You're about to join Niels Kaastrup-Larsen on a raw and honest journey into the world of systematic investing and learn about the most dependable and consistent yet often overlooked investment strategy. Welcome to the Systematic Investor Series.

Welcome and welcome back to this week's edition of the Systematic Investor series with Alan Dunne and I, Niels Kaastrup-Larsen, where each week we take the pulse of the global market through the lens of a rules-based investor. Alan, it is wonderful to be back with you this week. Hope you're doing well. How are things in Dublin?

Good to hear you, great to be back on, nice winter sunshine I should say. Yeah, getting very festive and pretty, but nice around. So, looking forward to our discussion today. Plenty to chat about.

There is actually plenty to chat about with a couple of world exclusives, so I'm told. One, thanks very much to you, a new paper that we will be talking about today. And the other world exclusive I think is courtesy of SocGen, actually, which we'll get to a little bit later. So, needless to say, we've got a very solid lineup of topics today. But as usual, before we even get into any of that stuff, I'm always curious to know what has been on your radar recently.

Absolutely. Well, one of the big talking points in markets is the next Fed chair. And it's been something I've been monitoring for a while. I wrote a paper back in the summer about it, and at that stage Chris Waller was the favorite according to the betting markets, the likes of Polymarket in the US. But we've seen some very interesting moves in the last few weeks. Kevin Hassett has gone from being kind of second or third in the running to being a clear favorite now. So according to the Polymarket betting market, the likelihood is about 70% that he… Well, it's touched a high of 80%, and now it's about 70%. So, clearly money talks. So, the suspicion is somebody who has information is betting on him becoming the next Fed chair. I would guess that he would be a bit more dovish. He's obviously a cheerleader for the administration and he has been on the record saying he believes in the productivity boom and the disinflationary implications. So, certainly it's something to monitor and that's probably going to continue to be on my radar for the next few weeks.

Yeah, I mean it's a great topic. I don't know his background. Is he well known?

He is well known, I mean he is well regarded amongst serious economists. You know, he has the proper academic training. He did write a book back in 1999. He co-authored a book called I think it was Dow 36,000, at the time, which of course he was eventually right, but it just took a little bit of time to get there. You know, it fell in half first. But he is regarded as a serious supply side oriented economist with proper academic credentials. But obviously he's been very close to the administration and these days if you turn on CNBC, you'll see him every second or third day, it feels like, defending the administration's policies, which I guess is part of his job. But yeah, that's the suspicion that he's been so close to the administration that can he truly be independent if he takes on the job of Fed Chair?

I actually had this point further down in our conversation today, so I did a little bit of research, or at least I saw a headline about it, and my understanding is that we are now promised that we will know who it's going to be no later than the 25th of December. So, that will be interesting for sure. , on my radar, nothing nearly as exciting, except if you are in the crypto space. There's a little bit of good news, there's also a little bit of bad news, I think. So, the good news is that Vanguard, who is the second largest asset manager in the world, they've decided that ETFs and mutual funds that primarily hold cryptocurrencies can now be traded on their platform. And that is kind of changing a long-standing position that they've had on this. I guess that's good news for the space and for people looking to invest in these products. Maybe the other, maybe the bad news, so to speak, and we know that, probably, from our own industry, when markets go down or performance goes down and people rack up a few losses, it makes the headlines. And of course MicroStrategy, also now known as Strategy, is making headlines. And, you would think, it's only because they're down substantially from their highs in November 2024. But actually what caught my attention is that they're now facing some pressures over the positioning that MSCI is likely to take where it will remove them from their benchmark. I haven't, you know, studied the details as to why they wouldn't want to have it included, but there are some speculations that may have a negative impact in terms of people who just simply need to redeem or sell the stock, if, in fact, it's no longer part of that index. So, that was a little bit of what I noticed this morning. Now, we're going to do something slightly different this week because we had a couple of questions via LinkedIn which I think is kind of the main platform people find you at nowadays. Is that right?

