Backgrounder

[00:00:28]Jason Josephiac: Hi there. Yeah. So Meketa, we’ve been around since 1978. We’re celebrating our 45th anniversary. We have a long history of investment consulting, which we manage or advise on about 1.6 trillion there in terms of advisory. And then we also have an OCIO practice where we have discretion, which is about 16 billion.

And we cover all asset classes across the world. And we tend to work with institutional clients such as public pensions, private pensions, multi-employer plans, endowments, foundations, corporations, really across the board when it comes to the institutional marketplace.

[00:01:08]Adam Butler: And what is your role there, Jason?

[00:01:12]Jason Josephiac: So, both myself and Ryan are on what we call the Marketable Alternatives team. That’s a different way to describe hedge funds, where hedge funds have been a four letter word or four letter term for quite some time. And so, you can call us hedge funds, absolute return diversifiers or Marketable Alternatives, and we are both senior research consultants on the Marketable Alternatives team.

Hedge Fund Branding

[00:01:38]Adam Butler: Gotcha, okay. Yeah, I wanna, actually, let’s first start by digging into why the term hedge fund is so loaded nowadays. Like, why, what’s the, why is branding as a hedge fund gone out of favor?

[00:01:52]Ryan Lobdell: I’ll take a first stab at that, I think, it’s just a poor description of what’s going on under the hood. I think hedge funds was a term, a lot of people had allocations of hedge funds pre GFC through the GFC. They maybe didn’t perform as they expected. If you’re a trustee or a stakeholder you think, I have a hedge fund, it’s gonna do some hedging.

And then it didn’t do what I thought it was gonna do. So I think a lot of people had a bad taste in their mouth and so many people have moved away from that and started to think about what are better ways that I can describe these strategies or these assets in my portfolio, that actually reflect what are they gonna do and when are they gonna do that, rather than just hedge funds, which could be a whole host of different things.

[00:02:35]Jason Josephiac: Yeah. And our job as consultants is to make the complex simple, right? And a lot of our industry doesn’t know, favors by using these nebulous terms like hedge funds and saying hedge funds is like saying mutual funds or ETFs. I invest in mutual funds, I invest in ETFs. Like what? What does that mean?

And we have this nice asset allocation pie, right, that has a bunch of labels. But at the end of the day, there are no alternatives. There’s really five asset classes. That’s currency/FX, that’s interest rates, credit, equities, and commodities. You can be long or short those things. You can access most of those things in the public markets or private markets.

And you can get Beta 1 exposure, linear exposure, or more convex exposure through things like options. So I think as an industry, we need to throw out these terms like hedge funds, like private investments, like alternatives, because everyone thinks that they’re something that they tend not to be, and then they create an asset allocation that has a bunch of nice things with nice labels, but then when you live in the tails or go through those tough times, you quickly find out what you have that is actually negatively correlated, what is uncorrelated, and then what is positively correlated to those drawdowns.

Separating Alpha and Beta

[00:03:53]Adam Butler: Yeah. and we’re gonna get into why it really pays to have a good understanding of each of those three different correlation frameworks. Before we do, how do you think the hedge fund asset class conversation relates to the separation of alpha and beta?

[00:04:17]Jason Josephiac: One thing that became popularized, I think around the GFC, before the GFC was portable alpha, right? This concept that you can take some sort of passive exposure, equity beta rate, beta, credit beta, get that in a capital efficient manner, and then just slap a bunch of hedge funds, or attach a bunch of hedge funds to it because again, there was this mystique and this culture around hedge funds that was created because they had done quite well up to and somewhat through the GFC.

However, when you put a beta on top of another beta, if you take a beta 1,equity future, and you attach it with even a five beta, say for long/short, a long/short equity hedge fund, and you go through an event like 2008, you have leverage. And then if you don’t have something that can offset that extra embedded beta within your alpha or your hedge funds, then you become a forced seller.

You have to deleverage and then everyone’s oh, that didn’t work. I guess hedge funds don’t work. Or I guess portable alpha doesn’t work. Or, other terms like return stacking, I think we could throw out there, or in our case, RMS, risk mitigating strategies. which again, all this stuff is, it’s not novel.

They’re not novel concepts. They’ve been well-documented throughout time, us calling it RMS, risk mitigating strategies, versus portable alpha, versus return stacking. It’s nothing new. It’s more how do we package these things up so that it can better resonate with investors and people in the industry so that they’re, we don’t have this, no, curtain that everyone’s popping out behind, at different points in time. And then they point to some sort of just generic label and say, that didn’t work right? So we need to be really specific about the risks that we’re taking instead of bucketing things into these labels that really don’t help anyone.

[00:06:16]Rodrigo Gordillo: And you said something there that I think is super important, and I want to clarify, You said, you have this portable alpha and you’re putting that as a hedge fund that has a beta 0.5, and what you’re saying there is that you’re using leverage. I think what’s important to understand is that what you’re doing is levering up the same risk you already own. Leveraged by, on its own. if it’s within a diversifier, then let’s say, something that you have portable alpha on top or return stacked strategy, that has zero beta is different than stacking something on top that has 0.5 beta. That’s where the risk is, that the allocator may not have understood they were taking when buying a hedge fund, when they were doing portable alpha hedge fund. So leverage, I think with, especially in the retail space and the small foundations and pension plans, when those lever, double bull, double triple bear, triple bull ETFs came out, that’s a type of leverage that everybody seems to be afraid of. And I think part of the discussion needs to be about, leverage isn’t bad.

It’s how you use a leverage that could be bad, right? So that’s key behind, I think the, what you guys have put together specifically as well.

Risk Allocations

[00:07:30]Adam Butler: Yeah, so I mean that actually dovetails really nicely, because just, I think it’s useful to use the structure of the paper to guide our conversation and I think very wisely. The paper starts with a discussion of, thinking about diversification or asset allocation from the perspective that I think many investors perceive it, which is, I’ve got a certain amount of capital allocated to this asset or strategy. A certain amount of  capital allocated to this other one. If I’ve got 50% of capital allocated to this strategy and 50% allocated to this strategy, then I have 50% of my risk or I’m diversified.

I think you guys do a good job of drilling down through the capital allocation. nto the underlying risk exposures to frame the conversation as we’re not really concerned with how the capital is allocated so much as how we’re, how the risk is allocated in the portfolio. So maybe Jason or Ryan, I’m not sure which one of you feels most motivated to discuss this, but maybe walk us through how you guys perceive the difference.

[00:08:46]Ryan Lobdell: Yeah, I think that’s a pretty important part and I think attacking it that way and thinking about it is trying to find things that fit in nicely with the total portfolio in mind, kind of changes, changes the perspective a little bit, where historically everyone just has, you have all these line items and when you look at it, to your point, it looks really diversified.

I’ve got 10 things in there. They should all be different. They’ve got a 0.6 correlation or whatever the number is, on average. But when you look in and say, what happens when equities do poorly, they all do poorly. It’s not really diversified to Jason’s point earlier. So you’re just building a nice diversified growth engine.

It’s just all economic growth risk that you have in your portfolio, and the things that you thought might play defense. You’ve got this really robust offensive portfolio, which Jason likes to say, but you don’t have anything that’s playing defense. You have hedge funds, but to the points earlier, you’re doubling up on a lot of the risks you already have in there.

So they’re not really useful when you go through that environment and you really need the diversification. Diversification is, when you really need it to pay off, is in those poor environments when the bulk of your portfolio, the striving, the returns is suffering. If you can’t harvest it, and you don’t have anything that’s zigging when the rest of it’s zagging, it’s not really useful.

So looking through it that way and identifying, if most of my portfolio as an investor or an allocator is growth risk and tied to the stock market, I should be trying to find things that either are not tied to the stock market or move a lot differently so that I can rebalance between them and harvest that diversification. So that’s, I think, something that got lost for quite a while, in terms of how do I think about allocating the different risks or capital in my portfolio.

