ReSolve Riffs with Eric Crittenden on Combining Global Trend & Risk Parity for All Weather Performance
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*
As is often the case with sharp and curious minds, our guest this week travelled a meandering route through his career. While studying meteorology and public health in university, Eric Crittenden (CIO of Standpoint Asset Management) stumbled into an economics class and fell in love with complex dynamic systems. He then joined a family office that was uniquely focused on levering into technology companies in the run up to the Dotcom Crash, a debacle that strengthened his views on the importance of diversification and risk management. We discussed:
- From a purely cartesian market view, to recognizing the crucial role played by psychology and behavior
- Early appreciation for the “elevator down, escalator up” type of risk
- How to give investors both what they want and need
- His whitepapers, especially “Does Trend Following Work on Stocks?”
- Why it’s harder to raise capital for diversified strategies, but also harder to get fired
- Liquidity weighting versus risk weighting
- Why collecting a risk premium means you are on the “wrong side” of skew
- Disaggregating term structure from price appreciation in returns – why carry pays
Our conversation also covered the benefits of signal generation that combines different phenomena, why in theory, investors want diversification and risk management (but not so much in practice), and much more. A widely entertaining episode, with no words minced and even a moment of collective catharsis.
Thank you for watching and listening. See you next week.
Chief Investment Officer, Portfolio Manager
Standpoint Asset Management
Eric has over 20 years of experience designing and managing investment strategies, with an expertise in systematic investing for mutual funds and hedge funds. Eric plays an active role in the firm’s research, portfolio management, product innovation, business strategy, and client facing activities.
Eric:00:01:18Thanks, guys. Thanks a lot for having me.
Adam:00:01:27Eric, you are in Phoenix, Arizona. And Eric is an old hat on the trend following circuit. Eric, why did you come into this business and maybe share a little bit of your trajectory?
Eric:00:01:35Sure, yeah. Look at the gray hair. Just how I do these podcasts, I look older and older. I entered the industry right around the time Long-Term Capital Management was blowing up back in 1998. So that was my initiation into the industry. My story is similar to yours, Adam. I’ve worked in different aspects of the industry, I’ve worked for advisors, I’ve been a clerk, I’ve been an accountant, I’ve been a portfolio manager, I’ve worked for family offices, I’ve started hedge funds, I’ve worked for hedge funds. I feel like I’ve, with the exception of working on Wall Street, like in investment banking, I’ve seen a lot of how the microstructure works and the guts of the business and felt the pain, experienced the euphoria and been around the block a few times.
Eric:00:02:26So that’s a grind man, that’s a lot of roles to play. Like accounting and back office. It’s obviously just been an enormous source of frustration, any attempted diversification, especially trend until literally the last eight or nine months has been trying over the last decade or so. What has helped you to maintain your energy and enthusiasm for this thankless job?
Eric:00:02:59You know, no one’s ever asked me that question before. My enthusiasm, I guess the answer that pops into my head is I’m just not qualified to do anything else in life. I started off in college studying meteorology and public health, and eventually stumbled upon an economics class and just fell in love with the concept of dynamic systems and moved on to finance and then computer science. I started sprouting gray here in in the late 90s and thought, now it’s time to get out of college and go into the real world. So I did that. I don’t know, I love this job. I like the crushing responsibility of managing other people’s money. I’m weird like that. I can’t picture myself doing anything else. We’ll probably get into this during the podcast, I think a lot of the thankless nature of the role is our own fault, and there are solutions to it. So I have definitely felt that way over the years of just how fickle allocators are and certain clients and whatnot, but I’m optimistic that there’s a solution to 80% of that phenomenon and that’s a big part of the reason that I started Standpoint with my partners, and I’m enthusiastic about the next 20 years.
Eric:00:04:26I want to make sure that we cover the journey that got you to the thinking that you currently espouse and that informs the strategies, the way you implement them at Standpoint. Because I think you’re right, I think we have followed in some ways an interestingly parallel trajectory and I think I’ve had some of the shared experiences and part of that for me has always been starting out, notwithstanding some early career, thinking more traditionally about an equity focus and being overconfident about my ability to identify nascent trends and macroeconomic phenomenon and do aggressive stock picking. When I moved away from that I really began to prioritize diversification is the primary objective and then how can we layer on other types of risk management and other types of premia.
But over time, I’ve realized that it’s not all about creating the most efficient portfolio, that there are other drivers in the decision making process for investors. So I’d love to hear how you progressed through that journey. Did you start with that desire to really create the most efficient portfolio and then evolved towards acknowledging the psychological realities? Or did you realize those psychological realities right up front, and it’s been a struggle to create products that were able to meet in the middle there?
Efficiency and Psychology
Eric:00:06:04Well, I wish I could say it was the latter. But the truth is, I got to age 48 doing everything wrong with respect to dealing with clients and marketing. So like most quantitative, systematic oriented managers I had a huge ego coming out of college and thought I had it all figured out. And it’s just a math problem, math and discipline. And if I show people something that’s superior to what they’re already doing, they’ll make the switch over and we’ll all hold hands and sing and make money, and I’ll have my own private island and all those things. Wrong, wrong and wrong obviously. I remember a piece of advice I got from Tom Basso way back in 1999 about this, and he asked me what’s the most important thing in this business? What’s the most important attribute or characteristic? And I don’t remember what my answer was. But he said, no, that’s not true. It’s psychology. It’s your psychology and your clients’ psychology. And it’s where those things overlap. And I laughed and thought, no way, come on, it’s all about the math, it’s all about the formulas and the discipline, and I was absolutely dead wrong.
So it took a lot of me getting kicked in the face, working really hard for long periods of time, learning lessons and getting to age 48 before I realized that my life can be a lot easier, I can be a lot more successful and everyone around me if I stop preaching at my clients, and I start listening to them. And I start delivering something that is both what they want and need at the same time, not just what they want, that’s a recipe for failure, we all know that. And not just what they need but don’t want, that’s also a recipe for failure and that’s just a hard hurdle to get over and it’s one of those things where I wish I was smart enough to figure that out early on. I wasn’t, I don’t know too many people who were, because I would have been paying attention but we are where we’re at now and I think there’s lots of opportunities to cover both of those. You can deliver what people both want and need at the same time. So that’s what we intend to do.
Adam:00:08:15So what do you need? Hold on, I want to make sure we cover this. And you may be going here too Rodrigo, but I want to make sure we get it. What do they need, but not want.
Needs, Not Wants
Eric:00:08:26So it’s the same stuff you guys have been talking about for years. It’s the extreme diversification, it’s dispersion of opportunities. It’s things that are going to underperform the stock market when it’s soaring. It’s all the stuff that your research has shown. People need effective diversification. They need the discipline to rebalance into that at the right time, but they don’t want it. They don’t want it. In theory, they want it on paper, they want it in real life, day to day, month to month, quarter to quarter, what you’ll find is that the vast majority of people don’t want it. Maybe an individual wants it. But once you go up the chain of command to the investment committee and to the board and to the shareholders, it is impossible to get everybody on the same page and to get them all to have courage to do what you think is the right thing at that moment in time. And I’ve seen so many people, there’s a few firms out there that have been successful, and a lot of us theorize that they know something that we don’t, that they’re able to command that respect or get people on board. I strongly suspect that they’re doing something very different than convincing all those people to do something that they don’t want to do.
Rodrigo:00:09:48 And what would that be?
Eric:00:09:49I don’t know. One common denominator I see is that if you look under the hood where their assets are, there’s a few common denominators and one of them is the assets gravitate towards relatively low volatility products, and also to products that if you dig deep enough, they’re very multi strat in nature, or multi asset in nature and global in nature. So the idea there is, it may be harder to raise money for boring multi asset, multi strategy all weather type products. But it’s a lot harder to get fired. And if you’re not getting fired it means you can actually help clients, You can offer them something they can actually stick with, and stick around for the long term benefits.
Rodrigo:00:10:40So, tell me a little bit about the journey to get there. What were you delivering that you knew was right but they didn’t want, that and how you evolved into what you’re doing today?
Eric:00:10:55Cut me off if I go on too long here.
Rodrigo:00:10:58We got you today baby.
Eric:00:11:00I want to start…
Adam:00:11:01This will be like a mutual catharsis man, you just let it all out.
