March 28, 2025 • 61 mins
Alan Dunne and Mark Rzepczynski tackle the current market vibes, focusing on how factors like the 200-day moving average can shift market sentiment and affect portfolio strategies. As they navigate through the choppy waters of market performance, they discuss the importance of understanding uncertainty versus risk and how it impacts decision-making for both individual investors and managers alike. There’s also an exploration of how curiosity plays a crucial role for fund managers in adapting to ever-changing market dynamics. Join us for an insightful discussion on making sense of today's investment landscape.
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Episode TimeStamps:
01:04 - What has caught our attention recently?
04:09 - Industry performance update
06:22 - How markets and managers respond to tariffs
09:39 - Are we talking ourselves into a recession?
12:55 - Why the distinction between risk and uncertainty is important
16:26 - What is price telling us about market noise?
24:06 - How quant traders should approach uncertainty
28:59 - How the current economic landscape shapes systematic trading
31:52 - Feedback loops, reaction functions and monetary policy
36:05 - Advice for dealing with uncertainty as an investor
41:36 - Curiosity as a characteristic in fund...
Mark as Played
Transcript
Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
(00:01):
You're about to join NielsKostrup Larson on a raw and honest
journey into the world ofsystematic investing and learn about
the most dependable andconsistent, yet often overlooked
investment strategy.
Welcome to the SystematicInvestor series.
(00:23):
Welcome back to the latestedition of Top Traders Unplugged
where each week we take thepulse of the markets from the perspective
of a rules based investor.
It's Alan Dunn here this weeksitting in for Niels again who's
gone on his travels anddelighted to be joined by Mark.
Mark, how are you doing?
Good.
How about yourself?
Very well, yeah, all good here.
(00:45):
Spring sunshine is continuingin Dublin so we're happy with that.
How is all the stateside kept?
Well, Boston is starting toget a little bit warmer.
We got blue skies out here,you know, some of the full flowers
are coming up.
So spring is.
Spring has come.
Very good.
Good stuff.
Yeah, yeah, absolutely.
(01:06):
So a lot going on in markets,an interesting time.
We're coming up towards thepretty much the end of the quarter,
so it's certainly been aninteresting period.
Very choppy, I think, fair tosay, across a number of asset classes.
So we'll get to that in termsof performance in a little bit.
But we always start offasking, you know, what's been on
your radar lately?
(01:26):
Well, I start with a quotefrom my grandmother.
Not that she was a greattrader, but she used to warn me when
I'd go out, you know, becauseshe lived with us when I was growing
up, she goes, nothing goodhappens after midnight.
And that always comes to mindbecause when I look at financial
markets, I'll say that nothinggood happens below the 200 day moving
(01:50):
average.
Pretty good, yeah.
As soon as prices get belowthe 200 day moving average, it changes
people's, you know, a psyche change.
I think that there's adifference sense of sentiment, you
start seeing more selling, youknow, volatility changes a little
bit.
(02:10):
So I don't know why it's the200 day moving average, but once
you hit that, it seems likethings change.
Interesting.
I mean there is the age old,you know, the debate around technicals
and is there a merit in it?
But you're right, it does seemto be it to 200 day moving average
because it gets so muchtension in the media.
(02:31):
Is that it, that it's a flipof a switch to highlight that something
fundamentally has changed?
You know, I think it's justlike one of those long time indicators.
Just like when stocks hit newhighs, people behave a little bit
different.
But we'll sort of say thatthis is not applying to all markets
(02:54):
right now.
And I think we'll talk aboutthis in a little bit.
So, so we've got, let's saythe US General Stock market, you
know, S, S, s and P, NASDAQ,they're below the 200 day moving
average.
If we start looking atsectors, we've got some that are
way above 200 day moving average.
You go to the European Stockmarket, we've got a very different,
(03:16):
you know, type of market.
So, so what it tells ussomething about rotation.
It tells us something aboutwhere the sentiment is changing across
markets.
And that clearly then isreflected in people's behavior because
people say well if I'm downbelow the 200 day moving average,
(03:36):
well maybe I got to startrevising my portfolio.
I'm going to have to startthinking about what I might sell.
On the other hand you say likeokay, there are other stuff that
looks like they're performing well.
Maybe I should start to lookto increase the exposure on that
side.
Yes, for sure.
And I think that's somethingwe will get into in a bit more detail
as we go through the conversation.
(03:57):
And as you say, there are manykind of, I suppose, different pictures.
I guess when you look at thetrends and the technical picture
across global markets, it'scertainly some divergences there.
So maybe just to touch ontrend following and manage futures
performance at the outset toget that out of the way.
(04:19):
So on the month, The Soc GenCTA index is now down 25 basis points.
The SOC gen Trend index down alittle bit over 1%, 1.07% and year
to date.
And obviously that's the Q1SoC Gen CTA index down 2.23% and
SoCGen trend index down justover 4%.
(04:42):
So obviously a negative startto the year, a negative quarter.
And we've touched on thedrivers in terms of the choppiness
in obviously in equities andfixed income and reversals in some
commodity markets in February.
Any other observationsyourself Mark, in terms of CTA and
(05:04):
trend following performance in Q1?
Well, I think that we're earlyin the whole trend revising change.
So let's go back to ourinitial comment about you know, 200
day moving average.
Well, we had, you know, the U.S.
stock market, you know, sortof crossed over and below the 200
day moving average in the, inthe quarter and there's a view is,
(05:29):
is that, well, trend followingis down, something's wrong here.
Well, what we find is that ittakes time for some of these revisions
and trends to then actually beadjusted in the portfolio.
So trend followers, which aremore intermediate term, they'll start
to lower their exposure insome markets, increase the exposure.
(05:51):
And what we find out is thatwhen there's the transition period,
there might be underperformance.
And if the new trends start tolast longer, then we'll start to
see the outperformance of CTAsrelative to long only assets.
Absolutely.
Yeah.
So I mean, I think that'scertainly the view.
(06:12):
We're in that transition phasewhere, you know, as we've been highlighting
on many of the podcasts,uncertainty is unusually high.
We're seeing a lot ofobviously new policies coming in.
So maybe that's a good placeto start in terms of, you know, the
kind of the impact of thosepolicy changes on markets at the
(06:32):
moment.
Obviously tariffs has been thebig theme in Q1 and it has been very
much kind of on, off, on, offand more on than off, I guess towards
the end of the quarter.
But I mean in terms ofthinking about how managers, how
markets respond to that andkind of looking through all of the
policy impacts, how do youthink about that?
(06:56):
Well, first on tariffs inparticular, what's very interesting
is that it now matters whatare the contract specs that you trade
if you're in the commodities markets?
So are you looking for NewYork delivery versus London delivery?
So if you see that there's atariff gap for some of the metals
(07:19):
between New York and London,you see a gap in gold prices even
though their tariffs won't beaffected by gold.
So now what happens is thatwhile, you know, a lot of CTAs might
say, or a lot of managers say,like, well, you know, one contract
is the same as another.
You know, let's just look atliquidity as the main driver.
(07:40):
Now you have to sort of saylike, well, let's look at what are
the delivery provisions, whereare, where is delivery, where is
the market centered?
And those things start to havean impact on how you construct your
portfolio or what you mightsee in performance.
Yeah, for sure.
Obviously we're seeing that incopper in particular, isn't that
right?
LME copper lagging andobviously New York copper touching
(08:02):
all time highs during the week.
Yep.
But I think that the tariff isjust a representative of the broader
issue which, you know, I thinkis what we're seeing is that the
impact of uncertainty in markets.
And we'll start, I'll startthis with the whole idea is, is that
(08:24):
that most recessions are manmade because of bad policy decisions
or bad choices by marketparticipants and not from old age.
So when you think about arecession or you know, a recovery,
you could think of it as isthat you can almost think of it in
a mortality table.
(08:44):
This is that, you know, itages and then as we get older and
older there's more likelihoodthat something could go wrong with
our quote unquote economic health.
And if there's something goeswrong with their economic health,
then there's more likely thatthen that recovery is going to die.
So, so, so what is, what'sdriving the economic health right
now, which you touched on, isthe tariffs.
(09:06):
But, but the broader issue is uncertainty.
And we'll sort of say thatuncertainty is man made in this particular
case because it's not un.
Uncertainty about okay, whatare the crops going to be.
It's not uncertainty aboutwhat is going to be consumer demand
per se, but it's uncertaintyabout policy.
(09:28):
And so, so we'll say thatthat's, that's a choice that's being
made.
So as opposed to it's, it'ssomething that's exogenous, that's
being enthrust upon us.
Yeah, that's fair to say.
I mean it is interesting.
There is the argument that, Imean you mentioned kind of the economic
(09:48):
cycle tends to die because ofpolicy errors.
I mean there is a view thatthe cycle has got longer because
the economy has become moreservice oriented.
And historically some of theswings in the economic cycle were
driven by the inventory cyclewhich is very much a manufacturing
(10:09):
goods kind of cycle.
And obviously if you go backto the last kind of economic cycle
or the expansion it lasted, itwas one of the longest I think right
through the last decade and itwas only ended by Covid.
You could argue differentarguments are in that some people
would say well it would haveended anyway.
But I mean ostensibly Covidwas the end of it.
(10:32):
But as you say, you can havekind of more man made economic downturns.
And sometimes you hear theexpression we might risk talking
ourselves into a recessionwhich is a bit kind of like what
it feels like we'reexperiencing now where let's talk
about uncertainty.
And then uncertainty doesobviously have real economic impacts
(10:52):
because people I guesspostpone investment and postpone
consumption decisions.
So that seems to be thescenario, the potential scenario
now is not it.
There's a couple things weknow about the post World War II
period is that one, recoverieshave been longer to the amount of
(11:12):
time that we spend inrecession is less so and so if we
look at the mortality table ora life expectancy of recovery.
So if you look at Pre WorldWar II, post World War II, is that
we've done a pretty good job.
So to say that, that we don'tmake, you know, a lot of forced errors,
a lot of policy mistakes, thatdoesn't mean that they don't occur.
(11:36):
And that's the, that's theimportant issue to remember is that
just because we've made fewer,fewer errors in the past doesn't
mean that we won't make errorsin the future.
So and that could just be amatter of, you know, unintended forced
errors.
(11:56):
And that unintended forcederrors in this case, I would say
is uncertainty shocks.
Yeah, I mean, I mean peoplethrow the word uncertainty around
a lot, but I guess like whatis the uncertainty at the moment?
I guess it's one of thereasons it's so striking.
I guess it's you've gotuncertainty around the actual action
and you've got uncertaintyaround the impact of the action.
(12:18):
I would, would you agree with that?
I mean, from the perspectiveof, you know, Trump has been quite
erratic.
You know, tariffs were on,then they were off, they were delayed,
they're back on.
So, and, and then it's notclear is this a bargaining tool or
is this the end game?
So, so that leads a lot ofuncertainty as to what does this
look like.
(12:38):
But then also we haven't hadthese kind of policies for a long
time, so the actual economicimpacts of them are much disputed.
And then obviously because ofthat, we don't know how the policymakers
in central banks are going to react.
So I suppose it's kind ofuncertainty cubed, maybe in that
sense.
Right.
Well, taking a step back isthat we want to make a distinction
(13:01):
between risk and uncertainty.
So, and, and this is an ageold problem that some people thought
we, we eliminated.
But we'll sort of say that,you know, risk is what is countable,
which is measurable.
It's what we look at when wesort of say there's volatility.
Now a lot of people use theword risk and uncertainty interchangeably,
(13:24):
but we'll sort of say thatwe're making the argument that there's
a distinction between the two.
Will say that risk is what iscountable in the markets, which is
based on just the statisticalmeasure of this spread or, you know,
the deviations away from themean squared.
