September 2, 2025 • 46 mins
Defined-outcome and options-overlay ETFs take in roughly $3 billion a month, reflecting rising investor demand. In this episode of Inside Active, host David Cohne, mutual fund and active management analyst with Bloomberg Intelligence, and co-host James Seyffart, ETF analyst for Bloomberg Intelligence, spoke with Arnim Holzer, global macro strategist at Easterly EAB and a portfolio manager for the Easterly Hedged Equity strategy, about the investment philosophy behind the strategy, which focuses on asymmetric return patterns and minimizing drawdowns. They discussed how hedged-equity strategies serve as an alternative to traditional fixed income in portfolios, why the correlation between equities and fixed income has become unstable after the global financial crisis and how the strategy differs from traditional buffer ETFs. The podcast was recorded on Aug. 14.
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Episode Transcript
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Speaker 1 (00:15):
Welcome to Inside Active, a podcast about active managers that
goes beyond sound bites and headlines and looks deeper into
their processes, challenges, and philosophies and security selection. I'm David Cohne,
i lead mutual fund and active research at Bloomberg Intelligence.
Today my co host is James Seifert, ETF, analyst with
Bloomberg Intelligence. James, thank you for joining me today.
Speaker 2 (00:35):
Yeah, thanks for having me. David, happy to be back.
It's always fun to do these.
Speaker 1 (00:38):
Things, definitely. So we're today we're going to be talking
about a hedge equity strategy, which you know, kind of
reminds me of, you know, the popularity that's happening right
now with buffer ETFs, options over lay ETFs. What have
the flows been like to those products so far this year?
Speaker 2 (00:55):
I mean, if you are looking at those buffer defined
outcome ETFs as we call them, the options overlay ets
where you're getting income or protection of some sort, they
are arguably one of the hottest categories in ETFs in
the US as far as a percentage growth basis. I mean,
they're not taking in as much money as a standard
standalone s A P five hundred type product, but if
(01:15):
you're looking at it on a percentage growth basis, I mean,
it is some serious it's a serious category. And when
you combine the two of them, I mean, right now,
in the US alone, you're looking at for those defined
outcome ETFs, eighty seventy billion dollars in ETF, so only
on equity. There's some in other areas. And then if
you again, if you're looking at options overlay, again only
in equity, that's almost one hundred and ten billion dollar category,
(01:39):
which granted it's not a trillion dollar category, but it's big.
And the main thing I want to point out is
it's growing quickly. So they're taking in combined three billion
dollars a month like clockwork, pretty much for the year
of twenty twenty five. So if you're an issue or
advisor kind of targeting the same sort of strategy, it
should be looking pretty good for you that you can
maybe pull away some of the money that's going there.
(02:01):
You know, the fish are jumping in the boat. People
obviously like the ideas behind these categories, so it'll see
how it turns out.
Speaker 1 (02:07):
Well, there's definitely a lot of interest, which makes a
great segue to our guests today. I'd like to welcome
our name Holzer to the podcast. Our name is the
global macro strategist and client portfolio manager at Easterly EAB
and a portfolio manager on their Easterly Hedge equity strategy.
Our name thank you for joining us today.
Speaker 3 (02:27):
Thanks for having me, David, and great to meet you, James.
Speaker 1 (02:30):
So let's dive right in. What is the investment philosophy
behind the strategy.
Speaker 3 (02:34):
The philosophy is very simple. What we're trying to do
is create an asymmetric return pattern where we get more
of the upside of the S and P than we
get of the downside of the S and P, and
particularly minimize drawdowns so that what you do is improve
sharp ratios and sortino ratios, give investors a smoother ride,
(02:55):
but actually give them a much more efficient hedge dequity
approach than what's available and other products.
Speaker 1 (03:01):
Well, let's stick deeper. What is the investment management process like?
So how does it work in terms of how do
you approach this?
Speaker 3 (03:09):
Well, at our core, our firm is a is a
derivatives research firm, and the work that we did showed
that you know many many of the down drafts that
occur in the market historically are in the one to
two standard deviation area, in other words, between two and
ten percent down drafts, and so we're really not trying
(03:29):
to defend the deepest, you know, fifteen twenty percent down
drafts in any one moment. We're trying to basically make
relevant protection in that one to two standard deviation area
and really hedge that. And then if the market continues
to go down, we'll roll down further and we keep
our trades kind of short. In other words, the structure
(03:51):
of this is usually three to five week trades, and
the market really goes down twenty five or thirty percent,
you know, in a five to ten day period. By
monetizing more more irregular down drafts, more occurring down drafts,
you're actually able to protect more relevantly rather than waiting
for that big down draft that often occurs only once
(04:12):
every three four five years and you pay a lot
for that. So our idea is to monetize to make
offset from lower down drafts and then reinvest at those
rates and get a quicker clawback. And what you find
is a more relevant and actually a more efficient defense mechanism,
a more efficient participation mechanism that gives you better sharp
(04:35):
and sortino ratios than even the underlying S and P.
Speaker 2 (04:39):
So I'm going to jump in here real quick. Can you, like,
how are clients using this strategy? Are you seeing it? Like?
Are people using this as a core allocation? Are they
using it as defensive or tactical? Like? Exactly is it?
Speaker 3 (04:55):
Like?
Speaker 2 (04:55):
Where is it going in the portfolio?
Speaker 3 (04:57):
I guess this is a great question, James, And you're
going right to the meat of the issue. And if
you don't mind, let me you know, kind of construct
what the difference and how this and how this is
used versus other funds, other buffer funds and kind of
defined risk funds are basically defending one for one down
(05:19):
drafts and participating and giving up some upside participation to
do that. And they're really dumbing down. They're really muting
volatility kind of equally on the upside and the downside.
And that's really the problem, I would say into the
Great Financial Crisis, which was we've got to figure out
how to give our investors a less volatile ride, because
(05:39):
the moments that they dealt with in terms of the
tech wreck and in terms of the Great Financial Crisis
were primarily not correlation expansion or beta problems. They were
primarily volatility issues, and that volatility scared investors. Now what
happened post to GFC is really interesting. The problem that
we see occurred post the GFC is that correlations became
(06:01):
much more unstable and David and James the real issue
with modern portfolio theory is that it optimizes to volatility.
But what we found, the kind of conundrum that investors
and advisors have, and we talk to advisors every day,
is that when you need correlations to be stable, which
is the assumption in modern portfolio theory, they're uniquely unstable.
(06:23):
And so your real problem from the Great Financial Crisis
going forward and has been seen in the last five
years post COVID, is that correlations across multi assets are
just not stable. And so, for example, fixed income has
been more often correlated to equities in the last four
or five years than uncorrelated. And so the problem that
you have from a portfolio management point of view is
(06:46):
not so much giving a lower volatility to the overall portfolio,
which is why people use the buffer funds. The traditional
buffer funds that defend one for one, we defend twice
the notional to the downside, and the reason is we're
trying to the correlation problem and the beta expansion problem.
And so by defending that downside with twice the notional
(07:07):
downside and put spreads, what we do is we squeeze
the beta risk to zero as the market goes down
into our put spreads. That's a very different problem. And
what we're doing is we're saying, look, your big issue
from a portfolio management point of view, is it across
even your equities alone, James, your correlations blow out much
more meaningfully than they used to. And part of that
(07:28):
is because inflation, because multi assets really perform differently than
they used to. So what I would say is, in
the past, you just use it as kind of an
additional volatility MUTER. Now with our fund, what we're seeing
is people are using it as a the diversification part
of fixed income. They're substituting that piece. So not anybody
in a sixty to forty model needs forty percent of
(07:51):
their portfolio for income purposes. Of that forty percent in
their allocation, often fifteen or twenty percent of that was
actually for diversification per pose. So we're a very good
substitute from a diversification point of view to plug in
in that part of the portfolio. But now more and more,
what we're actually seeing, after particularly eighteen, but more twenty two,
(08:12):
where you saw S and P core positions, this core
satellite idea and equity portfolios. What you're seeing is some
folks say, wait a second, if the S and P
went down nineteen percent in twenty twenty two, how good
a core position was that? Really? From a risk management
point of view, the fact that our fund was down
less than three percent, if you had had that at
(08:32):
the core. And yes, it's an active fund, and yes
there's a fee management fee, but on a net basis,
being down under three from a risk management and an
efficiency point of view, it becomes a very interesting core
equity allocation. And we're beginning to see more advisors say,
wait a second, can't I look at this hedge dequity
almost like a factor fund. Yes it's not growth or
(08:57):
value or capsize or dividend, but it's a factor of volatility.
And this you know, these funds manage actively the way
they play the volatility range, and that factor adds value
as an equity fund. So we're beginning to see people say, wait,
a second, this can be actually a core equity allocation,
and over the last three years it's you know, it's
it's outperformed, for example, equal weighted SMP with half of
(09:20):
the risk. So it's a very interesting core equity piece
given how well it's performed.
Speaker 1 (09:27):
A way to partially replace traditional bonds that that section
of the portfolio. But now it's taking up more of
the equity side.
Speaker 3 (09:37):
Would you say, yeah, I think I think the the
the issue for equity investors, particularly in this environment. And James,
you know you probably see this quite a bit with
the growth in some of these specialty funds, but you
know AI extended tech, you know, very focused renewables, energy funds.
You know, in the old days, there was you know,
(09:57):
years ago, there was the marijuana based funds. You're seeing investors,
you know, obviously you know the frontier emerging markets. You're
seeing investors say, look, I think where there's not perfect information,
I can get very high alpha in some parts of
my equity portfolio. But David, the problem with those allocations
is that you expand the potential for beta risk, for
(10:18):
beta expansion risk, and so if you want to search
for return and more of these younger clients. These forty
and fifty year old clients are looking for relevancy in
their equity portfolios. The problem with that as an advisor,
and I talk to advisors every day, is they're saying, yes,
I understand they want crypto, I understand they want AI.