[00:10:33]Adam Butler: Yeah, I think it, it’s useful to refer to your paper where you’ve got a list of, I’m gonna, call it 10 different asset class categories or what have you.

You’ve got private equity, global equity, US equity, non-US equity, real estate, high yield hedge funds, commodities, TIPS and investment grade bonds. All of them with kind of a five to 20% allocation adding up to a hundred percent. When you look through this portfolio, it really sounds like it’s diversified, right?

You’ve got all these different words in there. they all, real estate’s buildings, equities are stuff like tech stocks and stuff. It sounds like you’re diversified, but when you actually look through it, what it is is that kind of 93% in this case of the risk is allocated in the same direction, which is let’s call it cyclical risk or, business cycle risk, and only 7% is in the, in different directions, which we might consider to be legitimate diversifiers.

[00:11:38]Jason Josephiac: Yeah. I …

[00:11:38]Ryan Lobdell: think there, there’s another, probably, part of the onion peel back there, to your point on real estate. We look at these assets, particularly with the private markets assets, they look very diversifying.

But if you actually de-smooth the returns, go back and look at 08, it all drew down at the same time. And particularly now, if you think about 2022, just last year, maybe they, you did, they didn’t mark down. They’re uncorrelated, but you didn’t have liquidity for them. Many of them were calling capital.

So you didn’t really have anything that you could have used in that environment  to benefit the portfolio or to use, to pay benefits or to pay your grants, or make outflows of your portfolio, and not have to touch that equity piece of it. Yeah.

[00:12:21]Jason Josephiac: And some, go ahead. Go ahead. When we talk about those things in private markets, it’s not that, of course Ryan and I have our own biases, right? But we appreciate having all the players on the field, whether it’s the defensive players or the offensive players. It’s just that, we believe to some extent, and this all depends on the investor, what drives them, what their objectives are, what their constraints are, how they’re set up, how they’re incentivized, but it’s finding what is the right balance across all those, all of those players and one investor’s balance may be different than another.

Another investor’s balance, however, going back to the analogy of sports, like how often do you have a football team that goes to the Super Bowl with only their offensive team? And how often do you have a football team that wins the Super Bowl that has a crummy defense? Now, that might happen every once in a while, but that is more of an anomaly.

And if we’re really trying to build long term, robust, durable, portfolios, or build a dynasty when it comes to a football franchise, then you need to have a high quality offense and a high quality defense. And each one of those teams, the defensive team and in the offensive team, they both have to matter, right?

So we want everything to matter, but not one thing to matter too much. and just to pull the thread on, on that analogy a bit more, like sometimes when we talk about risk mitigating strategies or negative, negatively correlated strategies, people think that it only bleeds and it’s gonna have a negative return. Most long vol strategies will have a negative long-term return. But you need to see through that by seeing how it interacts with the rest of your portfolio. How does the defense interact with the offense? And your defense can also score points, right? Like for football, pick six, run back for a touchdown after interception. A fumble recovery run back for a touchdown, a safety.

Now that doesn’t happen all that often in the course of a football game. And of course, your offense is gonna score more points than your defense over the course of a season. But just as importantly as scoring points on defense, even more importantly, you can position your offense to put them in a position of strength, right?

By turnover on second downs deep into the opponent’s end zone. So we need to think about how our defense can also score, but more importantly, how you can put your offense, your private investments, your private credit, your private equity. How you can help fund those things during times of distress.

The Dennis Rodman Effect

[00:14:56]Rodrigo Gordillo: I like the Chris Cole analogy of Dennis Rodman. Because that’s a perfect analogy for that. Like a thing that may, that bleeds and that tracks from your offense, over and over again. But it’s got such good defense when needed that it, the whole is greater than the sum of its parts, right?

So Dennis Rodman couldn’t shoot if his life depended on it, wasn’t able to dribble the ball in the same way, pass the ball in the same way. He did one thing better at an amazing standard deviation from anybody else in the league. And it was one thing, and it was getting those rebounds, right?

It’s getting those rebounds and being able to just toss it off to the best players and that made them a winning team. I, the question is, would the Bulls have done as well as they did without Dennis Rodman? I think the answer, if you asked Michael Jordan, would be no. Yeah, that’s the same analogy.

[00:15:47]Jason Josephiac: Yeah, that’s…

The 60/40 Risk Imbalance

[00:15:47]Adam Butler: Just riffing on that, I think without, we, I think we’ve taken that, those sports analogies about as far as you can, but I think they were useful to prove the point, but, I think a lot of people traditionally have felt that they don’t just have the offense on the team. That’s why they have 60% invested in equities and 40% invested in high grade bonds, on average, That the sort of traditional template 60/40 portfolio. So maybe walk us through how this risk x-ray or risk lens of viewing the portfolio helps people understand how the traditional 60/40 is not as well balanced as they might believe.

[00:16:26]Jason Josephiac: Yeah. I will just keep it quickly with this sports analogy there, because with bonds, right? What is that? Is that offense or is that defense? maybe it’s special teams, right? Because it’s, you can pretty consistently score three points through field goals, but at the same time, sometimes your special teams can blow you up.

Where if your punt defense or kickoff defense gets burned, that can hurt quite a bit. So what does that mean in terms of the investment landscape? It means that you don’t really know what the correlation of bonds is going to be versus equities. And if you look at that correlation from the mid seventies up to 2000, that correlation was structurally positive.

If you look at it post 2000 up through 2021, that correlation was, for the most part, structurally negative. Now most of us have lived our careers, I would say, post-2000. So we’ve been conditioned to think that bonds are structurally, negatively correlated with equities. However, they are temporarily conditionally, negatively correlated with equities. yeah,

[00:17:35]Adam Butler: Sure. And then of course, having six, having 40% of your portfolio in bonds and 60% of your portfolio in equities, even if the bonds were a consistent, reliable diversifier, they still wouldn’t have the opportunity to express their full diversification potential, because they aren’t in the portfolio with equities in a balanced way.

[00:18:01]Rodrigo Gordillo: Yeah, look, I think there’s this, there’s even more to double click into that, right? Because what, when we say 60/40, what does that actually mean? The equities are largely the same in terms of volatility. Like most people are doing mostly large cap, it’s whatever the 40 is interesting because I think we lie on, average when I talk to allocators, they’re looking at a duration of seven to eight years, right?

So that volatility is way lower than the equity market. And so when you put on your risk goggles and don’t care about the dollar approach, you put on your risk goggles in that proportion, in that medium duration and high vol equity, the risk allocation is over 90% equities and 10%, less than 10% to bonds.

But what if you, that 40 ends up comprising 30 year Treasuries, right? All of a sudden actually you’re hitting 50/50 there. A 50/50 allocation between equities and bonds is, long-term 30 year bonds is, probably gets you there, right? So it’s not even the dollar amount. Now we’re having to talk about what duration are you talking?

Looking into it, and in the last few years, many advisors and investors have been lowering duration because of that risk that they were seeing coming. and so that takes it even more out of whack, right? So I think truly understanding things from a risk lens., I think, Ryan, you said we have moved away from that.

I don’t think we were ever there. I don’t think anybody, aside from academics 50 years ago, were thinking about this from like, how do I allocate my risk around my portfolio? It’s always been a very naive dollar game. And I think part of this discussion needs to be the great awakening of people recognizing the risks that they’re taking and how they could use it to their advantage, right?

So that piece that you guys did there with the 10 different asset classes, when I look at it, I’m seeing, all of ’em except for fixed income is really that there’s two risks, and it’s mostly growth. So how are you guys educating? You’re using a lot of sport analogies obviously, but, where do you take it from there? First before I, I’m sure you’ve pitched this a few times. How receptive are committees and allocators to the risk story? Are you finding a lot of resistance there? Is there a lot of acceptance? How are you feeling about that discussion?

Discussions: Resistance and Acceptance

[00:20:25]Jason Josephiac: It’s gotten better.