Okay, so it's a countable measure.
(13:47):
When we talk aboutuncertainty, what we're saying that
this is something that's not countable.
There are now uncertaintyindices which, with a Look at, okay,
the number of news reportstalking about monetary policy, the
number of news reports thatmight talk about, you know, you know,
policy changes in government spending.
(14:07):
So we'll sort of say that bylooking at the count of stories and
the amount of words aboutuncertainty, about the words of policy
changes that we can then use,you know, sort of like large databases
from news organizations tostart to count or measure what is,
(14:28):
you know, normally noncountable, which is the volatility.
So, so in that sense is that,that we're making a separate distinct
difference between these two.
And if you look at some of theresearch that has been found and
even some of the work thatI've done is that if you look at
these uncertainty indices,you'd say that it is a separate factor
(14:51):
from volatility.
And when you think about ourvolatility, our volatility is often
backward looking because wehave to count, you know, data or
returns from the past and thenlooked at the volatility.
So that's, that's in the past.
And then our assumption isthat the risk that we count in the
past will then apply to the future.
(15:13):
Doesn't always happen.
Uncertainty is saying, I don'tknow what's happening with certain
policies.
And so therefore it creates aenvironment where it's ambiguous
what will be like theregulation that I face, what will
be the monetary policy that Imight face, what will be the tax
(15:34):
policy or fiscal policy Ihave, or what is the trade policy.
So the idea that it's notclear what the environment I'll live
in is different than the riskin the market.
So we've had a spike in Vicvix, it's come down.
You look at the VIX termstructure, it's inverted.
(15:54):
So we have high volatility inthe front end and it's, and then
we have lower volatility longer.
But if you look at forexample, these uncertainties in indices,
this is that the measure oftariff uncertainty is through the
roof.
Okay.
If we look at just overallglobal policy uncertainty, that's
also at the highs, it'ssimilar to what we saw during the
(16:17):
pandemic in 2020.
So we'll sort of say thatthese two are distinct and different.
Yeah, I mean, that's interesting.
I mean, but I guess one of thethings we say about trend following
and managed futures technicalanalysis is the idea of price discounting.
(16:38):
All the relevant informationand you know, trend followers followed
the price for that reason.
So I mean, taking thatperspective at the moment, and you
know, because we've got somuch Noise, so much uncertainty.
And taking, you know, maybethe perspective of the wisdom of
the crowds, you know, if youlook at what the price is telling
(17:00):
us, I mean, what would you sayfrom that, looking at the price.
So what is the market, wouldyou say telling us about all of the
noise that's going on?
Right.
Well, let's look at the USStock market might be a perfect example.
Is this is it.
It's telling us is thatthere's given this higher level of
(17:22):
uncertainty that's differentand distinct from risk is that we're
saying is that I want to bemore cautious about what I'm on,
how much money I'm going toput into risky assets.
We'll sort of say that, youknow, Europe also faces uncertainty,
but Europe is in ideas is thatthey've talked about like, well,
we're going to increase ourdebt financing in some, some sense
(17:46):
that, you know, we have theECB that's being, you know, more
accommodative and more easing.
So while there's uncertaintyabout what's happening in geopolitics
and then, and we'll sort ofsay different regulatory policies,
we'll sort of say that there'smore certainty about what's happening
in Europe than there is in theUnited States.
So what we see that whenthere's higher uncertainty, there
(18:09):
generally will be a view thatyou're going to reduce your exposure
to risky assets.
Now, uncertainty could be bothgood and bad.
This is it, as I always sortof say.
Like when you think about, youknow, the whole idea of fat tails
and distributions.
I said fat tails.
This is sort of like you get abig prize at Christmas, okay, A big
(18:30):
box and it's ticking.
It could either be, it couldeither be a clock, a new watch, or
it could be a bomb.
You don't know.
So it could be each either oneof the tails.
But what we sort of say that,that given this higher uncertainty
is, is that then there'sgenerally a movement away from risky
assets.
Okay.
So that's in the financial side.
(18:51):
There has to be a higher riskpremium associated with holding risky
assets.
When you look at the realeconomy, if you are going to make
an investment decision, yousay like, well, if I don't know what
the tariff situation would be,I don't know what tax policy will
be.
I don't know what monetarypolicy may be.
(19:12):
Maybe I'll hold off by capital expenditures.
If I'm, you know, if I'm aconsumer and we see this in some
of the, in some of thesentiment numbers is that maybe I
might be more cautious onmaking large purchases of disposable
non disposable goods.
So now what you'll also do isthat you'll see that then there's
(19:35):
going to be a slowing or callof decision making in terms of a
dollar cost average.
So if I'm going to make aninvestment decision instead of sort
of saying like well I'm goingto rebalance all of my portfolio
at once, I might say well I'lltake, I'll start to slowly rebalance
given this uncertainty.
(19:57):
So, so what does that mean fortrend followers is, is that in a
high uncertainty environmentwhere people rotate assets to those
that are less risky, there'sgoing to be opportunities.
In a high uncertaintyenvironment where there's going to
be more caution and slowerbehavior of both hedgers and speculators,
(20:19):
then that means is thatthere's more likely to be sort of
autocorrelation in the timeseries, which means is that there's
more likely to be trends.
Now the problem comes in isthat all of our trend followers is
that when we're, we all,either explicitly or implicitly,
(20:41):
we're all signal to noisetraders, okay?
And that's all quants aresignal to noise traders.
And when we say that they'resignal to noise traders is that we're
looking at a signal and thenwe have to discount that by noise.
So if I have a shallow trendbut the noise has increased, it could
be an actual volatility orthis uncertainty.
(21:04):
Then what happens is, is thatI might actually have to take smaller
positions because the return,return to risk ratio is lower.
Or if let's say I had a trendthat was relatively strong but now
the noise has gone up, wellthen my signal to noise ratio has
gone down.
Which means is that I might tocut back my exposure because that
(21:27):
the, the reward I'm gettingfor the risk that I take may not
be as the same as what it wasthree months ago.
That makes sense obviously.
And we're seeing that inequity markets higher risk premium
mechanically should meanfuture earnings are discounted at
a higher rate, which wouldjustify lower stock prices.
(21:49):
So that's true.
I mean bonds I guess have beenkind of rangy up and down so you
could see some flight toquality there.
And obviously gold I guess hasbeen the standout trend maybe of
late.
And you can draw certaininferences from that.
I mean, is that uncertainty,is it geopolitics, is it inflation,
(22:14):
does it matter?
It's a trend I guess is whattrend followers would say.
Well, gold is a realinteresting case because we'll sort
of say that there are certainknee jerk responses that we have
to gold.
And one is this fact is thatwell, if inflation goes up, I gotta
have more purchases purchases gold.
So inflation has gone down andyet we still have now the new highs
(22:37):
in gold.
So there has been some recentresearch by Earp and Harvey Campbell.
Harvey, and they've looked at,you know, the gold market and they,
they've done this in, in thepast and so, and what they showed
us is that one of the big, youknow, that there's been a sort of
change in the market based on,you know, gold ETFs.
(22:58):
So, so what?
Because we've made it cheaperto actually transact in gold.
We've, you know, we've thefinancialization of gold.
This is that that createseasier for people to demand gold
and push prices up.
And the other issue that wehave is, is that there's been a lot
of buying by central banks,especially in the case of, of China.
(23:23):
And what we'll sort of saythat and, and I've been thinking
about this issue a little bitmore deeply is that one of the key
issues in macro finance rightnow is what is a safe asset.
And so, and whether there'sthe supply of safe assets is large
enough, let's say in treasury bills.
Now you could think of a safeasset in, in a broader sense is that
(23:46):
I want to have an asset wherethe government can't, you know, appropriate
it or I could probably hide mywealth, you know, from sanctions.
That's what central banks maybe doing.
There may be other people thatare buying this as an alternative
safe asset because it's harderfor governments to be able to get
at your gold.
(24:08):
And maybe just taking the,this kind of uncertainty topic and
from the perspective of modelbuilding quant traders, I guess the
uncertainty is just, it's afeature of the market.
I mean you mentioneduncertainty being a different factor
to volatility, which makes sense.
(24:29):
It's also just I guess a feature.
I mean from the perspective ofquantitative investors, quantitative
fund managers, the modelsdon't know that uncertainty is higher.
They're just looking at eitherthe price series or the macro data.
I mean is it something that,is that, is that just the nature
(24:51):
of it or is it something that,that, that I, I guess quant traders
should try and specificallyallow for, do you think?
Well, this is of course one ofthe age old questions is that should
you adjust models or not?
And then, and should you chasemodels with constantly, you know,
tinkering and we'll sort ofsay that we know from trend following.
(25:17):
Like for example, this is thatregardless of all the tinkering you
have, if you look at the long,long data that we have, is that intermediate
trend following seems to work.
You know, best.
This is that.
So if you, if you want totinker is as long as you sort of
use as a bas and you know, asyour, your prior or your base, stay
(25:37):
stick in the intermediate areabecause that's going to always serve
you well.
This is that sometimes thelong run will do better and sometimes
the longer term trends will do worse.
Short term is, is sort ofsomewhat ephemeral, but you stick
in that intermediate range,you know, plus or minus a little
bit, you're going to do well.
I think that this is one ofthe key issues that what we have
(26:01):
with, with just overall quanttraders in general and their use
of information.
And so there have been someresearchers that have talked about
that there, there are twotypes of traders.
That's interesting.
As always, we break everythinginto dualities.
Everything has to be two,there's got to be two types.
(26:22):
So, so but the two types, we'dsay that is how they use an information
usage.
We'll say that a quant is moreof a searcher and an adapter.
So what he does is he takes alarge database and then he can say
like how do I search throughthat database, find factors that
I think that are significant,then adapt them and optimize them,
(26:46):
you know, given all of theinformation I have.
So that you're constantlysearching for the, you know, the
optimized choices that you make.
On the other hand, adiscretionary trader is an expert.
He's saying I'm not going tobe searching for an optimal solution
as much as I have a view ofthe world.
And then when I process theinformation, especially those information
(27:11):
that's non count countable.
So the information that I cangain or I can manipulate as, as an
expert.
Okay, so now let's look atwhat the environment we faced is,
is that if you have a lot ofuncertainty, then behavior may change,
(27:31):
which means that systematiclinks may be broken or they may change.
Okay.
We find this with a lot ofregime work.
So which I think is, you know,very important in the quant area.
So what we do is we consider,we find out is, is that there may
be behavior of certain riskpremium or certain or certain factors
(27:54):
that do well overall, but theymay have periods where they do better
or worse based on the regime.
The simplest regime that wealways have Is let's say look at
the business cycle, right.
So, so we can look at theinflation cycle in as the regime.
So what?
You could also sort of saythat there are uncertainty regimes
(28:17):
and as an uncertainty, ifthat's, we have an uncertainty regime,
then we might say thatbehavior differs in that regime.
And so therefore some of thesystematic links that we normally
see will change.
We should then adapt to that.
The problem comes in is thatwhen we look over history is that
(28:40):
how many of these regimes dowe actually have?
So how many high uncertaintyregimes do we have?
And you know, can we go backand look in history and sort of say
that this particular regimethat we see of high uncertainty across
a lot of policy variables asit ever occurred in the past.
That's up to debate.
(29:01):
Yeah, I mean it's very hard to say.
I mean it's only been a fewmonths, so I mean it feels like this
has been a drawn out process,but I mean in the grand scheme of
things it's not yet.
And obviously the marketimpacts, you know, were the opposite
for the first, like inDecember we had the Trump trade,
we had equities up, we had Ithink gold down.
So pretty much the opposite ofwhat we've seen since the first few
(29:25):
months of the year.