But the beta risk of these funds it might look
(10:39):
like a one point four beta to the S and
P in quiet times, But if you get a liquidity moment,
or you get a big decline in the SMP, that
one point four or one point three beta could become
a two point five beta, and then what do I
do with my equities? They could really hurt my clients.
And so using a fund like ours that squeezes beta demonstrably,
(11:01):
you know, it goes from a normal forty to forty
two beta to towards a zero beta. In twenty eighteen,
we actually made money when the market was down. In
twenty two we squeezed that down to less than a
point one beta. In those kind of extreme environments. Allows
your equity portfolio to stretch for return with higher alpha funds.
But at the same time, David, in the decline moment
(11:24):
that creates a beta risk, you have that you have
that defensive fund in the middle that provides that balance. Yeah.
Speaker 2 (11:32):
I know it's cliche, but like everyone's saying, it's the
death of the sixty forty. But the more and more
I talk to people that are allocators, like advisors and institutions,
it really is kind of gone. For the most part.
It's becoming more like or at least what is in
those sixty and forty categories has expanded. It's like sixty
thirty ten or seventy twenty ten where they're doing more
strategies like yours, like those alpha strategies are going thematic
(11:54):
investing or crypto or something along those lines. In those
satellite positions. Things really have changed as far as the
allocation side of things goes, and from my point of view,
it really exacerbated things in twenty twenty two, and you know,
your equities and your bond's went down together. I think
that's part of the growth we're seeing in strategies like
yours and buffers and overlays. So I guess my next
question would be, is there a tactical component to your
(12:16):
equity exposure, like are you going after low vall stocks
or is it just beta to the S and P
five hundred on the equity leg. Can you just talk
a little bit about that.
Speaker 3 (12:24):
So we'll get into the structure. So the biggest risk
as a forty year financial professional, the biggest risks you
have in markets is really mismatches, right, It's leverage and
it's mismatches. So the mismatch issue is you don't want
to own single stocks if you're trying to reduce beta risk.
(12:45):
If you're trying to reduce risk, that correlations blow out.
So we own the S and P. The structure owns
the S and P through spy, and we leverage the
structure thirty percent extra exposure through a swap with Golden Sacks.
So we're in essence a one thirty thirty five, So
it's thirty percent swap with Goldman Sachs. So we get
(13:05):
one hundred and thirty percent exposure, which right away gives
you additional exposure to an asset that starts at the
bottom left and goes to the top right. So that's
a good thing. We then sell up to one hundred percent.
We never sell the thirty percent, any thirty percent of
that swap, any of that exposure in calls in the
two to four percent range. On a let's say a
one month trade, and we use that to finance two
(13:29):
hundred notional two hundred percent of our notional in putspreads
in a one to two standard deviation, which would be
two percent down to seven percent down a ninety eight
ninety three put spread. That's a one to two standard deviation. Now,
the reason we do that is basically, we want to
get exposure to where declines normally happen, and when those
(13:50):
declines happen, we're going to monetize excess return, right because
we're hedging two hundred percent of our notional, not two
hundred percent of the hundred not not you know, one
hundred percent. Most buffer funds are constructed on three month
trades and they only defend their notional so they don't
have leverage, so they don't get access return from the
(14:12):
S and P and they don't get excess return from
their hedge because they're only they're only hedging their notional amount.
They're one hundred dollars basically, so we get access return
if the market does go into our range, and as
the market recovers, we have room to rise into our
sold calls, into our short calls. That's financial structure is
(14:32):
in a positive income, positive data, so we don't bleed,
and that's a very important thing because many option structures
provide defense, but they bleed, so you're losing return of
the market. And because we never sell, we never short
calls on that thirty percent of the swamp, we always have.
In the worst market for us, which would be something
like twenty seventeen, where there's no volatility in the market
(14:54):
goes straight up, we're going to get thirty to thirty
five percent of the market with about thirty five percent
of the volatile. It's a you know, forty percent of volatility.
It's a very it's a very safe structure even in
a very low vol straight up market, but most investors
don't buy us for that environment because they have other
equity products that really work in that environment. What happens
is normally, after very low vall environments, you get a
(15:16):
high vowel event and we we do exceedingly well in
those events. But that structure is not is not discretionary.
It's a it's a structure, a systematic structure that we've
researched works now that the strikes of that whether it's
a three week trade or a five week trade, whether
it's a ninety eight ninety three put spread or a
(15:37):
ninety six you know, you know eighty five, the range
might vary a little bit based on the math of
where the options are, the volatility is, and that kind
of constructs the actual put you know puts, and the
dimensions of the trade. But the structure of the trade
is always in place and stays relevant to the market.
(15:59):
So if market goes up, we're following up the market,
and then if the market falls from that elevated level,
we start to defend in that range where some of
the longer traits, the three month trades can become very irrelevant.
If the market goes up, their puts may be irrelevant
to normal declines. And again if the market goes down
through their puts, they may no longer participate to the downside.
(16:21):
And what we do instead is we stay relevant to
the up and to the down of the market because
our trades are shorter. So that's the structural difference. It's
not so much discretionary as it is systematic based on
the math of the market.
Speaker 2 (16:35):
So I guess basically like I get you're saying, the
structure is determined based on what's going on in the
market and how options are being priced, whether it's the
state of the time value to kay vega, what all
those Greek letters that go into valuing it. That's what
you're determining where things are. So do you distinguish it
all between secular and secular changes or are you just
kind of maintaining your same sort of structure no matter
(16:57):
what's going on in your your situation is basically determined
by what's going on in the market and how where
your hedges correct.
Speaker 3 (17:04):
The structure is systematic, but the levels where it trades
depend on the math of the market. And the benefit
of that has really shown through because if you're really
fixed in your structure and your very long term you
can't adjust to the math of volatility, and you can't
(17:25):
adjust to the skew of the options market. And the
benefit of our structure is if skew is to the call,
you know we're able to take advantage because we don't
have to trade our trade at a particular level versus
where we are. If skew is to the call, we
can set our call, our short calls at a much
(17:46):
higher level, which gives us more room to participate up
so our percentage of participation will actually be better in
that environment. And if skew is to the put, you know,
then we're able to sell our put spreads a little
bit more optimally in a different fashion as well. Whereas
the structures, you know, some of the buffer funds and
some of our competitors are very stuck in a dogmatic
(18:09):
trade that is numerically basically structured. They can't adjust to that.
And so that's very important, particularly when you recognize that
the changes in the options market the last several years
and the really the retailization of options has given us
tremendous advantages because it's allowed us to do, I think,
to even adjust our structure more optimally then we might
(18:32):
have envisioned five ten years ago when the structure started.
We just passed our ten year anniversary this last month,
by the way. But when the structure was initially envisioned,
I don't think we recognized the potential for some of
these ranges. With skew and retail interest zero one two
day to expery that has you know, really increased the
(18:55):
liquidity and some of the ranges for the technical part
of options that that I don't think anybody expected and
it's actually helped our product.
Speaker 1 (19:03):
So if we if we think about this for our
listeners that don't understand options, you know, if they're thinking
about it, how does this strategy typically behave you know,
relative to S and P five hundred during rallies versus corrections.
So if we just kind of simplify it.
Speaker 3 (19:21):
So there, there's there's It's really like a light that
has the characteristics of a particle and has the characteristics
of a wave. So so the particle is the equity market, right,
so we follow the equity market. If the equity market
goes up, we have a high correlation to equities. We
have you know, for those who know you know correlation,
we have a we have a well over ninety R
(19:42):
squared to the equity market. So we participate well as
the market goes up. When the market goes down, if
it goes down very little, yes we go down a
little bit as well. But if the market goes down
through the one to two standard deviation area, which is
kind of in that two to seven percent area, if
it goes into that area and volatility rises, that's the
(20:04):
wave issue. We start to correlate to volatility and we
get a benefit from that and our puts start to
generate return. And so the idea here is we really
the factor that we're making money off of is the
cyclicality of volatility. So investors have historically been hurt by
volatile times. Some people call it volatility drag, it hurts portfolio.
(20:25):
Some people like to call it beta expansion. But what
we do is we participate with equities on the in
normal markets and in upward rising markets. But if there
is any kind of cyclicality to volatility or a volatility rises,
that gives us a second form of compensation, and we're
able to take advantage of that because of the nature
(20:47):
of our trade, which has a tendency to buy volatility,
you know, kind of on the cheap side, and sell
volatility more on the rich side. We have a tendency
to sell equities on the you know, in the normal markets,
because we sell calls, you know, in that two to
four percent above where we are. So we sell calls
(21:07):
equity up on the upside, and we tend to buy
equity on the downside because as the market goes down,
our extra defense is compensating us, is monetizing us, and
we'll roll to a new structure and the excess goes
into units of the S and P. And so what
you see with a structure like this that is overdefended
is we get overcompensated for the downside, which means we
(21:29):
have money to buy low and when the when the
market mean reverts, and historically the market has always mean reverted, thankfully,
that means that we have a tendency to buy more
units in those lower amounts, which means we claw back fast,
which helps you overall portfolio because you have an asset
that's starting to come back sooner than the market, you know,
(21:49):
than other products in the market.
Speaker 2 (21:52):
So you just basically said that volatility actually is pretty
good for the returns of this type of strategy. So
I guess my question would be what is the worst, Like,
what are you going to underperform the standard beta of
the market the most?
Speaker 3 (22:04):
Is it?
Speaker 2 (22:05):
Based on what you said, I'm going to guess it's
a low volatility regime where the market is ripping. Essentially,
that is when you're going to have the highest in performance.