Eric:00:11:05Yeah. I worked for a really large family office in Kansas back in the late 90s. I thought they hired me because I had a pretty good understanding of options pricing theory, and I was a decent programmer and really good at finance and investments, like I had the background. And they were setting up the family office that wanted to be relatively sophisticated. And in the interviewing process I thought this is a perfect fit, this family has a tremendous sum of money and they got rich fast and they want to diversify and keep this money, long term. Turns out, I couldn’t have been more wrong. What they wanted was a way to figure out, and then this was the third quarter of 99, what they wanted was to figure out how I could help them get more leverage than the two to one leverage they already had concentrated in technology stocks, and so they were interested in writing puts and using the proceeds to buy calls and to make more money.
So, coming out of college, I’m a pretty risk averse guy. I care about the compounded return, I understand and have a deep respect for risks that aren’t easy to see before they happen. You know, that elevator down escalator up type risks. And it was real easy for me to model out the NASDAQ and say, one down quarter and you guys could be negative equity at that level of leverage. Just the empirical data shows you multiple instances where you guys would be negative equity. And so I thought I will be able to convince them to diversify into gold and bonds and other asset classes. You set up some trusts, blind trusts and put a reasonable investment policy together like that. That’s what I wanted to do. No, no interest. So, to make a long story short we butted heads forever and ever and I got asked to leave. They continued doing what they were doing and you all know what happened to the NASDAQ after that. I ended up in Phoenix, I started a hedge fund here, it was called Blackstar Funds. You probably came across the paper.
Adam:00:13:42I remember your early papers on trend following stocks were formative.
Eric:00:13:48Yeah, so wrote that paper and several others that never got any coverage that I thought were much more powerful than that particular paper. That paper was really just on my downtime, just putting stuff together. I’m like, Hey, I did this research. I’ll write this paper.
Adam:00:14:03What are the other themes that you covered that I got to go back and review?
Eric:00:14:08One was called The Nonrandom Behavior of Declining Stock Prices. And this one, it was a one-page paper. And I really felt that this one was super powerful because essentially what I did is I collected the data on every stock that ever traded in the US from 89 to I think it was 2009 maybe and adjusted it for dividends, divestitures, mergers, all those things and had all the bankrupt stocks in there, whatnot. And then I calculated their annual calendar year returns for each stock. So if a stock had been in there for 10 years, it had 10 returns. And then I dumped them all into a database and then I plotted it as like a cumulative distribution and fully expected to see that log normal distribution that I was taught in business school. You got the big right tail, it’s got Cisco and Intel and Microsoft in there. And then you’ve got the mode, and then you got this little left tail which is Enron’s and some other companies that went bankrupt. And then I created the log normal distribution just using a random number generator and it lined up perfectly. You couldn’t tell the difference until you got to the left tail. And what do you think we saw over on the left tail? The academic distribution just had this tiny, tiny little tail. And then the real life had this enormous giant tail of massive, massive failure.
So that was illuminating to me because I thought well, that’s where academics actually are inconsistent with reality. So if you’re a believer in alpha, if you’re a believer in any excess returns, I’ve just identified to myself at the time what that likely source is. It’s either shorting those stocks, which is not the truth, that that’s not what ended up being, or simply avoiding them which was closer to the truth. Now there’s more to it, transaction costs, taxes, fees, operational headache, locating shares, all the financial engineering that goes into synthetically setting it up with a futures contract or whatever, but that was interesting to me. And I don’t think a single person ever contacted me about that paper. They all love the Trend Following on Stocks paper.
Adam:00:16:20Does that line up with…was it the Bessembinder paper on the Capitalist Distribution? Do those theses lineup, you think?
Eric:00:16:32I suspect so. I think a lot of people read what I wrote and walked away saying that’s an argument for indexation. Maybe 60% of people said as an argument for indexation, and the other 40% said that’s an argument for active management, and avoiding indexation. And I was perplexed as to why at the time, even though I actually agree that it’s an argument for indexation, at least on one level. Bessembinder, I think he’s a professor here at Arizona State University or one of those guys that contacted us is, I can’t remember, I remember reading his paper, I can’t remember if it corresponded with our findings or not, that’s a long time ago.
Rodrigo:00:17:15Okay, so you have the Blackstar paper set you down a path of trend following on equities. And what happens then?
Eric:00:17:23Well, I want to take a detour here and go back to college and just share with you guys a story. And I think you guys will like this. When I was in college after I had switched to finance, I was in a class, I don’t remember if it was investments or futures and options. But in one of the classes, the there was a project where we had to write the code ourselves to calculate the efficient frontier. So it was up to us to go collect data on asset classes and pick the start date, pick the end date, and then write the code and all the linear algebra and all that other stuff to come up with the efficient frontier.
Adam:00:17:57What programming language were you using at that time?
Eric:00:18:00That was Fortran or Pascal?
Eric:00:18:05I was in Kansas, and I love the people in Kansas but it is the most boring place in America. So there’s nothing to do. I started a club on my campus called The Students of Finance Club and we just brought together people that worked at commodity trading firms. There’s a lot of commodity trading going on in Wichita, Kansas, and Koch Industries is there. So I had a bunch of people, PhDs from foreign countries, they got recruited to America and they ended up in Kansas, and they’re just bored out of their minds. People that worked on hedging desks, people that worked at Cargill, corporate farming syndicates, the whole gamut of anyone who was trading commodities, futures, contracts, swaps, forwards, whatever. And eventually found us and there was this little clique of people that I would hang out with, and we would try to pass the time living in Kansas, dodge tornadoes and have fun with our Fortran, Pascal, and I think VBA came along at some point in there too. And we had a copy of TradeStation, had a couple of buddies that were decent hackers, so I had like Bloomberg, So long story short, we had all the data we could ever want and we had some reasonably effective programming environments to crunch this data.
So I took that project seriously and I said, I’m going to go build the efficient frontier. I’m going to do this my way. So I collected data on everything. And I put it all in there and I wrote the code with the help of some friends and I came up with this just amazing asset allocation, static asset allocation strategy that had a Sharpe ratio of one, which is enormous. That’s just enormous. And I think the start date was sometime in the 60s or early 70s. So this would have been 1997 or 96ish when I was doing this project. So I turn it in and the teacher says, what did you do here? I said, well, what do you mean I did the assignment. And he’s like, I don’t understand what some of this stuff is. And he starts picking through it. And one of the indexes in there it was like the … CTA Index, or the Star 300. It was one of those old CTA indexes, and there was like a 40% allocation to this index. And I remember saying, well, I didn’t know the difference, I was a newbie at the time. I’m like, I don’t know the difference between that and other things. And he said, not to get rid of that, like nobody invests in those things, that’s like market timing or something like that. Just use stocks and bonds, and maybe real estate. I’m like, okay, so I kicked everything out. I kicked out all the alternatives and the trend component and the deterioration was amazing.
Adam:00:20:57You’re looking at a Sharpe ratio of like .45,
Eric:00:20:59Yeah, it was .4, it was between .4 and .45. But here’s the thing, it became very sensitive to shady periods of time, like the 1970s. You had lost decades, because nothing stands up during that period of time. It may have been kick out gold, all kinds of stuff. So I went back to him and I said, no, man, you’re doing this wrong, like this stuff clearly makes a huge difference. And his ambivalence and lack of interest in it stuck with me forever. I thought, no, I’m going to talk some sense that this guy, this is finance, this is investing. Even back then I understood the path traveled risk of a retirement plan and how you can’t just bet it all on one or two asset classes. I mean, you can, but there’s no reason to do that if the other ones add a lot of value and they solve problems. And he had just no interest. I started whining to my other students and none of them had an interest and like to just shut up, let’s get your grade, let’s move on, there’s parties tonight. It stuck with me forever. Just how much of a difference it made by kicking out these alternative risk premia. And now I’m 48. I was probably 24 at the time. I’ve never forgotten that. So I tell the story every chance I get, sorry.
Rodrigo:00:22:18No, the thing is that it is time dependent. And I’m sure that during the 70s and 80s, having that CTA in there was huge, while equities and bonds had basically zero Sharpe ratio for decades, at least a decade there in real terms, based on our research. What’s interesting about the last decade is that a traditional 60/40 portfolio has a Sharpe of two, probably over the last 10 years, notwithstanding 2020. And adding the CTA during that period is probably, brought down that Sharpe ratio lower, but nonetheless still high. Maybe I’m wrong about that.
