ReSolve Crew Riffs on Inflation Volatility and Smarter Portfolio Allocations

After a multi-decade slumber, inflation has been dominating the economic and financial zeitgeist over the last twelve months. The sustained sell-off in both US stocks and bonds at the start of 2022 was an unfamiliar sight to investors that grew accustomed to the negative correlation that created the once mighty 60/40 portfolio. Are we entering a new paradigm where inflation has both higher mean and variance? Adam, Mike and Rodrigo lay out their views for navigating inflationary times, including topics such as:

  • The difference between sustained and volatile inflation
  • Large supply and demand mismatch, combined with a reversal of globalization gains of recent decades
  • The huge difference in effects between monetary and fiscal stimuli
  • The post-war years as a better analogy than the 1970’s for the current backdrop
  • Different types of inflation and varied downstream effects
  • Path dependency and the wide dispersion of possible scenarios
  • Whether transitory or sustained, it’s hard to disagree that we now have higher inflation volatility
  • What types of strategies can thrive during inflationary periods
  • Shifting regimes and the ‘primordial soup’ of portfolio construction
  • Transition phases and leadership changes on decade-long cycles
  • Why commodity-sensitive stocks haven’t really protected portfolios in inflationary shocks
  • The case for multi-asset trend and global macro momentum strategies
  • Protecting against inflation volatility and prolonged bear markets – a historical perspective
  • Portfolio construction for a new macroeconomic scenario

This is “ReSolve’s Riffs” – live on YouTube every Friday afternoon to debate the most relevant investment topics of the day, hosted by Adam Butler, Mike Philbrick and Rodrigo Gordillo of ReSolve Global* and Richard Laterman of ReSolve Asset Management.

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Mike:00:01:41Happy Friday, gents.

Rodrigo:00:01:43All right. Happy Friday. What a day we have.


Rodrigo:00:01:47Cheers. Were we all out last night together? We’re all drinking water, or is that a gin tonic, Mike?

Mike:00:01:54I too am, yes, I was partaking in a bit of drink. And thus, I’m taking a day off to recover, if you will. But hopefully …

Rodrigo:00:02:09We are at our sharpest today. Yes.

Adam:00:02:11Remember the time when we could recover in like a matter of hours. And now it’s like that recovery time is measured in days, sometimes weeks.

Mike:00:02:20Yes. I’m familiar with that.

Rodrigo:00:02:21I got visitors here and they want to go out for a night of dancing. And I woke up this morning and I said to my wife, do I actually have to go out two nights in a row? Is this how you’re going to torture me today? Do I have to drink alcohol? It’s a tough life, man.

Mike:00:02:40Remember the days where it was you knew where you were going on Tuesday, Thursday, Friday, Saturday?


Mike:00:02:47Oh my God, anyway. Well, before we get started, let’s give everybody the typical disclaimer that we’re going to have a wide ranging conversation covering lots of stuff and it’s not investment advice. It’s maybe educational and an opportunity to learn, and thus not investment advice. So, even three guys on a Friday afternoon, who are all sipping soda water, if you want to get investment advice, get it somewhere else, I guess. And with that, I think we’re going to talk about inflation. And one of the things, I noticed one of the inflation memes that was really interesting from the Super Bowl was 50 Cent and his inflation that he’s incurred over the last couple of decades. Going …

Adam:00:03:32I saw that 50 Cents to $2, to a buck 50.

Mike:00:03:36Yeah, buck 50. I do love that. And then the ensuing hubbub about who do those rap singers belong to, the Millennial generation or the Gen X.

Rodrigo:00:03:49It was fascinating. I was at a Super Bowl party that spanned the ages and you could just see the Boomers were like, that was the worst Super Bowl halftime show I’ve ever seen in my entire life. As like, guys my age are tweeting out like that was the greatest Super Bowl party ever, ever hands down, amazing. And we’re just all making fun of each other because it was just pure honesty, right? Like, if you didn’t live it, you aren’t going to like it.

Adam:00:04:18Well, it was pretty cheeky, actually for the Super Bowl organizers to skip right over Gen X last year. You know, it was like 30 years of Boomer-oriented halftime shows, they skipped right over the Millennials last year with the weekend. And then I guess they remembered that Gen X…

Mike:00:04:36Well, this is the thing, right? This is the tension because the Gen X, I mean clearly all of those singers are born in the Gen X era, that 19 sort of 65 to 1980 era and the millennials also claiming them as that’s our generation’s music. And the Gen Xers are like, here we go again. We go straight from Boomers to the Millennials and us Xers are left with — there was no music for us. We didn’t, you know, Pearl Jam wasn’t a thing and nor was 50 Cent and Dr. Dre. But yeah, I certainly thoroughly enjoyed it. And it spoke to some of my formative years. But anyway, that’s …

Why Inflation?

Rodrigo:00:05:16Anyway, inflation everywhere, inflation everywhere, 50 Cent, and dominating the Google searches these days. So, we thought we’d talk a little bit about it. So, Adam, you want to set it up? Why are we talking about inflation just generally?

Adam:00:05:35Well, we’ve had some of the highest CPI prints year over year in decades just in the last few quarters. And obviously markets, and both equities and bonds are finally reacting to this uptick in inflation. Strangely, we aren’t seeing inflation expectations priced in further out on the curve. If you look at five-year, five-year breakevens, they really just haven’t budged. So, I don’t think investors are pricing in sustained inflation, which is interesting, given I was listening to Vincent Deluard talk about a large study on historical inflationary periods that he conducted. He went and curated inflation data from dozens of countries over the last few 100 years. And so he’s got thousands of country years of inflation data as his sample. And his finding was that once inflation ticks above 5%, for a couple of quarters in a row, five years from now, inflation is still five, greater than 5%.

So, once you sort of move into a higher inflation regime, then those get embedded both mechanically, in the fact that companies are now feeling comfortable about raising prices, cost of living is going up, that means that employees are demanding higher wages, so it gets priced into wages. And then finally it gets priced into the expectations, the adaptive expectations, and people begin to believe that inflation will persist for a long time. We’re clearly seeing sort of — people are still in the transitory phase right now. And we’ll start to see a shift one way or another in the longer term inflation expectations. We have to keep an eye on the five-year, five-years and see what plays out there. But I mean, clearly, what’s happened here is in reaction to the March 2020 lockdowns, governments fire hosed trillions of dollars like directly into people’s bank accounts. People paid off credit cards and unleashed a buying spree. So, that’s one side of the coin.

The other side of the coin is that, at the same time, people were flush with spending money, full economies and production lines were shut down around the globe. And so you’ve got too much demand and too little supply. And that’s of course, being complicated even further by the fact that we’re moving into a deglobalization phase. So, globalization, obviously highly disinflationary as you’re able to migrate labor overseas. So, all of the manufacturing gets cheaper and cheaper and cheaper, as the jurisdictions with cheap labor are able to continue to bring prices lower and lower, lower until that was exhausted largely in 2017 when China flipped its energy policy. And so now we’re beginning to see deglobalization and actual repricing at the corporate level and at the employment level. And so we’re entering a very different regime here. So, I think that’s what motivates a timely conversation about inflation.

Mike:00:09:21Right. So, we’ve got kind of a combination of both demand and supply shocks happening sort of simultaneously, combined with some pretty significant monetary inflation that in this case, unlike sort of that 08 or sort of the last commodity boom in that early 00s to 08, which was oh, there’s this money being printed and it’s all going to get into the system. It never really did. Global growth was enough to offset whatever inflation was occurring. It wasn’t actually getting through the system, but today and the largess and the different type of monetary interactions, along with some complicating factors around supply chains and demand shocks, you’re starting to see actual inflation manifesting right through to the end user, the end individual and companies and supply chains and things like that. So, it seems to be quite a sea change.