Speaker 3 (22:11):
Is that right? Right? So, if we think about tail
risk being kind of a one in five to seven year,
like real tail risk being a one into five to
seven year kind of event. I would say the opposite side,
you know, the right tail risk, not the left tail risk,
the right tail risk, which is the very low VALL
and you know, fifteen to twenty five percent up year
with VALL with the vis being let's say six to
(22:33):
eight and realizing you know, three to four. The twenty
seventeen year is a perfect example of that kind of
a tail year that it doesn't necessarily the strategy doesn't
lose money, but it's it's more that thirty to forty
percent participation in the S and P and lowish VALL,
(22:55):
but you don't get that very high sixty to eighty
percent of the SMP that we'd like to ex effect
with you know, forty percent of the volatility. That's that
kind of a market is unusual. But even an up
market if you get cyclicality in volatility, and we've seen
some of those the last few years where you get
a fifteen to twenty percent return but the VIX is
(23:15):
still at fourteen to eighteen, that kind of a year
where you have and you have a couple of little
scares is a perfectly fine year for us. It's really
the year where you get that perfect storm of no
volatility and straight upward to the to the right that
that makes us look pedestrian. In other words, will be
you know, we'll have a slight advantage over high yield
(23:37):
at about the same risk or maybe a little less risk,
but it won't be that fifty to seventy sixty to
eighty percent of the s and P with forty percent
of the risk kind of year, which is a home run,
you know. Thankfully, I would say sixty to seventy percent
of the time we're in our sweet spot. Maybe ten
percent of the time. It's more of that twenty seventeen
kind of year. But the good news is in those
(24:00):
kinds of years, James and David, everything else in your
portfolio is just on octane, high octane, and so no
one's really worried about this part of their portfolio.
Speaker 1 (24:11):
So if you think of another situation, how has it
behaved in rising rate or inflationary environments where traditional fixed
income is kind of struggled.
Speaker 3 (24:20):
It's a it's a it's a really good question. If
you if you look at two thousand, you know, twenty two,
for example, I was referring to it before the strategy
was down was down two point seventy five percent and
the market was down you know, close to nineteen percent
(24:40):
depending on how you looked at it. You know, eighteen
plus percent. That's a very significant defensive performance. And you
know that's an environment where if certain data points had
worked out a little bit better, you know, we could
have been basically flat on the year. We have a
we have clients that came through that period that came
(25:02):
to us and basically said, we're going to up our
allocation to you because we realize that having too much
in the core S and P category. Now, granted, you
know people were paying you know, James, I know you're
going to love this comment, but people were paying seven
basis points right for the S and P and feeling
great that you know, passive is great, and owning the
(25:24):
S and P is great because it's passive and that
does better than active managers. And you paid seven basis
points for the SMP, but you're down eighteen plus percent
for that seven basis points. And granted, folks pay more
to own our fund, but you know they were down
two point seventy five percent, So not many of our
clients were unhappy with owning our fund at a normal
(25:45):
management fee. Versus the S and P. Because the S
and P doesn't truly give you defense. Indexes are not riskless.
And I think what you're beginning to see here, because
of this beta expansion risk, and because of the tendency
for the SMP, because it's a market cap weighted index,
it has much more beta expansion risk than people understood.
(26:06):
If you look at the equal weighted SMP versus you know,
even versus the market cap weighted SMP, you know, the
equal way to SMP was down eleven point five basically
in twenty twenty two versus the eighteen plus in twenty
two versus R two seventy five. So there is a
fair amount of kind of hidden risk within these indices,
(26:29):
passive indices. And I think what you're seeing advisors, and
I talk to advisors just about every day. What you're
seeing advisors basically say, is passive is interesting visa VI
the active conversation, right, but it's not necessarily as interesting
versus the risk management versus the risk efficiency conversation. And
I think that dimension of the conversation is a really
(26:53):
important one. Now, the traditional buffer funds, the traditional defined
outcome funds, they don't do beta. They don't control beta expansion,
so they don't give you the same benefit in this
particular discussion. But alternatives that are able to really claw
down you really drop down your beta expansion are actually
a very interesting conversation visa VIP passive. And I think
(27:15):
this is a topic that I've made a lot of
headway with with with modelers. You know, I go to
see you know, institutions, I go to see you know,
distribution channels when I talk to that their modeling groups,
And this is the place where you're starting to see
some very interesting headway because you can never make headway
on the passive active discussion. There's just it's a really
hard conversation to have anybody, you know, kind of open
(27:38):
up their mind to. But when you talk about the
passive active conversation around risk management, that actually is one
where the door is cracking and you're beginning to see
people really, really solid people say, wait a second, this
does make a difference if you're able to bring that capability,
that characteristic into portfolios.
Speaker 2 (27:58):
So let's get into something we've danced like the entire
time we've been talking here. Let's go into like a
little bit of a direct comparison to buffer or options
overlay ETFs. I mean for I don't know if the
listeners will know this, but there's like the last few
months there's been this blow up of AQR from the
likes of Clifford Assenas mainly writing papers basically attacking these
buffer products, saying they're overpriced and nothing but a marketing gimmick.
(28:20):
I kind of view it like there's pros and cons
to each, right, Like, I don't think it's just a
marketing gimmick. I think there's benefit for some people. They'll
be like, I know I'm going in here, and I
know exactly what my downside risk is. I know exactly
where things can go. And I think that's just like
easy for some people who don't understand finance and the
benefits of a portfolio construction to go in and know
what this is. And like, this has been a huge
(28:41):
area in the annuity market, right that this is structured
product is a huge thing at banks and high networth individuals.
So I guess, like, are you when you're talking to people,
are you directly competing with these types of products? How
do you compare yourself when you're trying to sell your product?
Speaker 3 (28:55):
You've already said it.
Speaker 2 (28:55):
You kind of move up and down with the market,
Like do you also get compared against these options over
where they're only selling calls to the upside, so you're
still subject to a lot of the downside, but you
get some income. Like how what is your main pitch
and like why you say in a succinct way, like
what is your argument? And like who do you agree with?
Speaker 1 (29:12):
More?
Speaker 2 (29:12):
Do you agree with the Clifford asking this QR side
of things? You do agree with the buffer? You more
like me sit in the middle of pros and cons
to each.
Speaker 3 (29:20):
Well, you asked me to be succinct, and you gave
me a question that literally could be like it don't
be succinct. Yeah, thank you for the podcast format, David. Okay,
let me first say, it really matters what problem you're
trying to address.
Speaker 1 (29:33):
Right.
Speaker 3 (29:35):
If you're trying to address the volatility problem, which I
really view as the you know, the tech wreck and
Great financial crisis problem, which was volatility scared people, some
of those structures are very interesting. And remember modern portfolio theory,
it doesn't just have an assumption that correlations are stable.
It also makes an assumption that individual utility functions are
(29:56):
very similar along risk and reward. And you know, I
I'm you know, I'm an orthodox you know economists from
from from Princeton, and I love that work, and I
studied under malcol and you know, Markowitz, I think is
you know, has done wonderful work. But some of those assumptions,
you know, probably need to be tested more behaviorally, and
I think there's been some good work around that. And
(30:17):
you know, so the Cliff, you know, and by the way,
tremendous respect for Cliff, and I think a lot of
the things he said are legitimate because I don't think
some of the existing products are really worth what what
they They don't necessarily offer as good a performance and
they don't necessarily solve the problem as well as they should.
But but I also would say this to Cliff, and
that is that the utility function of investors is much
(30:38):
more variable than you know, these conservative, moderate and aggressive
models or you know, depending on you use three or
use five. You know, it's very hard. Advisors have the
toughest job in finance, and they have to try to
fit individual client asset liability and and and behavioral tendencies
into these these models. And so what some of these
(30:59):
buffers and defined models have done. Is really solved for
is try to at the edge, you know, at the
incremental level, try to trim some of that to meet
individual investors' behavioral you know, kind of utility functions. And
in that regard, even though they may not be perfect,
(31:20):
they probably help some advisors solve for Okay, this client's
got more volatility fear than they it would be willing
to acknowledge in stress. I'm going to solve for that
problem by lowering some of the volve. Now, these products
I don't think solve the problem as elegantly as they should.
I think they're you know, they're too long a trade.
I think they're not asymmetric. They certainly don't solve the
(31:43):
twenty fifteen to the future problem, which is really beta expansion.
But I think that's what those funds have done, and
so to that extent, I think the cliff is a
little harsh, But to the extent that those funds, because
they're not asymmetric, because they can become irrelevant because they
don't solve the problem that is really the future problem,
which is really how do you manage and constrict beta
(32:06):
expansion in a world where fixed income no longer has
a bull market behind it and is negatively correlated. I
think they're anachronistic and they're really not effective. And when
we show our numbers against our competitors, it's it's very
clear that it's a better solution to be a symmetric
and squeeze downside risk. It's it's very clear. And if
(32:28):
you look at our upside downside capture ratios, it's very
obvious that the asymmetry makes a difference. So we can
still solve for the volatility problem, but we really solve
for this this beta expansion problem. Now, the other question
that you ask is, you know, why have these products
been so popular? Part of it is because from a
(32:49):
marketing point of view, they're very easy to market, compliance approves,
the very straightforward documentation. You know, they seem optically to
do what they say they're going to do, and so
they solve the problem. They scratch an itch, but they
don't necessarily give you the deep tissue massage that you
(33:11):
need to be resilient in that crisis situation. And that's,
you know, that's a very big difference. And I think,
and to that extent, I think if Cliff had looked
at a broader set of funds. We were not included
in his data set. But if he had included a
broader set of funds, I think he might not have
(33:32):
come quite so harshly down on the entire you know,
tard the whole industry. But but the main point is correct,
which is, if you're paying anything for a fund that
doesn't really solve the real problem, you're paying too much.
And and so that's you know, one of the things.