Eric:00:22:54No, you’re right. You’re right. And my rebuttal or the what I would point out is that decade over decade the portfolio that has plenty of trend in it basically has the same Sharpe ratio and the same descriptive statistics regardless of what market environment you’re going into. It doesn’t change very much, it’s very stable. But if you say no, get rid of that stuff, just give me stocks and bonds, you’re all over the place. You’re an absolute hero over the last 10 years.
Eric:00:23:22But you’re a zero in the preceding 10 years. And in the 70s, you’re guaranteed out of business. Having a negative…
Rodrigo:00:23:28You gave away consistency, and you give exposure to luck. And if everybody’s got luck on their side and you have given consistency you’re going to get fired.
Adam:00:23:42Well, the other dimension to this is the either/or nature of the problem which is contrived. Obviously, what you’re doing now it’s a one plus one equals three type solution. And we do something similar in several of our products. But it’s this idea, it’s the sum to one idea, I’m sure when you were creating your efficient frontier you had that sum to one constraint, no shorting. And if you use the sum to one constraint in order to add two alternatives, you’re going to take away from stocks and bonds. And in reality, certainly for institutions, and if you allocate to the right kinds of products, even if you’re not an institution, if you’re just a regular retail investor, it’s not an either or, it’s an and. You can have your cake which is whatever it is, the 60/40.
Adam:00:24:41Oh my god, I love it. Eric, meet Mike.
Rodrigo:00:24:50Mike just came on with aviator glasses in a camo shirt of some sort. I don’t even know what.
Adam:00:25:01It’s like someone at Top Gun. Anyways, you’re going to have the full allocation in your case a full stop, like 100% allocation to global equities, and then layer on the trend following. In our case, you can have 100% or even like 200% allocation to a global diversified all weather portfolio and then layer on trend following and a few other risk premia. It’s this portable alpha perspective which is just not what anyone ever talks about but of course that is the answer. It’s not that either or it’s the and.
Eric:00:25:37We live in a linear zero sum world. And at the risk of pissing off some of my peers in the industry, I’ll call out the CTA industry a little bit. So you guys know this, when you’re running a global trend program, or any program that uses futures contracts, you only need about 10% of the money under management to control all those futures contracts. The other 90% of the money is just sitting there. And most macro managers are going to invest that either in a laddered bond portfolio, or in T bills. But there’s no rule or law that says you have to do that. You’re completely free to go invest in other appropriate assets if you want to.
So in that context, Adam, what you’re just saying is that yeah, you can get three products for the price of one. And if you trust your manager to not take too much risk, the efficiencies available from that approach are tremendous, but most people don’t think that way right now. And I think a lot of that’s our own fault. I think that in our industry and the alternative investment industry, CTAs, risk parity, we’ve shot ourselves in both feet so many times over the years. There’s just easier ways I think to get the point across.
Mike:00:26:53Can I push back on that a little bit? Isn’t that a little bit of a function of proliferation of ETFs and certain US equities as an example, dominating performance and taking the spotlight off of diversity?
Eric:00:27:07Yeah, that’s an element. Certainly yeah. Over the last 10 years. In the preceding 10 years it’s basically the opposite. But yeah, I completely agree with that.
Rodrigo:00:27:19So let’s continue on the journey here. So you see this value and the CTA, it marked your journey and you’ve just moved on from the family office. What do you do after that?
Eric:00:27:34Started Blackstar Funds. That was a great way to learn about the inefficiencies of dealing with hedge fund investors and family offices and allocators and whatnot, and really tried hard. Built some nice long/short equity programs. Mike, we were talking about the paper that I wrote a long time ago called Does Trend Following Work on Stocks.
Mike:00:27:59Oh, yeah. That’s a classic, that Blackstar paper.
Eric:00:28:02Yeah. So that was basically the strategy. And that strategy worked exactly as I expected it to and it’s still alive today at a different firm. I don’t work there anymore, but it’s their strategy now. Love that strategy, we just could never raise meaningful money for it. Not sure why. I think a lot of it is that it tends to…that program underperforms after a sell off during a recovery, and that’s when all eyes are on the market and everyone’s hypersensitive and looking to make that money back real quick. So it’s just that style even though I think it works, and I think it collects a certain risk premium in the marketplace, it happens to be almost 100% misaligned with the cognitive psychology of investors, meaning that they’re terribly fearful when you’re leveraged up and making money, and they don’t like it and you’re making their life miserable, and then they’re terribly greedy and want to make that money back fast after a drawdown and you just de-levered and went into armadillo mode, and they want you to be taking risks. That was my experience with that program which is why I don’t think it’s a good way to do business with people because it’s so misaligned with the psychology of investors.
Adam:00:29:18So it’s probably worth…we actually talked about this a little earlier too Mike, we skipped over what the actual theme of the paper is. So for those who haven’t read it, and keep in mind it’s like a what now? 20 year old paper, 15 year old paper.
Mike:00:29:322007, was it?
Adam:00:29:35So maybe just go into the general theme of the paper so that at least we can put a pin in that.
The Blackstar Paper
Eric:00:29:42So at the time I was running a fund of funds at a firm called Blackstar. I was trying to find systematic equity managers. We found all the CTAs that we wanted to allocate to. We were trying to find systematic equity managers that were trend following in nature and just couldn’t find any. Just couldn’t. Scanned the globe, and there were a couple that claimed to but when you looked under the hood they were doing stuff that I wasn’t comfortable with. It wasn’t rules based trend following. They all told me it doesn’t work, trend following doesn’t work on stocks, it only works on futures. I thought that is a really bad answer guys. That makes me question the whole trend following approach. So I said, alright, well, after a while I said, I’ll just build it myself and find out who’s right and who’s wrong. So I went and built a really simple – if a stock hits an all time high you buy it, puts the stop loss at 10 ETRs, calibrate your risk to be I think it was 20% across the whole portfolio. So you divide that by the number of open positions, super simple.
Everything I do has at most three variables, back tested it, included all the D listed stocks, use liquidity filters, equal risk weighted positions, went back to early 1970s, worked great. I mean, the back test is beautiful. So I thought, well, somebody is wrong, it’s either me or them. So eventually became confident enough in it to actually launch a product around it. And I ran that product from 2005 until I left my previous firm in 2018. And it did exactly what I expected it to. So I thought that that was… so to this day I don’t understand why people feel that trend following doesn’t work on stocks, it appeared to, to me. Higher returns, lower drawdowns, lower volatility. There’s more work involved and a lot of corporate actions and you need a portfolio margin account. You have to use leverage at times, well within my repertoire.
Rodrigo:00:31:38It’s not as tax efficient, sorry, margin efficient because you actually have to do a full borrow?
Eric:00:31:46No. So that was a long only version. In a long/short context I would use index futures to get the short exposure to avoid pain. Managing the borrowing cost and holding those shares is an absolute nightmare because the borrowing cost could be 4% one day and 90% a week later. They rip those shares away from you when the stock really starts going down as no, that’s… I learned real quick to avoid that like the plague. But you can do it pretty easily, you can financially engineer a very effective hedge using index futures and just lean on that.
Adam:00:32:25I think what’s interesting about this because I think most people think about trend following in the context of moving averages or time series momentum. But your definition, I found really intuitive and it works, I think really well for equities. I don’t think it works so well for futures, certainly not for commodity futures. But I like it because it was largely parameter-less in terms of the selection criteria. There were parameters on your risk management and on the portfolio formation but it was just simply, had it hit an all-time high. Like I think that was a really intuitive and parsimonious way to define whether something is in a positive trend or in a negative trend. I guess a negative trend is a little tough because hitting an all-time low, is that how you define it? Was at an all-time low or 52-week low or how did how did you specify it on the? How to do that? You were just hedging with futures. So you didn’t do the short side.
Eric:00:33:28So with the futures, because if you use the certain mixture of futures contracts, you essentially get the coverage of the Russell 3000. So if you’re not long positions, synthetically your net short, then you’re not paying the borrowing cost even though it to some degree it would be showing up in the in the futures contract. But I will take issue though with your statement that you don’t think it works on futures. I think it works better on futures, in particular commodity futures. I think that trend following, I do not get what people are talking about when they say trend following doesn’t, it does not work very well, it hasn’t worked recently. I see that in the track records. I just don’t see that in the actual markets themselves.