I mean, granted, what you'resaying about structural ships potentially
in a new regime, that aside, Imean, is an environment like this,
I guess better or easier for asystematic process?
I mean, in terms of cuttingthrough the noise, I guess you're
talking about discretionarymanagers being experts.
(29:48):
It would strike me as being aparticularly difficult time to kind
of evaluate policy and, and,and kind of predict policy.
But what are your thoughts on that?
Is there anything we could saywith, with any degree of confidence?
Right.
Well, let's, you know, goingback to this, the dichotomy we had
between the quant searchersand adapters, the optimizers and
(30:09):
the experts.
Let's say if you believe thatthe environment here is uniquely
different, meaning that wecan't really point to other periods
in the past like this, then wesort of say that you'd want to discount
the quality of experts.
So, so which you could sort ofsay that they, they don't have expertise
(30:30):
for the simple reason theyhave no past experience where they
could call upon to say this ishow we've seen this event in the
past, this is how the marketwill react and this is what we need
to do.
Now we could theorize aboutthis as an expert, but we may not
have countable data which wecan Use under that.
(30:50):
It's sort of say that while wehave more information and we'll sort
of say that there may be aregime change.
Let's just say that I mighthave a bias to sort of say that you
want to load up on more quanttraders because they could say that.
Well, I'm just going to letthe data speak for itself.
(31:10):
I'm not going to worry aboutwhat policymakers are saying in news,
you know, to the news.
That may not be what they sayin Twitter.
It's all I'm going to do islook at what is actually happening
into the price action.
And this is for trendfollowers or even non trend followers.
So in a world where, you know, P.E.
(31:32):
you sort of say what, whatwould we like P.O.
policy makers to do?
And you say that they do whatyou say and say what you do.
If we don't know whetherthat's occurring, then it would seem
as though let's look at thesecond best solution which is let's
follow what markets arebehaving and what they're telling
(31:53):
us.
Yeah, that's true.
I mean the other dimensionhere is the fact that we have feedback
loops, which I guesscomplicates the picture as well.
And one of the I guessfeatures and discussion points of
late is is there a Trump putand where is it?
Because it seems unusual forpoliticians or a president to be
(32:20):
not unhappy with stock pricesgoing down and seemingly complacent
or unworried about thepossibility of recession.
So the market is kind ofskeptical and kind of thinking, well
there might be an about turnat some point and obviously if there's
not, if stock prices continueto go down, that creates feedback
(32:41):
loops into the real economyand possibly into monetary policy
as well.
So feedback loops I guess areimportant too, which makes it even
more difficult to account forright now.
Another way to put this inthis is that if we were having an
(33:02):
academic discussion witheconomists, they would sort of say
we always want to know, knowwhat is the government's and let's
say the central bank'sreaction function.
So if I understand thereaction function, then I can know
where the put is.
So if I don't know what thereaction function is, then this is
where we call uncertainty.
(33:23):
So we'll sort of say that atdifferent times.
This is that, you know, inmonetary policy we often talk about
the Taylor rule, you know, butas a simple measure of monetary policy,
that would be a form of areaction function.
So now we'll sort of say andlet's look at the specifics of monetary
policy and, you know, usingthat as an example of uncertainty
(33:46):
is this, is that you say,well, what is the Fed's reaction
function?
Well, we have higher, youknow, consumer sentiment about inflation
over the long run.
It's probably above 3%.
We have, you know, survey workthat has actually said this, is that,
you know, consumers are reallyconcerned about inflation.
(34:07):
And they actually sort of saidthat if, if they had their way, they
would like to have inflationat about 0.2%, not 2%.
So now with the Fed, afterthey heard all the survey data, the
conclusion that they had isthat, well, we didn't do a good job
of it.
Explain why we need to havehigher inflation, because that's
good, good for us as policymakers.
(34:30):
So, but if you look at whatthe consumer wants, they want 0.2%.
They're expected to have 3%.
We've got a Fed that you know,sort of cut.
And they said, oh, we mightdelay cuts, but, you know, they,
they cut in December, they hadthe 50% cut in, in September.
And if anything, you mightargue that this is a time to, you
(34:53):
know, raise rates.
So, or at least that, that youwant to consider that because you
are still Nowhere close to 2%.
So, so what is the reaction function?
And further example ofuncertainty is the fact that they
have the quantitative tightening.
We've gone from 25 billion to$5 billion, you know, a month.
(35:15):
It will start in not sodistant future.
And you sort of say, like,okay, we're closer to three than
we are to 2%.
We know that quantitativeeasing was to try to get economy
boosted and in some sense getinflation higher.
Now we're sort of saying isthat, well, what we want to do is
(35:38):
we're still way over the Fedbalance sheet prior to the, you know,
COVID pandemic of 2020.
But we want to slow down ourquantitative tightening from 25 to
5 because we think that thisis important as a policy measure,
(35:59):
so that creates more uncertainty.
We've spoken a lot about uncertainty.
I mean, obviously there are soobvious points to sum up by saying,
you know, obviously getreflected in markets in terms of
risk, premia, etc.
(36:19):
You know, we're talking aboutwhether it lends itself more to discretionary
or systematic trading.
The difference between riskand uncertainty.
Taking it all together, youknow, uncertainty is elevated.
What should investors takeaway from that, would you say?
Well, there's a couple things.
What's going on is that if youare, you know, someone who doesn't
(36:45):
expose yourself to alternativeinvestments, so so one would be to
say is, is that you want toreduce your exposure to risky assets.
So, so if you, if you sort ofsay that because you're risk averse
and we'll say that there'salso aversion to ambiguity.
So which is, which is probablymore representative of, of uncertainty
(37:07):
is that you'd sort of say likethat you want to try to move to safe
assets.
So we've got higher T bill rates.
So that's really not that bad.
But then you sort of say thatif you do that, then you cut off
your potential gains underthis uncertainty environment because
as we've talked about this isthat uncertainty could be both good
(37:29):
and bad.
You know, we could have, we'refocusing in on the downside of uncertainty
because we know that thefinancial shocks are asymmetric.
If there's a downward shock,that it's going to have a much greater
or negative shock, it's goingto have a much greater impact on
markets than it would be ifthere's a positive shock.
(37:50):
So, so you say like, well,what's the next best alternative?
If I can't, instead of justgoing straight to cash, how can I
participate if thisuncertainty is actually positive?
Now what suggests this is thatto increase your exposure and to
alternative investments.
And it seems as though that,you know, from some of the research
(38:11):
that I've seen recently is Isaid if you increase your exposure
to trend following, that'sgoing to be a positive because one
is that because you're tradingboth assets from the long and short
side that you can then be ableto participate in case something
goes bad or if it goes well.
Okay, so we'll say it has morevariable beta is that second is,
(38:34):
is that you can increase yourexposure in the set of markets you
choose.
So not only are you exposed tothe US but you're exposed to currencies,
you're exposed to commodities,you're exposed to European markets.
And, and the fact that there'sa disciplined rule that, you know,
for example, this is that whenwe talked about the, our, my grandmother's
(38:55):
rule of staying out over midnight.
Well, a trend follower wouldsay like, well, if the trends are
going down is that you got toreduce your exposure.
And if you looked at this asjust as a simple case is that they
would probably catch, and Ithink some of the trend followers
have done a good job ofcatching the rotation across sectors
(39:16):
or across the globe in equity markets.
And you know, we'll sort ofsay that large brokerage firms have
been tracking what theyconsider trend following exposure,
you know, they probably, youknow, they do an okay job.
They may not be as good as ifyou could do this on your own.
But it shows that there hasbeen a change in the exposure or
(39:42):
the overall equity beta forCTAs in this.
First quarter and the overallthe equity beta has come down and
it's now more biased towardsoverseas equities.
Is it, isn't that it?
Yep.
And, and, and in fact this isexactly what you want.
And what we find is, is, isthat, and let's go from a more of
(40:04):
a behavioral exp you level is,is that whether it's individual,
an individual that's beingadvised by an ria, if it's a pension
that has a committee, is thatwhen you have high uncertainty, the
committee will probably bebiased or most people are going to
be biased to take no actiongiven its high uncertainly.
(40:26):
Let's just stick with what wehave, okay?
Because I don't know what's happening.
And so if you have a model,it's, it's going to say like, well,
since that model is, islooking for the price trend, that
model is usually lookingthrough that price trend and it's
going to discount it by thevolatility, okay.
To some degree either in theposition size or, or the signaling
(40:51):
itself that they would sort ofsay like, well, if I see that there's
a time that I should berotating in European markets in equities,
well, we're going to start toincrease our European equity exposure.
We don't care about theuncertainty which just sort of said
the signals are telling us this.
And, and I think that if you,if you looked at the end of last
(41:13):
year in December, we had sortof like Trump euphoria.
And we'll probably sort of saythat there is a new hope of American
exceptionalism and we'llprobably sort of say that there is
more pessimism in Europe.
If you started to follow theprice action in January, you sort
of said like, well, I'lldiscount all of this and I'll just
(41:35):
make that rotation, whichwould have been a positive.
Good stuff.
I mean we've covered a lot on uncertainty.
I know you add another topicwhich is kind of maybe somewhat related,
but not, not obviously, but,and that's the whole idea of curiosity
and curiosity as acharacteristic in fund managers or
I guess, or marketparticipants and the importance of
(41:57):
this.
So I mean, what inspired this thought?
Well, let me put this, I'llstart with this is that we're having
this, you know, podcast.
It's in in the still in themorning in Boston is that this is
one where we should be sittingby a fire and, you know, bringing
out the, the, the drinks andhaving more of a casual conversation,
(42:17):
you know, so we're going to goa little bit far afield, but I think
this, it's important, youknow, sort of bigger meta question.
So, so I was out, you know,visiting some friends and my son,
who's an MBA at university inNotre Dame.
And so one of the economicsprofessors, a friend of mine, who
said, would you like to have some.
A dinner with a couple of ourbright students?
(42:38):
I said, sure.
Love to find out what they're doing.
So one, one of them is goingto, you know, a large, you know,
commodity trading firm.
Another person was going to.
Two people are going toinvestment banks.
Another one was going to, youknow, a multi, multi strat.
So, so they're allaccomplished instead of, say, all,
(42:58):
you know, fairly nice, nicepeople, but.
So they're all smart.
But then I asked a question asI walked away from the dinner.
Is that did they seem curious?
And then I, and I went to.
Had a breakfast the next daywith another friend of mine who's
a Confucius scholar.
(43:19):
So, but I said like, I asked afriend, I said like, look, you've
been teaching for, you know, anumber of decades.
Do you think that students aremore or less curious than you thought,
you know, 40 years ago?
And it could be sort of ageism.
But he said he thought thatthey were less curious.
And so I asked the question,and I oppose this to almost any manager.
(43:42):
This is that how can you teachcuriosity or how important is curiosity
with, you know, choosing a manager?
And, you know, if you want tobe very practical or how do you make
someone more curious?
And so, Alan, I'm going to askyou the question because we're sitting
by the fire with our drinks.
(44:04):
How do you think you could,you know, and how would you actually
measure whether a manager is curious?
Yeah, good, good questions.
I mean, definitely one for,for a late night by the fire with,
with, with, with, with a few drinks.
I mean, I think, I mean, Ithink there's a few things.
I mean, there is a school ofthought that around the world there's
(44:27):
more of a kind of a trend ordesire for deterministic outcomes.
I mean, that people are lesstolerant of the gray area and it's
either black or white.
And so I'm wondering, has thatbeen reflected in the students?
That the answers are A or B,but there's maybe not a curiosity
to look for potential grayareas or solutions.
(44:49):
So that maybe that's just one thing.
Can you teach curiosity?