Generally, yes, yeah. So, I put it out there this week to see if there was any topics or suggestions and we had two suggestions, thankfully.

Yes, absolutely. We had one from Paisley, who is an industry colleague, I think it's fair to say, and she writes, I'd love to hear your thoughts on how trend following can weather this storm of constant political shocks from the current US administration. Seems like another few years ahead of us of shifting focus and policy pivots that could cause trouble for trend. (It's a very catchy headline, actually - trouble for trend.)

That's true, and it's obviously a very topical question we've seen this year, obviously in the early part of the year around Trump Liberation Day (we've nearly forgotten the name of it now) announcement, very choppy. And I've certainly got this feedback from investors of, could we be in this environment where we'll have policy being announced and then being retracted, etc., and leading to choppy markets? And I think it's definitely a valid concern. I mean, you can take two ways of answering this. The blunt answer is, yeah, it's possible. We don't know. We never know what the future holds. At the same time, I think there are other perspectives we can take. We have seen instances in markets like this before when trend following has been in drawdowns. If we go back to the 2012, 2013 period, 2012 in particular was very much a risk-on/risk-off was the term people were using a lot to characterize markets. And it felt like we were always going to be in this kind of on/off type of risk cycle. At the time, it was very much related to the European debt crisis and would it be solved or not? But ultimately, what do we see? We saw a change in the fundamentals, at some point, where we saw weaker economic growth and a breakout in European bonds, and a sell-off in the euro and a breakout in oil prices. So, typically that's what you see. Markets go through these choppy phases and ultimately they can be testing for investors, particularly investors in trend following. But eventually, in the past, we have seen breakouts or new pieces of information coming into the market. The other example would be we had a tough period in the latter part of the last decade. Performance did start to improve around 2019, but then we had Covid, which was kind of a new jolt for markets and knocked the economy out of secular stagnation and into a new regime. So, I think. There is an old expression, I don't know where it comes from, “And this too shall pass”. So, I think we’ve got to hold onto that and say yes, it is tricky with these kind of policy reversals. Yeah, you could definitely make the argument that it will continue. But equally, we have seen this type of thing in the past and eventually it has passed and we have seen better conditions for trend followers.

I would add two things to that. One is that you would think that the environment that Paisley is referring to might be great, actually, if you're a short-term manager because the moves are generally short-term and there are quite a few ‘changes in direction,’ and so on, and so forth. But actually, this year has turned out to be a pretty horrible year for short-term strategies. So, I think that's an interesting takeaway from investors because I think the intuition is that it should be the opposite way around. So, I think that's one thing that people should be aware of. And the other thing that I kind of take away from your comment where you mentioned specifically like periods around Liberation Day, in my conversation last week with Andrew, he's always a great sport when he's on, he did mention that most of the outperformance that they have seen in their strategy this year came around Liberation Day where potentially they were either too slow, just that was the fact that they were too slow to react or they were ‘in the right markets’ and didn't get hurt by some of the, the movement. So, I mean those are just very interesting observations. I think it doesn't necessarily take anything away from trend, but it does suggest, certainly, that there will be specific events in a year that can either go, you know, against you or in your favor. And that's obviously why people need to take the long-term view. All right, so, appreciate the question, Paisley. And also I do appreciate all the likes that you give us on LinkedIn and other social platforms. Love the support. Thank you so much for that, Eric (and I'm deliberately not saying their last name. I have no permission necessarily to do that), but Eric is also a long-term friend and listener of the show. But he has a question that I think might be a little bit difficult for us to answer. He's writing, If you have time, how are managed futures in general positioned for a yen carry unwind?