Adam:00:34:17I guess just to clarify that particular specification of trend, by you buying all-time highs. But I will say though, that it is interesting that you say that, because I mean, certainly if you look at the indices or relatively naive ensemble strategies for futures trend following notwithstanding the recent run, obviously this year has been well, call eight or nine months has been a revival renaissance for trend following but say more about why you think the last 10 years has also been reasonable for trend following strategies.
Trend and the Last Ten Years
Eric:00:35:01It’s tough. I don’t have total transparency into the returns that roll up into those indexes, that everyone can see have gone sideways for 10 years. So if you’re looking at the SG Trend, or Barclays CTA, or the V top 50, everyone can see that the returns have sucked for 10 years. So you might be wondering why is Eric insinuating that that’s not the case, I see it too. Now, a big part of that is the collateral yield from the low interest rates is just taking the 5% tailwind off the table. So, CTAs used to get five, 6% on their 90% of their money, it’s just sitting in cash that went away. So obviously, if you were making 10, you’re now making six or five, but that doesn’t explain all of it. There’s a little more deterioration in those indexes beyond that.
What I will say is that over the years I’ve talked to a lot of people in the industry, a lot of PM’s and sales people in the managed futures industry. And they all started giving up right around, I’d say 2013 was a cathartic year, it was a turning point where a lot of people started closing their shops down and concluding that it doesn’t work as well anymore. And things were still tough up until like you said, November of last year is when trend following got a bid and started working again. And in my discussions with these people, I picked up on a reoccurring theme that seemed to be lost on them. A lot of these guys, I would say most of them were really putting a lot of changes into the programs. Like they were no longer running simple, medium term or long term trend following approaches. They were layering and all kinds of new stuff, that was interesting. That worked really well over like a three-year window leading up to it. And it was funny to watch this happen because I’m very sensitive to the whole curve fitting, adding new stuff in, parameters, I’m allergic to parameters, three is the max for me. And each additional parameter that you add on top of that, in my opinion cuts the credibility of your system in half, each additional parameter. I’m standing on an island there, but I stick with that till I die.
Eric:00:37:32Yeah. So I guess what I’m saying is, a lot of people changed what they do between 2013 and 2016. Such that even if you look at it and say, as a trend following firm, if you look at what’s going on in that program, it’s meaningfully different from what they were doing from 1984 to 2012. So a lot of changes, a lot of changes. When I implement really simple old school trend following rules, the stuff that you could have done in the 60s where you’re buying a 200 day high and you’re executing two days after you get the signal and you’re risking 1% per trade or whatever. When I model those things out, I do see some deterioration after 2011, when you’re using an equal risk approach. But when you use a liquidity weighted approach, I see no deterioration at all if you leave collateral yield out of the equation. There’s certain CTAs out there if you go look at their track record and you remove the collateral yield from it, you look at it and say, these guys haven’t missed a beat. They don’t look any different than they did two and three decades ago, I’m talking about big firms.
So firms that are so big, that they have to be trading on a liquidity weighted basis, there’s no way they can equal risk weight palladium with the 10 year Treasury, that’s just impossible. And they’re so big that they can’t be trading meaningful amount of canola, or rubber, or even like soybean meal. So if you model it out the way you know they have to trade and you keep the… it’s medium to long term trend following, you ignore interest rates, it actually looks pretty good. I think a lot of people just aren’t aware of that.
Adam:00:39:23So walk me through this. Liquidity weight being weighting by past 20 day open interest, past 20 day average daily volume, what is?
Eric:00:39:4020 day median open interest. It works with volume too though. I mean, any proxy for liquidity, and if you use the median rather than the mean, you’ll get a relatively stable value through time.
Adam:00:39:51And so what I guess the contracts that would meet some of the major equity contracts a lot of the Treasury contracts, many in the energy complex.
Eric:00:40:06For brent crude, copper. Carbon emission credits, I think it’s the seventh or eighth largest market in our portfolio, completely uncorrelated all other markets, has nothing to do with anything and it’s super deep and liquid, and most people have never even heard of it. Iron ore. There’s all kinds of stuff out there going on that no one ever talks about.
Adam:00:40:33So where do you trade iron ore?
Eric:00:40:35SIMEX, Singapore. It’s not in our portfolio yet we’re considering adding it in. That’s what I’m watching that’s really become liquid. Well, everyone’s focused on Bitcoin. Carbon emission credits are up more than Bitcoin over the last I think year and a half or two years. And it’s deeply, deeply liquid.
Adam:00:40:56Yeah, we trade those too. Say more about you’ve observed managers diversifying away from core roots in traditional trend following techniques. You never found that an attractive move, incorporating stuff like carry or seasonality or any of the other reasonable anomalies or any other more esoteric methods?
Eric:00:41:35 II’m so glad you asked that question. Nobody ever asks me that. I have really controversial and strong opinions on this topic. So you might want to put your helmet on.
Mike:00:41:50I have it in my back pocket, let me just get it out.
Adam:00:41:54Not that kind of helmet Mike.
Eric:00:42:00Trend following, I hate the phrase trend following I have always hated it. When I came out of college, I was setting up arbitrage positions and doing stuff that I felt was really sophisticated. When I first came across the concept of trend following, I thought that’s the dumbest thing I’ve ever heard here. You want me to go chase performance, It’s something my niece would do, like Beanie Babies or something like that. I just didn’t like it.
Rodrigo:00:42:27And it’s like you trade.
Eric:00:42:28Yeah, it took me a long time to arrive at the conclusion that trend following as practiced is really just avoiding trends going against you, and providing liquidity to the one group of market participants that can afford, that are willing and able to pay you a risk premium, and those are hedgers. One thing I love about futures that I don’t like about stocks is the futures markets are really simple. You can basically evaluate who the participants are. You’ve got commercial hedgers, you’ve got large speculators and small speculators. And the futures markets are essentially a zero sum game. So for me to make $10,000 somebody else necessarily has to lose $10,000. And it’s actually worse than that because the regulators have to get paid, the exchange, the broker, the clearing firm, everyone has to get paid. So technically, it’s a negative sum game. At first that sounds like bad news, like why would I want to participate in a negative sum game? Until you realize that these markets, the futures markets, the forward markets were created for hedgers to unload unwanted risks, certain risks they don’t want to take on their balance sheet. And by doing that, they’re essentially either locking in profit margins or input costs, which is very very similar to, a close cousin to the phenomenon of insurance. And we know that insurance economically it should not be a free phenomenon, you should pay. Like when you’re seeking comfort ,you pay.
So remember, back earlier in this conversation I was talking about the people that joined my club, at Wichita State, that worked on hedging desks. I remember a time scratching my head looking at what they were doing. We compared the models and whatnot, and I kept looking at what they were doing and I thought, what is your problem guys? Like why are you trying to lose money? Why aren’t you trying to make money? And it just perplexed me until one day I realized that they’re compensated based upon creating negative covariance to the risk on their company’s balance sheet. They’re not trying to make money in the futures markets, and they could pretty consistently, not day to day, but they lose money and they lose a lot of money. They lose like 150 to 300 basis points a year. But it’s in a very counterintuitive way. It’s through a form of an opportunity cost, like missing out on a big trend in copper, because they’re naturally already long copper, if they’re a copper mining company, or missing out on a big downtrend in crude oil.
And then I thought, Well, okay, who trades opposite these guys, because these guys have deep pockets and they can afford to lose money. And in fact, they’re compensated. The more money they lose, the better off economically the firm is because that loss is negatively correlated with a much bigger position on their balance sheet and their core business. I noticed they love buying weakness and selling strength. And then it clicked in my mind that trend followers are the only people crazy enough to step up and provide them liquidity. And most trend followers don’t even realize that that’s what they’re doing. All they are is a weird hybrid market maker at a long term frequency, that’s benefiting from an inverted form of insurance.
Rodrigo:00:46:08Well, yeah, the concept of willing losers, which I think Chris Schindler takes offense to, because they’re very willing to, they see it as a win, the hedges they are putting on as a win to create stability for the organization. So, if you’re going to make excess profits in a zero sum game there has to be a structural reason why you expect to get paid for that. And that totally makes sense to us as well.