[00:20:27]Ryan Lobdell: Over time, I think. it helps, right? When these things have done pretty well recently, I think there’s just some natural interest, whether that’s performance chasing or whatnot, that just helps when things have done well and they’ve done what you said they would do in those environments that have occurred. That always helps.

I think the next step from the risk, looking through the risk lens, is talking to different people about how to organize the assets that can be helpful in recognizing those risks and thinking about it less through, let’s allocate to 10 different asset classes, but instead let’s use some sort of functional framework.

It’s all the same stuff under the hood. We’re just redrawing the boxes and maybe we’re allocating, we have a growth portfolio, so I know that portfolio has, it’s gonna drive returns. We’re gonna throw private equity in there. We’re gonna throw our public equity in there. We’re even gonna throw high yield in there too.

And then on the other side of that growth portfolio, if we just separate it out, we’ve got some sort of diversifying or diversification bucket too that’s gonna house things like fixed income, risk, mitigating strategies, or other flavors of that. And oftentimes we might think about that kind of diversifying group of it as breaking it out into two separate roles.

Even within there, you think about it as maybe you have an anchor part of your portfolio and an offset part of your portfolio. The anchor being stuff like short term fixed income. Really short. Intermediate fixed income. Cash could be in there too. Then the offset stuff being things like those risk mitigating strategies, whether that’s long volatility, trend following and other really more powerful diversifying stuff in there as well.

And it seems that, people allocating in that functional framework has slowly become more common. I think some of the original kind of plans that ventured into that space were European and Canadian pension plans. Now that’s becoming more broadly accepted across the US as people think about it through that framework.

I think that can be really helpful in reorienting the discussion, rather than just say, we’ve got these 10 asset classes and yeah, we’re gonna report to you every once in a while. Hey, this is the risks. It’s still all growth risk. No, let’s actually talk about our allocation that way, group it together that way. That can be, I think, very helpful in fully understanding how and where and why those risks are allocated.

Risk and Structuring Plans

[00:22:49]Adam Butler: So. are the plans set up to be able to reorient their investment framework to view things through a risk lens? Because often when you view things through a risk lens, it leads to a very different portfolio constitution and almost always, in order to hit required return targets, it requires the use of leverage, whether implicit or explicit, So how is it, how is a plan typically structured? Do, is that structure conducive to this framework? If not, how have some plans approached reorienting or restructuring their constraints and opportunity set in order to be able to take maximum advantage of this way of thinking.

[00:23:37]Jason Josephiac: Yeah. I’ll comment on something high level there then. And then I think Ryan might have some more details, but many institutional investors have their model framework for asset allocation, whether that’s in the endowment world, the endowment model. And I’ll use my jazz hands there, and there’s nothing wrong with the endowment model. It’s just what does that really mean to the folks that are running that model? Because it can mean a lot of different things to a lot of different people. Same thing for, and I’ll do my jazz hands again, LDI, right? What does LDI really mean? And if you take those two examples, you really have to choose between do I think about the world of investing in terms of relative risk, relative return, or do I think about the world  of investing from an absolute risk, absolute return standpoint? And once you decide what camp you’re in, I think you’re either going with the conventional, strategic asset allocation of all the different buckets and the labels, or you’re thinking about the world in terms of these, more of these like functional risk frameworks.

And there’s no one right answer. You need to pick and choose based on the situation that you’re in. But if you can strip away some of the inertia, and I guess I would call it conventional wisdom, but it’s conventional wisdom for a reason, right? Because it’s worked for a long time. But that doesn’t mean that something else couldn’t have worked just as good.

In terms of the potential long-term return, but more importantly, less about the return and more about the path of that return. And if you live in the relative risk, relative return world, you care about things like tracking error. You care about things like funded status, volatility. You care about things like league tables.

But we need to think about who is the true end client, who are the true end beneficiaries and what their purposes are. Yeah, exactly. What is their purpose? Like, why do you exist? You exist to send dollars out the door every single month, every single quarter, or every single year. The receivers of that don’t care how you did it.

They just wanna make sure that you get it. Hence, that’s why we I think, come from this world of more absolute risk, absolute return, and making sure that we can raise a probability of having a better path at any given point in time, as well as throughout time. Because if you take, okay, say my expected return is, call it 10%, I need to reach 10%, but what if your minimum required return is 5%?

There’s a lot of wiggle room in between 5% and 10%, and what if you’re 10% over 10 years, the probability of achieving that is, call it 90%. I’m just, using rough numbers. But what if you could achieve, say, 8% over rolling 1, 3, 5, 7, 10 year timeframes with a higher probability of achieving that 10% over those same timeframes, right?

[00:27:01]Rodrigo Gordillo: It’s achieving, it’s hitting that target throughout. Rather than hitting that target over a 20 year lifespan. So I think we talk about path dependency risk and adverse scenario risk as a big issue. In terms of hitting that, it’s consistency of returns that, that I think everybody, like everybody in this conversation really leans towards and tries to bring people towards, because that’s what actually matters.

Relative Performance Objectives

[00:27:30]Adam Butler: When you have a liability it’s not just that the path matters experientially, the path matters in terms of your ability to meet that liability. The short-term and in the long-term. Which feeds back a little bit to the question. I know on this, on the sell side, you’ve got mutual fund managers or banks, index providers, what have you, that legitimately have a relative bogey objective. When you look at the buy side and you like actually the end, those who are representing end clients, right? Those in the endowment space or the, the pension space, et cetera. I struggle to understand how you can calibrate to a relative performance objective. Can you flesh that out for me? Like what are some legitimate use cases for relative performance objectives for people who manage other people’s money for a purpose?

[00:28:31]Ryan Lobdell: I think, that’s a really good question. and it’s a tough one to answer I think, in figuring out how to set up what’s the right governance structure, I think on how a lot of these plans are set up.

They have a board that are actually the fiduciaries making decisions, and maybe they have staff that are implementing it. And from the board’s perspective, maybe they’re comfortable with a certain risk tolerance and they’re expressing that and say, hey, we’re comfortable with a 10% vol, or whatever that may be.

Maybe that’s equivalent to a 60/40. So let’s think about that as my reference portfolio. and I’m okay with you deviating from that, but I wanna know how far away from that am I going, what are the decisions that are driving me away from that? Am I okay with those decisions? And bringing it back to that point, I think that’s maybe the way that you can get around that, and thinking about whose responsibility is what? If the, if it’s the board’s responsibility to say, set the asset allocation, say this is what I want to do, and the staff’s responsibility to implement that, which is I think often the case, to have that reference point. So the board knows, hey, we’re, they’re actually implementing something that’s close to what we said we were.

Seeking out at the outset. I think that’s, I don’t know if that’s the best way to do it, or somewhere in the middle, but I think that’s a pretty common setup for many plans.

[00:29:48]Jason Josephiac: It doesn’t really,

[00:29:50]Adam Butler: It addresses the reality of the situation, right? Yeah. There’s, there is a question which we’re probably not going to debate today about whether the board is meeting their true fiduciary objectives by setting those kinds of policies. But…

[00:30:04]Rodrigo Gordillo: I will say that one of the issues from a litigation perspective, you’re a board member, is that when you’re sitting there, if something goes wrong and you’re sitting there in front of the judge, and what you’re asked is, did this professional, did this director do the prudent thing as it relates to the majority of professionals in their opinion on the matter, right? Is this a prudent thing? And they’re gonna, and you’re, if you grab a random sample of investment professionals right now, eight out 10 of them will tell you that the traditional endowment model or a 60/40 is the prudent thing. And a deviation of 20% from that for the year that you’re getting sued for may be a problem, right?

I’m sure you can make a case and still win, but it is one of those hurdles that you’re gonna have to jump over in order to win that case, right? So it always comes down to what is the professional body of investments, of investors? What did they tend to lean on? And that’ll be your bogey.

I think there’s a lot to that when it comes to being a director. And the best we can do is in this group or as professionals that are thinking about it from a risk perspective, is slowly nudge the whole group towards better thinking. And hopefully by the end of our careers we’ll be, we’ll be all in tune.