Adam:00:10:22It’s worthwhile I think contrasting to 2008 because I think all three of us were guilty of observing the unprecedented monetary stimulus that was perpetrated by central banks in 2008 and 2009 in response to the global financial crisis. I remember perceiving at the time that the mechanics were going to be a massive increase in M2, banks flush with reserves, and it’s going to unleash a major lending boom. And that would then drive inflation. Turns out all of that stimulus was contained within the financial economy and never really trickled down into the real economy. And so what ended up happening is that you had capital restructuring of corporations, was sort of the primary reaction function to that, right.

So, companies went out, they borrowed a lot at low rates, but instead of ramping up productive capacity, or making large capital investments, instead, they went to the debt market, borrowed, and then used that to buy back shares or issue dividends or whatever. So, you had this sort of — it enabled this 10 years of financial engineering, right, was very, very good for the capital owners, but didn’t really do much for the real economy. And now we’ve got real money in real peoples’ bank accounts driving real demand at the same time, as you have these interesting supply shock dynamics unfolding. So, yeah, I think we’ve entered a different regime. Rod, you’re muted.

Mike:00:12:04You’re muted, Rod.

Rodrigo:00:12:09Sorry, guys. Yeah, I think we talked about this last week, but the real demand is actually quantified by an extra 20% demand on the ports, right. So, this supply chain issue that we’re seeing has come from the demand side for the most part. Ports just haven’t seen that level of increased demand in the last 20 years. They’re not designed for it so there’s going to be a lot of work to be done if we’re going to continue to put stimulus checks in people’s bank accounts and/or increase their income based on labor demand. So, this is one of the — another one of the key drivers that is really manifesting today in the CPI numbers. But there’s also the other side, which is what about the long term deflationary impetus, right, the fact that we have continued improvement in technology, the demographics. The other side of the equation is that this is only momentary. People are going to go back to work, they’re going to start buying less stuff, the fiscal spend is going to be that much. And at the end of the day, this is transitory. By the end of the year, we should be back to normal and Bob’s your uncle, right?

Mike:00:13:18Population plays a role in that as well. So, population growth, demographics, debt, and the technology, sort of… And I think technology plays a role, longer term, but it’s going to take a while. So, you’ve got wages, which are very, very sticky, it’s hard to roll back wages. And so you’re going to see companies, I think, looking at automation, autonomous driving, all those types of efforts, in order to control costs and reduce costs, but are going to take time to work through the system. You have to retrain a different labor force, you have to implement that technology, you have to build it, you have to build the software side, you have to engineer it, you have to build the hardware side of it. It is a much, I think, a much longer process to actually achieve what might be fruitful in gains that can offset some of the wages. So, it’s pretty interesting.

The other thing, and I know, we want to talk about the concept of inflation, but also inflation volatility, right? So, there’s that there’s the mean rate of inflation, and then there’s variants around that mean rate. And those are very important concepts to sort of separate a little bit. And a lot of folks are talking about the 70s as the analogous period. And I think that it’s a little bit narrow-sighted to do that. And the example that we’ve all talked about on multiple occasions is that post World War II scenario where price controls were rescinded from a war economy. And in 1946 was that the first piece of that where these price controls were removed, and we had this burst of inflation, and then a new equilibrium, and then another burst and a new equilibrium.

And so it wasn’t just the inflation rate was increasing, it was this larger variance around the mean that provided more uncertainty with respect to these two dynamics that have a lot of play in asset class pricing, which are inflation and growth, obviously, liquidity playing a role too. But that inflation expectation, having a larger variance has significant impact for asset classes. And there’s that great piece from Man that we’ll be sharing. But we haven’t had inflation volatility or inflation, per se, since sort of 1990. So, we’re at 30 years of extremely low inflation, and a very, very consistent and low volatility around that mean. And I think that bears significant consideration as well as you think about this.

The Types of Inflation

Rodrigo:00:15:57So, you just kind of addressed a bunch of specific situations around inflation. And there’s another thing, the definition of inflation is so wide varying, right? What is inflation? I know, Adam, you’ve written a bit on this, but what are the different types of inflation that we mean when we mean inflation?

Adam:00:16:16Well, yeah. So, there’s sort of supply shock inflation, where something happens, think about the oil embargo, and the Iranian revolution in the 70s, obviously, restricting the flow of oil, and therefore the price of oil skyrocketed and triggered broad price increases through the economy, because virtually everything that’s manufactured requires energy. So, that’s kind of the traditional supply end. Then there’s the demand side, which is we’re sort of seeing some of that today in combination with supply led inflation, right.

You have a major shock upward in aggregate demand as a function of governments expanding very sizable deficits. Again, like Mike said, we have major deficit spending during wartime, I want to say four years in a row of 15%, or higher deficits as a percent of GDP during wartime, the last couple of years, we’ve seen 12-13% of GDP in deficit spending. So, that just leads to a major demand shock. And in combination with a little supply, that leads to too much money chasing too little production and a rise in the price level.

And then there’s monetary inflation, where governments devalue their currency by directly printing more money into the system. And other countries lose faith in the purchasing power of that currency, and they begin to sell it and the people that are in the economy begin to move away from using the country’s unit of currency, and start denominating trade in the currency of other countries or barter, that sort of thing, right. And I know as we’ll talk about, there are different asset class reaction functions, each of those different types of inflation. So, there’s no single portfolio panacea that solves the problem of all types of inflation.

Mike:00:18:26Right. You need a broad swath of opportunities as you look through history, how each inflationary cycle manifested and changed. Even the 70s sought several different types of inflation manifest during that sort of very, very memorable stagflationary time period. And within that longer time period, there was actually lots going on where oil didn’t do so well for a while, but other forms of inflationary hedges did. And so it behooves asset allocators and investors to really think that through because you don’t want to buy an inflation hedge. And I see in the comments, some folks talking about yeah, gold and TIPS really kind of worked over this period. And yeah, there’s just different things that are at play in the asset models. Go ahead.

Rodrigo:00:19:22Yeah, well, which period, right? So, gold actually worked pretty well from the bottom of the commodity — of the COVID crisis to the end of the year, because rates went from being relatively positive to negative, right. So that, gold tends to do well when real rates are going to the downside. That happened. That was a phase of inflation. Then came lumber, then came energies, right. So, over the last two years, we’ve seen inflation manifest with different commodities.

You know, TIPS is an interesting one because everything I’m reading about TIPS and what we’ve seen in terms of inflationary regime, they really don’t do anything but just keep your purchasing power. They don’t do anything outside of real returns. Right? So, maybe that’s its job. That’s what it is designed to do, as an offset to your portfolio, to the things that are losing money in real terms and may not be great. And so we got to, as we go through these — the data and what has done well, in the past, I think we have to be cognizant of the fact that what has done best in the past as like the number one inflation hedge, may not be what is going to do best in the future. So, do we want to kind of bring up those asset classes first, or we want to talk about kind of the framework?

Adam:00:20:37No, I think … to sort of summarize a little bit, right, I mean, Mike and I kind of laid out the current inflation case, more sustained inflation, right. I would maybe add as well, a decade or more of profound underinvestment in transition energy and material sources, right. Like, a massive amount of underinvestment in the development of new oil and gas properties. You know, nobody wants to burn coal anymore, which is great. But that was a cheap source of abundant energy. And if you look at the current reserves of virtually every energy product nowadays, along with aluminum, copper, nickel, all of these commodities are near record low inventory levels, and there has been no investment.

And as you go through the annual reports of the major energy companies, they’re all saying we’re not investing because under the climate targets, any investments we’re going to make in oil and gas will run counter to the objective to hold temperatures to a rise of 1.5% by 2050. So, there’s these competing cross dynamics. The problem being yes, we need a sustainable future, and yes, we should be investing in clean tech. But we need to have enough clean tech online in order to be able to replace what we’re losing from underinvestment in traditional sources of energy in the meantime, right? So, anyways, just to sort of encapsulate, that’s kind of the sustained inflation picture.