Mike:00:46:38There’s externalities to the market. The market is a zero sum game, but there is externalities to the players in the market that provide for them being willing to pay some excess return to somebody to take that risk from them.
Eric:00:46:53Right. And their 3% loss which is totally suitable for them, can be your 15% gain, if you’re using economic leverage. Let me let me tell you about that. I read a paper once, I can’t remember where I found this, but they were talking about sources of corporate gains. Oh, yeah, that’s what it was. So if you hedged, and I think this was a manufacturing companies, might have been aircraft. If you hedged, your borrowing costs were so much lower, the yields you had to pay to bond investors were so much lower than if you didn’t hedge, such that you could lose an extra 100 basis points a year on your whole hedging book and you would make that back and then some, on the debt side of the business. So here’s another thing that no one understands and it’s like, why are they willing to do this? Well, it’s because it actually lowers their borrowing costs. Another source of return that’s not well understood.
Mike:00:47:58And increases their multiple. If your company is able to smooth its earnings through this process and have more consistent earnings, you’re going to get a higher multiple, I would think.
Rodrigo:00:48:15No, I literally on point, I just went off a website that explicitly looked for consistency in earnings to choose the high yielding high dividend stocks. So that is a variable that analysts are looking for to provide to the public. It’s also a nice little narrative to sell to.
Adam:00:48:34It’s explicitly in the quality factor literature and it’s well documented and the weighted average cost of capital, the variable. The variability of earnings is definitely a major explanatory variable.
Rodrigo:00:48:48Everybody’s gaming everybody.
Eric:00:48:50I’ll give you another couple of examples real quick.
Eric:00:48:54My grandfather was a wheat farmer, the other one was a hog farmer. And I promise you, they loved losing money on their hedges. Loved it, because it meant that the farm was hitting triples. And also when I ran a long short equity program, the best days were when I was just getting killed in the hedge, because it meant that the core portfolio was going up. Was I fretting over how much I was losing on the hill, sometimes I probably was. But net you want to lose money on the hedge. So I love hedgers. It’s not an adversarial relationship, I think medium and long term trend followers provide liquidity to hedgers and collect a sustainable risk premium, and they don’t even realize it. That’s why I’m comfortable doing it. It’s a theory and you can’t prove it because it’s all circumstantial because the markets are anonymous but I think that’s why it persists and why it’s sustainable.
Rodrigo:00:49:52Put income risk off the table and you are taking risk and directional risk in order to be able to capture that, so it makes sense that you’re going to get profit from that.
Adam:00:50:04Why should you also get convexity?
Eric:00:50:09That has to do with, it should, I don’t know that should be the right the right word, it just turns out that’s the way it is. I think that in order for this to, I’m not sure if it’s causal, but the reason it’s so misunderstood and no one ever talks about is the nature of the returns is through the opportunity cost of missing out on these big trends. It’s not a slow and steady, like we’re picking up. It’s not like true insurance, where you’re underwriting a risk premium and you’re getting those payments every single month. It needs to be more complicated and messy and indirect than that. And you guys have run trend following programs. I’m sure that in any given five year window, 80% of your gains comes from some small sector. All from one sector, right? And then that sector becomes a dog for 10 years and two other sectors are responsible for 90% of your gains. But that’s how you get people to part with lots of value and not hate you for it and not regret it. It’s in the form of an opportunity cost. They didn’t have to write you a check. They missed out on huge move in copper because they wanted the certainty of cash flows. And that’s okay to them. In fact, they’re better off for having done that.
Adam:00:51:19Yeah, it’s just it’s counterintuitive to think that to position trend following as both selling insurance and expecting positive skew. That certainly is a, theoretically, that’s more of a stretch. Empirically, we do observe over timeframes that are meaningful to intermediate and longer term trend followers a positive skew. So if we’re collecting an insurance premium then that’s not the profile that you would expect.
Eric:00:51:50Adam, that’s why I was very careful with my words. I said a counterintuitive inverted form of insurance, I think was my exact wording. So yes.
Adam:00:51:59I’m not trying to pin you down. I think it’s a perfectly reasonable component, that may I explain a good chunk of the returns, but you did sort of dance around. I don’t know if that’s for our benefit or just because you got sidetracked but my original question was, I understand why you love trend following. Seems to me that there are other reasonable risk premia. One of them that seems reasonably obvious is people naturally don’t want to own negatively skewed markets. So if you’re willing to step in and buy negative skew, then that is a reason to earn a risk premium. And we certainly observe that it’s not obvious how to specify skew. But over a wide ensemble of specifications there’s definitely a premium there. Carry obviously has a very direct risk premium. So what is it about those premia that you are less enthused about?
Risk Premia and Trend
Eric:00:53:03That’s a great question. I want to share with you a couple of observations. How to frame this. So for a long time, I’ve thought that if you’re collecting a risk premia, you’ve got to be on the wrong side of skew. I’d never bought this argument that you want to buy right skewed stuff. And I always thought to myself, well, no, then you’re premium payer at that point, which seemed inconsistent with the trend following narrative that I was buying into. So I did this analysis and I said, okay, I understand that when you get the signal to go long soybeans, that at that moment in time the skew is to the right. But what happens after you’re in the trade? Well, I analyzed 1000’s and 1000’s of simulated trades historically and after you’re in the trade the skew flips, and you’re actually taking negative skew on average after that. Doesn’t mean your P&L is left skewed, because you’re using stop losses. But you definitely are primarily experiencing negative skew in the P&L of your individual trades.
Adam: 00:54:15 But the stop losses themselves are mimicking a long option position. So the combination of the trend position and the stop loss mimics a hedge option position. So this is why I struggle with thinking about trend following as ensuring or offsetting. I mean, I buy what you’re saying and I totally buy that you can have a large number of negatively skewed trades that in aggregate, for example, end up having positive skew because of the different conditionalities and the diversification across the different trades and different times. But are you persuaded that this explains that as well?
Eric:00:55:13Well, I don’t know if persuaded. I’m persuaded that it’s a reasonable way to source risk premia in markets that aren’t redundant with stocks and bonds. Beyond that, the rest is all theory. It’s all theory. And some of it’s very important to me because I have to sleep at night too. I will tell you that what you said is true. The stop loss is essentially, now you’re bringing in reinsurance, like you’re laying it off onto someone else beyond a certain point, which makes sense. You’re still underwriting risk, you’re still taking a certain amount of left skew. But when you get to a certain point, you say that enough is enough, I’m going to hand it off to someone else and take a loss. And they’re stepping into something that’s got even more left skew. So you can think of it in a reinsurance context. I don’t know if that helps, but I’ve framed it that way in my mind before.
Adam:00:56:07No, it’s fine. And we don’t need to dwell there. But I do want to get to stuff like all the other potential alternative risk premia within future stuff like seasonality, or carry for example.
Eric:00:56:22I’ve disentangled and essentially, what’s the word I’m looking for?
Eric:00:56:31Yeah, disaggregated, decomposed all the trend following trades from all the markets going back into the 1960s, and tried to figure out how much of it came from actual price appreciation and how much of it came from term structure. And for medium term trend following programs, about 35 to 40% of the returns come from the term structure component. And for long term it’s just over 50% of the returns, actually came from the term structure component. And so, the carry is a big part of that. Meaning that if a market is generally in backwardation, or if it just goes into a heavy backwardation, the way that we’re transforming those different contracts into a signal is reflecting that backwardation as an uptrend. And then if you keep rolling it, you have the benefit of selling high and buying low over and over and over again, you make a lot of money. So I would argue that a trend following program that’s looking at the futures markets on our total return basis is to a large degree unknowingly factoring the carry into the signal generation process.
Rodrigo:00:57:47So it’s a negative trend but positive carry you’re taking that into it. So that’s what you mean by total return basis. You’re looking at both things before you make a trend shift with a long or short?