And what we try to do is really get the arias,
(33:54):
you know, to get advisors, you know, even small institutions
and even some institutions that we're talking to, to really
understand the portfolio risk allocation implications of having something at
the center rather than using an MPT a modern portfolio
approach looking more towards a total portfolio approach, where you
start analyzing your risk in holistic terms and not trying
(34:16):
to put everything into style boxes, but saying, how does
this firm add to the risk efficiency of my fund?
And when you look at that and you say, wait
a second, if this fund has better sharp and sortino
than the market, than the equity than SMP, that means
I can take that budget that lowered risk that and
I can use that efficiently somewhere else, And that concept
(34:40):
is very valuable of risk budgeting. We have not seen retail,
we have not seen small institutions really do that. But
I've spent some time recently with consultants and some small
institutions who really are starting to understand volatility has been
used by very big institutions for a long time to
just sell vol They just sell, I'll sell, I'll sell
(35:01):
all until it doesn't work, it blows up, and then
when it blows up, it's interesting to sell all again.
But because it seems like a one way trade, that's
the way everyone's used it. But very few people have
used this idea of a hedge VOWL kind of management
approach which takes advantage of vowel ranges and cyclicality evolve
almost like an equity factor. And I think that piece
(35:25):
because what happens with a lot of these factor funds
is they get so overused that they disintermediate the value added,
whether it's cap whether it's value, whether it's growth, whether
it's small or low vowel funds or dividends. Those factors
start out with a certain ir but when more and
more people pile in, they lose their value. What's interesting
(35:46):
about volatility This has been this issue has existed for years,
but very few people have really piled in. In fact,
I think most people have not used volatility correctly. I
think we use it correctly. And I think that opportunity
as an equity care characteristic to harvest is what differentiates us.
And and that's notably different from you know, the kind
(36:07):
of traditional buffer funds that you see out there.
Speaker 1 (36:10):
So we're starting to run out at a time. But
since you are a global macro strategist, I would be
remiss if I didn't ask you about the markets. You know,
we've read your you know, your market overview for April
has what has changed in your view since then?
Speaker 3 (36:27):
Well, you know, prior, prior to the pandemic, we would
have thought there was some room for the FED to
create some kind of easing, you know, maybe maybe even
just twenty five basic points. But obviously since you know,
Liberation Day, some of that has changed. And I think
(36:48):
it would be unrealistic to assume that the FED, you know,
that the FED has has an easy path here. We
we believe secularly that the inflation equilibrium has changed post pandemic.
We think that it probably means that that our star,
although no one wants to talk about it. I'm still
(37:09):
wondering what's gonna happen at Jackson Hole. But it seems
like we think rates are a little bit higher, will
remain a little bit higher, and that inflation will will
remain a little bit higher. And the call that you
know that Scott Besson has had to drop rates one
hundred and fifty basis points, we think that probably a
lower number is going to be realistic. I think it's
going to be a real challenge for the Fed. You know,
(37:31):
we have a highly unorthodox president, we have some unconventional times.
We think that the mortgage market is probably the bigger
problem that the FED needs to solve for I think
if you look at the economy, obviously there's some labor
issues that are picking up. There's still some incipient concern
about inflation with the trade tariffs. But I just don't
see the FED having the freedom to drop rates as
(37:55):
much as the market is expecting. I think potentially, you know,
this fourth quarter, we could see one decrease. I don't
think we're going to see as many as the market
would anticipate. But I also think that the Fed really
should be looking in terms of the balance sheet, the
mortgage side. I think the Treasury Secretary should really be
looking at, you know, the privatization of Fanny and Freddy.
(38:18):
I think the problem we have to solve war here
that also affects you know, inflation, is what's going on
in the housing market. And so while we're in very
unconventional times, very unorthodox times, there is a way to
thread this needle. Productivities come in relatively well. You know,
there is a potential that the tariffs could be could
(38:39):
end up at just a low enough rate that the
combination of companies with margins and some of the sellers
taking some of the peace and consumers still getting a piece,
that it not be so disruptive if productivity remains relatively high,
and that would probably mean rates come down, but not
as much as people are expecting. I think that means,
you know, medium terms to long term bonds are not
(39:00):
a great place, which witness my comments about correlations on
bonds not being a great diverse fire and why you
need these kind of alternatives that give you some beta
expansion protection. I think that that's still true, but we
need to thread this needle and volatility and implied correlation
in the market is kind of complacent, you know, just
(39:20):
to give you a sense, when we look at skew
in options, given where the market is near market highs,
we would expect the option skew to be pretty significantly
to the put. But in actuality it's only modestly let's
say point three point four standard deviations to the put,
I would expect it to be, you know, over one
standard deviation to the put. The reason for that is
(39:42):
people just frankly, are not selling their calls. It's not
that they're necessarily over you know that they're underbuying puts.
They're still buying buying puts, but they're really not selling
their calls. There's a lot of retail. When I was
talking before about their retail impact on the market, you
should see some people selling their calls, right, monetizing and
and kind of defending. So the hedging piece isn't necessarily changing,
(40:04):
but the speculative piece is kind of staying in place.
And so that connotes a little bit of a little
bit of you know, uh, just a little bit of apathy,
a little bit of complacency, and the implied correlation because
of these because of because of the dispersion trade, which
sells options on the S and P and buys vow
(40:26):
on the single stocks, is really pushing the vics down,
I think, to areas that are probably a little low
for where the macro risks and the FED risks still are.
So it's a position that I think kind of warrants. Okay,
the market can be wrong for longer than I can
be right, so you need to participate. But I think
(40:46):
investors should be aware that you know, there's still you know,
there's still a relatively tight thread, a tight needle that
we have to thread here, and and you know we
still have some concerns.
Speaker 2 (40:59):
Alright, So last question and then we'll wrap up. You
just spoke about a whole host of things with Ward's,
the FED and the economy. So I guess, like what
is the primary risk? You see, this is going to
kind of be a two parter, like from any economic standpoint,
from the FED cutting rates, like are you most concerned
with inflation? Are you most concerned with the unemployment? Job market?
(41:20):
Are you work concerned with productivity? Which I guess goes
to the job market. The other thing you mentioned is
the housing market is frozen, and Trump and everyone is
talking about lowering rates. But if you look back to
the last time the FED lowered rates, the tenure actually
went up and the mortgage rates market actually went up.
So is that actually going to solve things? And then
like after that part, like of all those things, what
is the primary risk the stock market? There's a huge
(41:41):
talk about like the stock market is not the economy anymore.
It's kind of become disassociated in some ways. Do you
agree with that, Like, can you just talk about the
primary risk you're seeing from both an economic point of
view and a stock point of view.
Speaker 3 (41:51):
I look, I think those are great questions. You know,
the American excellency is is is still in place. It's
taken a bit of a hit because of some policy uncertainty.
I think it's also taking a bit of a hit
because the fiscal the fiscal house is not in as
(42:14):
good as shape. The debt, you know, the the the
debt to GDB ratios do cause some concern. And part
of the reason why the US dock market has really
always been supreme basically, and it's hard for people to
understand this is that the Fed's backstop and the US
Treasury's backstop as the global financial system. You know, asset
(42:39):
of choice have been rock solid, and so you know,
the FED couldn't have dropped rates as much as they
have several times in our last several crises unless there
was tremendous uptake and desire to hold US treasuries. You know,
you can't drop rates like that as a central bank
if no one wants your paper, because we don't finance
ourselves completely domestically, right, So the question here really is
(43:04):
is you know, the US the put here, the FED
put really depends on a sound fiscal situation. Now, the
last auctions there were a couple in early August, you
know that weren't perfect, but for the most part, the bid,
the cover ratio and the amount that's been hit you know,
having to be taken by dealers has been manageable. But
you know, you don't want to get to the place
(43:26):
where people are concerned about your credit rating, where people
are concerned to the place where it affects the uptaking
your auctions, because if that occurs, more meaningful and we're
not at that level now. But that's the concern here
that you don't impugne policy and the importance of the
US the preeminence of the US Treasury in the auction process,
(43:46):
because that would in fact handcuff the FED. And so
when you see the long end, you know, kind of
steepen on some of these pieces of news, it gives
you a sense, okay, with the inflation issue. The inflation
issue is still here, and the treasury risk premium is
coming back. What we want is the treasury risk premium
(44:07):
to be as low as possible and not handcuffed the FED.
But there's also a natural equilibrium that productivity seems to
be high, and the natural demographic and supply chain dis
globalization issues seem to be raising the natural rate of inflation.
So all those things give you a much narrower band
(44:28):
of where rates can be, and pees you assume some
drop in rates here, and pees assume some improvement to earnings.
That do have a productivity dependency, and with lower educational
inputs to our productivity, more of these productivity inputs are
(44:49):
dependent on AI and all these software innovations. Usually this
kind of productivity takes three, four or five years to
fully be felt. We're still in the investment phase of
Productivit is that going to be seen in a quicker timeframe.
Because of the nature of the disruptive nature of AI.
I have a sense that that part of it's correct,
(45:09):
but I think more of it depends on interest rates
than the market may want to acknowledge, and so squaring
that circle is actually the risk. James, are we going
to be in a place where the FED is more
handcuffed than we'd like to admit. That's why I think
when you look at the vic's futures contracts, the front
end has dropped noticeably into the fifteen range. But if
you look from a month ago and you look at October, November, December,
(45:32):
you still see very high levels for the VIX futures curve.
And that tells me smart money understands that that threading
of that needle is not as easy as implied correlations
as the current you know, cash level of the VIX
would would would signal.
Speaker 1 (45:49):
Well, this is great. Unfortunately we have to end here.
Thank you again our name for joining us. It's been
my pleasure and great meeting you, James.
Speaker 2 (45:58):
Good seeing you again, David, wonderful to me was well,
our name, This was fun. That last part was my
favorite part. I think the macro topics.