Yeah, I mean it's a difficult one to answer in some senses because we haven't had the unwind yet. So, I mean, the yen is a little bit stronger the last few days. I think, clearly, trend followers are short yen. It's been a trend for a while. I think it's actually quite an interesting trend, if you look at it, particularly for the yen crosses and markets like Euro/yen, Swiss/yen, I mean, these have been very popular, bearish calls from market commentators. Swiss/yen in particular was Japan's going to be hiking, the Swiss are going to have to coast. The Swiss yen goes down. I've heard this argument so many times in the last two years and yet it continues to trend higher. So yes, if we have a yen carry wind, I would expect it to be negative for trend followers in those markets. As ever, the full impact will depend on the speed of the move and the context of what else is happening in the world. But on the flip side, you know, trend followers have definitely participated in that yen weakness which has been much more persistent and prolonged than I would say most people have expected.

Yeah, but maybe you could even suggest that most of the exposure is not necessarily outright in the end, but it might be in JGBs at the moment. So, that's another twist in that story. Great stuff, okay, let's move on to the trend following update since we're kind of touching on this already. My trend barometer finished yesterday at 39, which is on the weaker side. And it is kind of suggesting a neutral to a little bit weak start to December, which I think is also what we're going to discover in the performance numbers in a couple of minutes. But since we just finished November, I'm always interested in hearing kind of your thoughts when you look at the landscape. Was there anything that stood out to you in the month of November? December is a little bit too young, so to speak, to have had any meaningful stories, I think.

Not really, no. I mean we've obviously had a tough start here in trend following and then a recovery and a bit of flatlining I think since then. So, you know, I mean, for many managers now, it's shaping up to be certainly not as bad as it looked a few months ago. But no, I mean nothing apart from what we've kind of previously discussed, I'd say.

Yeah, I mean one thing, because it never really gets mentioned, but if I look at the landscape, I would say many trend following managers, at least the ones that I keep an eye on, I think it was like the fifth or sixth consecutive positive month, maybe the fifth consecutive positive month. That doesn't happen too often. We talk about the difficult start to the year, but there's been a lot of, you know, decent performance following the first half of this year. Now, from a performance point of view as of Tuesday, 2nd December, and by the way, I think yesterday was a pretty okay day for most CTAs, but as of Tuesday BTOP 50 was down 22 basis points for the month, up 1.22% for the year. SocGen CTA Index down 35 basis points for the month, down 1.64% for the year. The SocGen Trend Index down 27 basis points for the month, up 19 basis points for the year and the Short-Term Traders index down 8 basis points so far, but down 5.41% in 2025 which is, as I've mentioned before, based on its volatility it's a reasonably big number. On the other hand, MSCI World continues to move higher, up 11 basis points so far in December up 20.72% as of last night. The S&P US Aggregate Bond Index down 11 basis points, but up 7.1% so far this year, having a good year. And the S&P 500 pretty flat, 3 basis points to the positive as of last night, up 17.84% so far this year. All right, I mentioned we have two world exclusives. One is coming, because that is your new wonderful paper. The other one is actually that SocGen very kindly allowed me to share the tentative 2026 lineup and the AUM cutoff levels they're looking at in order to qualify for the indices. And I'm focusing on the SocGen CTA Index which is the broader index, and the SOCGen Trend Index which is more narrow and has fewer earned constituents. So, if we look at the broader, the SocGen CTA index, the cutoff level for 2026 looks like it's going to be around US$1.9 billion in the program. That means we have a few new people joining that index. One of them is our friends CFM, their ISTrends program. So, that would have seen a decent significant increase in AUM, I would imagine, in the last 12 months, congratulations. The other one is a new name for me, AFBI, I’ve never come across that name before. It turns out that you have. But also, it turns out that it is almost a local, from a Dunn Capital perspective, because they're also based in Florida. And so maybe I should have known of them, but it is a multi-manager firm. That's probably why it hasn't been on my radar. And a third program that is qualifying for the SocGen CTA index for 2026, it looks, like is the Crable Advanced Trend program. So that's a great effort. It's also a little bit interesting to me because, for those of us who've been around for three decades more, we know Crabel for one thing and that is being one of the premier short-term managers. But now, as far as I can tell, their larger strategy is no more short-term. It's actually their trend following program. And I think it tells you something about the long-term viability of short-term versus long-term strategies. That is my own words, of course. They may not agree with that, but I think it's an interesting development. Now, we have some people that came into the index. That means we have some people who will be taken out of the index due to this AUM criteria. So, we have Epistein that is being removed from the index. We have another Crable program. So that is not the shortest one they have but the shorter one which is Crable Gemini. That program is being removed. We have Graham Tactical Trend but that was more to avoid the duplication of the Graham Quant Macro program which, from my understanding, has some overlap, in terms of allocation, to the same trend model. So, I think that was a call that SocGen made which makes total sense. All right, then we have the SocGen Trend index, and boy has it become difficult to be part of that exclusive group because the cutoff level, I actually don't know if this is higher or lower than last year, but the cutoff level for 2026 looks to be US$4.64 billion in one strategy. That is not an insignificant amount of money in a strategy. That means one change coming into the index is PIMCO Trends program. being removed is a firm that's very well known in our industry and that is Systematica, actually also Swiss based, Leda Braga's firm. So, a little bit of a, I don't know… What are you most surprised about? What are you most excited about, Alan, when you see these names going in and out of the index?