Peer Risks and End Goals

[00:31:19]Ryan Lobdell: Yeah, I think that’s a big issue there is the peer risk. As much as we all say it doesn’t matter, we still, everyone still thinks about it. We try not to think about it, but we still do. We still, what are our competitors doing? What’s that plan doing? We all want to know what’s someone else doing, whether or not we know that’s like a behavioral bias or not, it’s just a hard thing to fight against for sure.

And I think to your point, I’ve tried to nudge people in the right direction. and I think the question or comment made earlier about plans being set up to, I think what you were getting at is actually thinking about equal, allocating equal risk across different things is maybe exactly a smart thing to do well.

At least moving them to a functional framework. They’re not, they’re nowhere close to that equal risk part. But at least we’re saying, hey, we’re not recognizing this is, what the risk we’re allocating to. And maybe that nudge, that’s a nudge or a step in that direction, I think.

[00:32:14]Rodrigo Gordillo: Yeah. and the other issue absolutely when thinking about adverse, or adverse scenarios is, especially with LDI, we talked about this, Jason, is what is the end goal?

Is the end goal to give, to promise a person at the end of this process, a nominal dollar amount every year for X amount of years? Is that what we really meant when we said we’re gonna, we got you covered for retirement? I don’t think we did. It’s just that it’s nice to be able to have a guarantee, income and that, for that to be matched up against cash flows in your bond portfolio.

It’s amazing that we can do that. But, that’s not real unless we can guarantee zero inflation, right? All of a sudden when inflation rears its head, which it’s done for the first time in four decades in a real way, we need to start thinking about actually taking out the facade. that being, that LDI is riskless from the perspective of what is the end client looking, to get from the perspective of what is the end client looking to get?

We need to take visual risk in our P&L in our portfolios to have some inflation risk, I imagine. So this is another area that, I’d be curious to get your thoughts on Jason. how that, I don’t know if you’re dealing with ADIs and how they’re thinking about that now that it’s front and center?

[00:33:32]Jason Josephiac: LDI is obviously something I have thought about a lot over the past, say 10 years or so, and. I always just ask the simple questions, right? And there’s never any simple answers, but it is. why do we assume that people will continue to be happy with nominal dollars, year in and year out, based on all the different stuff that can happen in the world?

And I always use the example of, in what environment do pensioners become upset that their standard of living is being depleted every year because inflation is running hotter than it has for a long time? At what point do politicians, which politicians will do a lot of different things in their own self-interest and in hopefully, in a longer term, in the best interest of the constituents that they serve?

But if inflation is an issue, then is that going to find its way through government intervention and regulations across pension plans, whether public or private. And the answer is, I don’t know. We don’t know, but we know that risk exists, and what is the probability of that? We think about all these things in terms of what is probable and what is possible, right?

And you can’t build a portfolio and go throughout life just thinking about all the possibilities, because if you did that, you’d be like a hermit in your basement and would never go out and see the light of day. But you have to be aware of all those possibilities and at what point do those possibilities become more probable? And inflation could be one of those things that kind of tips, LDI into a different sort of, way that folks think about it going forward, and the adoption of that will differ, based on plan sponsor, by plan sponsor. It won’t be all at one time, but perhaps there is some sort of thing that happens that makes people, radically change the way that they do things. Unfortunately, perhaps that is too late. Who knows? But that’s why we are here, right?

We’re here to talk about those things that people should have on their radar. It’s up to them how much they want to do something about it, or how much they want to continue to invest in the way that they have been investing for the past 10, 15, 20 years. And at the same time, if people didn’t have these ways of thinking and these structural asset allocation models, then all the things that we’re talking about, those inefficiencies, wouldn’t exist or they wouldn’t exist as much.

Selfishly, we want some cohort of the population to adopt this stuff, but we don’t want everyone to adopt it. Because once they do, then those inefficiencies become not as inefficient and folks will lose their competitive edge and competitive vantage, and then we’ll have to constantly adapt and move on to the next thing over some measured period of time.

[00:36:27]Adam Butler: That’s right. Yeah. It’s, just closing the loop on the inflation question for end stakeholders and whether politicians will move in the direction of a building or regulating enforcement of meeting those objectives.

It’s probably worthwhile noting that all of the pensions that service the politicians are indexed to inflation.  

[00:36:53]Rodrigo Gordillo: Is that right? Yeah. Defined benefit inflation protected outflows. Good for them.

Risk Mitigating Strategies

[00:36:59]Adam Butler: So it’s not lost on them anyways, the importance of it. but anyways, we can move on from that. This is definitely getting into the, into contentious territory that we probably didn’t mean to stray into for the purpose of, but, alright, so you’ve mentioned risk mitigating strategies a few times.

Obviously this is the topic of the paper. We’ve talked about the fact that bonds alone can serve a role in helping to balance risk in a portfolio, especially if you look at those risks through a risk lens. What is the potential opportunity of adding a risk mitigating strategy sleeve to this functional risk framework for, and allocators? How do you position the potential advantages of adding this to the toolbox?

[00:37:46]Ryan Lobdell: Yeah. I think it just plays a different role. particularly if it’s just core bonds that’s, maybe it’s flat. Let’s just put 2022 aside for the last few decades, flat or modestly positive. That’s great, but maybe it’s not a, maybe it’s not enough.

Maybe we want something with that packs a little bit more punch, that’s up a little bit more. And then once we start to think about these other types of environments, these inflationary environments like 2022, how are they gonna perform? Then they’re not gonna, they didn’t perform well and they’re probably not gonna perform well if that persists or happens again, at some time out in the future.

So are there other things that we can put in there that maybe are less reliant on that? As Jason mentioned, that correlation hedge between equities and bonds that are maybe more structurally oriented and correlated negatively to equities, that we can have a little bit more confidence in producing the outcomes that we’re hoping for, or looking at things that maybe still rely on that correlation. A correlation trade, but a different one than bonds do.

So maybe instead of bonds you’re talking about, let’s think about looking at trend following strategies, which you could argue is also a correlation hedge or a correlation trade-off, but much, much different than what bonds are doing and much more dynamic than what they’re doing. So having a diversified set of hedges I think, can be really powerful in recognizing, particularly if we’re in a period where macroeconomic vol has increased.

And if we think that’s gonna continue, we don’t know what the future’s gonna hold. We need to, I think not only have we said this, but a lot of other people have said it, you need to diversify your diversifiers and increase the coverage or the breadth that you have from your defensive part of your portfolio or your risk mitigating piece and not just rely on bonds.

Risk Responders

[00:39:37]Adam Butler: It’s really hard to stay out, or stay away from the inflation discussion, because it does raise the question of, when you think about portfolio volatility, is it volatility on a, in terms of the real value of the corpus or the nominal value of the corpus? Because you could easily have a situation where the nominal value is relatively stable, but on a real basis it is fluctuating pretty dramatically because of this macroeconomic or inflation volatility. I almost want to set aside the inflation discussion and just maybe focus on nominal risk for the purpose of this conversation. unless anyone has any objections.

[00:40:19]Rodrigo Gordillo: I feel the opposite here, because I think we should go through the responders, right? We should understand what the levels are and really dig in on this, on the expectations of those different responders. Because I think the, what I love about the title of risk mitigation strategy is that it’s not prescriptive, right? It’s not like equity tail hedge, that’s prescriptive equities go down.

We have a low basis risk response. Risk mitigation strategy can actually cover a lot of things and I think many of the responders in there have the opportunity to mitigate inflation risk as well. And probably did in 2022. So I don’t think we need to disaggregate. I think we can talk about it as a full risk mitigation framework for the major blind spots that traditional equity and bond portfolios have.

But I’ll leave that up to you guys. I would love to start with understanding, we talked a little bit, Ryan, about the different things that you could allocate beyond Treasuries, but maybe let’s walk through your responders and what their role is.