Speaker 1 (46:06):
And James, thank you for being my co host today.
Speaker 2 (46:09):
Thanks for having me.
Speaker 3 (46:09):
David and I.
Speaker 1 (46:10):
Want to thank our listeners. If you liked the episode,
please subscribe and leave a review. Also, if you'd like
to see more of our research, go to bifund go
and bi Stocks Go on the terminal until our next episode.
This is David Cohne with Inside Active
Welcome to Inside Active, a podcast about active managers that
goes beyond sound bites and headlines and looks deeper into
their processes, challenges, and philosophies and security selection. I'm David Cohne,
i lead mutual fund and active research at Bloomberg Intelligence.
Today my co host is James Seifert, ETF, analyst with
Bloomberg Intelligence. James, thank you for joining me today.
Speaker 2 (00:35):
Yeah, thanks for having me. David, happy to be back.
It's always fun to do these.
Speaker 1 (00:38):
Things, definitely. So we're today we're going to be talking
about a hedge equity strategy, which you know, kind of
reminds me of, you know, the popularity that's happening right
now with buffer ETFs, options over lay ETFs. What have
the flows been like to those products so far this year?
Speaker 2 (00:55):
I mean, if you are looking at those buffer defined
outcome ETFs as we call them, the options overlay ets
where you're getting income or protection of some sort, they
are arguably one of the hottest categories in ETFs in
the US as far as a percentage growth basis. I mean,
they're not taking in as much money as a standard
standalone s A P five hundred type product, but if
(01:15):
you're looking at it on a percentage growth basis, I mean,
it is some serious it's a serious category. And when
you combine the two of them, I mean, right now,
in the US alone, you're looking at for those defined
outcome ETFs, eighty seventy billion dollars in ETF, so only
on equity. There's some in other areas. And then if
you again, if you're looking at options overlay, again only
in equity, that's almost one hundred and ten billion dollar category,
(01:39):
which granted it's not a trillion dollar category, but it's big.
And the main thing I want to point out is
it's growing quickly. So they're taking in combined three billion
dollars a month like clockwork, pretty much for the year
of twenty twenty five. So if you're an issue or
advisor kind of targeting the same sort of strategy, it
should be looking pretty good for you that you can
maybe pull away some of the money that's going there.
(02:01):
You know, the fish are jumping in the boat. People
obviously like the ideas behind these categories, so it'll see
how it turns out.
Speaker 1 (02:07):
Well, there's definitely a lot of interest, which makes a
great segue to our guests today. I'd like to welcome
our name Holzer to the podcast. Our name is the
global macro strategist and client portfolio manager at Easterly EAB
and a portfolio manager on their Easterly Hedge equity strategy.
Our name thank you for joining us today.
Speaker 3 (02:27):
Thanks for having me, David, and great to meet you, James.
Speaker 1 (02:30):
So let's dive right in. What is the investment philosophy
behind the strategy.
Speaker 3 (02:34):
The philosophy is very simple. What we're trying to do
is create an asymmetric return pattern where we get more
of the upside of the S and P than we
get of the downside of the S and P, and
particularly minimize drawdowns so that what you do is improve
sharp ratios and sortino ratios, give investors a smoother ride,
(02:55):
but actually give them a much more efficient hedge dequity
approach than what's available and other products.
Speaker 1 (03:01):
Well, let's stick deeper. What is the investment management process like?
So how does it work in terms of how do
you approach this?
Speaker 3 (03:09):
Well, at our core, our firm is a is a
derivatives research firm, and the work that we did showed
that you know many many of the down drafts that
occur in the market historically are in the one to
two standard deviation area, in other words, between two and
ten percent down drafts, and so we're really not trying
(03:29):
to defend the deepest, you know, fifteen twenty percent down
drafts in any one moment. We're trying to basically make
relevant protection in that one to two standard deviation area
and really hedge that. And then if the market continues
to go down, we'll roll down further and we keep
our trades kind of short. In other words, the structure
(03:51):
of this is usually three to five week trades, and
the market really goes down twenty five or thirty percent,
you know, in a five to ten day period. By
monetizing more more irregular down drafts, more occurring down drafts,
you're actually able to protect more relevantly rather than waiting
for that big down draft that often occurs only once
(04:12):
every three four five years and you pay a lot
for that. So our idea is to monetize to make
offset from lower down drafts and then reinvest at those
rates and get a quicker clawback. And what you find
is a more relevant and actually a more efficient defense mechanism,
a more efficient participation mechanism that gives you better sharp
(04:35):
and sortino ratios than even the underlying S and P.
Speaker 2 (04:39):
So I'm going to jump in here real quick. Can you, like,
how are clients using this strategy? Are you seeing it? Like?
Are people using this as a core allocation? Are they
using it as defensive or tactical? Like? Exactly is it?
Speaker 3 (04:55):
Like?
Speaker 2 (04:55):
Where is it going in the portfolio?
Speaker 3 (04:57):
I guess this is a great question, James, And you're
going right to the meat of the issue. And if
you don't mind, let me you know, kind of construct
what the difference and how this and how this is
used versus other funds, other buffer funds and kind of
defined risk funds are basically defending one for one down
(05:19):
drafts and participating and giving up some upside participation to
do that. And they're really dumbing down. They're really muting
volatility kind of equally on the upside and the downside.
And that's really the problem, I would say into the
Great Financial Crisis, which was we've got to figure out
how to give our investors a less volatile ride, because
(05:39):
the moments that they dealt with in terms of the
tech wreck and in terms of the Great Financial Crisis
were primarily not correlation expansion or beta problems. They were
primarily volatility issues, and that volatility scared investors. Now what
happened post to GFC is really interesting. The problem that
we see occurred post the GFC is that correlations became
(06:01):
much more unstable and David and James the real issue
with modern portfolio theory is that it optimizes to volatility.
But what we found, the kind of conundrum that investors
and advisors have, and we talk to advisors every day,
is that when you need correlations to be stable, which
is the assumption in modern portfolio theory, they're uniquely unstable.
(06:23):
And so your real problem from the Great Financial Crisis
going forward and has been seen in the last five
years post COVID, is that correlations across multi assets are
just not stable. And so, for example, fixed income has
been more often correlated to equities in the last four
or five years than uncorrelated. And so the problem that
you have from a portfolio management point of view is
(06:46):
not so much giving a lower volatility to the overall portfolio,
which is why people use the buffer funds. The traditional
buffer funds that defend one for one, we defend twice
the notional to the downside, and the reason is we're
trying to the correlation problem and the beta expansion problem.
And so by defending that downside with twice the notional
(07:07):
downside and put spreads, what we do is we squeeze
the beta risk to zero as the market goes down
into our put spreads. That's a very different problem. And
what we're doing is we're saying, look, your big issue
from a portfolio management point of view, is it across
even your equities alone, James, your correlations blow out much
more meaningfully than they used to. And part of that
(07:28):
is because inflation, because multi assets really perform differently than
they used to. So what I would say is, in
the past, you just use it as kind of an
additional volatility MUTER. Now with our fund, what we're seeing
is people are using it as a the diversification part
of fixed income. They're substituting that piece. So not anybody
in a sixty to forty model needs forty percent of
(07:51):
their portfolio for income purposes. Of that forty percent in
their allocation, often fifteen or twenty percent of that was
actually for diversification per pose. So we're a very good
substitute from a diversification point of view to plug in
in that part of the portfolio. But now more and more,
what we're actually seeing, after particularly eighteen, but more twenty two,
(08:12):
where you saw S and P core positions, this core
satellite idea and equity portfolios. What you're seeing is some
folks say, wait a second, if the S and P
went down nineteen percent in twenty twenty two, how good
a core position was that? Really? From a risk management
point of view, the fact that our fund was down
less than three percent, if you had had that at
(08:32):
the core. And yes, it's an active fund, and yes
there's a fee management fee, but on a net basis,
being down under three from a risk management and an
efficiency point of view, it becomes a very interesting core
equity allocation. And we're beginning to see more advisors say,
wait a second, can't I look at this hedge dequity
almost like a factor fund. Yes it's not growth or
(08:57):
value or capsize or dividend, but it's a factor of volatility.
And this you know, these funds manage actively the way
they play the volatility range, and that factor adds value
as an equity fund. So we're beginning to see people say, wait,
a second, this can be actually a core equity allocation,
and over the last three years it's you know, it's
it's outperformed, for example, equal weighted SMP with half of
(09:20):
the risk. So it's a very interesting core equity piece
given how well it's performed.
Speaker 1 (09:27):
A way to partially replace traditional bonds that that section
of the portfolio. But now it's taking up more of
the equity side.
Speaker 3 (09:37):
Would you say, yeah, I think I think the the
the issue for equity investors, particularly in this environment. And James,
you know you probably see this quite a bit with
the growth in some of these specialty funds, but you
know AI extended tech, you know, very focused renewables, energy funds.
You know, in the old days, there was you know,
(09:57):
years ago, there was the marijuana based funds. You're seeing investors,
you know, obviously you know the frontier emerging markets. You're
seeing investors say, look, I think where there's not perfect information,
I can get very high alpha in some parts of
my equity portfolio. But David, the problem with those allocations
is that you expand the potential for beta risk, for
(10:18):
beta expansion risk, and so if you want to search
for return and more of these younger clients. These forty
and fifty year old clients are looking for relevancy in
their equity portfolios. The problem with that as an advisor,
and I talk to advisors every day, is they're saying, yes,
I understand they want crypto, I understand they want AI.
But the beta risk of these funds it might look
(10:39):
like a one point four beta to the S and
P in quiet times, But if you get a liquidity moment,
or you get a big decline in the SMP, that
one point four or one point three beta could become
a two point five beta, and then what do I
do with my equities? They could really hurt my clients.