Eric:00:57:57Yeah. Again, it’s the whole collapsing the parameters away and consolidating it into an actual signal that’s meaningful. The peso during the tequila crisis back in the 90s is a great example. It’s just going down. But the backwardation was enormous, the interest rates are enormous. So a trend follower’s seeing no trend, even though everyone else is thinking while the peso is collapsing, you’re paying an enormous amount to short it. So if you have markets that are in heavy contango like energy was in the mid-2000s, everyone’s, they’re punching you in the face for not being long crude oil as it goes to 150. But the annualized contango was 30%, there’s no way to make any money. But if you factor those both into your signal generation process where you can get the best of both worlds and sometimes you get the double sword, like a downtrend in the VIX, where you’re getting the contango as a profit center and the downtrend in the prices at the same time.
Adam:00:58:57I would echo your observations there definitely, and so when we examine the relationship between diversified carry and diversified trend, they end up having a reasonably high correlation, like on the neighborhood .5, .6. Certainly that that argues that total return trend explains a meaningful portion of carry. But a couple of other things, I think are interesting. One is, markets spend a lot of time not trending. What is the definition of carry, is the return you expect if the price doesn’t change. So if the drift is zero then your expected return is the carry.
So one of the interesting…again going back to sort of theoretical rationale, one of the reasons I like carry is because it seems theoretically to be a perfect complement to trend in so far as when there’s a meaningful trend and excessive carry. So there’s some sort of endogenous or exogenous shock that’s creating a major move. Carry is not explaining that, that’s something else. When there’s no major shock that’s driving a major move in price, then carry is what pays you, right? It’s like, you’ve got random drift around zero and so it’s the carry that ends up being the center of gravity, that your clipping coupons from the carry while there’s no trend. Does that resonate with you at all? Or do you have any alternative views?
Eric:01:00:54In theory, I would love it if that’s the way it actually played out. And it may be on some level, I’ll share with you my experience. These markets, there’s a lot of counterintuitive nonlinear relationships. And when trend followers are collecting a lot of carry, it tends to correspond with some sort of a supply/demand imbalance. So let’s just rewind one year. I remember at the time having to go short, lots and lots, basically every energy market on the planet in February of 2000. And talking to a lot of my peers in the industry that said, we’re not going to go short, the prices are down too much, it’s irresponsible to go short, crude it’s already down all the way down to $60 a barrel, what’s it going to do? Go negative? And I took a lot of heat for saying, yeah, technically it can go negative because the storage costs can exceed the salvage value of a toxic substance when the storage facilities fill up. I’m from Kansas, I know what it’s like when storage facilities are full. The marginal cost of storage can go up to infinity because there’s nothing else you can do with the stuff other than dump it on the side of the road and get fined by the government.
So the carry in energy, it was a lot like the sugar trade in the 80s, when sugar was trading below the cost of production, and nobody in a right mind wanted to short it but that was the greatest trade ever because the amount of contango that was built up into it, because of the government subsidies, allowed you to just keep rolling that position over and over and over again for like a year and a half, and that being, the biggest one of the greatest trend following trades of all time, even though the price never went down. So the crude oil and heating oil and gas oil trade, it was the storage cost, it was the carry component, but the carry component because there was a massive supply/demand imbalance at the time, is what created that. And I see this over and over historically. Like the best futures education that I think a person can get is to go read the papers by a guy named Holbrook Working And he’s a guy from the 20s, 1920s to the 1940s. And it’s the best coverage of how futures markets work, who they were built for, where the risk premiums are, who makes money, who loses money, that you could possibly read in my opinion, and that’s where I’ve got these concepts from and then I look around and say, the carry I agree, the carry is a huge possible source of return. I just think that it’s integrated and it has a dependent or a causal relationship with trend.
Adam:01:03:36I mean, I’d say we have found them to be enormously complementary, but I like that view. I want to make sure that we get to the vision for Standpoint because we talked about trying to give investors what they need, but not what they want. And I think your vision for Standpoint is, let’s give the investors what they want and some of what they need. So tell me about what motivated that change and what the vision for Standpoint is.
The Vision for Standpoint
Eric:01:04:12What motivated it? Fatigue. So here’s what happened, it’s my own fault, but I spent most of my life trying to convince people to do something that they weren’t already doing. And something that would cause psychological stress for them and their investment committee, and that is bringing in uncorrelated returns, increase your Sharpe ratio, lower your portfolio volatility, improve your future, get rid of catastrophic risks that may or may not happen and have a nice ride.
Adam:01:04:46So we handle the silence for that vision then or is this like a post mortem for this?
Eric:01:04:53So I tried this and I thought I would be persuasive enough and I was, I was persuasive enough to get a lot of people to do that to the tune of a lot of money at one point in time. But it didn’t work out well for them, because of what you guys already know. And that is that if they do this and it underperforms the S&P 500, or 60/40 portfolio for more than x quarters, they’re going to get fired, they’re going to lose clients.
Rodrigo:01:05:17They get the diversification they paid for, they’re going to get pissed off.
Eric:01:05:21Yes, exactly. Unless the diversification happens to be you’re also going up or the market’s going down, in which case I’ve got other problems but you’re not in the crosshairs.
Adam:01:05:30Yeah, which happens half the time, it just hasn’t been the last 10 years.
Eric:01:05:37Right. So, after I left my previous firm I had to take some time off, non-compete, which is great, taking time off. And I never would have been able to muster up the courage to just shut down all the term, the data and sleep past five in the morning and just take time off unless it was due to a non-compete. But I did that and the clarity of mind and clarity of thought that I was able to have I think changed because I realized that, I look back over the 20 years that I’ve been in the industry, 23 actually, and realize that what these people actually want is what I do with my own money. They don’t want pure trend. They don’t want pure managed futures. They don’t want pure anything. What they really want is what I do with my own money which is a blend of trend, equities and some bonds written through via the risk free rate of return. And I thought, I’m perfectly positioned and able to run a portfolio for other people, that’s the same thing that I do with my own money. And if that’s what they want, I also feel that that covers, there’s an overlap between what they need and what they want, there’s some overlap, and Standpoint’s job is to basically own that piece of real estate and say, look, we’re not going to shove stuff down your throat that you don’t want, we’re definitely not interested in giving you something that you don’t need. We’re gonna find out where those two things overlap. And it just happens to be this multi asset approach where you take our best ideas with respect to global trend, applied to things like energies, grains, stocks, livestock bonds, currencies, and global equity beta, tax efficient, fee efficient, low turnover, global equity beta. You bring those two things together which is what I do with my own money. And when I show that to potential clients, they say, yeah, that’s fantastic. So it’s a heavy dose of what they need and a heavy dose of what they want.
Rodrigo:01:07:40They get a lot of sugar with that medicine, right?
Eric:01:07:43Well, I’ve heard that analogy before. I am not a fan because I don’t feel like it’s sugar. I think that, here’s my thesis and I can be wrong on this, is that if I went out and I built a pure high vol super negatively correlated or uncorrelated alts program, which I think I’m qualified to do and I offered it at a really low fee, I could just beat people up and get them to do maybe 5%. Maybe, and I’m talking about serious career risk. Maybe. Realistically, it’s more like between one and 3%. But if I give them the blended approach, 10%, that’s not out of the question at all. Once you build establish trust and credibility and you establish a track record, getting to 10% or even 15 in some cases 20 is not out of the question. But that other thing, not a chance.
Rodrigo:01:08:45Do you think a lot of that larger allocation has to do with categorization? Are you able to sell it as an equity alternative rather than a managed futures sleeve that you should do between five and 10%?
Eric:01:09:03I’m uncommitted on the classification at this point. Standpoint has only been around for two years. I’m not far enough along to have a strong opinion there. So I’m relying on the partners and clients to give us feedback. So far, they’ve been really happy with the idea of it’s just a multi asset fund. It’s just a multi asset program. It never causes anyone any heartache. It’s never in first place, never in last place. It’s just where we go when we don’t have any other great ideas and I think it’s a great place to be. I’m not trying to win any awards. I’m not trying to win any sprints, I don’t want to be a gladiator. I want to win the marathon. And I think this is the right way to do it.
Adam:01:09:47How do you get over the…I only raise this because you raised the point that this is the way you manage your own portfolio. I mean, full disclosure. I wouldn’t touch a long only position in US equities here or even global equities with a fucking 90 foot pole. So are you actually genuinely bullish on equities here?
Eric:01:10:25Absolutely not. Not a chance, are you kidding me?
Adam:01:10:28But enough people are that you think that you need to include that as the base. Now a base layer.