The day would be pretty sad if I got excited about, you know, new entrants into the SocGen CTA index. But I am, yeah, a little bit surprised. AFBI I am familiar with them. I always sort of thought of them, as you say, as a multi manager, that kind of. They're not multi manager as in external managers, but yeah, multi-PM model obviously. They haven’t been around in this current iteration for that long, so maybe they've just grown sufficiently in terms of AUM to warrant justification. But it certainly would be more in the kind of quant macro side. As you say, you know, Crable... So, is multi product not in that at all? Because, historically, that would be obviously the product most associated with Crable. Gemini obviously has had some diminished assets lately, so, probably not surprising to see that moving out. But yeah, I mean it is interesting, as you say. I mean the AUM threshold is very interesting in that it is at such a high level this year and, I guess, speaks to how we're seeing maybe the largest trend followers getting bigger and just consolidating their position in the index.

So, I'm not going to go through the whole CTA index, that's too many names. But I can mention the 10 names that looks like, I should stress, looks like to be in the SocGen Trend Index. That's obviously closest to my heart. It looks like it will be Alpha Simplex Managed Futures. It looks like it will be AQR Managed Futures, Aspect Core Trend, Graham Tactical Trend, iSAM Vector, Lynx Program, Man AHL, Alpha, Pimco Trends, Transtrend, DTP, and the Winton Trend program. So those are the ones we need to keep an eye on if you're in this space, but hopefully also on some of the names that did not make the index this year. All right, now, which is something we normally do a little bit earlier in our conversation. So, I'm excited about having it now after the trend following segment. It is your current macro view, Alan. There should be enough to focus on as a macro observant, but what have you focused on?