And so using a fund like ours that squeezes beta demonstrably,
(11:01):
you know, it goes from a normal forty to forty
two beta to towards a zero beta. In twenty eighteen,
we actually made money when the market was down. In
twenty two we squeezed that down to less than a
point one beta. In those kind of extreme environments. Allows
your equity portfolio to stretch for return with higher alpha funds.
But at the same time, David, in the decline moment
(11:24):
that creates a beta risk, you have that you have
that defensive fund in the middle that provides that balance. Yeah.
Speaker 2 (11:32):
I know it's cliche, but like everyone's saying, it's the
death of the sixty forty. But the more and more
I talk to people that are allocators, like advisors and institutions,
it really is kind of gone. For the most part.
It's becoming more like or at least what is in
those sixty and forty categories has expanded. It's like sixty
thirty ten or seventy twenty ten where they're doing more
strategies like yours, like those alpha strategies are going thematic
(11:54):
investing or crypto or something along those lines. In those
satellite positions. Things really have changed as far as the
allocation side of things goes, and from my point of view,
it really exacerbated things in twenty twenty two, and you know,
your equities and your bond's went down together. I think
that's part of the growth we're seeing in strategies like
yours and buffers and overlays. So I guess my next
question would be, is there a tactical component to your
(12:16):
equity exposure, like are you going after low vall stocks
or is it just beta to the S and P
five hundred on the equity leg. Can you just talk
a little bit about that.
Speaker 3 (12:24):
So we'll get into the structure. So the biggest risk
as a forty year financial professional, the biggest risks you
have in markets is really mismatches, right, It's leverage and
it's mismatches. So the mismatch issue is you don't want
to own single stocks if you're trying to reduce beta risk.
(12:45):
If you're trying to reduce risk, that correlations blow out.
So we own the S and P. The structure owns
the S and P through spy, and we leverage the
structure thirty percent extra exposure through a swap with Golden Sacks.
So we're in essence a one thirty thirty five, So
it's thirty percent swap with Goldman Sachs. So we get
(13:05):
one hundred and thirty percent exposure, which right away gives
you additional exposure to an asset that starts at the
bottom left and goes to the top right. So that's
a good thing. We then sell up to one hundred percent.
We never sell the thirty percent, any thirty percent of
that swap, any of that exposure in calls in the
two to four percent range. On a let's say a
one month trade, and we use that to finance two
(13:29):
hundred notional two hundred percent of our notional in putspreads
in a one to two standard deviation, which would be
two percent down to seven percent down a ninety eight
ninety three put spread. That's a one to two standard deviation. Now,
the reason we do that is basically, we want to
get exposure to where declines normally happen, and when those
(13:50):
declines happen, we're going to monetize excess return, right because
we're hedging two hundred percent of our notional, not two
hundred percent of the hundred not not you know, one
hundred percent. Most buffer funds are constructed on three month
trades and they only defend their notional so they don't
have leverage, so they don't get access return from the
(14:12):
S and P and they don't get excess return from
their hedge because they're only they're only hedging their notional amount.
They're one hundred dollars basically, so we get access return
if the market does go into our range, and as
the market recovers, we have room to rise into our
sold calls, into our short calls. That's financial structure is
(14:32):
in a positive income, positive data, so we don't bleed,
and that's a very important thing because many option structures
provide defense, but they bleed, so you're losing return of
the market. And because we never sell, we never short
calls on that thirty percent of the swamp, we always have.
In the worst market for us, which would be something
like twenty seventeen, where there's no volatility in the market
(14:54):
goes straight up, we're going to get thirty to thirty
five percent of the market with about thirty five percent
of the volatile. It's a you know, forty percent of volatility.
It's a very it's a very safe structure even in
a very low vol straight up market, but most investors
don't buy us for that environment because they have other
equity products that really work in that environment. What happens
is normally, after very low vall environments, you get a
(15:16):
high vowel event and we we do exceedingly well in
those events. But that structure is not is not discretionary.
It's a it's a structure, a systematic structure that we've
researched works now that the strikes of that whether it's
a three week trade or a five week trade, whether
it's a ninety eight ninety three put spread or a
(15:37):
ninety six you know, you know eighty five, the range
might vary a little bit based on the math of
where the options are, the volatility is, and that kind
of constructs the actual put you know puts, and the
dimensions of the trade. But the structure of the trade
is always in place and stays relevant to the market.
(15:59):
So if market goes up, we're following up the market,
and then if the market falls from that elevated level,
we start to defend in that range where some of
the longer traits, the three month trades can become very irrelevant.
If the market goes up, their puts may be irrelevant
to normal declines. And again if the market goes down
through their puts, they may no longer participate to the downside.
(16:21):
And what we do instead is we stay relevant to
the up and to the down of the market because
our trades are shorter. So that's the structural difference. It's
not so much discretionary as it is systematic based on
the math of the market.
Speaker 2 (16:35):
So I guess basically like I get you're saying, the
structure is determined based on what's going on in the
market and how options are being priced, whether it's the
state of the time value to kay vega, what all
those Greek letters that go into valuing it. That's what
you're determining where things are. So do you distinguish it
all between secular and secular changes or are you just
kind of maintaining your same sort of structure no matter
(16:57):
what's going on in your your situation is basically determined
by what's going on in the market and how where
your hedges correct.
Speaker 3 (17:04):
The structure is systematic, but the levels where it trades
depend on the math of the market. And the benefit
of that has really shown through because if you're really
fixed in your structure and your very long term you
can't adjust to the math of volatility, and you can't
(17:25):
adjust to the skew of the options market. And the
benefit of our structure is if skew is to the call,
you know we're able to take advantage because we don't
have to trade our trade at a particular level versus
where we are. If skew is to the call, we
can set our call, our short calls at a much
(17:46):
higher level, which gives us more room to participate up
so our percentage of participation will actually be better in
that environment. And if skew is to the put, you know,
then we're able to sell our put spreads a little
bit more optimally in a different fashion as well. Whereas
the structures, you know, some of the buffer funds and
some of our competitors are very stuck in a dogmatic
(18:09):
trade that is numerically basically structured. They can't adjust to that.
And so that's very important, particularly when you recognize that
the changes in the options market the last several years
and the really the retailization of options has given us
tremendous advantages because it's allowed us to do, I think,
to even adjust our structure more optimally then we might
(18:32):
have envisioned five ten years ago when the structure started.
We just passed our ten year anniversary this last month,
by the way. But when the structure was initially envisioned,
I don't think we recognized the potential for some of
these ranges. With skew and retail interest zero one two
day to expery that has you know, really increased the
(18:55):
liquidity and some of the ranges for the technical part
of options that that I don't think anybody expected and
it's actually helped our product.
Speaker 1 (19:03):
So if we if we think about this for our
listeners that don't understand options, you know, if they're thinking
about it, how does this strategy typically behave you know,
relative to S and P five hundred during rallies versus corrections.
So if we just kind of simplify it.
Speaker 3 (19:21):
So there, there's there's It's really like a light that
has the characteristics of a particle and has the characteristics
of a wave. So so the particle is the equity market, right,
so we follow the equity market. If the equity market
goes up, we have a high correlation to equities. We
have you know, for those who know you know correlation,
we have a we have a well over ninety R
(19:42):
squared to the equity market. So we participate well as
the market goes up. When the market goes down, if
it goes down very little, yes we go down a
little bit as well. But if the market goes down
through the one to two standard deviation area, which is
kind of in that two to seven percent area, if
it goes into that area and volatility rises, that's the
(20:04):
wave issue. We start to correlate to volatility and we
get a benefit from that and our puts start to
generate return. And so the idea here is we really
the factor that we're making money off of is the
cyclicality of volatility. So investors have historically been hurt by
volatile times. Some people call it volatility drag, it hurts portfolio.
(20:25):
Some people like to call it beta expansion. But what
we do is we participate with equities on the in
normal markets and in upward rising markets. But if there
is any kind of cyclicality to volatility or a volatility rises,
that gives us a second form of compensation, and we're
able to take advantage of that because of the nature
(20:47):
of our trade, which has a tendency to buy volatility,
you know, kind of on the cheap side, and sell
volatility more on the rich side. We have a tendency
to sell equities on the you know, in the normal markets,
because we sell calls, you know, in that two to
four percent above where we are. So we sell calls
(21:07):
equity up on the upside, and we tend to buy
equity on the downside because as the market goes down,
our extra defense is compensating us, is monetizing us, and
we'll roll to a new structure and the excess goes
into units of the S and P. And so what
you see with a structure like this that is overdefended
is we get overcompensated for the downside, which means we
(21:29):
have money to buy low and when the when the
market mean reverts, and historically the market has always mean reverted, thankfully,
that means that we have a tendency to buy more
units in those lower amounts, which means we claw back fast,
which helps you overall portfolio because you have an asset
that's starting to come back sooner than the market, you know,
(21:49):
than other products in the market.
Speaker 2 (21:52):
So you just basically said that volatility actually is pretty
good for the returns of this type of strategy. So
I guess my question would be what is the worst, Like,
what are you going to underperform the standard beta of
the market the most?
Speaker 3 (22:04):
Is it?
Speaker 2 (22:05):
Based on what you said, I'm going to guess it's
a low volatility regime where the market is ripping. Essentially,
that is when you're going to have the highest in performance.