I'm not sure you can teach it.
You can probably cultivate itsomewhat, I would have thought, in
some shape or form, I'm guessing.
I mean, it's an interesting question.
How important is this in allof the characteristics when assessing
managers?
(45:11):
Is it more important than openmindedness or other important characteristics?
I think it's definitely relevant.
I mean, yeah, certainly youdon't want people who are, I mean,
it's classic.
You like managers who haveconviction, confidence, but not at
the detriment of being openminded to the fact that they could
(45:32):
be wrong in their analysis.
I would say so, certainly important.
But where does that rank inthe hierarchy of manager quality?
So I'd push that one back to you.
So that is an interesting question.
Is this, is that, do you wanta manager with conviction?
Okay.
Or is that more important thana person who is open minded or curious?
(45:59):
Said like, well, I reallydon't know the answer.
And it's almost interestingthis is that because you often have
to evaluate a manager within,you know, let's say you meet him
for an hour, you read somenewsletters, you get a pitch deck.
It's almost as though that ifthey come in and say, like, you know,
Alan, I just don't have a lotof the answers here, is that I'm
(46:19):
curious on a lot of issues,but I don't know if I have the answers
and I want to be open mindedto what is the right solution.
You probably sort of say like,they respect him.
I don't know if I'm going togive them money.
But the curiosity thing is Idid come through and, and it, you
know, the conversation joggedmy memory of something that I read
(46:42):
in an article and I read abook about this is that that it's
a book called VisualIntelligence and it's by a woman
named Amy Herman.
And you say like, well, whatdoes visual intelligence have to
do with, you know, moneymaking and quant trading?
And what she did this is thatshe's an art historian.
(47:05):
And so she actually wasworking on a project where she would
train New York City policedetectives on how to become more
observant and then ask better questions.
And the way she would do it isthat she'd take them to the Met,
the art museum, and show thema painting and then ask them to describe
(47:28):
what they saw.
And so say some guys were very literal.
You know, they say like, well,I see, I see this person is wearing.
They're Wearing a, you know,blue suit.
And then someone else says, Iwent, he's in.
He's got a certain background.
And then she asked him to say,like, well, what are the assumptions
that you make when you makethese observations?
(47:51):
And so.
Or what?
You know, can you separateyour biases from the facts of what
you see?
And all of a sudden it sort ofsaid, like, I always thought that
this is a really good skillthat you'd want to have managers
to have, or at least yourresearchers to have, is to say, this
is that can they separate whatthey see from the facts versus what
(48:13):
the bias is that they bring?
And can they be, you know,have they honed their skills of observation,
which is sort of an outgrowthof your curiosity.
If you're curious, then you'regoing to sort of increase your skills
of observation.
If you have betterobservational skills, then you might
find things that other peopledon't see.
(48:36):
Because in some sense, if youand I went to the art museum and
we looked at the samepainting, okay, when you think about
that as that painting is information.
So I see the information, yousee the information.
The information is fully disclosed.
Okay?
It's all on the canvas.
(48:56):
But the two of us would seesomething very different between
the two of us.
Yeah, no, that's true.
And I mean, I'm struck by thatat the moment in terms of, obviously,
the policy dynamics that areplaying out in the US and more broadly,
I mean, depending on.
Obviously, if you bring up onekind of ideological lens to that,
(49:20):
you might see it in adifferent way than if you approach
it with another ideological lens.
And that's one thing.
But I mean, to pick up on acouple of things that you say.
I mean, there is the idea of.
I think it's fromDruckenmiller, strong conviction,
but loosely held.
So that's kind of that idea.
You do want conviction, but atthe same time, you're keeping it
(49:42):
in your mind concurrentlythat, you know, there's a good chance
it's wrong, even though youhave high conviction about it.
So not everybody has maybe themental dexterity for that.
And then obviously, as yousay, as well, I think, you know,
there is a skill in tradertrading of that creativity of being
able to see things differentlyand even to, you know, investing
(50:03):
more generally.
Obviously, if you see theworld, the opportunity is the same
as everybody else, you'll bepositioned the same way and your
portfolio won't be any better.
So.
So I think there is thatcreative element to it as well.
And I think, as you say, youcan you can if you ask a lot of questions
or are trained to, to ask alot of questions.
(50:24):
And that, that, that in itselfcultivates a curiosity.
So I think all of those relevant.
Yeah, I mean are quants more,more curious than discretionary traders?
Some.
You know, I will sort of saythat you know, if there is one takeaway
(50:44):
before he change topics oranything is that I want to make sure
I highlight if all of thelisteners remember one thing, it's
what you said, not what I said.
And that's the one that saysthis is that you know, the Druckenmuller,
you know, I have strongconviction or I have strong opinions
(51:05):
weakly held.
Which is sort of like thewhole idea of curiosity in a nutshell
is this is that you shouldhave conviction, you should have
strong opinions, this is whatyou believe or this is what you see.
But if someone comes with newfacts or shows you a different sets
of facts is that you canchange your mind.
(51:27):
So yeah, and I think thatthat's, that's critical.
Second thing is thateliminating ideological biases is
that nowhere in our discussiontoday that we mentioned any politicians
names.
And this is almost as thoughthere is no need for names.
What you want to do is justlet's look at the policies, let's
(51:50):
look at the price action,let's look at where the fundamental
trends are going.
So in terms of a framework ofsay that first we look at f price
trends, then we look atfundamental trends, then we look
at the regime, then what wesort of say is like where's valuations
are there extremes?
Where are there potentialmistakes that are being made?
(52:12):
And then what's the sort ofsignal to noise or trend to noise
ratio and all these things.
If you sort of use that assort of like a rubric on how to sort
of look at things you're goingto do pretty well.
And you know, in terms ofwhether it's an expert discretionary
trader or quant, this is thatthere was Andy Grove who used to
(52:34):
run intel and so and he wrotethe one book that I always love is
that Only the Paranoid Survivewhich I think is a, is a great title
for any book for, but foranybody who's in financial markets
is that Only the paranoid will survive.
But he said to us like he hadthis didactic approach that he'd
(52:55):
always ask one more question.
So, so if someone said, I saidlike well we're going to do this.
And he goes why?
And then they say like becauseof this.
And he goes why?
And I say asking one morequestion about that.
And in some sense if youfollow that process and if you can't
get good answers, then youhave to sort of say well where can
I stop?
(53:16):
Where I do have reasonableanswers that I can be comfortable
with.
And so in some sense the trendfollowers said like, well when they
ask the question of ask onemore question, they asked a question,
well, why prices?
And then they'll say well what fundamentals?
But they say I don't know whatthe link between fundamentals and
(53:37):
price.
So therefore I'll assume thatprice is where it's all all in, you
know, all the information is.
I'll stop there.
Others will say I can go onelevel deeper or I could look at a
second order effects.
So depending on what type ofperson you are, that will determine
the type of trading you'reactually going to do or engage in.
(53:59):
Very good conscious that we'removing along in time.
And there was another topicthat you had I was curious to get
your thoughts on.
And that's the whole area ofportable alpha.
It's definitely a topic thatwe're hearing more and more about
and it's been an approachthat's been around for a long time.
(54:20):
It's kind of come and gone alittle bit, but it's kind of made
a comeback coupled with someother terms like return stacking,
et cetera.
So when you see the currentrenaissance for portable alpha, what's
your perspective?
You know, I am just, you know,I think that there's been an ebb
(54:40):
and flow in portable alpha andpart of it has been because the,
it, it's not the portableportion that's the problem, it's
the alpha portion.
It's been the problem.
So, so oftentimes or sometimesis, is that the, the products on
the alpha generation of theportable alpha haven't produced what
people wanted.
(55:01):
But when you think about it,this is that one of the number one
things that we want to try todo and what we sort of see that the
inevitable flow or tide ofwhere finance is going is how do
I increase the efficiency ofmy trading, how do I increase the
efficiency of my use of capital?
(55:23):
And if, and, and, and thenwhat we'll sort of say is third is
how can I decompose my returnsbetter so that I don't think about
asset classes, but I thinkabout factor exposures and as, and,
and I think that the portablealpha is the extension, the natural
(55:43):
extension of we'll sort of saythis, the movement towards, you know,
factor factorization ofmarkets, not the asset allocation
of markets.
So if I can think in terms offactors, then I can say I have a
basic core.
It could be cash, it could bebonds, it could be stocks.
(56:04):
And then on top of that, whatI want to do is I want to change
the mix of my factors that Ihave or exposures.
And so if I could take bonds,when you think about it, a bond is
a combination.
If it's a, let's say acorporate bond, it's a combination
of Treasuries plus a spread.
And the spread represents,they will call it the risk premium
(56:27):
associated with credit.
So now why do I always have tohave that risk premium of credit
attached to a bond?
I could take my treasuryexposure and then use that as the
underlying instrument and thenput some portable alpha on top of
that and basically sort of sayinstead of going from Treasuries
(56:49):
to corporates, I could take myTreasuries and then I could use that
as collateral to put trendfollowing on top, or I could put
on, you know, momentum or Icould put on some other risk premium.
So in some sense, is that whatI got to think about is this, is
that I've got these buildingblocks of cash, bonds, stocks, and
(57:10):
then on top of that, I have acertain amount of risk premium.
And portable alpha allows meto now mix and match my risk premiums
with an underlying asset.
I think that that's, that'svery compelling.
And I think that the priceshave come down so the market is more
competitive.
I think that the productofferings in terms of alpha are better.
(57:33):
And so I think overall this isthat for large institutions, this
seems the much better way tosort of run a portfolio than maybe
what we're seeing in some ofthat, where you give all of your
cash directly to a manager.
Yeah, absolutely.
I mean, there is a.
I guess there are cyclical andsecular considerations to it in the
(57:56):
sense that I agree, you know,there's a greater appreciation of
the importance of capitalefficiency, et cetera, driving this.
But also, I mean, it doesappear to be maybe a symptom of the
market environment we've beenin with the S and P doing whatever.
It's been 15% annualized forat least for five years, probably
(58:17):
for 15 years.
So when you combine anythingwith the S and P, it looks fantastic.
So, I mean, it will beinteresting to see if we're still
how durable it is.
But I definitely agree withyou around the capital efficiency
point right now.
So we, we started with mygrandmother, so we could end with
(58:40):
her too, God rest her soul.
This is that in some sensethis is that, you know, when stocks
are above the 200 day movingaverage and they continue to be above
there, is that that.
Well, then you just want tohave your beta exposure.
You don't really need to talkabout portable alpha because.
Because all you do is, is thatyou don't need the portable alpha
(59:01):
because you just have yourequity exposure and that's, that's
enough.
So.
And in fact, if anything, thisis that if you sort of take some
of your equity exposure andthen say, I'm going to use by the
s and P500 and put a portablealpha on top of it, well, that's
actually going to be a dragversus just holding the exposure
outright.
(59:21):
So now we're abstracting fromthe, you know, risk structure issues,
but in some senses that, no,now that we have a number of assets
that are below the 200 daymoving average, you could sort of
say like, well, you know,maybe sort of the vanilla isn't what
I want to do.
Maybe I should start to saythis is that the cost of, you know,
(59:43):
paying up margin, using thatstock to, to.
To as collateral for aportable alpha strategy, maybe this
makes a little bit more sensegiven that the directional beta that
I'm receiving is declining.
Well, good stuff.
I mean, I think portable alphais a topic that is hot on the hot
(01:00:05):
topic at the moment anddefinitely on everybody's radar.
So I think we will hear moreand more about that and come back
to that topic again.
But I think we're up on time.
So next week Niels is back, sohe will be here to take any questions.
So send your questions throughfrom Mark and myself and from all
(01:00:28):
of us here at Top Twitters Unplugged.