[00:41:23]Ryan Lobdell: Sure. so I’m, how we frame it in the paper, is mostly relative to equity markets or economic growth risk, just given that’s the largest driver of portfolio returns as we’ve talked about.

So, it’s thinking about if we’re gonna allocate away from bonds, what are the types of poor equity environments that we might encounter? And trying to group those into somewhat broad categories, thinking about it. You may have an environment like a Q1 of 2020. You have a really sharp equity drawdown, high velocity happens really quick, unexpected, maybe it occurs over days to weeks.

That might be an environment I want to have some protection from. So in that, for that type of environment, you may think about allocating to first responders or strategies that are that first line of defense in that selloff. So there you have things like long Treasuries, which has been used by many people for quite a long time.

But maybe you think to your, to the inflation point, if that happens, I want to have other tools in the toolkit. I want to be able to consider, let’s talk about long volatility strategies, let’s talk about tail risk. Those are all tools that could be used there. And it could even go beyond that if we’re just describing what the goal is.

If it’s a functional framework, we’re just trying to find strategies that’ll produce that specific outcome that will produce. Modest to material gains in that type of equity drawdown. And then if that extends to something more sustained, like 2022 or, the GFC 2008, we wanna have something that’s gonna kick in there. I would argue, and this is maybe my own personal bias, those types of environments can probably be the most damaging, that really long, drawn out, sustained, depletion in what your capital base is. So we want to have stuff that’s gonna kick in there and being that second line of protection in that drawdown.

So things like trend following or CTAs, commodity trading advisors or managed futures, whatever term you want to use. I think the core of that is just trying to capture that second piece or second part of a drawdown. And then the third part is just diversifiers. So if we don’t have an equity drawdown, and we really want to hold these two things for the long term, maybe we need something that’s gonna do well, that’s gonna produce positive returns when the other two aren’t working through a flat market or a bull market.

So let’s think about allocating to diversifiers more broadly. And by that in the paper, we just mean things that are probably either in isolation or combination, point plus or minus 0.2 equity beta. so oftentimes maybe you’re thinking about things like, macro risk premium, multi strategies, relative value strategies, equity market neutral.

Some of those things can vary quite a bit. But then going back to what are we solving for? Let’s look for something that’s diversifying to those first two components, to the rest of our portfolio, not doubling up on risk factors and providing that kind of what you might think of as a wrapper or allowing you to hold those two first two hedges until you need ’em.

[00:44:26]Jason Josephiac: Yeah. Yeah. and even the term of risk mitigating strategies, I think even internally we struggle with even calling it that because how were, how are most people trained? They’re trained on the efficient frontier. The only way to get more return is by taking more risk. And that’s true for a total portfolio, right?

But when you’re looking at the individual components, the individual ingredients, that is not true because you need to take into account these correlation effects, whether they’re structural, correlation effects or they’re more kind of temporal. And, what Ryan just described is we think of that as preparing, right?

We’re preparing, we’re not trying to predict. This is the I Don’t Know Portfolio. That’s what we’re trying to help clients and people build, the  I Don’t Know Portfolio. The Prepare Portfolio instead of the Predict Portfolio. It’s not because that we don’t think we can identify decent investment strategies and partners. But if you go down the rabbit hole of trying to, “ pick the best manager”, like what does that even mean? What does the best manager mean? Over what timeframe and what environment? That’s why you need say, all the different players in the field. you need the defensive line, you need the linebackers, you need the secondary, you need the free safety and the strong safety. Because you don’t know what the equity drawdown is going to throw at you. Is it gonna be like a some sort of Hail Mary pass, and that’s the case? You wanna make sure that you have some people you know, that are deep, that can cover that.

Trend Following and Volatility

[00:45:56]Rodrigo Gordillo: Yeah, I like the I Don’t Know Portfolio. Your, the title of your next paper should be like Shrug Emoji, just that’s what you’re gonna launch because it is, it’s true, it is covering for other contingencies, but you do have to have an understanding of what your first, second, and third responders are likely to do in different, scenarios. Let’s talk about trend following. For example. How do you see that as what scenarios is trend following and CTAs and all that expected to do well in that second responders?

[00:46:27]Ryan Lobdell: Yeah, I think it’s just that big meaty bulk part of the crisis or the drawdown, it’s going to do poorly probably, because oftentimes I think across most of the institutional allocations there, the core is medium to long-term trend. So in those times where there’s a full commo moment in markets, they’re probably gonna suffer. I think they did on average, actually probably exceeded expectations in March of 2020. I would’ve expected if you described the environment some quick shift in direction, that they’re probably not gonna do so great.

Yeah. But they, most of ’em held up. Okay. So that was, I would say a nice surprise, but in that environment, that’s why you have the other things to kick in, those first responders. Long vol does really well in that environment when trend following performs poorly or maybe Treasuries do, depending on what the macro variables are doing, or are also tail risk that could kick in too.

So having things that help in those times when those trend following strategies might miss it. and you don’t probably want to over-optimize the trend following strategy to solve for every single environment, because then you lose the other attributes of it with, as with anything else.

And then maybe when markets reverse up into a bull market, too. They’re probably gonna suffer at that fulcrum point as well. So that’s where maybe you have the diversifiers to kick in there, and take a little bit of the edge off that way as well.

[00:47:50]Rodrigo Gordillo: And on the diversifier side, do you expect them to maintain, their AUM in a kind of like a 2020 environment, provide positives? Like, where do you see that is a minor nuisance or a positive, expectancy during shocks?

[00:48:07]Jason Josephiac: Yeah, the way we would think about a diversifier is that more beta neutral, market neutral sleeve, is it having a better skew profile than bonds, while also being able to compound at a higher absolute return.

So think about, as a synthetic coupon, in a sense it’s not contractual cash flows, but it should have a similar sort of profile, again, with better skew and hopefully a higher annualized return, and that’s really there. It’s not just there as a behavioral sort of hedge, right?

It’s there because in timeframes like say 2011 through 2019, first responders and second responders, long vol and trend, they weren’t that additive, at least from a return standpoint. But again, if you rewind history and history played out differently, then they would’ve been. So you, again, you can’t predict these things.

You need to always have these players on the field because you just don’t know. And then, and I’ll expand a little bit on first responders there, the long vol and tail risk where, when folks here long vol, they immediately tend to go toward ….. The money crash puts on the S&P 500.

While that has benefit, it’s in what proportion do you do that, and are there other things you can do that can complement that? So you can manage the path dependency. You’re not just, you don’t have this pin risk at, I only make money if markets are down at least 20, 30% because in a year like 2022, that doesn’t work, right?

But if you have strategies that are trading around vol, at more at the money vol- straddle types of strategies, or even, to some extent strangles, you can help raise the probability of having a decent outcome, regardless of the shape of the drawdown, whether it’s, fast and vicious, or whether it’s long and drawn out, or anywhere in between.

And doing a cross asset class also can help raise up probability of better outcomes. Where, who knows whether it’s gonna come from, the funding markets or the credit markets or the FX markets or the rate markets or the equity markets. You really do not know where last year if you were mostly trading equity vol and your attachment points were down closer 15, 20 and you’re trading those front month contracts, or three months out? That didn’t really go that well.

However, if you’re trading FX vol, if you’re trading rate vol, if you’re trading, commodity vol, you probably had a pretty decent year. And it just goes back to that diversification. Not only the diversification of RMS as a holistic sort of framework, but also diversification within each one of the three components.

Perfect World Strategies

[00:50:53]Adam Butler: So how do you guys think about actually, as the rubber hits the road with portfolios, right? Maybe it makes sense to start with, in an ideal world, here’s what we would advocate for, and then work backwards towards the practical reality of where client funds actually stand in terms of their strategic asset allocation.

And then how can you optimize to build in as much exposure or as much diversification alongside these more traditional portfolios. In a perfect world, what would a most resilient, prepared for anything strategy look like? Let’s start there and then let’s talk about some of the constraints that we typically face when dealing with actual funds.

