for sure and so on and so forth. But you're right and I do think that the next five or 10 years, given what's happening in the world right now, I know from listening to many of your podcast episodes, that there is a lot of concern out there in terms of what the world could look like, and we are in a slightly different place from where we've been before. And so I truly believe that the next five or ten years, what will make or break your portfolio is whether you get the strategic asset allocation right.

Starting point is 00:44:51 And so back to Ray Dalio and his holy grail, I think that is the only thing we as investors can do, and that is to try and find things that are truly uncorrelated, not on a daily basis, not on a monthly basis, maybe not even on a yearly basis, but in the long run and then build something whereby you don't have to sit and worry about your portfolio every single day or every single month. We had a call here not too long ago, and we were talking back and forth about this interview here today and what we want to talk about.

Starting point is 00:45:22 And the one comment you had was, to be successful in trend following, you just have to fight against all your basic human instincts. And I sort of like that statement. Could you please elaborate on that, especially for those who have been doing that trend following and have tried to go through the pain of fighting against everything that you think is true and right? From an overall point of view, you could argue that nature could not have designed a worst investor than you and I, right? So in every single way, we've evolved, right? So we've evolved for immediacy and instant gratification.

Starting point is 00:45:55 We've evolved for certainty. We've evolved for taking action. But success in investing really takes dealing with uncertainty. It takes restraint. It takes patience. And it takes not listening to your own God, right? So when you combine our kind of human design with CNBC and Bloomberg, where you constantly have this breaking news and trade recommendations, which of course deep down are only qualified

Starting point is 00:46:24 guesses about an unknown future, it really sets a lot of investors. for disappointment when it comes to making the right decision. And I think, in fact, I think there was a study or something that was published by Fidelity where they had done a review across all their client accounts and found that those who had done the best over the long run were typically people who had either forgotten that they had an account in the first place or they had passed away, i.e. people who did not do a lot of trading. And so this is actually quite topical for our time. discussion right now because we have this huge resurgence in day trading with the Robin Hooders.

Starting point is 00:47:05 Unfortunately, I think that when the next bear market comes, I think a lot of these investors will be completely wiped out. So one, there's a clear correlation between activity and investment performance. Those who do the worst tend to be the ones who ironically keep the closest eye on the markets. And I think it was Jim O'Shaunisei who wrote in the book, What Works on Wall Street, something like the first thing you have to do as a behavioral investor is to recognize that you are just as susceptible to the same dumb mistakes and crippling behavior as the next person. So we need to be aware of that. But of course, there are certain biases that I think I was referring to when we spoke initially.

Starting point is 00:47:47 And that is things like ego, right? We have this tendency to be very overconfident essentially. And we see this in many different ways in life, right? If you ask someone if they're considered themselves a good driver, I think you'll find that a huge percentage will say, yes, I'm a great driver, right? I even heard about a study where they asked, I think something like 700 men, if they thought of themselves as good looking. And again, you have this huge percentage saying, oh, yes, almost to the point where you feel

Starting point is 00:48:19 that they're like only five sit-ups away from dating a supermodel, right? And so overconfidence is a big problem for us as investors. The other thing is that we're very conservative as people, right? We like the status quo. We don't really like change, which is very hard to deal with when it comes to investing because it changes all the time. And of course, the other thing which I think Kahneman came out with is that we have this different perception of gains versus losses.

Starting point is 00:48:46 Losses feels much harder on us as investors, which leads us to take the wrong decision at the wrong time. Then another bias I can think of is we have this, I think, It's called attention bias, where we think of the possibility of really a dramatically bad outcome much more than the probability of it actually happening. And so, again, with the fear we have can often play with our decisions when it comes to investments. And then, of course, we have emotions we have, generally speaking.

Starting point is 00:49:18 It really does cause investors to overall underreact to information, I would say. So this is really why trend following in a sense is different, right? Because we want to take out all of these emotions and biases from the investment strategy and just follow rules and not trying to predict anything. And interestingly enough, at the end of the day, it comes back to human behavior. And so if you take an example from the equity world, just to take a step away from trend following, one person that has really worked out human behavior very well is Amazon's Jeff Bases. because what he's basically built his business on is specific behaviors that he felt would never change,

Starting point is 00:50:02 namely that we would always want things as cheaply as possible and as quickly as possible. These are very basic behaviors. And look what he's done. I mean, the richest man in the world. So Niles, where can the audience learn more about you, your two podcasts and Dun Capital? Thanks for asking. I think the best place to learn about Don and the journey we've been on is really on our our website where there is also a lot of educational resources. So there for that, you can go to

Starting point is 00:50:28 Doncapital.com and you have to register to get access to all of the information, but that's purely for regulatory purposes. And of course, if people want to follow kind of the ongoing journey, then the podcast is top traders on blog.com. Before we let you go, I have one question that I think that I'm probably not the only person here in the audience who are thinking about is, do you have a go-to resource? Is there a any kind of best-selling book in value investing, we would have the intelligent investor. You know, that's the Bible. Do you have something similar about trend following that it's a must resource? We are very big on book recommendations here on the podcast. There are a few different

Starting point is 00:51:10 resources on trend following, of course, and it all boils down to usually books or white papers, right? So the CME groups or the largest futures exchange on their website, there is in particular one short white paper, I would call it, called Dr. Lindner revisited. I think that's a great introduction because it actually looks at some research that was done back in 1983, I think, and then revisit whether it's still whole. So that's a good way of getting into that. But if you don't mind me being a little bit selfish here, because I actually created this guide where I put in like a hundred different books that I think all investors should be at least contemplating, diving into. And in that guide, there is actually quite a few books mentioned

Starting point is 00:51:56 specifically on trend following. And I think from what we've done, I think the link is top traders on plucked.com forward slash TIP. And when you go there, you actually also get a book that I co-wrote specifically on trend following. So I would say that's the best place to go. Fantastic. The website Niels mentioned is top traders unplugged.com slash TIEP. That's TopTraders unplogged.com slash tip for Nils's book guide and his free book. We'll make sure to link to that. And the other thing that we will be linking to is your new episode with Presta Niels, where you're talking about the failure of the US dollar.

Starting point is 00:52:39 So we'll make sure to link to that in the show note together with the two other resources that you just mentioned. Niels, thank you so much for being so generous with your time and teaching us about investing and trend following. Thanks so much, guys. It was fun, and thanks for having me. All right, guys. There was all the Preston and I had for this week's episode of the Ammasters Podcast.

Starting point is 00:53:00 We'll be back again with another episode next week. Thank you for listening to TIP. To access our show notes, courses or forums, go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any decisions, consult a professional. This show is copyrighted by the investors. podcast network. Written permissions must be granted before syndication or rebroadcasting.

We Study Billionaires - The Investor’s Podcast Network - TIP308: Trend Following Investing w/ Niels Kaastrup-Larsen (Business Podcast)

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