Eric:01:10:35Okay, I’m glad you asked that question. Is why I like you guys, you don’t pull the punches. You’re like, that’s like bullshit, come on. In bonds either. Bonds, I mean, I’m not signing up yield, out of your mind? So here’s how I look at that. Half my portfolio is going into market cap weighted global equity ETFs. I’ve also got my macro oriented futures program, and guess what stock indexes are in that program? The exact same indexes that underlie those ETFs. So if we go into a brutal vicious bear market, which will surprise me not at all, I expect at some point to start layering into short positions in those indexes and the futures. And I’m eternally hopeful that the exposure from those short positions will go a long way towards inoculating the portfolio against that long only, but also give me the ability to not generate taxes or transaction costs or turnover on the long only side of the portfolio. So that is how I explain it to myself and my clients. I’m real curious as to what you think about that.
Rodrigo:01:11:52We’re in the same boat,
Adam:01:11:53Do something similar?
Rodrigo:01:11:55We sub advise planning in Canada, an ETF in Canada and a plan in the US. That is basically the best beta we can put together. Includes fixed income, includes equities and it’s a risk parity portfolio and then you have a systematic long short global macro, that did exactly what you expect it to do, especially this year as bonds would get destroyed. The systematic global macro got that position close to zero, if not zero. I also, over the years, we’ve come to the same conclusion that you need to give people that global growth, that beta, that belief in humanity while also providing some tactical support when that dream dies momentarily. So yeah, we’re with you 100%. And then you can have ,we do have the systematic part completely separate for those poor souls that end up following us and buying into the tribe.
Adam:01:12:58 Yeah, I guess the only difference is, we would say that I am equally enthused on a risk adjusted basis with the prospects for fixed income as an equities. I’m more sort of agnostic, rather than wanting to put all my eggs in the equity basket. And I think that there’s enough of a probability for some meaningful returns in commodities in certain environments. Plus, I don’t know if you read our Rebalancing Premium paper, but while the plane goes above me, hope you guys can still hear me. But I would argue there may be enough of a premium just from rebalancing commodities just because of the massive amount of diversity, and the pretty amazing ambient volatility that that rebalancing premium in commodities may rival the equity risk premium over the long term. So I guess that’s where we would go. It’s that big bet on equities that we’ve missed out on over the last decade. We’ve diversified away from equities and we’ve been in commodities and we’ve been in fixed income and certainly lacking concentrated exposure to equities has been challenging not just from a performance standpoint, but from a client satisfaction perspective right in there.
We always go back and forth on whether there actually is a long term tracking error aversion for clients with stocks, or if it’s just that there’s a massive tracking error right now because stocks are the only asset class that have done well.
Rodrigo:01:14:46Which stocks? And which stocks certainly from 2003 to 2007 nobody wanted to own American equities. It was all about Brazil, Russia, India, China baby. It was the emerging markets. It was commodities in Canada, commodity stocks. And US was the last thing on Canadian’s minds and most of the international community is fine. Americans will always be home country bias. But, when that tracking error kicks in, tracking error’s a variable thing. Now it’s Bitcoin, I don’t know. So it’s always tough to figure out what people want. But we’ll see. I don’t know. It’s a tough game, nonetheless.
Mike:01:15:26The 70s is a great, you’ve pointed out the 70s previously, but at the end of the 70s 1980, going into 1982, they were not, I’m sure the enthusiasm around equities or US equities at that point was fairly muted. Wall Street was…
Eric:01:15:44That’s where the phrase Equities in Dallas came from. I think it was from Liar’s Poker. Or the worst thing that could happen to you was, you get sent to the equities department in Dallas. He worked for an investment bank. So that’s how out of favor equities were in 1983.
Adam:01:16:02No doubt. So let’s not…sorry. Go ahead.
Eric:01:16:07One thing I would love to you guys to talk about a little bit. And no problem if you don’t want to, I just wanted to share it because I don’t think anyone realizes this is that, bonds had a negative real rate of return from 1940 to 1983. Negative.
Rodrigo:01:16:2768% real drawdown.
Eric:01:16:29Yes. So I don’t know if you saw the video that I did in the bond simulator that I put together that’s on the Standpoint website. But I took a lot of heat for that because it was back when I think the 10 year yield was 80 basis points, or might have even been 60 or something like that. And bonds are just screaming higher and people just aren’t…Look, if something’s worked for 40 years, it’s bulletproof, even when the yield now is 200 basis points below the rate of inflation. How do you do it?
Mike:01:17:02How could it not though? You have a whole group of individuals who have entered into the workforce in the various positions in the financial services world and have only observed that trend? They’ve only seen that, that’s all they know. How could you leave what’s treated you so well for so long and just all of a sudden say now’s the time that I’m going to shift entirely my viewpoint against all of my observations and experience through my entire career? And that’s what makes this particular endeavor so hard to be successful at, I think you have to be earlier, you have to be before the narrative and that’s the other thing that I think trend following systems do is they put you in trades long before there is a narrative oftentimes, they get you out of those trades long before the narrative has actually dissipated.
The price is telling you something and so you would exit via your rules. But the guardians of the narrative carry on for much longer than the actual price continues. And so you think about that in a 40 year time frame with those individuals. It’s sort of the same story different fractal.
Eric:01:18:32It’s a beautiful way of I had a saying a long time ago, I haven’t mentioned it in a long time is that trend following protects you from narratives, is what it does. Narratives are super powerful and super dangerous. And trend following allows you to just not care and just stop the bleeding and move into stuff that’s working long before people tell you it’s okay to invest this way.
Adam:01:18:59Jason Russell who’s not on here, but you might know Jason from past lives, but made his bones under Ed Sakoda said that, and has been trading futures for 25 years now. But he said, Ed used to say that trend is the evolution of the story. You see the story evolve in front of your eyes. You’re in it long before, you’re in it when it’s page 14 news and you’re out of it when it moves from page one news to page three news. I like that. Are you doing anything in the crypto space? We got to give the people what they want, right? I mean, we’re talking about…Where are you on the crypto side?
Eric:01:19:54So, a couple things. I did not add Bitcoin or Ether futures to the portfolio at the end of last year, partially because Ether futures didn’t exist yet. But Bitcoin futures were the 79th most liquid futures market by my calculations, the way I calculated. I don’t use notion of value, I use risk.
Adam:01:20:14You’re cut off as a 78th, right?
Eric:01:20:1775th. There’s some politics there man, let me tell you. So half my clients are like, don’t you dare bring that garbage into the portfolio. And the other half are like, dude, what’s your problem? This is the future, why are you not doing this? And then I got to deal with two boards of directors, I got my corporate board and the mutual fund board. And some of these guys are 100 years old, so they’re like, it’s a fraud or it’s the future. So I got to navigate all that stuff.
Rodrigo:01:20:45And the SEC and we’ve heard stories about it the moment you wake up in the West Shore, SEC and NFA. The moment that you add it, you’re getting an insta visit from regulators.
Eric:01:20:56For the record, I love the SEC, I support them. You’re awesome. I’ll add it. I’ll put it in there next year if it’s one of the 75 most liquid futures markets in the world and I’ll just say, hey, look, I’m providing liquidity to hedgers. This is a tiny market. What we do is liquidity weighted. So, 80% of the risk premiums we collect are coming from 20% of the most liquid markets. This one’s in at the bottom. If it climbs a totem pole, great. If it doesn’t, it is what it is. And if that costs me some clients, then it is what it is. But I’m gonna stick with my discipline and that is, if there’s a futures contract on it, it’s because of hedgers, if there’s open interest there, and I’ll provide liquidity to them, if that’s what they want. So that includes Ether, Beanie Babies, whatever. So that’s your answer.
The other thing I would say is that, several years ago when I was, after I left my previous firm and I had to take a couple years off, I had lots of free time. So I built a trend following system for the crypto enthusiasts in my life. And I know some really wickedly intelligent people much smarter than me, that went to better schools, Stanford that are deep, deep in the crypto space and they’re doing all this analysis, and I kind of challenged them and I said, I’ll build your real simple trend following model, and you run it and we’ll see who makes more money in the model, while you and your bullshit with the analysis of what you’re doing? So I think those guys made more money last year than I’ve made in my whole life. And they’re like in their 20s. And I don’t know if it’s from the model I built them, I suspect it was, but we’ll see. I don’t trade it. So the only thing I do is invest in my own stuff along with the shareholders. So I don’t do anything else and that’s by design, so I’m just going to have to miss out on any crypto stuff, and I’m okay with that.