Thanks for tuning in and we'llbe back soon with more content.
Thanks for listening to theSystematic Investor podcast series.
If you enjoy this series, goon over to itunes and leave an honest
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If you have questions aboutsystematic investing, send us an
(01:00:48):
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And remember, all thediscussion that we have about investment
performance is about the pastand past performance does not guarantee
or even infer anything aboutfuture performance.
Also, understand that there'sa significant risk of financial loss
with all investment strategiesand you need to request and understand
(01:01:10):
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Thanks for spending some ofyour valuable time with us.
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where each week we take thepulse of the markets from the perspective
of a rules based investor.
It's Alan Dunn here this weeksitting in for Niels again who's
gone on his travels anddelighted to be joined by Mark.
Mark, how are you doing?
Good.
How about yourself?
Very well, yeah, all good here.
(00:45):
Spring sunshine is continuingin Dublin so we're happy with that.
How is all the stateside kept?
Well, Boston is starting toget a little bit warmer.
We got blue skies out here,you know, some of the full flowers
are coming up.
So spring is.
Spring has come.
Very good.
Good stuff.
Yeah, yeah, absolutely.
(01:06):
So a lot going on in markets,an interesting time.
We're coming up towards thepretty much the end of the quarter,
so it's certainly been aninteresting period.
Very choppy, I think, fair tosay, across a number of asset classes.
So we'll get to that in termsof performance in a little bit.
But we always start offasking, you know, what's been on
your radar lately?
(01:26):
Well, I start with a quotefrom my grandmother.
Not that she was a greattrader, but she used to warn me when
I'd go out, you know, becauseshe lived with us when I was growing
up, she goes, nothing goodhappens after midnight.
And that always comes to mindbecause when I look at financial
markets, I'll say that nothinggood happens below the 200 day moving
(01:50):
average.
Pretty good, yeah.
As soon as prices get belowthe 200 day moving average, it changes
people's, you know, a psyche change.
I think that there's adifference sense of sentiment, you
start seeing more selling, youknow, volatility changes a little
bit.
(02:10):
So I don't know why it's the200 day moving average, but once
you hit that, it seems likethings change.
Interesting.
I mean there is the age old,you know, the debate around technicals
and is there a merit in it?
But you're right, it does seemto be it to 200 day moving average
because it gets so muchtension in the media.
(02:31):
Is that it, that it's a flipof a switch to highlight that something
fundamentally has changed?
You know, I think it's justlike one of those long time indicators.
Just like when stocks hit newhighs, people behave a little bit
different.
But we'll sort of say thatthis is not applying to all markets
(02:54):
right now.
And I think we'll talk aboutthis in a little bit.
So, so we've got, let's saythe US General Stock market, you
know, S, S, s and P, NASDAQ,they're below the 200 day moving
average.
If we start looking atsectors, we've got some that are
way above 200 day moving average.
You go to the European Stockmarket, we've got a very different,
(03:16):
you know, type of market.
So, so what it tells ussomething about rotation.
It tells us something aboutwhere the sentiment is changing across
markets.
And that clearly then isreflected in people's behavior because
people say well if I'm downbelow the 200 day moving average,
(03:36):
well maybe I got to startrevising my portfolio.
I'm going to have to startthinking about what I might sell.
On the other hand you say likeokay, there are other stuff that
looks like they're performing well.
Maybe I should start to lookto increase the exposure on that
side.
Yes, for sure.
And I think that's somethingwe will get into in a bit more detail
as we go through the conversation.
(03:57):
And as you say, there are manykind of, I suppose, different pictures.
I guess when you look at thetrends and the technical picture
across global markets, it'scertainly some divergences there.
So maybe just to touch ontrend following and manage futures
performance at the outset toget that out of the way.
(04:19):
So on the month, The Soc GenCTA index is now down 25 basis points.
The SOC gen Trend index down alittle bit over 1%, 1.07% and year
to date.
And obviously that's the Q1SoC Gen CTA index down 2.23% and
SoCGen trend index down justover 4%.
(04:42):
So obviously a negative startto the year, a negative quarter.
And we've touched on thedrivers in terms of the choppiness
in obviously in equities andfixed income and reversals in some
commodity markets in February.
Any other observationsyourself Mark, in terms of CTA and
(05:04):
trend following performance in Q1?
Well, I think that we're earlyin the whole trend revising change.
So let's go back to ourinitial comment about you know, 200
day moving average.
Well, we had, you know, the U.S.
stock market, you know, sortof crossed over and below the 200
day moving average in the, inthe quarter and there's a view is,
(05:29):
is that, well, trend followingis down, something's wrong here.
Well, what we find is that ittakes time for some of these revisions
and trends to then actually beadjusted in the portfolio.
So trend followers, which aremore intermediate term, they'll start
to lower their exposure insome markets, increase the exposure.
(05:51):
And what we find out is thatwhen there's the transition period,
there might be underperformance.
And if the new trends start tolast longer, then we'll start to
see the outperformance of CTAsrelative to long only assets.
Absolutely.
Yeah.
So I mean, I think that'scertainly the view.
(06:12):
We're in that transition phasewhere, you know, as we've been highlighting
on many of the podcasts,uncertainty is unusually high.
We're seeing a lot ofobviously new policies coming in.
So maybe that's a good placeto start in terms of, you know, the
kind of the impact of thosepolicy changes on markets at the
(06:32):
moment.
Obviously tariffs has been thebig theme in Q1 and it has been very
much kind of on, off, on, offand more on than off, I guess towards
the end of the quarter.
But I mean in terms ofthinking about how managers, how
markets respond to that andkind of looking through all of the
policy impacts, how do youthink about that?
(06:56):
Well, first on tariffs inparticular, what's very interesting
is that it now matters whatare the contract specs that you trade
if you're in the commodities markets?
So are you looking for NewYork delivery versus London delivery?
So if you see that there's atariff gap for some of the metals
(07:19):
between New York and London,you see a gap in gold prices even
though their tariffs won't beaffected by gold.
So now what happens is thatwhile, you know, a lot of CTAs might
say, or a lot of managers say,like, well, you know, one contract
is the same as another.
You know, let's just look atliquidity as the main driver.
(07:40):
Now you have to sort of saylike, well, let's look at what are
the delivery provisions, whereare, where is delivery, where is
the market centered?
And those things start to havean impact on how you construct your
portfolio or what you mightsee in performance.
Yeah, for sure.
Obviously we're seeing that incopper in particular, isn't that
right?
LME copper lagging andobviously New York copper touching
(08:02):
all time highs during the week.
Yep.
But I think that the tariff isjust a representative of the broader
issue which, you know, I thinkis what we're seeing is that the
impact of uncertainty in markets.
And we'll start, I'll startthis with the whole idea is, is that
(08:24):
that most recessions are manmade because of bad policy decisions
or bad choices by marketparticipants and not from old age.
So when you think about arecession or you know, a recovery,
you could think of it as isthat you can almost think of it in
a mortality table.
(08:44):
This is that, you know, itages and then as we get older and
older there's more likelihoodthat something could go wrong with
our quote unquote economic health.
And if there's something goeswrong with their economic health,
then there's more likely thatthen that recovery is going to die.
So, so, so what is, what'sdriving the economic health right
now, which you touched on, isthe tariffs.
(09:06):
But, but the broader issue is uncertainty.
And we'll sort of say thatuncertainty is man made in this particular
case because it's not un.
Uncertainty about okay, whatare the crops going to be.
It's not uncertainty aboutwhat is going to be consumer demand
per se, but it's uncertaintyabout policy.
(09:28):
And so, so we'll say thatthat's, that's a choice that's being
made.
So as opposed to it's, it'ssomething that's exogenous, that's
being enthrust upon us.
Yeah, that's fair to say.
I mean it is interesting.
There is the argument that, Imean you mentioned kind of the economic
(09:48):
cycle tends to die because ofpolicy errors.
I mean there is a view thatthe cycle has got longer because
the economy has become moreservice oriented.
And historically some of theswings in the economic cycle were
driven by the inventory cyclewhich is very much a manufacturing
(10:09):
goods kind of cycle.
And obviously if you go backto the last kind of economic cycle
or the expansion it lasted, itwas one of the longest I think right
through the last decade and itwas only ended by Covid.
You could argue differentarguments are in that some people
would say well it would haveended anyway.
But I mean ostensibly Covidwas the end of it.
(10:32):
But as you say, you can havekind of more man made economic downturns.
And sometimes you hear theexpression we might risk talking
ourselves into a recessionwhich is a bit kind of like what
it feels like we'reexperiencing now where let's talk
about uncertainty.
And then uncertainty doesobviously have real economic impacts
(10:52):
because people I guesspostpone investment and postpone
consumption decisions.
So that seems to be thescenario, the potential scenario
now is not it.
There's a couple things weknow about the post World War II
period is that one, recoverieshave been longer to the amount of
(11:12):
time that we spend inrecession is less so and so if we
look at the mortality table ora life expectancy of recovery.
So if you look at Pre WorldWar II, post World War II, is that
we've done a pretty good job.
So to say that, that we don'tmake, you know, a lot of forced errors,
a lot of policy mistakes, thatdoesn't mean that they don't occur.
(11:36):
And that's the, that's theimportant issue to remember is that
just because we've made fewer,fewer errors in the past doesn't
mean that we won't make errorsin the future.
So and that could just be amatter of, you know, unintended forced
errors.
(11:56):
And that unintended forcederrors in this case, I would say
is uncertainty shocks.
Yeah, I mean, I mean peoplethrow the word uncertainty around
a lot, but I guess like whatis the uncertainty at the moment?
I guess it's one of thereasons it's so striking.
I guess it's you've gotuncertainty around the actual action
and you've got uncertaintyaround the impact of the action.
(12:18):
I would, would you agree with that?
I mean, from the perspectiveof, you know, Trump has been quite
erratic.
You know, tariffs were on,then they were off, they were delayed,
they're back on.
So, and, and then it's notclear is this a bargaining tool or
is this the end game?
So, so that leads a lot ofuncertainty as to what does this
look like.
(12:38):
But then also we haven't hadthese kind of policies for a long
time, so the actual economicimpacts of them are much disputed.
And then obviously because ofthat, we don't know how the policymakers
in central banks are going to react.
So I suppose it's kind ofuncertainty cubed, maybe in that
sense.
Right.
Well, taking a step back isthat we want to make a distinction
(13:01):
between risk and uncertainty.
So, and, and this is an ageold problem that some people thought
we, we eliminated.
But we'll sort of say that,you know, risk is what is countable,
which is measurable.
It's what we look at when wesort of say there's volatility.
Now a lot of people use theword risk and uncertainty interchangeably,
(13:24):
but we'll sort of say thatwe're making the argument that there's
a distinction between the two.
Will say that risk is what iscountable in the markets, which is
based on just the statisticalmeasure of this spread or, you know,
the deviations away from themean squared.
Okay, so it's a countable measure.
(13:47):
When we talk aboutuncertainty, what we're saying that
this is something that's not countable.
There are now uncertaintyindices which, with a Look at, okay,
the number of news reportstalking about monetary policy, the
number of news reports thatmight talk about, you know, you know,
policy changes in government spending.
(14:07):
So we'll sort of say that bylooking at the count of stories and
the amount of words aboutuncertainty, about the words of policy
changes that we can then use,you know, sort of like large databases
from news organizations tostart to count or measure what is,
(14:28):
you know, normally noncountable, which is the volatility.
So, so in that sense is that,that we're making a separate distinct
difference between these two.
And if you look at some of theresearch that has been found and
even some of the work thatI've done is that if you look at
these uncertainty indices,you'd say that it is a separate factor
(14:51):
from volatility.