Yeah, a few things I wanted to touch on. Just obviously in the context of moving into December, a lot of focus on the Fed, expectation now that we'll see a rate cut. Maybe going back two, three weeks there was a lot more uncertainty about it, but expectations have definitely tilted. And, obviously, it is interesting that we're seeing the Fed cutting rates at a time when inflation has settled very much above target and the trajectory towards 2%. The momentum has slipped and there is a clear split within the Fed, as well, between those saying no, this is not really the way to go forward because inflation has proven stickier than expected, and maybe the governors Waller and Williams and probably Powell is ironically probably more in the dovish camp. But one thing that I saw that was interesting was the San Francisco Fed had a research piece out, looking at the impacts of tariffs. So, they did a cross sectional study, over 40 years, across different advanced economies looking at, from a purely economic perspective, the hard data; how tariffs have impacted unemployment and inflation historically. And obviously, the historic changes in tariffs have been much smaller relative to what we're seeing now. But it is interesting all the same. Actually, what you've seen historically is unemployment tends to rise straight away when tariffs come in. Consumers seem to take a step back. Actually, inflation tends to fall initially, but then in the year after, in the subsequent two years, tends to rise to a reasonable degree. So, I mean it's certainly plausible. I mean a lot of commentators have been arguing that we could be seeing a delayed impact of the tariffs in the US economy. Obviously, wholesalers, importers may have taken the hit on the tariffs. So, I think, from that perspective, there is a little bit of maybe complacency around the markets. With this, I think the Fed probably will cut. But cutting in this environment where inflation is already above target and there is still that residual uncertainty of the impact of the tariffs. I think there's certainly complacency from that perspective. But I think taking, a step back, just thinking about the bigger picture is interesting. Obviously, we've transitioned, we've all set into a new macro regime. And I think one of the things that is evident in that regime is the change in bond markets. And if you look at bond markets outside the US (you touched on JGBs already), JGB yields have been rising steadily. We've seen the same thing in European markets; German 25-year yields up to their highest levels in a number of years. So, the bond market is telling us something here I think, which is interesting. And I think it's symptomatic of that change in regime where we've gone from this excess capital world, when we had negative yielding government bonds all over the world, to now, this world of more positive yields and the trend higher in an environment like European bonds, yields trending higher without much news behind it, and Japanese markets continuing to trend from a yield perspective. So, I think that is telling us that there is more competition for capital. Obviously, we've had the extreme investment in data centers, AI etc., and that is fueling demand for capital to an extent, and on the public side, rising defense spending. But all of that together is telling you that the savings investment relationship has shifted more towards stronger investment demand, pushing up pressure on yields versus the old regime where we had excess supply pushing down yields. So, I think that is a risk factor in markets. We haven't really seen it hitting the US market yet. 10-year yields are still around 4.1% or so. So, the US has probably been the outlier. But certainly, that is one thing that I'm focused on. And I think the other thing that I think is interesting at the moment is we've had this… A lot of people I talk to draw a parallel between now and the mid to late 1990s and say, look at the markets, tech boom, it's a productivity boom. Does that mean that the equity market can keep going on for another few years before we see a turn down? Clearly there are parallels between tech stocks doing very well, but, actually there are differences as well. And I think, even on the AI productivity side, the ‘90s was quite interesting because as we got into the mid to late ‘90s we had the development of the Internet, but that wasn't what was fueling productivity at the time. What was fueling productivity growth at the time was more use of personal computers. That technology had come in previously. So, you had this coincidence of an old technology that was starting to permeate the economy and you were getting to productivity benefit on that side, on the supply side. But also you had the demand side of more spending on the Internet infrastructure. So, if you compare that today we're seeing the impact of AI from a demand side in the sense that there's spending on chips, spending on data center, and that's actually pushing up GDP arithmetically. That's spending as part of GDP. But the other side of the equation is, well, are we seeing the productivity gains yet? And there's mixed evidence. So, there are two studies. McKinsey have done a study on this recently, the state of generative AI adoption, and basically saying a lot more trialing than actual use so far. And there was also a study out from the St. Louis Fed as well, looking at, are we seeing actual gains from productivity? And again, similar, some gains at the margin. But I think people sometimes misinterpret that kind of distinction between the demand side and the supply side. Yes, we're seeing the demand influence, but it’s a bit early to say we're seeing the supply side benefits yet. You know, there are different views on that. So, I think this parallel with the 1990s is a bit superficial. And the other big thing in the background, and we'll talk about a little bit later because I touch on this, it's critical point in my paper, debt levels are much different than they were in the 1990s. The debt to GDP level in the US is double what it was in 1999. In 1999, 2000, there was a fiscal surplus in the US. So that's dramatically different. We're in a much more unstable environment now when we have this confluence of elevated equity valuations and high debt levels. So yeah, interesting that people draw that parallel, but I think we're in a much more unstable and riskier macro backdrop now than we were in that kind of mid to late 1990s period.