Adam:01:22:55I think we Gen-Xers just have overdeveloped amygdala’s, there was something in the water. And when we came of age, you haven’t even been tempted by some of the pure arb’s like the Bitcoin basis or some of the OTC stuff.?
Eric:01:23:15I have been because several smart people have pointed out that there’s 10 to 20% potential annualized returns that are pretty close to risk free, not quite risk free. But I owe Standpoint, my full attention. Standpoint is a new, yes, it’s less than two years old so it gets 158% of my attention. The answer’s no and it’ll probably be that way for the next several years.
Rodrigo:01:23:44Good discipline man. I like that.
Adam:01:23:49Really early in the in the chat Matt was asking about the paper that I analogized with Bessimbinder. Can you say the name of that paper and whether it’s still available?
Mike:01:24:08I posted a link in the YouTube.
Adam:01:24:12It wasn’t the Blackstar Trend. It was a different paper that I hadn’t played with.
Eric:01:24:19I actually don’t remember the name, but I can look it up real quick.
Adam:01:24:24Well, what Google cues should we leave them with so they can go look it up themselves if it’s not.
Rodrigo:01:24:32I like to say that we’re going to leave them the show notes, but we don’t have any so I just say oh, just put them in the show notes later.
Eric:01:24:41Matt will probably say, I think Matt I actually talked to that guy on several different occasions.
Adam:01:24:46I’m sure he’ll dm you. I wouldn’t worry about it. If it’s not top of mind then we’ll move on. Mike Harris was asking about your equity trend following model. Mike, go read the white paper dude. What is it? Trend Following on Stocks by Blackstar Funds.
Mike:01:25:03That one I posted in the, I thought I did anyway. Is it not the right one?
Adam:01:25:09I don’t know. I don’t see the link anywhere and maybe it’s in the…
Mike: 01:25:13Way at the top.
Adam:01:25:14Really? I don’t see it.
Rodrigo:01:25:15 I don’t see it. Maybe put it up again.
Mike:01:25:18In YouTube or where are you guys talking about?
Rodrigo:01:25:19YouTube. Are you doing it on Twitter?
Mike:01:25:21It’s on YouTube. It’s right under Matt breaking the markets question. I think we’ve left people with enough breadcrumbs who they can find it. Blackstar.
Mike:01:25:33Oh, gosh, Does Trend Following Work on Stocks. It’s on the UPenn CIS site and you have to Google does trend falling work on stocks Blackstar
Mike:01:25:54There’s your breadcrumbs.
Eric:01:25:56If you want to have some fun, go look at the Blind Taste Test video on the Standpoint website. Have you guys looked at that?
Adam:01:26:03I’ve heard you describe that, go ahead. That’s a good story, go ahead and describe that.
Eric:01:26:08It was just pure fatigue. They got me to the point where people tell me they don’t want trend. I don’t want managed futures. I hate it. It always loses money. It sucks. It’s ruined my life. So what I did is I created a blind taste test for people. And I would mix asset classes together but I wouldn’t label them, it was just be A, B, C, D and E and ask people, look at these long series of returns, this annualized return, the ball the drawdown, the correlation with other markets, what do you think? And this wasn’t scientific, but I’ve done this a couple 100 times over the years. Well over 95% of the people will choose the combination that’s managed futures and global equities over everything else. And then I’m a total dick guys, I would ask him like, you have to eliminate one completely, and 95% of people eliminate the S&P 500. Because you’re like, I don’t know what that is.
Adam:01:27:03Or you rub their face in today. That’s what I like about you.
Rodrigo:01:27:09Were these equity lines, just like visual equity lines that you’ve shown?
Eric:01:27:14I would do annual calendar returns and then down at the bottom it would have you can watch the video, it’s pretty funny. The video is kind of a simplified version. But I’ve done this in different ways, and I was tired of getting kicked in the face. I’m like, you know what? Let’s just do this in objective terms, let’s see where you really stand. And there were other times where I didn’t make a video of this one but with the high net worth people I would have real estate and tech stocks, I would have all this stuff. And I would walk them through it, and they would build a portfolio and then I would reveal to him what they built. And it was basically the exact opposite of what they did in real life. In real life, their lowest allocation was the highest allocation and vice versa across the board. So I’m like, well, when you’re forced to be objective and you’re calm and rational and you don’t know what the labels are, you build the exact opposite of what you do in real life.
Adam:01:27:58It’s pretty hard to make friends and influence people by your credit, I love it.
Mike:01:28:03How do you find putting people’s cognitive dissidence is right in their face?
Adam:01:28:09We do it all the time.
Rodrigo:01:28:13 My wife doesn’t like.
Mike:01:28:16 I’m sitting by myself often and people are crying. There’s crying and I’m alone.
Adam:01:28:22Most days, Rodrigo.
Eric:01:28:23You’re all talking at the same time.
Eric:01:28:27There’s a caveat. Right? And that is, look, I know, I’m an asshole and you’re mad and I put you on the spot and all this other stuff. But I just want you to take a look at this thing and you tell me, it’s a free country, do what you want. And I don’t tell them that they’re dumb. I don’t tell them they’re doing the wrong thing. I just share it with them. And oftentimes, I’ll frame it in a way of I do this, and most people are very surprised at the results. And then they look at what I’m doing and they say, you know that’s actually, that makes a lot of sense to me now. So there’s a way to be diplomatic, but you’re never going to get anywhere unless you get people to confront their cognitive dissonance. First question is, how do you do it? You can tell your wife she has bad breath in a way that gets you punched in the balls or in a way that gets you patted on the back. That part’s up to you. So with clients, it’s the same thing.
Mike:01:29:19My balls hurt.
Adam:01:29:21Men are from Mars, women are from Venus by Eric Crittenden.
Mike:01:29:25I can tell you, I haven’t figured it out yet because my nether regions are sore.
Eric:01:29:30Yeah. I drink like four times a year. So this is…
Adam:01:29:33Oh, wow. Okay, cheers to that. What are you drinking? It looks like a Guinness.
Eric:01:29:39I have some Guinness actually. But it’s a Yeti Stout.
Mike:01:29:44I heard of the Yeti.
Eric:01:29:47Yeah, it’s super good. Tastes like chocolate and caramel and probably some alcohol. So as I said I drink maybe four times a year so they start getting too crazy. Just cut…
Rodrigo:01:29:58I feel loose man. I liked it.
Mike:01:30:03You poured that nice bottle or the bottle of Guinness into the glass with a nice frothy top and you have a, I don’t know, this is probably going to put me in the wrong bucket but your seven year old says well what’s that dad, that looks awesome and I’m like it’s a milkshake give it a try. She stuck her finger in that got a hold on, she was expecting obviously a chocolate shake of some kind, had a finger full of Guinness that was, I don’t like Guinness.
Rodrigo:01:30:32… stories are always…
Adam:01:30:39All right, let’s cut poor Eric free. He’s obviously deep in his cups now after one beer. But Eric, I was telling the guys before cuz I was telling we were. We were swimming before and having a meeting but I was really looking forward to this conversation and it didn’t disappoint, and would definitely look forward to doing this again at any time informally or in front of the camera. So really appreciate … That’s right.
Mike:01:31:10That’s a good one. Here’s the chart. Hide the name.
Eric:01:31:16Well, thanks, guys. I really appreciate this. I was going through your website. I’ve known about you guys forever, but I never found the time to really do a deep dive on what you do. I still haven’t done that but I spent the last couple days looking at your website. Very thorough, very diligent, it’s clear that you guys been doing this for a very long time and you ask good questions and I like your skepticism and your courage. It’s rare guys. So thank you for having me on, I really appreciate it and I look forward to the next conversation.
Rodrigo:01:31:52Every success on the new venture.
*ReSolve Global refers to ReSolve Asset Management SEZC (Cayman) which is registered with the Commodity Futures Trading Commission as a commodity trading advisor and commodity pool operator. This registration is administered through the National Futures Association (“NFA”). Further, ReSolve Global is a registered person with the Cayman Islands Monetary Authority.