But then Rodrigo laid out some points that might lead you to think that this inflation is actually quite transitory. And by the end of the year, early next year, we could be in a disinflationary environment again, right. Another reason we could be in a disinflationary environment is the Fed is not standing pat here, right? The governments of the world are concerned about the fact that we are seeing these high inflation prints, and they are taking steps to counter it. Central banks look like they’re behind the curve, they’re going to step in and they’re going to raise rates over the next few months. If they raise them too aggressively, maybe that causes the economy to stall, demand to stall, we go into recession, and a deflationary environment. Maybe the government institutes price controls or profit controls on companies.

I was just reading over the last couple of days, the Washington Post just had an article out about how the Democrats have been polling and the concept of price caps or corporate profit controls are polling extremely positively. And so while the Council of Economic Advisers in Washington are not yet advocating for this, and in fact, they’re pushing back against it, and I think we would all agree those policies have a lot of potential problems, these are the types of steps that are being considered.

So, we’re not here to make the case for inflation or for disinflation, we’re saying we’re now in an environment where all these things are on the table for the first time in decades. And probably we’re going to see all of them at some point over the next 10 or 20 years. We’re going to see rocking inflation like we are now, maybe even worse, and for longer. At the same time we’re going to see major periods of deflation as governments and other dynamics play into this and swamp the inflation dynamic for a period. So, like Mike said, we need to prepare for different types of inflation and a lot more volatility in the inflation-deflation dynamic.

Mike:00:24:46Yeah. I’d love to poll the audience here. Type in one if you’re in the inflation sustained camp that, hey, this inflation is here, it’s more permanent. Throw in a two if you think the inflation remains sort of transitory, right? So, give us some indication of how you’re feeling in the audience as to what your thoughts are. Are you one in the more inflationary sustained camp or two in the transitory and some sort of return to normalcy camp, and let us know how you’re feeling as we go through this.

Rodrigo:00:25:20Yeah, and I think while we wait for that, it’s important to visualize what inflation volatility looks like, right? This is a paper, a series of papers that Man has put up, but this particular paper goes back to 1926. And it helps us visualize what CPI volatility has looked like for over a century. And what’s obvious here is how lucky we’ve been in the last 20 years to be in a period of such benign inflation that tends to be good for a number of things, right. It tends to be good for planning, it tends to be good for business building, and equity markets tend to thrive in that type of environment. When you have a bit more uncertainty — and by the way, you can have a more and more narrow market that way. When you have a bit more uncertainty, there’s going to be more dislocations across the landscape of investments. But I thought it was useful to share this chart for everybody to see.

Mike:00:26:19And just to highlight it a little bit more, from 1990 to today, we’ve experienced inflation volatility of like around 1.3%. If you go back prior to 1990 into the late 1800s, so the previous sort of 100 years, you had inflation volatility that ran around 4.8%. Remember, this is inflation volatility. As Adam laid out, this swing from, oh, it’s disinflationary, it’s inflationary. These things were happening much more regularly, and had significant impacts on asset prices, where from 1990 we’ve had a fairly stable state of disinflation, which leads to certain asset classes, like stocks, for example, or real estate, really having some pretty pronounced returns and at low volatilities. And so as we potentially move into a regime that has more inflation, and I think we can all sort of concede that, well, certainly inflation volatility, whether this is transitory or not, the volatility of inflation has increased.

And thus, that is an era that’s new. And that’s a key concept here that I think is maybe not as understood as it could be because it’s new. It hasn’t happened in 30 years. And so we have a whole suite of investors, portfolio managers, allocators, who have had an experience in their career, careers lasting 20-30 years, that is purely one environment. And so it takes some time for that Overton window to pass through acceptance and sort of accepting a new reality, potentially, if that’s the case. So, just to give some more highlights on how that chart was sort of representing the information.

Rodrigo:00:28:07So, what was the poll question there? So, we can just — We got two thirds that has said one and …

Mike:00:28:13One that they’re more than in the inflationary, sustainable camp and a couple, about a third are in the more transitory camp. So, that’s great. I think that …

Rodrigo:00:28:25It’s all about — the other thing is always, what do you mean by that, Mike? Like, I think it’s persistent. And for me, persistence means 12 months out, right. Are we thinking five years out, are we thinking… maybe the people that think it’s transitory, it is 12 months to 18 months. That’s a lot of time for — that we can have runaway inflation, for and a lot of opportunities to make money.

Mike:00:28:49Well, like you said, is it the 40s where we’ve got this burst, and we’re going to now have a new equilibrium, but that’s it’s going to settle down, or is it this persistent sort of 70s scenario where yeah, here’s this type of inflation. Oh, and then here’s another type, and oh, here’s some more inflation for you. And oh, by the way, the central banks are going to get involved and they’re going to constrain liquidity in order to fight the inflation. Oh, again, this comes back to inflation volatility versus just inflation. And that’s, I think, it’s hard to argue that inflation volatility is not upon us. That I think, we can categorically say, the evidence points to yes, that’s here.

And maybe it settles down, maybe it’s the 40s and we get another five or 10 years where it attenuates, I don’t know. But you want to think about how to prepare portfolios for that and how those dynamics like growth and inflation, which we talk about a lot, we have our market target, we talked about those asset classes that perform well. Maybe it’s time to pop that chart up, Rod, and observe that you know, okay, so we’ve got to now take real steps in portfolios to prepare for a slightly different regime than we’ve had previously, and maybe it’s significantly different. And maybe Rod, you want to walk through this slide.

Growth and Inflation Dynamics

Rodrigo:00:30:12Yeah. So, I mean, those who have been following us have probably seen this before. But this is just again, like stepping back. And from a fundamental framework perspective, understanding what moves the markets are really largely two dynamics, right. You got your growth dynamics and your inflation dynamics. And different asset classes are going to do differently whether we’re in a period of accelerating growth versus decelerating growth or accelerating inflation or decelerate inflation. And when you look at the vast majority of portfolios today, we see almost everybody really hovering in that bottom two quadrants, mostly in the bottom right quadrant, which is the requirement to thrive in that environment is benign inflation and persistent growth shocks.

And what does well in that environment is developed equities and developed bonds, right. And so that’s where we are today. That’s where we’ve been for the last 10 years. And the question is, if we are in an inflationary regime, I don’t think we even have to question that. We have seen inflation. And what we’ve seen perform really well has been what is expected in this framework, which is, in a rising inflation, environment, commodities, gold, TIPS are going to be a decent offset.

Adam:00:31:26Emerging equities are interesting too. I mean, emerging equities as of yesterday, I think it was yesterday, they were up on the year, right, while developed markets are down sort of five to 10% or more.

Mike:00:31:40Yeah. And this is one of those interesting things from a decade long experience. If we went back to 2000, US equities had done so well. And then from 2000 to 2010, 11, 12, 14, US equities have really struggled. But what did well? What did well? Emerging markets did well, the Canadian resource economy did well, the currencies related to those types of countries did well, international real estate did well. And so we’re in a situation where if you look at the last decade of returns and valuations on, let’s say US equities that represent that disinflationary growth quadrant, they’ve pulled a lot of those future returns into current valuations.

Contrast that with emerging markets over the last 10 years. Much better valuations, price action has not been great over the last decade. And so they haven’t pulled those future returns into today. So, if we’re thinking about how is this going to be over the next 10 years, as you mentioned, Rod like, where’s the puck going to be? You know, you have to make those considerations when you’re making your allocations.

Rodrigo:00:32:53Yeah. And I think let’s take a look at the empirical data. So, we just said, theoretically, these asset classes should do well in an inflationary regime. Let’s kind of go through some of Man’s conclusions from that same paper, and just take a look which asset classes do well, which asset classes struggle? If I can find it here, yeah, let me share the screen. Okay. So, again, this is going back to 1926. And the two columns to look at here is the periods of inflation on the right hand side here. So, when they looked at the 1926 to now period, they found that 19% of the time we experience, we’ve been in an inflationary regime, and the other 81% of the time, it’s other, right.

And as expected from that framework, you’re seeing the best performing asset class is energies, right. And I think a lot of that has to do with looking at the 70s that was a big player in the energy space. Is that going to be the case in the future? We don’t know. I think we talked a little bit about this. Other kind of long only asset classes again, commodities, industrials, aggregate commodities, gold, precious metals, those are kind of from a passive allocation perspective. We’ll talk a little bit about the other categories here, which is trend, all asset trend, commodity trend, those tend to do really, really good job during inflationary periods.