Yeah, I mean, one observation, one question for you. Regarding the AI, one of the things that kind of stood out to me was exhibit one in the McKinsey, which I'm sure you know by heart, in the McKinsey paper. It looks at the kind of the use of AI by the responders to their survey. And in 2017, 20% responded yes, which actually to me that's surprisingly large. Back then you wouldn't have thought that, but I mean, today it's like 88%. I mean, it just really shows you how much the penetration is or at least the use of AI. I mean, even I would fall into that category because I do use ChatGPT from time to time. Anyways, the other question I had, and I can't remember if you answered it because I do find it very interesting what you say about the longer-term rates and how they're not really coming down. In fact, they're creeping up, and in parts of the world they're really creeping up. I mean, do you think that a lot of that is driven by just fiscal dominance that we have now? That this is what they really fear, the market participants, that politicians will simply do whatever it takes from a fiscal point of view to get through their agendas and, as you say, just leave the economies even worse off from a debt point of view?

Yeah, I think it's a number of factors. I mean, as I said, the economic explanation is long-term bond yields reflect the savings versus investment. And this was the reason why… The conundrum in Greenspan's era, why were bond yields going down all the time? Because of this excess savings from Asia. And then in the 2010s bond yields went negative. Why? Because there was so much capital around. And the view was the technology firms didn't need a lot of capital. Software isn't something that is capital intensive. But now we've moved into this AI economy where there is huge capital being deployed in data centers and spending on chips and then on the public sector, as you say, we've got rising defense spending, whereas previously we had a peace dividend in the 2000s. And, you know, every time there's a problem the cost of living goes up. We need more fiscal support, not less. So, the political environment is such that there's no appetite for austerity or fiscal restraint. And I think that's what we're seeing in that trend higher in bond yields.

Yeah, cool. All right, now let's get to the second world exclusive. Thanks to you again, Alan, because you have been busy working on a really terrific paper. I very much look forward to talking about it and I really do hope people will go and download it, which we'll come to later on. If you don't mind, I would like to start out by just reading two quotes that you start out your paper with. One by a guest that I hope you will get for your series and the other one by a guest that you already had on your series and who's returning very soon. So, the first one, the first quote is, “What is the biggest single mistake investors make? It is that they conclude that the way things are today is the way it'll always be and the things that have been happening will continue to happen.” That is, of course, Howard Marks wise words. The other one is from William White, or Bill White, and he says in his quote that you use, “These systems always break down. The lesson is be prepared.” And then you (and I'm not going to steal your thunder) actually also have a very, very good introduction that kind of sets out the backdrop and why this paper is really something. It's a must read without a doubt. So, I think maybe it's better for you to start out. I will hopefully be able to ask a few relevant questions along the way. But I don't want to steal any of your thunder here.