[00:51:46]Ryan Lobdell: Yeah, I think the nice part about a functional framework is it’s customizable so you can move things around. You can pick different tools and re-weight across them, whether it’s this or at a total portfolio level. And in terms of what’s optimal, I think first we’re all probably just very biased on what that number would be.

It’s probably, in my mind and Jason’s mind and I would guess you guys too, probably a lot higher than anyone else would say, because thinking about it through that risk lens, so I feel like it’s pretty uncommon that you don’t run into any of those constraints. I think the first thing that we would say, and we think this probably makes sense, and I don’t think it limits itself just to how much should I allocate to risk mitigating strategies.

It could be with anything. If you want an allocation to something to actually make a material difference on the portfolio, you gotta do it in size. You gotta do it, maybe the number’s different, but just call it five, 10% just to make a difference. If you’re gonna go into something, whether it’s risk mitigating strategies, considering some framework like that, or even whether it’s high yield and you’re hoping that’s gonna make a difference, and you’re doing it at 1%, 2% of your portfolio, the next question is maybe, is it worth a headache? Is it worth me going down that path because it’s probably not gonna meet my expectations when that event happens?

[00:53:11]Adam Butler: High yield on a risk basis or on a capital basis? Because if you’re adding 5% to a short-term interest rate strategy in a portfolio, on a capital basis, you’re not getting any diversification at all. You need to allocate 10 X your portfolio to get any benefit from it. But if you’re allocating a small cap emerging market equity sleeve, then obviously you need a lot less to have a similar impact.

[00:53:40]Ryan Lobdell: Yeah, I, so by 10%, I guess I was speaking on a capital basis. Just think that’s how I think most work through that conversation.

But you bring up a really interesting point is, once you do that, then thinking about what’s the capital efficiency of it, because a lot of these strategies are very capital efficient. I don’t have to put $1 up to get a dollar of exposure. Maybe I put up 20 cents. Am I okay with that, and that risk tolerance might change, based on the sophistication or just the experience or other different constraints as well.

And that’s, I think, a really unique part about a lot of these strategies is while we say do 10% to make a difference, maybe you could allocate if you think about it and how many dollars you’re putting up. Maybe you could allocate 2% to tail risk and have that make a material difference. So I think it just depends on how it’s framed.

Optimal Weightings and Making Room

[00:54:32]Rodrigo Gordillo: Yeah, so you’re going, when you’re discussing the functional framework, you’re laying out all the pieces and I doing an interview and seeing which parts may fit in independently, but you’re not going in and saying, listen, there is an optimal risk mitigation strategy weighting and this thing, or maybe you can tell me, is there, have you guys put together a, like straight out of the box, this is an op, this is the optimal weighting for RMS, and this is how much capital efficiency exists. Do you guys have something like that?

[00:55:04]Jason Josephiac: It’s really case by case, right? And then it’s, that’s next to impossible to do because you have to factor in the behavioral element. But how do you do that? Like it, it’s by using math to show what the power of this stuff could be. Now, of course, we’re all, we’re our own worst critic, right?

We’re always thinking, how has this played out over the past, and why won’t it necessarily play out like that in the future? So there’s a lot of subjectivity around how much conviction you may have in having something like the RMS framework or a package of RMS within the strategic gas allocation. and it really needs to be investor by investor. There is no cookie cutter answer to that because of all the other things that we talked about. The governance, the structuring, the incentives, the biases and the behavioral aspects and the composition

[00:55:58]Adam Butler: Of the portfolio, right? If you’ve got a plan or you’ve got an allocator that’s already got an extremely diversified, global risk premium, strategic asset allocation, they’re going to need a risk mitigating overlay. Maybe a smaller allocation, or need to think about it differently than somebody who’s more of a traditional kind of 60/40 endowment portfolio, hand wavy, kind of allocation, right?

[00:56:23]Jason Josephiac: Yeah, for example, like an endowment. And again, I’m using a generalization here. If I think, when people think of endowments, they tend to think of a lot of private investments. So in that situation, would you want more first and second responders and less diversifiers, perhaps, right? But we could definitely make a case for why we believe having diversifiers there or that market neutral sleeve also makes a lot of sense because of behavioral aspects.

Also in the context of relative to bonds, how much of a bond allocation does that endowment hold, and how would they view the diversifier sleeve, relative to the bonds that they hold? And you don’t really know that until you go through those conversations. But that’s just one example of how an investor could think about the offset of first and second responders and diversifiers, relative to what they already hold in their as allocation.

[00:57:12]Rodrigo Gordillo: And also the idea of making room in your portfolio versus not having to make room in your current portfolio allocation. So if you have a sophisticated endowment that already has and is well aware of how derivatives work and portable alpha works, they may, I imagine, may be amenable to, okay, we’re gonna, we’re gonna have these separately managed accounts for trend managers.

We’re gonna have separately managed accounts for tail protection. And you don’t, you just have to put up some Treasuries and we’ll use that as collateral to implement on top. So that 15% Ryan, that you were talking about is, you keep your a hundred percent portfolio and you’re adding an extra 15% on top?

And then there’s probably ways of where, or certain clients and investors that don’t have that sophistication, where they’re actually gonna have to make room in their portfolio to include that RMS portfolio, whatever that is. And I imagine that way you’re doing it through ETFs, mutual funds and hedge funds, direct actual allocations. Yeah. so that’s another layer, right? Like you can make capital efficiency, but you don’t have to, and there’s pros and cons of both.

[00:58:18]Ryan Lobdell: Right? It’s just a framework that people can use, and take and implement how you see fit, whether that’s a capital sleeve of your portfolio, whether it’s, we wanna allocate this amount of risk, whether it’s, we wanna stack it on top of duration beta equity, beta, multi-asset beta, however you wanna do it. It’s meant to be flexible and used however best fits within a plan. and something I think that is probably important in the sizing discussion too, is thinking about what’s the liability structure? Am I negative 5% cash flow on an annual basis, or am I positive cash flow? Am I a hundred percent funded or am I 50% funded? That might drive some big differences in how much might be viewed as optimal by an investor to allocate to this or other diversifying strategies.

Receptivity and Fire Departments

[00:59:09]Adam Butler: What’s the receptivity to the entire framework versus somebody preferring to go at it piecemeal, right? It seems to me that you’ve constructed something that, where all the pieces fit very nicely together and are mutually complementary.

Do you find that people see that vision and want to want to work each of the different sleeves into their portfolio framework, or do you people typically want to go piecemeal, like they recognize the value in the first responders, they want to put some long vol in the portfolio or, oh yeah, I recognize the value of adding some of these strategic diversifiers. How do the conversations go from that perspective?

[00:59:52]Jason Josephiac: It depends on where they’re coming from. If they, if an investor already has a say, a well built out hedge fund program or absolute return program, then they already have the diversifier sleeve covered. And then they might not be so interested in that sleeve of the RMS framework.

They might wanna focus more on first and second responders. So that’s an unnatural, I wouldn’t call it bolt on, but a way that they can further diversify an already existing allocation. Where, if there’s an investor that doesn’t have any exposure to any of these types of strategies, then you’re starting from square one.

And what we want to avoid is doing these hypothetical simulations or model portfolios, whether it’s using managers or benchmarks, and then having them look at the last few years of performance. Because again, who knows what’s gonna happen in the future. Now for example, in 2020, first responders long vol did well in 2021.

That beta neutral diversifier sleeve did well. In 2022, second responders, trend following did well. So if you’re looking at any one of those years in isolation, you’re like, I want just, I want more of just that. And, that’s why we need to put these things in a full context and show them packaged together, but then also dig into the weeds and show them, separate it out and, illustrate that this is, this was supposed to happen in 2020 in that type of environment.

This was supposed to happen in 21. This was supposed to happen in 2022. Now, we didn’t know those things would happen, but we have the functional risk set up to protect against all those different types of environments.