And then the big losers are again, what we expect, right consumer durables, long equities is going to struggle, long duration fixed income, the 30-year Treasury had in that inflationary regime and annualized rate of return of negative 8%. You know, high yield fixed income, negative seven, the 10-year treasury, negative five. What else are we looking at?

Adam:00:34:54Interesting, residential real estate. I think a lot of people have a perception that owning a home is good protection against inflation. And, in fact, if you look back historically, all the way to 1877, I think this goes, the real estate, residential real estate has delivered a return of negative 2%, annualized during inflationary periods. And I would argue that given the current structure of residential real estate, where loan-to-values are much, much higher in the current environment than they were in other inflationary periods, and we’re starting from a much lower initial rate, I would argue that the real estate market, residential real estate is as vulnerable as it’s ever been right now to rising rates. And I think a lot of Americans perceive that because you’re able to get a 30-year mortgage that that offers protection, and to some extent it does.

But what it means is that the ability to get credit to buy your home, for someone else to buy your home, it gets more and more difficult, right? So, for example, if I go back to 2019, the average rate on — so, the average monthly payment on a new mortgage in the US was about $1,700. The average payment at the end of 2021 is about $2,200. And that’s a combination of larger mortgages on average, and higher rates on those mortgages, right. So, what it’s going to have an impact on primarily is labor mobility and new household formation. So, young people are just not going to be able to afford to own homes, they’re less likely to have families or they’ll delay having families, they’ll have fewer children. So, these are not insignificant challenges, and the prices are not going to go up for a year.

Mike:00:37:13So, you have price volatility in the underlying asset. I suppose some of the inflation hedge on the residential real estate side comes from the fact if you’ve owned your home and you’ve paid it off, or you have this locked in payment, then your cost of living has a slightly reduced exposure, potentially than if you’re a renter. So, there’s a portion of it that can help. But again, so you’re offsetting that but if the price is declining, your balance sheet, your personal balance sheet isn’t improving, particularly but you’ve got a bit of a hedge there.

Adam:00:37:48And those, every line of credit, they get cheaper, they get harder to get, the collateral that you can use on the house is lower. Like, there’s lots of ways that it affects the economy. And like I said, historically, residential real estate has just not been a very good inflation hedge, negative 2% annualized returns during previous inflationary episodes.

Mike:00:38:08Rod, do you have the other sort of market chart with the — Were we going to bring that one up as well with — You want to do that as well?

Rodrigo:00:38:18Which one, the 1970s and then 2000s?

Mike:00:38:20The one where it has the actual asset prices, and you’ve got the yellow and red boxes with the bear market …

Adam:00:38:27The partial correlation ones?

Rodrigo:00:38:29Yeah. Yeah. Sure. I mean, it’s kind of telling …

Mike:00:38:31Because I think that’s formative to wrap. It tells the same story, but it’s kind of  Because I think that’s informative to sort of…

Rodrigo:00:38:42Yeah, so I think it’s a similar story here. Let me just…

Mike:00:38:49Yeah, that’s the one.

Rodrigo:00:38:50Again, what we’re seeing here is that you have in the Y axis, near the top, you’re seeing what is correlated to persistent positive growth shocks. And near the bottom of the Y axis is persistent negative growth shocks. And the X axis to the left, it’s persistent negative inflation shocks or deflation or disinflation. And then to the right is persistent positive growth, inflation shocks. And when you examine where everybody largely is at, we just talked about real estate, we’ve talked about 60/40. You know, we could add private equity in here. We could add private credit like they’re all going to live in that top left, they’re going to be highly correlated to a disinflationary growth environment, right.

And so 60/40 is also way up there with equities because it’s 60/40. Even though you only have 60% of equities, the risk contribution from equities is 90%. So, whatever equities do your 60/40 is going to follow. So, the treasuries don’t provide much protection in terms of bear markets. So, the big blind spots clearly right now, if we’re going to, when you see a period of inflation volatility, you see a lot of dislocations, right. So, first of all, one of them is inflation and therefore a possible solution might be commodities. You see here that commodities are the only thing on the top right quadrant that can protect or offset some of the losses here from 60/40.

But also this type of inflation volatility leads to dislocations that oftentimes lead to bear markets that have negative growth shock consequences. And a 60/40, as we know, tends to have these very prolonged bear markets, because again, they’re dominated by that equity component. And so there’s major blind spots in traditional portfolios right now, both from the inflation side, and the persistent bear market, not these, like liquidity shocks that we’ve experienced in the last 10 years, but rather, an actual changing of the guard from a bear market perspective. So, that’s, I think it’s an informative graph as well.

Mike:00:40:51Yeah, it really highlights where we’ve been over the last 10 years. And so you’ve had a market cap adjustment, because those assets that are in the top left quadrant have done so well. And so people have probably allocated a little bit more there. And the allocations that they had 10 years ago have grown significantly in comparison to the other opportunities to invest. So, unless you’ve been rebalancing judiciously and continuing to allocate to these other quadrant assets, which would have been a drag for the last 10 years, you would have faced significant pushback from the asset owner potentially, because they’re not keeping up with everybody else who’s just doing something that’s more simple, easier to understand.

And this comes back to well, are we managing assets over one decade? Are we managing them over decades? How are we thinking about that? Are we making a prediction with the allocation to the top left quadrant, versus preparation? So, how might we think about being prepared for all the manifestations and then thinking about how we might impart some prediction or tilts to the portfolio? So, it seems to be a pretty opportune setup for the last decade’s darling to become the next decade’s dog, potentially.

Adam:00:42:17I think that’s a really, really key point, right? Because I think the best example of that is the weightings in the S&P 500 where, obviously, it’s been an unbelievable decade for big cap tech. And big cap tech is currently or you know, within the last few weeks anyways, was by far the largest sector in the S&P, larger as a proportion of total market cap than in any other time, other than the last couple of years in the 1990s tech bubble. And so you’ve got some companies and some sectors in the S&P that are designed to do well in inflationary periods. And if you go back and examine the returns to sectors over the past century, conditioned on inflationary environments, there’s only a few sectors that actually do okay. And even the best ones don’t really do that well.

So, energy historically has done the best with about a one or 2% annualized return real during inflationary episodes. Mining, gold companies, they’re sort of flat to slightly down to slightly up. Healthcare, flat, they’re slightly down to slightly up. So, sadly, the sectors that should do well, in an inflationary regime represent a minuscule portion of the total S&P right now. And the sectors that are most vulnerable to an inflationary regime currently represent by far the largest allocation in the S&P. So, this, I think, is a bad situation, especially for developed market equities and US cap-weighted equities in particular.

Mike:00:44:11Yeah, and we’ve seen that transition previously. I mean, we’ve lived through the tech boom, where we saw tech become a very large part of the S&P. How big was Exxon in that? And then fast forward to 2008, where Exxon becomes the largest company in the S&P. Fast forward 10 years from that and again, you see that energy weighted, those large companies have become much smaller. And then so if you’re going to accept market cap weighting, then that’s your allocation. And until it changes, you’ll be behind the curve, I suppose. If you have a regime change, you’re going to have much smaller allocations to things that do well, and you’re going to have much larger allocations to things that do poorly in an environment which has changed from disinflation and growth and the discount rate that we’re applying to these growth companies into the future for 20 or 30 years, those are going to suffer. And you’ll end up with those sectors that do well, but you’re just going to have a very small allocation until they grow into the new cash flows as the markets readjust themselves.

Rodrigo:00:45:24Yeah. And this is where the passive market cap weighted portfolio, cheap portfolio that everybody’s bought into, will suffer and where I think active management may have opportunities at every level, right. Like, from stock selection to bond selection to active long-short manager selection. And in AQR’s paper, what I’m showing here is kind of their view of what — if we are in an inflationary volatility regime what to do. And again, from that quadrant chart, it’s not surprising that you want to diversify internationally. Because generally speaking, where there’s inflation, there’s emerging markets that are commodity driven, that are benefiting from the rising commodity prices. You might see other global opportunities by the fact that the dollar tends to suffer and it’s easier for international markets to compete.