Speaker 3 (22:11):
Is that right? Right? So, if we think about tail
risk being kind of a one in five to seven year,
like real tail risk being a one into five to
seven year kind of event. I would say the opposite side,
you know, the right tail risk, not the left tail risk,
the right tail risk, which is the very low VALL
and you know, fifteen to twenty five percent up year
with VALL with the vis being let's say six to
(22:33):
eight and realizing you know, three to four. The twenty
seventeen year is a perfect example of that kind of
a tail year that it doesn't necessarily the strategy doesn't
lose money, but it's it's more that thirty to forty
percent participation in the S and P and lowish VALL,
(22:55):
but you don't get that very high sixty to eighty
percent of the SMP that we'd like to ex effect
with you know, forty percent of the volatility. That's that
kind of a market is unusual. But even an up
market if you get cyclicality in volatility, and we've seen
some of those the last few years where you get
a fifteen to twenty percent return but the VIX is
(23:15):
still at fourteen to eighteen, that kind of a year
where you have and you have a couple of little
scares is a perfectly fine year for us. It's really
the year where you get that perfect storm of no
volatility and straight upward to the to the right that
that makes us look pedestrian. In other words, will be
you know, we'll have a slight advantage over high yield
(23:37):
at about the same risk or maybe a little less risk,
but it won't be that fifty to seventy sixty to
eighty percent of the s and P with forty percent
of the risk kind of year, which is a home run,
you know. Thankfully, I would say sixty to seventy percent
of the time we're in our sweet spot. Maybe ten
percent of the time. It's more of that twenty seventeen
kind of year. But the good news is in those
(24:00):
kinds of years, James and David, everything else in your
portfolio is just on octane, high octane, and so no
one's really worried about this part of their portfolio.
Speaker 1 (24:11):
So if you think of another situation, how has it
behaved in rising rate or inflationary environments where traditional fixed
income is kind of struggled.
Speaker 3 (24:20):
It's a it's a it's a really good question. If
you if you look at two thousand, you know, twenty two,
for example, I was referring to it before the strategy
was down was down two point seventy five percent and
the market was down you know, close to nineteen percent
(24:40):
depending on how you looked at it. You know, eighteen
plus percent. That's a very significant defensive performance. And you
know that's an environment where if certain data points had
worked out a little bit better, you know, we could
have been basically flat on the year. We have a
we have clients that came through that period that came
(25:02):
to us and basically said, we're going to up our
allocation to you because we realize that having too much
in the core S and P category. Now, granted, you
know people were paying you know, James, I know you're
going to love this comment, but people were paying seven
basis points right for the S and P and feeling
great that you know, passive is great, and owning the
(25:24):
S and P is great because it's passive and that
does better than active managers. And you paid seven basis
points for the SMP, but you're down eighteen plus percent
for that seven basis points. And granted, folks pay more
to own our fund, but you know they were down
two point seventy five percent, So not many of our
clients were unhappy with owning our fund at a normal
(25:45):
management fee. Versus the S and P. Because the S
and P doesn't truly give you defense. Indexes are not riskless.
And I think what you're beginning to see here, because
of this beta expansion risk, and because of the tendency
for the SMP, because it's a market cap weighted index,
it has much more beta expansion risk than people understood.
(26:06):
If you look at the equal weighted SMP versus you know,
even versus the market cap weighted SMP, you know, the
equal way to SMP was down eleven point five basically
in twenty twenty two versus the eighteen plus in twenty
two versus R two seventy five. So there is a
fair amount of kind of hidden risk within these indices,
(26:29):
passive indices. And I think what you're seeing advisors, and
I talk to advisors just about every day. What you're
seeing advisors basically say, is passive is interesting visa VI
the active conversation, right, but it's not necessarily as interesting
versus the risk management versus the risk efficiency conversation. And
I think that dimension of the conversation is a really
(26:53):
important one. Now, the traditional buffer funds, the traditional defined
outcome funds, they don't do beta. They don't control beta expansion,
so they don't give you the same benefit in this
particular discussion. But alternatives that are able to really claw
down you really drop down your beta expansion are actually
a very interesting conversation visa VIP passive. And I think
(27:15):
this is a topic that I've made a lot of
headway with with with modelers. You know, I go to
see you know, institutions, I go to see you know,
distribution channels when I talk to that their modeling groups,
And this is the place where you're starting to see
some very interesting headway because you can never make headway
on the passive active discussion. There's just it's a really
hard conversation to have anybody, you know, kind of open
(27:38):
up their mind to. But when you talk about the
passive active conversation around risk management, that actually is one
where the door is cracking and you're beginning to see
people really, really solid people say, wait a second, this
does make a difference if you're able to bring that capability,
that characteristic into portfolios.
Speaker 2 (27:58):
So let's get into something we've danced like the entire
time we've been talking here. Let's go into like a
little bit of a direct comparison to buffer or options
overlay ETFs. I mean for I don't know if the
listeners will know this, but there's like the last few
months there's been this blow up of AQR from the
likes of Clifford Assenas mainly writing papers basically attacking these
buffer products, saying they're overpriced and nothing but a marketing gimmick.
(28:20):
I kind of view it like there's pros and cons
to each, right, Like, I don't think it's just a
marketing gimmick. I think there's benefit for some people. They'll
be like, I know I'm going in here, and I
know exactly what my downside risk is. I know exactly
where things can go. And I think that's just like
easy for some people who don't understand finance and the
benefits of a portfolio construction to go in and know
what this is. And like, this has been a huge
(28:41):
area in the annuity market, right that this is structured
product is a huge thing at banks and high networth individuals.
So I guess, like, are you when you're talking to people,
are you directly competing with these types of products? How
do you compare yourself when you're trying to sell your product?
Speaker 3 (28:55):
You've already said it.
Speaker 2 (28:55):
You kind of move up and down with the market,
Like do you also get compared against these options over
where they're only selling calls to the upside, so you're
still subject to a lot of the downside, but you
get some income. Like how what is your main pitch
and like why you say in a succinct way, like
what is your argument? And like who do you agree with?
Speaker 1 (29:12):
More?
Speaker 2 (29:12):
Do you agree with the Clifford asking this QR side
of things? You do agree with the buffer? You more
like me sit in the middle of pros and cons
to each.
Speaker 3 (29:20):
Well, you asked me to be succinct, and you gave
me a question that literally could be like it don't
be succinct. Yeah, thank you for the podcast format, David. Okay,
let me first say, it really matters what problem you're
trying to address.
Speaker 1 (29:33):
Right.
Speaker 3 (29:35):
If you're trying to address the volatility problem, which I
really view as the you know, the tech wreck and
Great financial crisis problem, which was volatility scared people, some
of those structures are very interesting. And remember modern portfolio theory,
it doesn't just have an assumption that correlations are stable.
It also makes an assumption that individual utility functions are
(29:56):
very similar along risk and reward. And you know, I
I'm you know, I'm an orthodox you know economists from
from from Princeton, and I love that work, and I
studied under malcol and you know, Markowitz, I think is
you know, has done wonderful work. But some of those assumptions,
you know, probably need to be tested more behaviorally, and
I think there's been some good work around that. And
(30:17):
you know, so the Cliff, you know, and by the way,
tremendous respect for Cliff, and I think a lot of
the things he said are legitimate because I don't think
some of the existing products are really worth what what
they They don't necessarily offer as good a performance and
they don't necessarily solve the problem as well as they should.
But but I also would say this to Cliff, and
that is that the utility function of investors is much
(30:38):
more variable than you know, these conservative, moderate and aggressive
models or you know, depending on you use three or
use five. You know, it's very hard. Advisors have the
toughest job in finance, and they have to try to
fit individual client asset liability and and and behavioral tendencies
into these these models. And so what some of these
(30:59):
buffers and defined models have done. Is really solved for
is try to at the edge, you know, at the
incremental level, try to trim some of that to meet
individual investors' behavioral you know, kind of utility functions. And
in that regard, even though they may not be perfect,
(31:20):
they probably help some advisors solve for Okay, this client's
got more volatility fear than they it would be willing
to acknowledge in stress. I'm going to solve for that
problem by lowering some of the volve. Now, these products
I don't think solve the problem as elegantly as they should.
I think they're you know, they're too long a trade.
I think they're not asymmetric. They certainly don't solve the
(31:43):
twenty fifteen to the future problem, which is really beta expansion.
But I think that's what those funds have done, and
so to that extent, I think the cliff is a
little harsh, But to the extent that those funds, because
they're not asymmetric, because they can become irrelevant because they
don't solve the problem that is really the future problem,
which is really how do you manage and constrict beta
(32:06):
expansion in a world where fixed income no longer has
a bull market behind it and is negatively correlated. I
think they're anachronistic and they're really not effective. And when
we show our numbers against our competitors, it's it's very
clear that it's a better solution to be a symmetric
and squeeze downside risk. It's it's very clear. And if
(32:28):
you look at our upside downside capture ratios, it's very
obvious that the asymmetry makes a difference. So we can
still solve for the volatility problem, but we really solve
for this this beta expansion problem. Now, the other question
that you ask is, you know, why have these products
been so popular? Part of it is because from a
(32:49):
marketing point of view, they're very easy to market, compliance approves,
the very straightforward documentation. You know, they seem optically to
do what they say they're going to do, and so
they solve the problem. They scratch an itch, but they
don't necessarily give you the deep tissue massage that you
(33:11):
need to be resilient in that crisis situation. And that's,
you know, that's a very big difference. And I think,
and to that extent, I think if Cliff had looked
at a broader set of funds. We were not included
in his data set. But if he had included a
broader set of funds, I think he might not have
(33:32):
come quite so harshly down on the entire you know,
tard the whole industry. But but the main point is correct,
which is, if you're paying anything for a fund that
doesn't really solve the real problem, you're paying too much.
And and so that's you know, one of the things.
And what we try to do is really get the arias,
(33:54):
you know, to get advisors, you know, even small institutions
and even some institutions that we're talking to, to really
understand the portfolio risk allocation implications of having something at
the center rather than using an MPT a modern portfolio
approach looking more towards a total portfolio approach, where you
start analyzing your risk in holistic terms and not trying
(34:16):
to put everything into style boxes, but saying, how does
this firm add to the risk efficiency of my fund?