And when you think about ourvolatility, our volatility is often
backward looking because wehave to count, you know, data or
returns from the past and thenlooked at the volatility.
So that's, that's in the past.
And then our assumption isthat the risk that we count in the
past will then apply to the future.
(15:13):
Doesn't always happen.
Uncertainty is saying, I don'tknow what's happening with certain
policies.
And so therefore it creates aenvironment where it's ambiguous
what will be like theregulation that I face, what will
be the monetary policy that Imight face, what will be the tax
(15:34):
policy or fiscal policy Ihave, or what is the trade policy.
So the idea that it's notclear what the environment I'll live
in is different than the riskin the market.
So we've had a spike in Vicvix, it's come down.
You look at the VIX termstructure, it's inverted.
(15:54):
So we have high volatility inthe front end and it's, and then
we have lower volatility longer.
But if you look at forexample, these uncertainties in indices,
this is that the measure oftariff uncertainty is through the
roof.
Okay.
If we look at just overallglobal policy uncertainty, that's
also at the highs, it'ssimilar to what we saw during the
(16:17):
pandemic in 2020.
So we'll sort of say thatthese two are distinct and different.
Yeah, I mean, that's interesting.
I mean, but I guess one of thethings we say about trend following
and managed futures technicalanalysis is the idea of price discounting.
(16:38):
All the relevant informationand you know, trend followers followed
the price for that reason.
So I mean, taking thatperspective at the moment, and you
know, because we've got somuch Noise, so much uncertainty.
And taking, you know, maybethe perspective of the wisdom of
the crowds, you know, if youlook at what the price is telling
(17:00):
us, I mean, what would you sayfrom that, looking at the price.
So what is the market, wouldyou say telling us about all of the
noise that's going on?
Right.
Well, let's look at the USStock market might be a perfect example.
Is this is it.
It's telling us is thatthere's given this higher level of
(17:22):
uncertainty that's differentand distinct from risk is that we're
saying is that I want to bemore cautious about what I'm on,
how much money I'm going toput into risky assets.
We'll sort of say that, youknow, Europe also faces uncertainty,
but Europe is in ideas is thatthey've talked about like, well,
we're going to increase ourdebt financing in some, some sense
(17:46):
that, you know, we have theECB that's being, you know, more
accommodative and more easing.
So while there's uncertaintyabout what's happening in geopolitics
and then, and we'll sort ofsay different regulatory policies,
we'll sort of say that there'smore certainty about what's happening
in Europe than there is in theUnited States.
So what we see that whenthere's higher uncertainty, there
(18:09):
generally will be a view thatyou're going to reduce your exposure
to risky assets.
Now, uncertainty could be bothgood and bad.
This is it, as I always sortof say.
Like when you think about, youknow, the whole idea of fat tails
and distributions.
I said fat tails.
This is sort of like you get abig prize at Christmas, okay, A big
(18:30):
box and it's ticking.
It could either be, it couldeither be a clock, a new watch, or
it could be a bomb.
You don't know.
So it could be each either oneof the tails.
But what we sort of say that,that given this higher uncertainty
is, is that then there'sgenerally a movement away from risky
assets.
Okay.
So that's in the financial side.
(18:51):
There has to be a higher riskpremium associated with holding risky
assets.
When you look at the realeconomy, if you are going to make
an investment decision, yousay like, well, if I don't know what
the tariff situation would be,I don't know what tax policy will
be.
I don't know what monetarypolicy may be.
(19:12):
Maybe I'll hold off by capital expenditures.
If I'm, you know, if I'm aconsumer and we see this in some
of the, in some of thesentiment numbers is that maybe I
might be more cautious onmaking large purchases of disposable
non disposable goods.
So now what you'll also do isthat you'll see that then there's
(19:35):
going to be a slowing or callof decision making in terms of a
dollar cost average.
So if I'm going to make aninvestment decision instead of sort
of saying like well I'm goingto rebalance all of my portfolio
at once, I might say well I'lltake, I'll start to slowly rebalance
given this uncertainty.
(19:57):
So, so what does that mean fortrend followers is, is that in a
high uncertainty environmentwhere people rotate assets to those
that are less risky, there'sgoing to be opportunities.
In a high uncertaintyenvironment where there's going to
be more caution and slowerbehavior of both hedgers and speculators,
(20:19):
then that means is thatthere's more likely to be sort of
autocorrelation in the timeseries, which means is that there's
more likely to be trends.
Now the problem comes in isthat all of our trend followers is
that when we're, we all,either explicitly or implicitly,
(20:41):
we're all signal to noisetraders, okay?
And that's all quants aresignal to noise traders.
And when we say that they'resignal to noise traders is that we're
looking at a signal and thenwe have to discount that by noise.
So if I have a shallow trendbut the noise has increased, it could
be an actual volatility orthis uncertainty.
(21:04):
Then what happens is, is thatI might actually have to take smaller
positions because the return,return to risk ratio is lower.
Or if let's say I had a trendthat was relatively strong but now
the noise has gone up, wellthen my signal to noise ratio has
gone down.
Which means is that I might tocut back my exposure because that
(21:27):
the, the reward I'm gettingfor the risk that I take may not
be as the same as what it wasthree months ago.
That makes sense obviously.
And we're seeing that inequity markets higher risk premium
mechanically should meanfuture earnings are discounted at
a higher rate, which wouldjustify lower stock prices.
(21:49):
So that's true.
I mean bonds I guess have beenkind of rangy up and down so you
could see some flight toquality there.
And obviously gold I guess hasbeen the standout trend maybe of
late.
And you can draw certaininferences from that.
I mean, is that uncertainty,is it geopolitics, is it inflation,
(22:14):
does it matter?
It's a trend I guess is whattrend followers would say.
Well, gold is a realinteresting case because we'll sort
of say that there are certainknee jerk responses that we have
to gold.
And one is this fact is thatwell, if inflation goes up, I gotta
have more purchases purchases gold.
So inflation has gone down andyet we still have now the new highs
(22:37):
in gold.
So there has been some recentresearch by Earp and Harvey Campbell.
Harvey, and they've looked at,you know, the gold market and they,
they've done this in, in thepast and so, and what they showed
us is that one of the big, youknow, that there's been a sort of
change in the market based on,you know, gold ETFs.
(22:58):
So, so what?
Because we've made it cheaperto actually transact in gold.
We've, you know, we've thefinancialization of gold.
This is that that createseasier for people to demand gold
and push prices up.
And the other issue that wehave is, is that there's been a lot
of buying by central banks,especially in the case of, of China.
(23:23):
And what we'll sort of saythat and, and I've been thinking
about this issue a little bitmore deeply is that one of the key
issues in macro finance rightnow is what is a safe asset.
And so, and whether there'sthe supply of safe assets is large
enough, let's say in treasury bills.
Now you could think of a safeasset in, in a broader sense is that
(23:46):
I want to have an asset wherethe government can't, you know, appropriate
it or I could probably hide mywealth, you know, from sanctions.
That's what central banks maybe doing.
There may be other people thatare buying this as an alternative
safe asset because it's harderfor governments to be able to get
at your gold.
(24:08):
And maybe just taking the,this kind of uncertainty topic and
from the perspective of modelbuilding quant traders, I guess the
uncertainty is just, it's afeature of the market.
I mean you mentioneduncertainty being a different factor
to volatility, which makes sense.
(24:29):
It's also just I guess a feature.
I mean from the perspective ofquantitative investors, quantitative
fund managers, the modelsdon't know that uncertainty is higher.
They're just looking at eitherthe price series or the macro data.
I mean is it something that,is that, is that just the nature
(24:51):
of it or is it something that,that, that I, I guess quant traders
should try and specificallyallow for, do you think?
Well, this is of course one ofthe age old questions is that should
you adjust models or not?
And then, and should you chasemodels with constantly, you know,
tinkering and we'll sort ofsay that we know from trend following.
(25:17):
Like for example, this is thatregardless of all the tinkering you
have, if you look at the long,long data that we have, is that intermediate
trend following seems to work.
You know, best.
This is that.
So if you, if you want totinker is as long as you sort of
use as a bas and you know, asyour, your prior or your base, stay
(25:37):
stick in the intermediate areabecause that's going to always serve
you well.
This is that sometimes thelong run will do better and sometimes
the longer term trends will do worse.
Short term is, is sort ofsomewhat ephemeral, but you stick
in that intermediate range,you know, plus or minus a little
bit, you're going to do well.
I think that this is one ofthe key issues that what we have
(26:01):
with, with just overall quanttraders in general and their use
of information.
And so there have been someresearchers that have talked about
that there, there are twotypes of traders.
That's interesting.
As always, we break everythinginto dualities.
Everything has to be two,there's got to be two types.
(26:22):
So, so but the two types, we'dsay that is how they use an information
usage.
We'll say that a quant is moreof a searcher and an adapter.
So what he does is he takes alarge database and then he can say
like how do I search throughthat database, find factors that
I think that are significant,then adapt them and optimize them,
(26:46):
you know, given all of theinformation I have.
So that you're constantlysearching for the, you know, the
optimized choices that you make.
On the other hand, adiscretionary trader is an expert.
He's saying I'm not going tobe searching for an optimal solution
as much as I have a view ofthe world.
And then when I process theinformation, especially those information
(27:11):
that's non count countable.
So the information that I cangain or I can manipulate as, as an
expert.
Okay, so now let's look atwhat the environment we faced is,
is that if you have a lot ofuncertainty, then behavior may change,
(27:31):
which means that systematiclinks may be broken or they may change.
Okay.
We find this with a lot ofregime work.
So which I think is, you know,very important in the quant area.
So what we do is we consider,we find out is, is that there may
be behavior of certain riskpremium or certain or certain factors
(27:54):
that do well overall, but theymay have periods where they do better
or worse based on the regime.
The simplest regime that wealways have Is let's say look at
the business cycle, right.
So, so we can look at theinflation cycle in as the regime.
So what?
You could also sort of saythat there are uncertainty regimes
(28:17):
and as an uncertainty, ifthat's, we have an uncertainty regime,
then we might say thatbehavior differs in that regime.
And so therefore some of thesystematic links that we normally
see will change.
We should then adapt to that.
The problem comes in is thatwhen we look over history is that
(28:40):
how many of these regimes dowe actually have?
So how many high uncertaintyregimes do we have?
And you know, can we go backand look in history and sort of say
that this particular regimethat we see of high uncertainty across
a lot of policy variables asit ever occurred in the past.
That's up to debate.
(29:01):
Yeah, I mean it's very hard to say.
I mean it's only been a fewmonths, so I mean it feels like this
has been a drawn out process,but I mean in the grand scheme of
things it's not yet.
And obviously the marketimpacts, you know, were the opposite
for the first, like inDecember we had the Trump trade,
we had equities up, we had Ithink gold down.
So pretty much the opposite ofwhat we've seen since the first few
(29:25):
months of the year.
I mean, granted, what you'resaying about structural ships potentially
in a new regime, that aside, Imean, is an environment like this,
I guess better or easier for asystematic process?
I mean, in terms of cuttingthrough the noise, I guess you're
talking about discretionarymanagers being experts.
(29:48):
It would strike me as being aparticularly difficult time to kind
of evaluate policy and, and,and kind of predict policy.
But what are your thoughts on that?
Is there anything we could saywith, with any degree of confidence?
Right.
Well, let's, you know, goingback to this, the dichotomy we had
between the quant searchersand adapters, the optimizers and
(30:09):
the experts.
Let's say if you believe thatthe environment here is uniquely
different, meaning that wecan't really point to other periods
in the past like this, then wesort of say that you'd want to discount
the quality of experts.