Within equities again, Adam talked about it like you’re likely if you take preventive steps to skew towards gold healthcare and energies, shorten duration for your fixed income, reduced credit risk, you can go to floating rate issuances. And then the alternative strategies, this is a big one. Nobody wants to do this right now, but it’s reduce your private equity allocations. I think they’re the most susceptible. Buy some commodities, and I think we’re going to make a case also for long-short multi-asset, right. This is this opportunity, I think this is where active management starts to shine again.

Mike:00:46:57Yeah, well, why don’t you talk a little bit about dispersion, Rodrigo, as well? Because I think that you’re on a roll here, keep going.


Rodrigo:00:47:05Well, I think that we tend to be talking about inflation exclusively. But the reality is that dispersion, of the dispersion of volatility means dispersion across all asset classes, right. There are downstream effects to having volatility go through the roof. I just mentioned a few. You have emerging markets that are going to benefit in a way that they have in the last decade, right? It’s been one place, benign inflation and persistent growth shocks, being able to see the future ahead of you. You’re going to pay money to the highest growth stocks, it’s cheap for you to borrow money in order to have that happen. When rates start going up, uncertainty gets higher, dispersion starts to happen. There’s going to be big losers, big winners, global diversification starts to help. Currencies start to go in a different way. It used to be US dollar and everything else.

Now we’re starting to see much more diversification between the pairs. And so it’s the idea that multi-assets tend to, and even risk parity, anything that’s just not S&P 500, or NASDAQ did so much better than S&P and NASDAQ in the 2000s, was due to the amount of opportunity sets they were. And so all of a sudden, you go from having a toolset that is, I have to buy the FANGs to an opportunity set that is much broader from within equity markets in value versus growth, energy markets. Like, these are really going to be dispersion opportunities that might save you and might give you not just an opportunity to minimize the loss of your purchasing power, but maybe even thrive during that decade, right, but it needs to be a massive shift in mindset.

And then you have to realize now that your tool set got huge. And you haven’t used, these are rusty — you have to relearn how to use them and to remind yourself why you hated them and discarded them. So, you probably have to go buy a few new tools again, right. Then you have to change your IPS in order to be able to add assets. So, it’s crazy to me just talking to different committees, how they’ve changed their investment policy statements to never be allowed to add alternative strategies or commodities in their portfolio because of their experience in the last 10 years. So, there’s going to have to be a major overhaul to be able to access that toolset. But it’s going to …

Mike:00:49:33The dispersion creates the opportunity, right? We’ve had one thing do really well, and everything else sucks. Okay, well, that’s kind of meh. But now you’ve got well, there’s going to be a myriad of things that are doing well at different times. And the thing that has been so reliable and so consistent may not be that reliable and consistent, right. So, if you have a suite of 20 asset classes that you can invest in and they’re all going to be up 15% and they’re correlated, well, there’s no opportunity really for any kind of outperformance other than levering that. Whereas if you have those same 15 or 20 asset classes that have significant dispersion in their returns, now, you’ve got some opportunity for the rebalancing tailwind, you’ve got some opportunity to position yourselves in the different asset classes. As you said, it’s the return of active management.

Rodrigo:00:50:30Yeah. And let’s just take one step back here, because I think this is a conversation about inflation. And when I speak with allocators, they are all contemplating what solutions. There are a lot of them, the first thing they’re doing is starting to lean towards more commodity based equities, which is interesting and useful. But a lot of them are thinking about these passive commodities, right? Like, let’s just do that. And I think I’m going to kind of — we talked about inflation volatility, but let’s talk about the tool of commodities, right, this idea that, look, we’re going to have a decade of inflation.

And when people, you said it earlier, Mike, everybody thinks about the 70s as the decade of inflation. But it wasn’t a decade of inflation. It was a decade of inflation volatility. What I’m showing on the screen now is in yellow, you have the commodities making 650% from point to point. Time capsule, you put it in your portfolio, wake up, 10 years later, you’ve killed it. And you’ve more than offset the losses in real terms that you’ve experienced from your equities and your bonds, which are the bottom two lines. But man that you have to hold on for a huge ride, right. You’re certainly solving the problem of the decade, but in between, the difficulty with using pure commodities as your tool to fight against inflation is whether you’ll be able to stick to it long enough to garner the fruits of your labor.

And so this is the 1970s. Again, the last commodity boom cycle was a similar thing. From 2000 to the peak of the commodity cycle, which was February 2011, you had massive volatility. Two major bear markets, one, 31% drawdown, another 60% drawdown. The drawdown in the 70s, I didn’t mention, was 37% and it took three years. Right. So, the issue, like how should we be thinking about this problem of inflation volatility? Should it be blunt instrument commodities? Or do we go back to this dispersion of opportunities and recognize that it’s more than just inflation, it’s more than just commodities, it’s opening up the whole tool set and how that can benefit you, not just from an inflation perspective, but from possibly even protecting you and thriving during bear markets. Right?

Mike:00:52:53It’s a function of the portfolio construction now, right? So, you’ve got this asset class, you say oh, well, I’ll just do commodities. And oh, God, I’m doing so great and in the middle of the commodities run in the 70s, you have a 37% drawdown over three-four years, that’s going to be a bit of a punch in the gut.

Adam:00:53:14And it presupposes that you know that going into an inflationary environment in the first place, right?

Rodrigo:00:53:20That’s the next point that I wanted to make. Because first of all, I also pointed out that, do you guys remember late 2007, all the major institutions, were buying up that Deutsche Bank Commodity Index as a passive allocation to commodities? Of course, again, wrong place at the wrong time, right before that 60% correction. A bunch of them got shaken out, and they missed the opportunity from the bottom, I think commodities bottomed in December 2008, and then went for a massive run again until February 2011. Right? So, it’s really tough to stick to, right? And that is the best outcome, by the way. In the last two decades, isn’t — during an inflationary or commodity boom cycle, that’s your best outcome?

The reality is, like you said, you have to time it right, right? Because the Man paper goes on to show us that inflation has only happened 19% of the time, in the last 100 years. The other 81% of the time, most commodity buckets have a negative carry. And if you include just all of them as a bucket, you have a positive carry of 1%, right. So, are you going to use this as a strategic tool forever? No. I mean, if this — because this is why nobody has them because they’ve experienced the 81%. And so now it’s up to the allocator to be a market timer. And that’s just a tough thing, right. So, I don’t think, I think my conclusion is that commodities on their own from an asset allocation perspective, where you are having to show that line item, may not be an ideal solution.

Mike:00:54:57Right. And I would add that in the two charts you showed in those inflationary regimes, the S&P does not do very well. And so yes, okay, there’s solutions. And why do we need the solutions? Well, 2000-2009, the return is very, very de minimis. And in the 70s, on a real basis, it’s a negative.

Adam:00:55:23The real return to US equities during the 19% of the time, you’re in an inflation regime, the real return compounds at negative 7%.

Mike:00:55:32That’s right. And so that’s what’s so important about inflation and inflation volatility, and its impact on asset class prices, right. This is why this is so pertinent and relevant for those who are allocating assets over multi-decade periods. Because it’s not a if, it’s when, so it happens, historically speaking, 19, let’s call it 20% of the time, so a fifth of the time, this happens. And if you are an allocator who allocates long term assets over multi-decades, you are assured that you are going to be in a period that has these inflationary dynamics. And thus, if you’re not allocating to assets that can help provide those real returns for those asset users, then you have to cut programs, cut spending, if you’re an individual. And so there are very real implications for the end asset user that are unpleasant if one just says I’m going to ignore this.