And when you look at that and you say, wait
a second, if this fund has better sharp and sortino
than the market, than the equity than SMP, that means
I can take that budget that lowered risk that and
I can use that efficiently somewhere else, And that concept
(34:40):
is very valuable of risk budgeting. We have not seen retail,
we have not seen small institutions really do that. But
I've spent some time recently with consultants and some small
institutions who really are starting to understand volatility has been
used by very big institutions for a long time to
just sell vol They just sell, I'll sell, I'll sell
(35:01):
all until it doesn't work, it blows up, and then
when it blows up, it's interesting to sell all again.
But because it seems like a one way trade, that's
the way everyone's used it. But very few people have
used this idea of a hedge VOWL kind of management
approach which takes advantage of vowel ranges and cyclicality evolve
almost like an equity factor. And I think that piece
(35:25):
because what happens with a lot of these factor funds
is they get so overused that they disintermediate the value added,
whether it's cap whether it's value, whether it's growth, whether
it's small or low vowel funds or dividends. Those factors
start out with a certain ir but when more and
more people pile in, they lose their value. What's interesting
(35:46):
about volatility This has been this issue has existed for years,
but very few people have really piled in. In fact,
I think most people have not used volatility correctly. I
think we use it correctly. And I think that opportunity
as an equity care characteristic to harvest is what differentiates us.
And and that's notably different from you know, the kind
(36:07):
of traditional buffer funds that you see out there.
Speaker 1 (36:10):
So we're starting to run out at a time. But
since you are a global macro strategist, I would be
remiss if I didn't ask you about the markets. You know,
we've read your you know, your market overview for April
has what has changed in your view since then?
Speaker 3 (36:27):
Well, you know, prior, prior to the pandemic, we would
have thought there was some room for the FED to
create some kind of easing, you know, maybe maybe even
just twenty five basic points. But obviously since you know,
Liberation Day, some of that has changed. And I think
(36:48):
it would be unrealistic to assume that the FED, you know,
that the FED has has an easy path here. We
we believe secularly that the inflation equilibrium has changed post pandemic.
We think that it probably means that that our star,
although no one wants to talk about it. I'm still
(37:09):
wondering what's gonna happen at Jackson Hole. But it seems
like we think rates are a little bit higher, will
remain a little bit higher, and that inflation will will
remain a little bit higher. And the call that you
know that Scott Besson has had to drop rates one
hundred and fifty basis points, we think that probably a
lower number is going to be realistic. I think it's
going to be a real challenge for the Fed. You know,
(37:31):
we have a highly unorthodox president, we have some unconventional times.
We think that the mortgage market is probably the bigger
problem that the FED needs to solve for I think
if you look at the economy, obviously there's some labor
issues that are picking up. There's still some incipient concern
about inflation with the trade tariffs. But I just don't
see the FED having the freedom to drop rates as
(37:55):
much as the market is expecting. I think potentially, you know,
this fourth quarter, we could see one decrease. I don't
think we're going to see as many as the market
would anticipate. But I also think that the Fed really
should be looking in terms of the balance sheet, the
mortgage side. I think the Treasury Secretary should really be
looking at, you know, the privatization of Fanny and Freddy.
(38:18):
I think the problem we have to solve war here
that also affects you know, inflation, is what's going on
in the housing market. And so while we're in very
unconventional times, very unorthodox times, there is a way to
thread this needle. Productivities come in relatively well. You know,
there is a potential that the tariffs could be could
(38:39):
end up at just a low enough rate that the
combination of companies with margins and some of the sellers
taking some of the peace and consumers still getting a piece,
that it not be so disruptive if productivity remains relatively high,
and that would probably mean rates come down, but not
as much as people are expecting. I think that means,
you know, medium terms to long term bonds are not
(39:00):
a great place, which witness my comments about correlations on
bonds not being a great diverse fire and why you
need these kind of alternatives that give you some beta
expansion protection. I think that that's still true, but we
need to thread this needle and volatility and implied correlation
in the market is kind of complacent, you know, just
(39:20):
to give you a sense, when we look at skew
in options, given where the market is near market highs,
we would expect the option skew to be pretty significantly
to the put. But in actuality it's only modestly let's
say point three point four standard deviations to the put,
I would expect it to be, you know, over one
standard deviation to the put. The reason for that is
(39:42):
people just frankly, are not selling their calls. It's not
that they're necessarily over you know that they're underbuying puts.
They're still buying buying puts, but they're really not selling
their calls. There's a lot of retail. When I was
talking before about their retail impact on the market, you
should see some people selling their calls, right, monetizing and
and kind of defending. So the hedging piece isn't necessarily changing,
(40:04):
but the speculative piece is kind of staying in place.
And so that connotes a little bit of a little
bit of you know, uh, just a little bit of apathy,
a little bit of complacency, and the implied correlation because
of these because of because of the dispersion trade, which
sells options on the S and P and buys vow
(40:26):
on the single stocks, is really pushing the vics down,
I think, to areas that are probably a little low
for where the macro risks and the FED risks still are.
So it's a position that I think kind of warrants. Okay,
the market can be wrong for longer than I can
be right, so you need to participate. But I think
(40:46):
investors should be aware that you know, there's still you know,
there's still a relatively tight thread, a tight needle that
we have to thread here, and and you know we
still have some concerns.
Speaker 2 (40:59):
Alright, So last question and then we'll wrap up. You
just spoke about a whole host of things with Ward's,
the FED and the economy. So I guess, like what
is the primary risk? You see, this is going to
kind of be a two parter, like from any economic standpoint,
from the FED cutting rates, like are you most concerned
with inflation? Are you most concerned with the unemployment? Job market?
(41:20):
Are you work concerned with productivity? Which I guess goes
to the job market. The other thing you mentioned is
the housing market is frozen, and Trump and everyone is
talking about lowering rates. But if you look back to
the last time the FED lowered rates, the tenure actually
went up and the mortgage rates market actually went up.
So is that actually going to solve things? And then
like after that part, like of all those things, what
is the primary risk the stock market? There's a huge
(41:41):
talk about like the stock market is not the economy anymore.
It's kind of become disassociated in some ways. Do you
agree with that, Like, can you just talk about the
primary risk you're seeing from both an economic point of
view and a stock point of view.
Speaker 3 (41:51):
I look, I think those are great questions. You know,
the American excellency is is is still in place. It's
taken a bit of a hit because of some policy uncertainty.
I think it's also taking a bit of a hit
because the fiscal the fiscal house is not in as
(42:14):
good as shape. The debt, you know, the the the
debt to GDB ratios do cause some concern. And part
of the reason why the US dock market has really
always been supreme basically, and it's hard for people to
understand this is that the Fed's backstop and the US
Treasury's backstop as the global financial system. You know, asset
(42:39):
of choice have been rock solid, and so you know,
the FED couldn't have dropped rates as much as they
have several times in our last several crises unless there
was tremendous uptake and desire to hold US treasuries. You know,
you can't drop rates like that as a central bank
if no one wants your paper, because we don't finance
ourselves completely domestically, right, So the question here really is
(43:04):
is you know, the US the put here, the FED
put really depends on a sound fiscal situation. Now, the
last auctions there were a couple in early August, you
know that weren't perfect, but for the most part, the bid,
the cover ratio and the amount that's been hit you know,
having to be taken by dealers has been manageable. But
you know, you don't want to get to the place
(43:26):
where people are concerned about your credit rating, where people
are concerned to the place where it affects the uptaking
your auctions, because if that occurs, more meaningful and we're
not at that level now. But that's the concern here
that you don't impugne policy and the importance of the
US the preeminence of the US Treasury in the auction process,
(43:46):
because that would in fact handcuff the FED. And so
when you see the long end, you know, kind of
steepen on some of these pieces of news, it gives
you a sense, okay, with the inflation issue. The inflation
issue is still here, and the treasury risk premium is
coming back. What we want is the treasury risk premium
(44:07):
to be as low as possible and not handcuffed the FED.
But there's also a natural equilibrium that productivity seems to
be high, and the natural demographic and supply chain dis
globalization issues seem to be raising the natural rate of inflation.
So all those things give you a much narrower band
(44:28):
of where rates can be, and pees you assume some
drop in rates here, and pees assume some improvement to earnings.
That do have a productivity dependency, and with lower educational
inputs to our productivity, more of these productivity inputs are
(44:49):
dependent on AI and all these software innovations. Usually this
kind of productivity takes three, four or five years to
fully be felt. We're still in the investment phase of
Productivit is that going to be seen in a quicker timeframe.
Because of the nature of the disruptive nature of AI.
I have a sense that that part of it's correct,
(45:09):
but I think more of it depends on interest rates
than the market may want to acknowledge, and so squaring
that circle is actually the risk. James, are we going
to be in a place where the FED is more
handcuffed than we'd like to admit. That's why I think
when you look at the vic's futures contracts, the front
end has dropped noticeably into the fifteen range. But if
you look from a month ago and you look at October, November, December,
(45:32):
you still see very high levels for the VIX futures curve.
And that tells me smart money understands that that threading
of that needle is not as easy as implied correlations
as the current you know, cash level of the VIX
would would would signal.
Speaker 1 (45:49):
Well, this is great. Unfortunately we have to end here.
Thank you again our name for joining us. It's been
my pleasure and great meeting you, James.
Speaker 2 (45:58):
Good seeing you again, David, wonderful to me was well,
our name, This was fun. That last part was my
favorite part. I think the macro topics.
Speaker 1 (46:06):
And James, thank you for being my co host today.
Speaker 2 (46:09):
Thanks for having me.
Speaker 3 (46:09):
David and I.
Speaker 1 (46:10):
Want to thank our listeners. If you liked the episode,
please subscribe and leave a review. Also, if you'd like
to see more of our research, go to bifund go
and bi Stocks Go on the terminal until our next episode.
This is David Cohne with Inside Active
Host
Gina Martin Adams
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