So, so which you could sort ofsay that they, they don't have expertise
(30:30):
for the simple reason theyhave no past experience where they
could call upon to say this ishow we've seen this event in the
past, this is how the marketwill react and this is what we need
to do.
Now we could theorize aboutthis as an expert, but we may not
have countable data which wecan Use under that.
(30:50):
It's sort of say that while wehave more information and we'll sort
of say that there may be aregime change.
Let's just say that I mighthave a bias to sort of say that you
want to load up on more quanttraders because they could say that.
Well, I'm just going to letthe data speak for itself.
(31:10):
I'm not going to worry aboutwhat policymakers are saying in news,
you know, to the news.
That may not be what they sayin Twitter.
It's all I'm going to do islook at what is actually happening
into the price action.
And this is for trendfollowers or even non trend followers.
So in a world where, you know, P.E.
(31:32):
you sort of say what, whatwould we like P.O.
policy makers to do?
And you say that they do whatyou say and say what you do.
If we don't know whetherthat's occurring, then it would seem
as though let's look at thesecond best solution which is let's
follow what markets arebehaving and what they're telling
(31:53):
us.
Yeah, that's true.
I mean the other dimensionhere is the fact that we have feedback
loops, which I guesscomplicates the picture as well.
And one of the I guessfeatures and discussion points of
late is is there a Trump putand where is it?
Because it seems unusual forpoliticians or a president to be
(32:20):
not unhappy with stock pricesgoing down and seemingly complacent
or unworried about thepossibility of recession.
So the market is kind ofskeptical and kind of thinking, well
there might be an about turnat some point and obviously if there's
not, if stock prices continueto go down, that creates feedback
(32:41):
loops into the real economyand possibly into monetary policy
as well.
So feedback loops I guess areimportant too, which makes it even
more difficult to account forright now.
Another way to put this inthis is that if we were having an
(33:02):
academic discussion witheconomists, they would sort of say
we always want to know, knowwhat is the government's and let's
say the central bank'sreaction function.
So if I understand thereaction function, then I can know
where the put is.
So if I don't know what thereaction function is, then this is
where we call uncertainty.
(33:23):
So we'll sort of say that atdifferent times.
This is that, you know, inmonetary policy we often talk about
the Taylor rule, you know, butas a simple measure of monetary policy,
that would be a form of areaction function.
So now we'll sort of say andlet's look at the specifics of monetary
policy and, you know, usingthat as an example of uncertainty
(33:46):
is this, is that you say,well, what is the Fed's reaction
function?
Well, we have higher, youknow, consumer sentiment about inflation
over the long run.
It's probably above 3%.
We have, you know, survey workthat has actually said this, is that,
you know, consumers are reallyconcerned about inflation.
(34:07):
And they actually sort of saidthat if, if they had their way, they
would like to have inflationat about 0.2%, not 2%.
So now with the Fed, afterthey heard all the survey data, the
conclusion that they had isthat, well, we didn't do a good job
of it.
Explain why we need to havehigher inflation, because that's
good, good for us as policymakers.
(34:30):
So, but if you look at whatthe consumer wants, they want 0.2%.
They're expected to have 3%.
We've got a Fed that you know,sort of cut.
And they said, oh, we mightdelay cuts, but, you know, they,
they cut in December, they hadthe 50% cut in, in September.
And if anything, you mightargue that this is a time to, you
(34:53):
know, raise rates.
So, or at least that, that youwant to consider that because you
are still Nowhere close to 2%.
So, so what is the reaction function?
And further example ofuncertainty is the fact that they
have the quantitative tightening.
We've gone from 25 billion to$5 billion, you know, a month.
(35:15):
It will start in not sodistant future.
And you sort of say, like,okay, we're closer to three than
we are to 2%.
We know that quantitativeeasing was to try to get economy
boosted and in some sense getinflation higher.
Now we're sort of saying isthat, well, what we want to do is
(35:38):
we're still way over the Fedbalance sheet prior to the, you know,
COVID pandemic of 2020.
But we want to slow down ourquantitative tightening from 25 to
5 because we think that thisis important as a policy measure,
(35:59):
so that creates more uncertainty.
We've spoken a lot about uncertainty.
I mean, obviously there are soobvious points to sum up by saying,
you know, obviously getreflected in markets in terms of
risk, premia, etc.
(36:19):
You know, we're talking aboutwhether it lends itself more to discretionary
or systematic trading.
The difference between riskand uncertainty.
Taking it all together, youknow, uncertainty is elevated.
What should investors takeaway from that, would you say?
Well, there's a couple things.
What's going on is that if youare, you know, someone who doesn't
(36:45):
expose yourself to alternativeinvestments, so so one would be to
say is, is that you want toreduce your exposure to risky assets.
So, so if you, if you sort ofsay that because you're risk averse
and we'll say that there'salso aversion to ambiguity.
So which is, which is probablymore representative of, of uncertainty
(37:07):
is that you'd sort of say likethat you want to try to move to safe
assets.
So we've got higher T bill rates.
So that's really not that bad.
But then you sort of say thatif you do that, then you cut off
your potential gains underthis uncertainty environment because
as we've talked about this isthat uncertainty could be both good
(37:29):
and bad.
You know, we could have, we'refocusing in on the downside of uncertainty
because we know that thefinancial shocks are asymmetric.
If there's a downward shock,that it's going to have a much greater
or negative shock, it's goingto have a much greater impact on
markets than it would be ifthere's a positive shock.
(37:50):
So, so you say like, well,what's the next best alternative?
If I can't, instead of justgoing straight to cash, how can I
participate if thisuncertainty is actually positive?
Now what suggests this is thatto increase your exposure and to
alternative investments.
And it seems as though that,you know, from some of the research
(38:11):
that I've seen recently is Isaid if you increase your exposure
to trend following, that'sgoing to be a positive because one
is that because you're tradingboth assets from the long and short
side that you can then be ableto participate in case something
goes bad or if it goes well.
Okay, so we'll say it has morevariable beta is that second is,
(38:34):
is that you can increase yourexposure in the set of markets you
choose.
So not only are you exposed tothe US but you're exposed to currencies,
you're exposed to commodities,you're exposed to European markets.
And, and the fact that there'sa disciplined rule that, you know,
for example, this is that whenwe talked about the, our, my grandmother's
(38:55):
rule of staying out over midnight.
Well, a trend follower wouldsay like, well, if the trends are
going down is that you got toreduce your exposure.
And if you looked at this asjust as a simple case is that they
would probably catch, and Ithink some of the trend followers
have done a good job ofcatching the rotation across sectors
(39:16):
or across the globe in equity markets.
And you know, we'll sort ofsay that large brokerage firms have
been tracking what theyconsider trend following exposure,
you know, they probably, youknow, they do an okay job.
They may not be as good as ifyou could do this on your own.
But it shows that there hasbeen a change in the exposure or
(39:42):
the overall equity beta forCTAs in this.
First quarter and the overallthe equity beta has come down and
it's now more biased towardsoverseas equities.
Is it, isn't that it?
Yep.
And, and, and in fact this isexactly what you want.
And what we find is, is, isthat, and let's go from a more of
(40:04):
a behavioral exp you level is,is that whether it's individual,
an individual that's beingadvised by an ria, if it's a pension
that has a committee, is thatwhen you have high uncertainty, the
committee will probably bebiased or most people are going to
be biased to take no actiongiven its high uncertainly.
(40:26):
Let's just stick with what wehave, okay?
Because I don't know what's happening.
And so if you have a model,it's, it's going to say like, well,
since that model is, islooking for the price trend, that
model is usually lookingthrough that price trend and it's
going to discount it by thevolatility, okay.
To some degree either in theposition size or, or the signaling
(40:51):
itself that they would sort ofsay like, well, if I see that there's
a time that I should berotating in European markets in equities,
well, we're going to start toincrease our European equity exposure.
We don't care about theuncertainty which just sort of said
the signals are telling us this.
And, and I think that if you,if you looked at the end of last
(41:13):
year in December, we had sortof like Trump euphoria.
And we'll probably sort of saythat there is a new hope of American
exceptionalism and we'llprobably sort of say that there is
more pessimism in Europe.
If you started to follow theprice action in January, you sort
of said like, well, I'lldiscount all of this and I'll just
(41:35):
make that rotation, whichwould have been a positive.
Good stuff.
I mean we've covered a lot on uncertainty.
I know you add another topicwhich is kind of maybe somewhat related,
but not, not obviously, but,and that's the whole idea of curiosity
and curiosity as acharacteristic in fund managers or
I guess, or marketparticipants and the importance of
(41:57):
this.
So I mean, what inspired this thought?
Well, let me put this, I'llstart with this is that we're having
this, you know, podcast.
It's in in the still in themorning in Boston is that this is
one where we should be sittingby a fire and, you know, bringing
out the, the, the drinks andhaving more of a casual conversation,
(42:17):
you know, so we're going to goa little bit far afield, but I think
this, it's important, youknow, sort of bigger meta question.
So, so I was out, you know,visiting some friends and my son,
who's an MBA at university inNotre Dame.
And so one of the economicsprofessors, a friend of mine, who
said, would you like to have some.
A dinner with a couple of ourbright students?
(42:38):
I said, sure.
Love to find out what they're doing.
So one, one of them is goingto, you know, a large, you know,
commodity trading firm.
Another person was going to.
Two people are going toinvestment banks.
Another one was going to, youknow, a multi, multi strat.
So, so they're allaccomplished instead of, say, all,
(42:58):
you know, fairly nice, nicepeople, but.
So they're all smart.
But then I asked a question asI walked away from the dinner.
Is that did they seem curious?
And then I, and I went to.
Had a breakfast the next daywith another friend of mine who's
a Confucius scholar.
(43:19):
So, but I said like, I asked afriend, I said like, look, you've
been teaching for, you know, anumber of decades.
Do you think that students aremore or less curious than you thought,
you know, 40 years ago?
And it could be sort of ageism.
But he said he thought thatthey were less curious.
And so I asked the question,and I oppose this to almost any manager.
(43:42):
This is that how can you teachcuriosity or how important is curiosity
with, you know, choosing a manager?
And, you know, if you want tobe very practical or how do you make
someone more curious?
And so, Alan, I'm going to askyou the question because we're sitting
by the fire with our drinks.
(44:04):
How do you think you could,you know, and how would you actually
measure whether a manager is curious?
Yeah, good, good questions.
I mean, definitely one for,for a late night by the fire with,
with, with, with, with a few drinks.
I mean, I think, I mean, Ithink there's a few things.
I mean, there is a school ofthought that around the world there's
(44:27):
more of a kind of a trend ordesire for deterministic outcomes.
I mean, that people are lesstolerant of the gray area and it's
either black or white.
And so I'm wondering, has thatbeen reflected in the students?
That the answers are A or B,but there's maybe not a curiosity
to look for potential grayareas or solutions.
(44:49):
So that maybe that's just one thing.
Can you teach curiosity?
I'm not sure you can teach it.
You can probably cultivate itsomewhat, I would have thought, in
some shape or form, I'm guessing.
I mean, it's an interesting question.
How important is this in allof the characteristics when assessing
managers?
(45:11):
Is it more important than openmindedness or other important characteristics?
I think it's definitely relevant.
I mean, yeah, certainly youdon't want people who are, I mean,
it's classic.
You like managers who haveconviction, confidence, but not at
the detriment of being openminded to the fact that they could
(45:32):
be wrong in their analysis.
I would say so, certainly important.
But where does that rank inthe hierarchy of manager quality?
So I'd push that one back to you.
So that is an interesting question.
Is this, is that, do you wanta manager with conviction?
Okay.
Or is that more important thana person who is open minded or curious?
(45:59):
Said like, well, I reallydon't know the answer.