Rodrigo:00:56:39Right. But we have to make it more palatable. I think again, going back to the — you’ve used a hammer, and you’ve used a saw, and now we have this massive toolbox and you don’t know what to do. So, now we need to introduce something that’s more palatable. We’re asking people to buy gold or buy commodities, and we’re showing how difficult that would be right, behaviorally. And so when I read this paper, I was like, okay, this really makes a lot of sense, because you want to have something that protects you during the 19% of the time we’re in inflationary regimes, but also something that has a positive carry and possibly pretty decent results the other times, right.

And so, not surprisingly, this is a Man report. They did a trend, a simple trend on bonds, FX, equity commodities, right. Again, this is not trend, commodities, right. This is all of them. And the point here being it’s because dispersions of asset class returns both on shorts and longs become much more abundant across the board. So, bonds trend was a massive inflation hedge, right. Commodity trend obviously got an inflation trend. Equity and FX did okay, right. So, all of a sudden, you just have opportunities everywhere to offset those negative returns you’re getting in real terms from equities, and fixed income. And then the other 81% of the time, the average of this all asset trend, is an annualized 15% rate of returns.

Now, the problem with the other 81% of the time is that there are many periods like the last decade where you have a single market dominating all of the returns, and you’re going to drastically underperform that and it’s going to be tough. But in spite of all the hate trend has gotten in the last decade, it’s still offered positive carry. It’s not like commodities, which we’ll show in a second, which had a pretty bad outcome.

Mike:00:58:33Yeah. So, let’s expand the toolbox? Yeah, what are we going to do? So, go ahead.

Rodrigo:00:58:40So, here, this is just again to finish off the thought here, AQR did, it’s kind of separated in three, we talked a little bit about what happens during inflationary shocks. There were a few comments by Brian in the comment section about persistent inflation, right, when you get to 4%, you stay that way. So, the middle bars here, the dark blue bars, is what happens to these different asset classes you’re in a persistent inflation, stable inflation. And then the light blue bars are when you have negative inflation shocks, right and commodities are linear, right? They do really, really well during periods of inflationary, positive inflationary shocks. They don’t do well, they don’t have a lot of positive carry during stable inflation and they really hurt you when it’s deflation, right? And the opposite of that is US Treasuries, right?

But then when you look at trend, you have this smile with a big thick center as well, where you have the opportunity to provide true positive carry even when inflation is persistent, right. Again, talking about the dispersion of opportunities. And the other one here is macro, right? So, trend and macro seem to have this smile across these three different regimes.

Adam:00:59:55The blue bars there are periods when your traditional portfolios are kicking ass, right? Like the light blue bar, when inflation is benign, there’s no material inflation shocks in either direction, your classic cap weighted 60/40 style portfolio is rocking, right. And you know, trend is doing something that’s kicking along. But the other traditional segment of the portfolio is going to completely dominate. What’s so great about trend and macro momentum or macro is that when those traditional markets that you love to hold are suffering, that’s when trend and macro have their best years. And so they really are a terrific complement.

Rodrigo:01:00:48Yeah. And so what did that — now we’re going to go back to those two decades because I think it’s important to kind of show what that looks like. And so this, I start here with the 2000 to 2011 period, and I’m going to add some multi-asset, right, some active multi-asset. The yellow line continues to be commodities with that 31% loss and that 60% loss. Of course, the strategy near and dear to our hearts is risk parity. So, we’re just using the Advanced Research Risk Parity Index here. What’s fascinating about this index is that it did just as well as commodities, from point to point almost like to the T, but without the volatility, right. A little bit of volatility there in 08, but largely speaking, it cruised through that inflationary period.

But importantly, the Goldman Sachs Macro Risk Premia Index, here we’ve scaled it to 10% and deducted a 3% performance fee, or fee on it. It actually absolutely crushes it, because again, that dispersion of opportunity, the ability to make money in trend and value and carry when there’s dispersion is just astounding, right? And if we take this to the 70s, it’s the exact same story, right? Like, risk parity does just as well, as – risk parity 10% volatility does just as well as commodities do without the volatility, without a 37% drawdown.

And then in this case, I’m using AQR’s Future Diversified Trend Index again, because of that diversification and the opportunity sets that are abundant, you do really, really well, right. So, if you’re thinking about an inflation hedge, I dare say this might be a good place to start. The real question is, why isn’t everybody buying into this? Why haven’t we discovered this and are doubling down and selling our private equity and buying as much as we can of this? And of course, it comes down to the fact that the last 10 years.

So, this is a chart showing the same asset classes from 2011, the peak of the commodity crisis to roughly now. Well it did okay. Again, positive carry for both strategies, but the S&P has absolutely dominated returns. Why not commodities? Well, you can see why not commodities, right? It began to go down after the commodity boom cycle …

Mike:01:03:19The peak in the cycle in 2011.

Rodrigo:01:03:21— and it hasn’t recovered in 10 years. And we’ve had one 55% drawdown and a bunch of other double digit draw downs in between. The other thing to point out is, this is indicative of all asset classes. But in the yellow line here, you’ll see that there’s not a lot of dispersion. It just kind of flat lined sideways for most of the last 10 years. And when you have little opportunity, when you have out of your 70 futures contracts that you can invest in one or two asset classes to truly lean on for returns, you’re just not going to — it’s not going to be your decade.

And so I read a tweet yesterday or the day before about how KKR has basically increased their allocations by over 50% in a single year. And they’re a billion dollar organization, right? This is what was happening to CTAs in 09 after the 08 crash. I remember it vividly. It’s one of the biggest and largest funds that — The alternative strategy funds in Canada was Man HL and everybody was doubling down on this. And over the decade, they started dying off the vine and now HL doesn’t even offer it in Canada. They literally closed it in November or December of 2019, four months before the COVID crisis, right.

So, this is why nobody likes these things. And the question we have to ask ourselves is, all right, maybe commodities are rough. But maybe we can, you know, the worst thing that can happen with multi-asset could be just a single digit rate of return if everything continues to back to normal. But if we’re right and there’s inflation volatility, it might be a massive opportunity that you’re missing out on, right.

Mike:01:05:03Well, and it’s — you’re taking a bet, whether you think you are or not. And so as you’ve mentioned, if you go to the previous chart, and you look at those periods in the 70s and whatnot, you’ll probably see that the biggest adoption of trend following futures in 1979 and 1980 because they outperformed the dominant equity index. Much like you may be seeing that today in the dominant equity index, having large and broad adoption and private equity and those types of things. And you look back at the last 10 years, you say, well, why would I own any of those other things, they’ve done nothing but reduce my potential returns.

I mean, this is performance chasing at its best, it’s that behavioral bias; how can I do things that haven’t done well? How am I going to sell that to a Board? How am I going to put it in portfolios? How do you as an advisor, you go in, someone comes into your office, and you say, okay, you need 30% exposure to these alternative asset classes. And they say, well, show me how that’s done over the last 10 years, and you show them equity line that is substantially below the simple strategy of buy and hold. And so that’s really, really a difficult conversation to have at all levels of strata, whether it’s institutional, retail, this is a really tough conversation to have. And you’ve seen that consistent narrowing of opportunities in the IPSs broadly across all of those, that continuum of asset owners. And so it happens over and over again.

Rodrigo:01:06:47Yeah. And we haven’t seen inflation, but we also haven’t seen prolonged bear markets, right. So, I think that the interesting part of this is that I just went through those charts, right, and I’m going to go through them again, but just highlight. You know, as you mentioned earlier, Mike, when there’s this type of inflation volatility, there are a lot of bear markets. And so how do these multi asset strategies do in bear markets? Well, they do really well. Right? 82% positive returns during the credit crisis bear market, and then the Goldman Sachs index. 28% positive returns during the 08 crisis. And then …

Mike:01:07:18I think that’s the — you mentioned, it’s a tech crisis that you mentioned just for those listening to those. Yeah, 82% versus 47% down in the tech crisis, and then 53% decline in the great financial crisis versus 28% for the global macro. Sorry, go ahead, just for those listening.