[01:01:31]Rodrigo Gordillo: Like each one of those responders, we can say with a level of confidence that in this environment they are very likely to do X. In this other environment, this other person likely to do Y.

What I can’t tell you is what fire, what type of fire is gonna happen in the next six months. And I think what, I think you guys probably experienced the same thing we did, which is in 2020, everybody wanted to only talk about tail protection and long volatility. 2022, everybody wanted about trend. Now it’s a combination of other things, because trend is giving back a lot. They’re just, they’re always trying to predict the next one. And I think the framework of preparation over prediction is the right framework to think of it from. It’s just have a bunch of different, moving away from sports analogies, but different fire departments to deal with different types of fires.

[01:02:19]Jason Josephiac: Exactly. And not getting too caught up on any single one manager. Because, I mean we do manager research, all day, every day. But to go back to 2020 and to see what long vol manager performed the best, like that has no bearing on the future. Yeah. Now, if you had a long vol manager that was negative in 2020, okay, then there’s something else going on there, right? If you had a trend follower that was negative in 2022, okay, there’s something structurally going on there. However, can even those bombs ahead of time, we do our best to do that. But how do you avoid that? How do you mitigate that risk by taking that more broadly diversified approach across managers that we believe are functionally doing different things?

And you always need to stay on top of that stuff, but you can’t just slot one to even three managers across those three buckets, the first responders, second responders, and diversifiers, and expect that to give you a robust, durable outcome, where the more managers that you add in, the more we can raise the probability of a successful outcome.

That isn’t to say that you want to have a hundred managers in the program, but you need something that can be reliable and robust and durable. And sometimes we hear, folks ask, hey, what RMS manager should I, should I hire? And we’re like, there is no one RMS manager you should hire, right?

[01:03:46]Rodrigo Gordillo: Here are the managers that we’ve vetted from the management team perspective, from the process of their approach perspective, from the reliability of the team and their pedigree. And they do this other thing too, by the way, that may or may not be amazing at the time that you need ’em to, but we don’t know whether it’s gonna be them. So here’s some solid managers, solid management, and here’s stuff that they do. You should probably use ’em all and you should do an ensemble approach. Yeah. that’s the way to do it.

Diversified Puzzle Pieces

[01:04:13]Adam Butler: It’s a, something that I think is often not contemplated is the, there is a trade off between adding more managers to do similar things versus like the trade netting that you might get from having a smaller number of managers that do, that kind of do a few things, right? If you’ve got a multi-strat manager that is giving you exposure to several potential diversifiers and has a diversified tail overlay, then you get to take advantage of the fact that one of the strategies in the multi-strat may be looking to add to a position in a market today.

And another diversifying strategy might be looking to lower a position in a strategy in a market today, and net, you just don’t need to trade nearly as much. and that can really add up in terms of, potential alpha, right? You trade that off against the fact that obviously you don’t wanna put all of your eggs in one basket with one manager.

There’s definitely a trade off or a balance, an optimal kind of balance to, to find there, where if you can find a smaller number of managers, that’s not a single manager, but where each manager provides a few, pieces of the puzzle, and those pieces are nicely diversified. So you get trade netting, you get fee netting. If there’s performance fees involved, et cetera, then that can be advantageous.

How do you guys think about that?

[01:05:42]Ryan Lobdell: Yeah, that’s a good point. It, it definitely, there’s a spectrum across the different buckets that we outlined in the paper. Like, within trend following, for example, it’s, you could, similar people could argue different views. Do you need three? Do you need five? Do you need 10? But the nice part about that is, say to Jason’s point, I mean we’re not, part of our job is manager selection, but we’re not perfect at it. I don’t have any confidence. I could tell you one through 10, those are the top trend managers. But I hope I could say, hey, I have a decent confidence in saying here is the top five or six or whatever that is.

And if you put them all together, and this also goes back to the question of how do you implement, how do you structure that? If you put ’em all together in separately managed accounts on a platform, they’re all very cash efficient. You do get some reduction involved, but because of the stuff they’re trading, you can lever it up a little bit and maybe as you get 10 managers, you lever them all up to 20% vol and you end up with a 15, which is what you’re hoping for, and you reduce that manager selection risk. So that’s my, might be how we would think about it there. When you go into diversifiers, I think to your point, there’s a lot of other strategies there. Much more diversified underneath the hood. And depending on how you’re tackling that problem of coming up with something that’s extremely neutral to factor risks and traditional risks, you could think about it as saying, let’s pick a couple multi-strat managers.

Maybe that gets you pretty close there. Or it’s let’s allocate to macro risk premium, fixed income, RV and all these other things. and tackling it that way. I think there’s probably a few different ways you could go about it, and I don’t know that we would say that there’s any one, I guess “optimal way”. It just depends on what are your constraints there, as an investor? Yeah.

[01:07:37]Jason Josephiac: Yeah.

End Investor Benefits

[01:07:37]Adam Butler: So let’s, we’re at an hour and a quarter and I wanna make sure we get to talk about the, what kind of benefit do you hope that in, the end investor is going to accrue from. Having awareness and taking steps in the direction of adding risk, mitigating strategies, from a portfolio performance standpoint, and then again from, the benefit to the end investor of these plans?

[01:08:02]Jason Josephiac: Yeah, ultimately, what is everyone trying to do? They’re trying to put up the highest return with the lowest amount of risk. Again, we can talk about funds as volatility and league tables, endowment model and all that stuff, but what is mission number one? Highest return, lowest amount of risk.

And that’s what we believe that the RMS framework can hopefully help provide investors by adding the, that thing that can zig when everything else is zagging and can add to the bottom line when it comes to return, with hopefully getting some semblance of a free lunch. The holy grail, right, is how can, how do you move northwest on that efficient frontier?

And there’s not many tools left in the toolbox that investors can use to do that. The ones that have been used, I think over the past decade now in terms of private investments have done a good job of moving it north, but I’m not so sure that it can move it west other than the optics of the, what Cliff Asness would say, the volatility laundering. And again, that’s not me or us saying that private investments are bad. They are good, but how do you make them better? You make them better by having something that can offset those risks so that you can have capital to deploy in those private investments when you go through those events. Bottom line for RMS and for investing in general is, how do you find that next frontier of diversification that can make your portfolio, I’m not sure if it’s optimal or just less crummy, because, not towards the right direction. Yeah. Because it what’s optimal. You only know that in hindsight. You don’t know that going forward.

[01:09:40]Ryan Lobdell: And I think a really important piece of that too is getting that benefit, but identifying things that are gonna give you enough liquidity so you can rebalance out of it into the other parts of your portfolio. If we or anybody constructs a risk mitigating or diversifying bucket and you have no liquidity and you just gotta run it side by side for years, it may not be a benefit at all if you don’t have the liquidity to capture those gains when you need it.

And I could imagine, and I’ve heard from many managers, that’s always frustrating, right? You have a really good year and all the investors come and say, hey, we want our capital back on the investor side. That’s exactly what they want. And hopefully those clients, to the manager, are the ones that are also gonna come back and top off in those down years.

So that you maintain that kind of structural or strategic allocation throughout time and you’re not trying to time, is this a good time to be in trend or a bad time? You’re just harvesting the gains and topping off, when you’re a little bit underweight. I think. I think that’s a really important way, and piece of an investor getting a benefit from some structure like this.

[01:10:44]Rodrigo Gordillo: Guess that’s a good point, right? One of the key things behind most, if not all of the recommendations within RMS is that they’re all liquid, right? When if you need the money, you can get the money borrowing, somebody within a hedge fund gating you, which is unlikely if they’re making money.

So that’s key. It’s the rebalancing premium that you get of grabbing the winner and giving it to the loser before they mean revert is crucial, if that risk mitigation strategy needs to be liquid. So that’s crucial there.

The Client Experience

[01:11:16]Adam Butler: So at risk of spoiler alert, what if a client, this resonates with an allocator, they wanna learn more about this. What is the process that they were to reach out to you? What is the process you walk them through to work toward a solution? What would the client experience be?