And it's almost interestingthis is that because you often have
to evaluate a manager within,you know, let's say you meet him
for an hour, you read somenewsletters, you get a pitch deck.
It's almost as though that ifthey come in and say, like, you know,
Alan, I just don't have a lotof the answers here, is that I'm
(46:19):
curious on a lot of issues,but I don't know if I have the answers
and I want to be open mindedto what is the right solution.
You probably sort of say like,they respect him.
I don't know if I'm going togive them money.
But the curiosity thing is Idid come through and, and it, you
know, the conversation joggedmy memory of something that I read
(46:42):
in an article and I read abook about this is that that it's
a book called VisualIntelligence and it's by a woman
named Amy Herman.
And you say like, well, whatdoes visual intelligence have to
do with, you know, moneymaking and quant trading?
And what she did this is thatshe's an art historian.
(47:05):
And so she actually wasworking on a project where she would
train New York City policedetectives on how to become more
observant and then ask better questions.
And the way she would do it isthat she'd take them to the Met,
the art museum, and show thema painting and then ask them to describe
(47:28):
what they saw.
And so say some guys were very literal.
You know, they say like, well,I see, I see this person is wearing.
They're Wearing a, you know,blue suit.
And then someone else says, Iwent, he's in.
He's got a certain background.
And then she asked him to say,like, well, what are the assumptions
that you make when you makethese observations?
(47:51):
And so.
Or what?
You know, can you separateyour biases from the facts of what
you see?
And all of a sudden it sort ofsaid, like, I always thought that
this is a really good skillthat you'd want to have managers
to have, or at least yourresearchers to have, is to say, this
is that can they separate whatthey see from the facts versus what
(48:13):
the bias is that they bring?
And can they be, you know,have they honed their skills of observation,
which is sort of an outgrowthof your curiosity.
If you're curious, then you'regoing to sort of increase your skills
of observation.
If you have betterobservational skills, then you might
find things that other peopledon't see.
(48:36):
Because in some sense, if youand I went to the art museum and
we looked at the samepainting, okay, when you think about
that as that painting is information.
So I see the information, yousee the information.
The information is fully disclosed.
Okay?
It's all on the canvas.
(48:56):
But the two of us would seesomething very different between
the two of us.
Yeah, no, that's true.
And I mean, I'm struck by thatat the moment in terms of, obviously,
the policy dynamics that areplaying out in the US and more broadly,
I mean, depending on.
Obviously, if you bring up onekind of ideological lens to that,
(49:20):
you might see it in adifferent way than if you approach
it with another ideological lens.
And that's one thing.
But I mean, to pick up on acouple of things that you say.
I mean, there is the idea of.
I think it's fromDruckenmiller, strong conviction,
but loosely held.
So that's kind of that idea.
You do want conviction, but atthe same time, you're keeping it
(49:42):
in your mind concurrentlythat, you know, there's a good chance
it's wrong, even though youhave high conviction about it.
So not everybody has maybe themental dexterity for that.
And then obviously, as yousay, as well, I think, you know,
there is a skill in tradertrading of that creativity of being
able to see things differentlyand even to, you know, investing
(50:03):
more generally.
Obviously, if you see theworld, the opportunity is the same
as everybody else, you'll bepositioned the same way and your
portfolio won't be any better.
So.
So I think there is thatcreative element to it as well.
And I think, as you say, youcan you can if you ask a lot of questions
or are trained to, to ask alot of questions.
(50:24):
And that, that, that in itselfcultivates a curiosity.
So I think all of those relevant.
Yeah, I mean are quants more,more curious than discretionary traders?
Some.
You know, I will sort of saythat you know, if there is one takeaway
(50:44):
before he change topics oranything is that I want to make sure
I highlight if all of thelisteners remember one thing, it's
what you said, not what I said.
And that's the one that saysthis is that you know, the Druckenmuller,
you know, I have strongconviction or I have strong opinions
(51:05):
weakly held.
Which is sort of like thewhole idea of curiosity in a nutshell
is this is that you shouldhave conviction, you should have
strong opinions, this is whatyou believe or this is what you see.
But if someone comes with newfacts or shows you a different sets
of facts is that you canchange your mind.
(51:27):
So yeah, and I think thatthat's, that's critical.
Second thing is thateliminating ideological biases is
that nowhere in our discussiontoday that we mentioned any politicians
names.
And this is almost as thoughthere is no need for names.
What you want to do is justlet's look at the policies, let's
(51:50):
look at the price action,let's look at where the fundamental
trends are going.
So in terms of a framework ofsay that first we look at f price
trends, then we look atfundamental trends, then we look
at the regime, then what wesort of say is like where's valuations
are there extremes?
Where are there potentialmistakes that are being made?
(52:12):
And then what's the sort ofsignal to noise or trend to noise
ratio and all these things.
If you sort of use that assort of like a rubric on how to sort
of look at things you're goingto do pretty well.
And you know, in terms ofwhether it's an expert discretionary
trader or quant, this is thatthere was Andy Grove who used to
(52:34):
run intel and so and he wrotethe one book that I always love is
that Only the Paranoid Survivewhich I think is a, is a great title
for any book for, but foranybody who's in financial markets
is that Only the paranoid will survive.
But he said to us like he hadthis didactic approach that he'd
(52:55):
always ask one more question.
So, so if someone said, I saidlike well we're going to do this.
And he goes why?
And then they say like becauseof this.
And he goes why?
And I say asking one morequestion about that.
And in some sense if youfollow that process and if you can't
get good answers, then youhave to sort of say well where can
I stop?
(53:16):
Where I do have reasonableanswers that I can be comfortable
with.
And so in some sense the trendfollowers said like, well when they
ask the question of ask onemore question, they asked a question,
well, why prices?
And then they'll say well what fundamentals?
But they say I don't know whatthe link between fundamentals and
(53:37):
price.
So therefore I'll assume thatprice is where it's all all in, you
know, all the information is.
I'll stop there.
Others will say I can go onelevel deeper or I could look at a
second order effects.
So depending on what type ofperson you are, that will determine
the type of trading you'reactually going to do or engage in.
(53:59):
Very good conscious that we'removing along in time.
And there was another topicthat you had I was curious to get
your thoughts on.
And that's the whole area ofportable alpha.
It's definitely a topic thatwe're hearing more and more about
and it's been an approachthat's been around for a long time.
(54:20):
It's kind of come and gone alittle bit, but it's kind of made
a comeback coupled with someother terms like return stacking,
et cetera.
So when you see the currentrenaissance for portable alpha, what's
your perspective?
You know, I am just, you know,I think that there's been an ebb
(54:40):
and flow in portable alpha andpart of it has been because the,
it, it's not the portableportion that's the problem, it's
the alpha portion.
It's been the problem.
So, so oftentimes or sometimesis, is that the, the products on
the alpha generation of theportable alpha haven't produced what
people wanted.
(55:01):
But when you think about it,this is that one of the number one
things that we want to try todo and what we sort of see that the
inevitable flow or tide ofwhere finance is going is how do
I increase the efficiency ofmy trading, how do I increase the
efficiency of my use of capital?
(55:23):
And if, and, and, and thenwhat we'll sort of say is third is
how can I decompose my returnsbetter so that I don't think about
asset classes, but I thinkabout factor exposures and as, and,
and I think that the portablealpha is the extension, the natural
(55:43):
extension of we'll sort of saythis, the movement towards, you know,
factor factorization ofmarkets, not the asset allocation
of markets.
So if I can think in terms offactors, then I can say I have a
basic core.
It could be cash, it could bebonds, it could be stocks.
(56:04):
And then on top of that, whatI want to do is I want to change
the mix of my factors that Ihave or exposures.
And so if I could take bonds,when you think about it, a bond is
a combination.
If it's a, let's say acorporate bond, it's a combination
of Treasuries plus a spread.
And the spread represents,they will call it the risk premium
(56:27):
associated with credit.
So now why do I always have tohave that risk premium of credit
attached to a bond?
I could take my treasuryexposure and then use that as the
underlying instrument and thenput some portable alpha on top of
that and basically sort of sayinstead of going from Treasuries
(56:49):
to corporates, I could take myTreasuries and then I could use that
as collateral to put trendfollowing on top, or I could put
on, you know, momentum or Icould put on some other risk premium.
So in some sense, is that whatI got to think about is this, is
that I've got these buildingblocks of cash, bonds, stocks, and
(57:10):
then on top of that, I have acertain amount of risk premium.
And portable alpha allows meto now mix and match my risk premiums
with an underlying asset.
I think that that's, that'svery compelling.
And I think that the priceshave come down so the market is more
competitive.
I think that the productofferings in terms of alpha are better.
(57:33):
And so I think overall this isthat for large institutions, this
seems the much better way tosort of run a portfolio than maybe
what we're seeing in some ofthat, where you give all of your
cash directly to a manager.
Yeah, absolutely.
I mean, there is a.
I guess there are cyclical andsecular considerations to it in the
(57:56):
sense that I agree, you know,there's a greater appreciation of
the importance of capitalefficiency, et cetera, driving this.
But also, I mean, it doesappear to be maybe a symptom of the
market environment we've beenin with the S and P doing whatever.
It's been 15% annualized forat least for five years, probably
(58:17):
for 15 years.
So when you combine anythingwith the S and P, it looks fantastic.
So, I mean, it will beinteresting to see if we're still
how durable it is.
But I definitely agree withyou around the capital efficiency
point right now.
So we, we started with mygrandmother, so we could end with
(58:40):
her too, God rest her soul.
This is that in some sensethis is that, you know, when stocks
are above the 200 day movingaverage and they continue to be above
there, is that that.
Well, then you just want tohave your beta exposure.
You don't really need to talkabout portable alpha because.
Because all you do is, is thatyou don't need the portable alpha
(59:01):
because you just have yourequity exposure and that's, that's
enough.
So.
And in fact, if anything, thisis that if you sort of take some
of your equity exposure andthen say, I'm going to use by the
s and P500 and put a portablealpha on top of it, well, that's
actually going to be a dragversus just holding the exposure
outright.
(59:21):
So now we're abstracting fromthe, you know, risk structure issues,
but in some senses that, no,now that we have a number of assets
that are below the 200 daymoving average, you could sort of
say like, well, you know,maybe sort of the vanilla isn't what
I want to do.
Maybe I should start to saythis is that the cost of, you know,
(59:43):
paying up margin, using thatstock to, to.
To as collateral for aportable alpha strategy, maybe this
makes a little bit more sensegiven that the directional beta that
I'm receiving is declining.
Well, good stuff.
I mean, I think portable alphais a topic that is hot on the hot
(01:00:05):
topic at the moment anddefinitely on everybody's radar.
So I think we will hear moreand more about that and come back
to that topic again.
But I think we're up on time.
So next week Niels is back, sohe will be here to take any questions.
So send your questions throughfrom Mark and myself and from all
(01:00:28):
of us here at Top Twitters Unplugged.
Thanks for tuning in and we'llbe back soon with more content.
Thanks for listening to theSystematic Investor podcast series.
If you enjoy this series, goon over to itunes and leave an honest
rating and review and be sureto listen to all the other episodes
from Top Traders Unplugged.
If you have questions aboutsystematic investing, send us an
(01:00:48):
email with the word questionin the subject line to infooptoptradersunplugged.com
and we'll try to get it on the show.
And remember, all thediscussion that we have about investment
performance is about the pastand past performance does not guarantee
or even infer anything aboutfuture performance.
Also, understand that there'sa significant risk of financial loss
with all investment strategiesand you need to request and understand
(01:01:10):
the specific risks from theinvestment manager about their products
before you make investment decisions.
Thanks for spending some ofyour valuable time with us.
And we'll see you on the nextepisode of the Systematic Investor.
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