Rodrigo:01:07:32Yeah. And those companies during that mid-70s bear market, that was a 42% correction in the S&P, and the — that’s nominal. And then you have the AQR Index up 138%, right. So, we just haven’t experienced these like good old fashioned bear markets. And a lot of this, this space has been vilified because they haven’t done fantastically well and really abrupt liquidity shocks. But that’s not what they’re designed for. Right? If we go back to these traditional ones, I think they will perform really, really well. And now you got to — so, one of the best things about all this is just going back to that target chart is you can you may be able to kill two birds with one stone. Right? We started this conversation with inflation protection and what could offset it. We showed that possibly the best option is multi-asset long/short.

And then by happenstance, we stumbled upon the fact that, oh, they also solved the bear market issue. So, I think we got to stop thinking about, particularly the multi-asset space as a just an alt that you want to have a nice to have to have a little bit of extra juice, and more about a pillar of portfolio construction, not a 5% allocation, but kind of think about it from a risk parity lens and say, okay, you got your equities and you got your bonds, everybody knows those. I got a third thing that the purist risk parity guys tell me I should have, commodity purely, but I know that’s not going to work. This may replace commodities and actually do a better job. Right?

Multi-asset Trend and Macro Trading are Better

Adam:01:09:16I think it’s worth talking about why multi-asset trend and multi-asset macro trading are useful and empirically more useful than just commodity trend and commodity macro trading. And it’s because sometimes the best place to bet on inflation is by shorting bonds. Sometimes the best way to bet on a negative growth shock is to short equities. And so just the commodity trend idea is, it seems intuitive, like you kind of want to get long commodities and you like the trend overlay. But you’re missing the opportunity from shorting some of the markets that are functionally designed to not do well in inflationary shocks, like bonds, for example. And that’s why the multi-asset trend that includes allocations to trend equities and trend FX and trend rates does substantially better than just the trend commodities in virtually every period.

Mike:01:10:26And there’s a reason why you get to kill two birds with one stone, as Rodrigo says, is that well, what causes major prolonged bear markets? Well, a lot of the time, it’s substantial and persistent inflation shocks.

Adam:01:10:44So, central banks need to step in and raise rates to the point to slow demand in order to contain inflation. Exactly. Yeah.

Mike:01:10:52Yeah. And so there’s a structural reason why you have this opportunity to hedge a portfolio against these two very critical risk factors with this approach. Because that’s driven by these inflation volatility, inflation and its volatility and those shocks that come with it. So, you’ve got some offset and that helps attenuate those large drawn out bear markets.

Rodrigo:01:11:20And Adam, just to put some numbers to the comment that you made about why not just trend commodities versus trend all assets? In the Man paper, you can see here that trend all assets during an inflationary regime …

Mike:01:11:32You’re not sharing your screen, Rod, if you’re …

Rodrigo:01:11:34I’m not going to share, I’m just going to talk.

Mike:01:11:36Oh, I’m sorry.

Rodrigo:01:11:36Yeah. So, trend all assets — Let’s talk about trend commodities annualized at 20% during the 19% of the time, that was inflation, so 20%, your inflationary periods and 8% in other, right, positive return? So, positive carry in other, 20% in inflation. The all asset did 25% annualized and 15% in other, right. So, this is an interesting thing. Again, the intuition is that you want to do commodities. And the intuition is, well, why don’t we do commodity trends? And then you’ve come to the conclusion that it’s not just about inflation. It’s about all of the dynamics, the knock on effects around inflation volatility.

Adam:01:12:13So, let’s — Sorry, Mike, you finish up.

Mike:01:12:15This last point, we hear this over and over again, as we’re interacting with allocators, investors, advisors, this whole idea, well, I’ll just buy some energy stocks, or I’ll do this little thing or I’ll allocate here and there. And it’s, well, it’s kind of a step in an okay direction. But if you can broaden your mind a little bit and open your mind and do the work in order to get comfortable with the strategies and understand how the allocation methodologies work, I think you can, you can get comfort and actually be excited about the opportunity to differentiate, given the potential for a slightly different regime, or a significantly different regime.

Where the Rubber Hits the Road

Adam:01:12:54So, let’s talk about how the rubber hits the road here, like for investors that want to take this kind of step, what are some of the options, right? I mean, obviously, one option, which may be a good first step is to take what Rodrigo said, which is, kind of trim back your 60/40 portfolio to free up some capital, and then allocate to a few trend and macro trading funds, right? To get some juice there on the inflation side, right. So, that’s kind of a simple step that I think most advisors can take to some extent. And then we’ve obviously done a lot of talking recently, published papers, etc., indices about this return stacking concept where you actually don’t need to take away exposure from your core holdings. But rather, you can stack these trend and macro trading strategies directly on top of full exposure to 60/40. So, maybe, Rod, you’re sort of the progenitor here, why don’t you talk about…

Rodrigo:01:14:03Yeah. And so this is, by the way, Milan, just added a comment here, like throw in some convexity and take advantage of that downside and maybe some upside from Newfound and Simplify has cool Structured Alpha Indices…. Yeah, of course, the Stacking Returns piece was written with Corey Hoffstein from Newfound. So, if you go to, you’ll be able to download the paper but the long and short of that is that you — again, talking about behavior, right? The reason everybody sold this out is because you’re dragging returns down in a decade where CTAs and global macro have done single digit.

Okay. So, what’s the solution to this? How can we give you what you need? How can you get that behavioral need for tracking the market that you care about and also get the sugar on top that protection on top, where you’re not going to give up on it in a decade where it does single digits? Well, today there are a number of products that have stacking embedded into their products, meaning you give them $100, you can get more than $100 of two different types of betas, bonds equities, so 90% bonds, equities, 60% bonds, or in an alpha and a beta, so of 50% SPY and 100% equity or the funds that we sub-advise have risk parities, stacked on top of that a systematic global macro.

So, you add, Simplify has some basic beta with convexity, Hoffstein has and Newfound has 75%, active equity, 75% active bonds, so it goes on and on. And then you can put them together in a way where, in the case of the report, we did 60 equities, 40 bonds, and then 30, CTA and 30 global macro, and we just did this analysis, Corey and I, for the last decade. The difference between the 60/40 and the stacked return is positive, there’s a positive carry there, an annualized return about one, but it’s kind of small, right? What does that mean? Well, you got your diversification and you didn’t give up on it. But then if you examine that same portfolio from 2000 to 2011, the stacking is like 500 basis points, it’s a massive dispersion, right. So, it’s a way to think about capital efficiency using 40 Act funds that allow you to stick to it. And then maybe if we’re right about inflation volatility, you get a boost and a bonus.

Mike:01:16:37Yeah, it’s addressing the behavioral vulnerability of tracking error. And at the moment, in today’s world, the tracking error’s with the 60/40 we … that’s not always the case, as we’ve experienced through our careers, that it’s not always the US 60/40 that is the premium or paramount tracking error issue.

Adam:01:16:58Well, you couldn’t talk investors into buying the S&P in 2007, they wanted nothing to do with it. Right.

Mike:01:17:05Yeah. And so again, it’s that, what is it that the end investor can actually tolerate is a very important part of the calculus that goes into what you can propose for them. And my estimation is that as we move through the next decade, we may see an attenuation of that peak tracking error being to the 60/40. Maybe not, maybe not, but that would be you know, my thinking is, I would propose that that’s a probable event. But who knows, what do I know? Sorry, go ahead.

Rodrigo:01:17:39I just wanted to — Corey, and I put these together today, actually. So, here you can see it, this is the last decade where the blue line is a 60/40 portfolio and the black line is the  Stacked Return Index, right? Some benefits, some excess return, not amazing. But better than the yellow line, which is the non-levered version, right, where you’re just making room in the last decade to add those diversifiers.

Mike:01:18:07But you’ve actually got to take capital allocation away from your 60/40 in order to add it over here. Rather, let’s stack it on top. Yeah.

Rodrigo:01:18:17And by the way, I’m not opposed to that. I think it’s awesome and you should do that, if that’s the only thing you can do and leverage is something that you can’t do. It’s just you then just have to think about it in a different way. But here’s the contrast, right, to the previous decade, 2000s. Even the non-levered index did significantly better and acted as that diversifier we’ve been saying and acted as a protection against bear markets. But certainly the stacked version of it did even better. So, anyway, food for thought in terms of like rubber hitting the road that is how they think about this. And that might be a behavioral way of getting better at it for yourself, your clients, your institution, whatever the case may be.