[01:11:36]Jason Josephiac: I think first we would ask for people to go to our website and look at thought, thought leadership and read the content that we’ve already put out there so that even before we have that initial conversation, they have a good framework and foundation and understanding for where we’re coming from.

Because if it doesn’t resonate with them through reading that paper and maybe looking at our webinars and whatnot, then the probability of, being able for us to be additive to their investment framework, it’s probably fairly low.

[01:12:07]Adam Butler: Jason, I, the client’s already come to you. He’s read your paper. He wants to know, okay, what are next steps? What is, what is the experience? What does the consultative experience look like?

[01:12:17]Ryan Lobdell: Yeah, I think it’s the same here as it is for most other things. We gotta start with education. Gotta make sure the stakeholders and the decision makers, whoever that is, whether that’s board, staff or otherwise, really understands the risks and why these things are working and how, and then talking about it from a total portfolio point of view, I think is probably the really important first step.

Not just staying isolated within an asset class bucket or an asset strategy bucket, or whatever framework it is. You gotta step back and see the whole forest, and don’t get just lost in the weeds and talk to people about, and have conversations about what are the risks that I have, that are embedded in my plan or system is that, am I really negative cash flow?

Maybe I wanna think about having more downside protection, or my positive cash flow. Maybe I wanna think about having more diversifiers and less first and second responders. So having those conversations and thinking about it from that perspective, and not only just from an assets point of view, but liabilities as well. Yeah, you’ve got to think about the two and the interplay between them.

Behavioral Aspects

[01:13:28]Adam Butler: Yeah, good, beautiful. What did we miss? There’s obviously lots of further detail, about the, about the framework, about breaking down the constituents of the underlying strategies, how they’re expected to perform in different environments and why, how that pieces fit together, how they complement portfolios and drive towards a potentially more efficient frontier, and, plan, experience. What else did we without, going down a bunch of other rabbit holes, any big picture things that we missed or that you might wanna hit on before we go?

[01:13:59]Jason Josephiac: I would say on the managers side, in terms of again, the hedge fund space or just, let’s just call it first responders, second responders, diversifiers, sometimes we find managers that have diluted their value add because they’re trying to solve more for that behavioral aspect of investors where if they can put up something that’s low-vol, but yet still a respectable return, then investors tend to gravitate toward that, and that’s not what we’re looking to do across the RMS framework. We want to get as much juice as we can out of managers because we believe across the three functional components of RMS, you get that correlation benefit. Over time, perhaps some trend followers, some long vol managers, some market neutral managers are not running their strategies as hot as they should because, and this is a fault, I think, a suboptimal for our industry in general.

People are too focused on the individual line items instead of the interaction across the line items. So the more capital efficient that we can get these strategies, I think the better, because then what’s the most precious for clients. It’s those dollars. And how do you use those dollars in the most efficient manner?

And the more efficiency we get there, the more dollars they have to deploy to other parts of the portfolio, whether it’s private credit, private investments, venture cap, public equities, public credit, that are less capital efficient. And I think the only way to do that, the managers need to, they just need to be open to working with, I think, clients in different ways, whether that’s through managed accounts or through funds of funds, things of that nature. And then we as an industry, I think needed to do a better job of talking about that correlation effect and that interaction effect and less about individual managers, individual, strategies and more about the whole package.

[01:15:59]Adam Butler: That’s a good insight. That line item risk is real, because it is a strange thing. We asked, chatted with Cliff about this. Why don’t you have, why don’t you run your strategies at much higher vol? And he answered well, because I, the, we, when we first launched, we did, right? Because we wanted to maximize capital efficiency. It is the most efficient way to deliver the value to the end client.

The reality is that most clients could not tolerate a line item at 20 or 25 vol. It just, you look at that line item, you’re in a 40% drawdown, which is like a, not even a one standard deviation event, and the client wants to pull the plug because the perception is that the strategy’s not working right?

So there’s this strange, there is this strange behavioral trade off. I think there’s a sweet spot where you’re maximizing capital efficiency, but you’re doing it in a way that is still palatable for the end investor who can’t help but at least be asked by the board on a line item by line item basis, why are we still investing? This manager’s in a large drawdown, right? So that is a complication, no doubt.

[01:17:01]Jason Josephiac: And yeah. And then I, sorry, go ahead.

[01:17:04]Ryan Lobdell: I was just gonna maybe add to that point. I think that goes back to thinking about constructing something that people can hold as a strategic allocation and not try and time it.

I think that’s really important, is coming up with a framework where you can think about, let’s just have this, it’s gonna be 10% of our portfolio and we’re gonna hold it forever and we can do that and thinking about it that way, because we don’t know, we can’t time it. We have no ability to do that.

That’d be nice, but I don’t have any confidence in myself to do that. So if we can create a framework, and what we tried to do in the paper was describe something where that might allow that to happen. And I think maybe another thing I might add that’s a little bit different, is our hope, I think in writing this paper that maybe is totally aside from the RMS thing, is just hoping that people will start talking about what risks do I have in my portfolio? Maybe you think RMS or how we’ve laid it out in the paper doesn’t make sense or there’s other strategies to include, but let’s at least have a conversation around what are the strategies I’m allocated to, and how should they perform in different environments? Cause I don’t think that happens probably nearly as much as it should. And that hopefully reframes the conversation. And to the point earlier, nudges everybody in the right direction.

[01:18:17]Jason Josephiac: Yep. Amen, and we don’t want managers to try to be all things to all people, because you can’t be. Now some firms I think can pull it off to some extent, but if they’re trying to solve, say for the, like the RMS framework and saying, okay, we’re gonna launch a long vol strategy, a trend following strategy, and a market neutral strategy. But their DNA is trend following or long vol or market neutral, in isolation. That tends not to end well. In some situations, it can work. But we want the specialist, the individual free safety, the individual linebacker in the defensemen.

We don’t want a bunch of Ed Reid’s on our defense. But again, if you have a top player, like Ed Reid, he can maybe play linebacker position too. Who knows? But we just want people to be true to who they are in terms of the strategies that they have to offer. And we can evaluate whether it makes sense to do something across the buckets on a case by case basis.

[01:19:19]Ryan Lobdell: If you’re Dennis Rodman, be Dennis Rodman. Yeah, that’s right.

[01:19:22]Jason Josephiac: The best expression.

[01:19:23]Ryan Lobdell: … of that. Paint your hair.

[01:19:24]Rodrigo Gordillo: Get those, yeah, those piercings. Embrace, fully embrace, be a weirdo. Awesome. that’s been, this has been great. Yeah. This is fantastic. Thanks for coming on and, giving us a recap of the paper and the ideas.

I know, Jason, you’ve been here before. I think the ideas have evolved a bit, and the new white paper, if you haven’t read it, go out, Meketa, meketa.com. what’s the, area there? The, thought leadership? Yeah, you’ll see it there. I think it’s four or fifth down the line. Definitely give it a read.

It’ll at least help you think about your asset allocation in terms of risk rather than dollars and get you prepared for what is likely to be a very different next decade than the previous decade.

[01:20:10]Jason Josephiac: And we’ll also plug our white paper that our colleague, Colin Bibi did on the functional framework that we’ve referenced quite a bit today.

[01:20:18]Rodrigo Gordillo: Yeah, and what’s the title of that framework? Is it of the paper? Is it called Functional Framework?

[01:20:24]Ryan Lobdell: It’s called Functional Allocation Framework. It was published in January of 23.

[01:20:29]Jason Josephiac: Okay. Awesome.

[01:20:32]Adam Butler: Wonderful. Sounds very complementary. All right, guys, thanks again. Keep us apprised of any new publications or concepts and we’d love to have you back on to explore them. Awesome. Yeah.

[01:20:44]Jason Josephiac: Thanks for having us. Always a pleasure.

[01:20:45]Ryan Lobdell: Yeah, thanks for having us. Appreciate it.