Adam:01:19:04We published an index page too for the return stacking index, and you can find it at

Rodrigo:01:19:10Yeah, yeah. And I think there’s one last thing, right, because when you have these discussions, the first thing that comes to mind is, wait, hold on a second. Are you telling me, like I was thinking about adding a 5% position to this as my diversified alternative sleeves, right. I have this, I have private credit, I have my long-short manager, I have my market neutral manager. What should I do with those? And I’m not opposed to having any one of those as an alpha overlay, especially if you can stack them. Okay. Because you can… the thing about market neutral, for example, is that it’s not designed to be a diversifier in periods of inflation or negative growth shocks, right? It’s designed to give you two different kinds of basis points a year. So, it’s kind of like the cherry on top, right, of your account, for example.

I see it as that where inflation is 10%, you’re going to get two to 300 basis points. So, negative 700 basis points of real return. You get deflation 400%, you’re going to get 200 basis points, that’s not going to change. The difference between those types of alts, and CTAs and global macro is that you would expect them to do really outsized double digit returns in both those prolonged periods of inflation, and prolonged periods of bear markets, if history and the analysis that we’ve done is any indication. And so the last thing I’ll say about alternatives that I try to point out, and I’ll show here is that the correlations of these alternatives — one of the biggest complaints about hedge funds is that they’re not really hedgey, right? Like, they’re supposed to be different, but they’re quite similar.

And I got to say that there is something to that. And just share my screen here quickly. There is something to that when we look at this slide, which I just grabbed the hedge fund indices in the HFRI database. We’re looking at activist hedge, equity hedge, market directional, event driven, special sit, value arbitrage, absolute return, convertible merger and relative value, market neutral. And then the first line is the S&P, their correlation to the S&P. So, we’ve ordered them, Corey and I, from most correlated to least correlated. And we do get again to the point where the only one that I see as lowly correlated enough to warrant it being called a hedge fund is the Market Neutral Index. But again, that’s not designed to be a pillar of portfolio construction.

When we move into the SocGen CTA and Macro Risk Premia, they’re non-correlated to equities, and non-correlated to fixed income, right, which I think we’ve talked about throughout this podcast. The other two that are worth mentioning in terms of non-correlation is the Currency Index, though, currency is already embedded in both the CTA and the global risk premia. And then the Short Bias Index that has the lowest correlation, but sadly, it also has a persistent negative carry to it, right?

So, when you are considering your alts sleeve, and you have a limit as to how much you can do, and you’re worried about inflation and bear markets, I got to say, like, you got to think about, believe that the private equities and all the things that are just other ways of equity, and really beefing up your inflation protection and bear market protection. I mean, we got to think about it this way.

Mike:01:22:41It’s a function of the real estate, right, so you’ve got limited real estate. And what is the real estate — yeah, portfolio real estate. And so what do you hope to achieve via the exposure to that portfolio real estate, and private equity is simply another asset class that does well in positive growth, benign inflation … yeah, its equity. So, it’s not going to give you that shock absorption on the way down. So, if you only have five to 10%, again, this is one of those really interesting pieces of portfolio construction. You need it to be non-correlated, and you needed to deliver outsized returns during that period.

So, things like long-short or market neutral, they’re going to do something but they’re not going to give you the outsized return that you need to contribute to the portfolio to offset the other poor performing asset classes in said portfolio. And so real estate, as you think about the allocation mechanisms within your portfolio, have to be thought through on a case by case basis for the limits and restrictions that different asset owners have. And that’s actually where I think that it really becomes important to have someone with some expertise to help walk you through that, because it’s going to be a little bit uncomfortable to and as I think you advocate, Rod, it’s like you need 30% of an allocation.

Rodrigo:01:24:13At least. You know us, we think about it from a risk parity perspective. And so there’s more complexity there, right. If it were up to me, you’d have a massive bond position, a small equity position, and you know, the right level of volatility in my multi-asset, so that I can have balance between the three pillars, right, imagine three pistons in a motor all being able to contribute the same amount of power, right? So, there’s ways that you need to — if you’re willing to have tracking error, you can think about it. But generally, like, from a practical perspective, most people are so married to their 60/40 that what I’m begging them to consider is just pro rata that down and add that third piston in your motor. You absolutely need it and are missing it and nothing else will do, right, in terms have the characteristics and qualities that these tend to have in the biggest blind spots in 60 and 40.

Adam:01:25:08Yeah. I mean, they could, in theory, just take their 60/40 portfolio, replace it with an allocation to NTSX for two thirds of it. So, now you’re getting a full exposure to 60/40 and then take the rest of the capital and allocate it to trend funds too. Like there’s a few ways to spin this.

Rodrigo:01:25:26There’s a few ways to do it, right? The concept of return stacking can be wide-varying. We just …

Mike:01:25:34That’s why it takes, I think, a thoughtful practitioner. Like you need — this is something that you know, on the surface may seem simple, but it’s actually — it requires some significant thought and you see that in the Return Stacking Index that that has been created. You know, there’s a list of publicly traded funds there and each of them offer different parts of this puzzle. And so when you X-ray through them, that’s how you get to this exposure that Rodrigo highlighted earlier having the 60/40 and 30% to global macro, etc., and getting this return stacked situation, you had to X-ray these types of funds and so there’s extra work there. As I mentioned earlier, this requires a deeper level of thought. It requires some actual understanding and learning because you need to be able to be comfortable with it when it’s uncomfortable, right. If you just do it, okay, that sounds good. I’ll do it. Well, when it gets hard you may abandon it. And when do you abandon it? You don’t abandon it when it’s working, you abandon it when it’s not working and thereby you accept the loss with, and call it the risk with no commensurate return. So, making sure you’re comfortable with these types of philosophy so that you can stick to it is incredibly important.

Rodrigo:01:26:58Yeah. Please, please, please do not take this as investment advice. I mean, this requires lots of discussions with your advisor or whoever it is that you trust the most. Like, you need to think thoroughly about all of this and implementation before you do anything. So, we’re happy to help and you can always reach out to us. Corey is in the chat as well. But, yeah, I mean, the Stacked Return Index, since we’ve launched it, it’s done exactly what’s expected of it, right, a nice little stack and in a low return environment, it might be just what we need. We think about it differently. And we have better solutions than ever.

Mike:01:27:37That’s all. Is there anything else we need to cover, boys?

Rodrigo:01:27:41I think that was pretty thorough. We’ve made our case.

Mike:01:27:45I’ve certainly enjoyed it. I learned a few things. I enjoyed it. It was a great Friday afternoon.

Rodrigo:01:27:51Yeah, yeah. I have lots more to say but I will leave it for another time. I got to go do my first Gaelic football match, gents


Rodrigo:01:28:00Very exciting. Very exciting.

Adam:01:28:02Good luck. Do not break a leg.

Rodrigo:01:28:03Anybody who hasn’t seen it, Google that to see how silly it may look to others that are not Irish.

Mike:01:28:11Well, the Irish folks on here are like, yeah, giving you the fist bump. Anyway, I think we’ve covered all the places where there’s reports and links as we’ve talked about them, we’ll probably throw those in the show notes. And as always, please Like and Share this with your colleagues. Even if you can think of one person that can benefit from this that helps us continue to provide this great content, it helps us attract other guests that we can bring on to counter our points or to give us a deeper understanding on the situation we’re in, where we’re headed. And yeah.

Adam:01:28:46Yeah. Reach out. You know where to get us.

Adam:01:28:47You can find hundreds of pages on these themes at Go back through our featured research list, and yeah, you’ll find all the info you can stomach on these topics.

Rodrigo:01:29:03All right, gents. Thanks, everybody for joining.

Mike:01:28:05Cue the music.

Rodrigo:01:29:06See you next week.

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