Sure. Well, maybe I'll just share why I wrote this. I mean, rather than go through it; there’s a link to the paper, so I won't go through it page by page. But I'll give you a sense of why. I mean, when I'm working with investors, whether it's family offices, or institutions, or high net worth individuals, there's been a few themes I think that have been recurring of late. Things like, clearly we're in a new macro regime, so, does that require a different in approach from an asset allocation perspective or from a portfolio construction perspective? That's one thing. A second thing is, then, what's the right way to think about integrating alternative investment strategies like trend following macro alongside traditional investments? And then, more recently we've had the growth of concepts like return stacking, portable alpha, etc. And how do we think about incorporating those? Very often they're positioned as building blocks. But what should an overall portfolio look like? So, these were all topics that I think I'm hearing a lot of. I wanted to set out a framework for how to think about that and particularly for how to think about the very changed macro environment. And when I talk about the changed macro environment, it's been very apparent, as we were talking about the change in the bond markets. But if you take a step back, we had a 40-year period of disinflation starting in the 1980s when Volcker raised rate and caused a recession. Inflation has been trending down because there was a confluence of positive factors; there was China coming into the world trade system, there was the Soviet Union, the fall of the Berlin Wall. There was an acceptance of neoliberalism, and free markets, and free trade. There was an acceptance of the need for central bank independence and inflation targeting. And all of these things were disinflationary forces which led to lower inflation, and more stable inflation, and more stable economic growth as well. We had what was called the Great Moderation. Now clearly, we've transitioned out of that into a new regime. Since 2022 we've had shocks with respect to Covid, the Ukraine war, but not just that. There's a sense that inflation is going to be higher and stickier. And this , I suppose, being reflected in a change in the bond equity correlation. And all of that is well known. But I think there are other vulnerabilities in the system, which I touched on earlier, particularly this coincidence of high debt levels at a time of high equity valuations. And why is that significant? Well, I don't hear a lot of people joining the dots on this. But if you think about it, the worst thing that can happen from a debt perspective is if we get into a recession. Why? Because you need to spend more, tax revenues go down, you get a big fiscal deficit. And if you look at the trajectory of the US debt/GDP ratio over the last number of decades, every time you've got a recession, you've seen you get a step change higher. So, if you get under a recession now, and why might you? We've got an increasingly financialized economy. US households own about, I think it's about US$40 trillion of equities. So, if you had a correction in equities or a bear market of the magnitude that we saw in 2000, 2002, the former IMF chief economist was suggesting that could knock US$20 trillion of wealth alone. So, we're much more levered into the equity market than we were in the past. And also debt levels are already at the point of concerns about fiscal sustainability. So that could be the straw that breaks the camel's back, and that increases the risks of what you're talking about from a fiscal dominance and financial repression perspective. So, the question is, we're into an environment where, yes, the bond equity correlation is less stable, more positive. You've got a greater risk of tail outcomes, whether it's runaway inflation or even deleveraging, disinflation or deflation. And at the same time, the policy framework has changed, central bank independence under threat, etc. And all of that just underpins this idea of the risk of fiscal dominance, financial repression, etc. So, what I wanted to address in the paper was, one, that macro change. Two, what are the problems with kind of the traditional approaches? And then what's a new framework? I mean, just briefly, the problems with traditional approaches are categorizing assets and strategies using blunt labels like ‘alternative’ or ‘traditional’, ‘public’, ‘private’. Something like credit is also often seen as a diversifier. But actually, it has a low correlation to equities when equities are going up. But it doesn't have a low correlation, it tends to be positively correlation, when equities are going down. So, is it really a diversifying asset? What I wanted to set out was not just the shortcomings of traditional approaches but also make a case for a stronger allocation to what I call adaptive strategies, trend following being one of those. So, strategies that can respond to a more changed macro environment. Systematically in the case of trend following. Obviously the likes of discretionary macro is the same. And also, I wanted to address, maybe a misconception (maybe that's a little strong) that trend following is often positioned as crisis risk offset, crisis alpha risk mitigation. So, you often have portfolios where you have equities for growth, bonds for defense. And trend following is more in the defense category. But actually the way I see it is they're more like the midfielders. Trend following can be proactive, it can be pro-growth, pro-risk at times when the equities are trending higher. They have the flexibility to add risk in those environments. But when conditions change, they have the ability to reduce risk and play more defense. So, I know you talked about the total portfolio approach before. So, basically they act in that way, that the total portfolio approach is trying to achieve, of pushing risk into those sectors where the opportunities are greatest. So, in my paper, it sets out to do two things. One, is to set out a framework and then a portfolio suggestion for this era. And where the portfolio, I suppose, differs from many of the conventional approaches is it looks at things from a risk perspective. So, I'm thinking in terms of risk contribution, not capital amounts. And the framework has a 40% allocation of risk to growth, 40% to adaptive strategies, and 20% to diversifying assets and strategies, and also uses tools like return stacking and leverage. And obviously places a primacy on adaptiveness as a key driver as opposed to thinking about trend following and adaptive strategies as just purely diversifiers. They're the mechanism by which the overall portfolio tilts its risk posture. So, within the paper, there's the chart showing the rolling equity beta of this adaptive portfolio, which swings much more dramatically from kind of negative to over 1, than say a 60/40 portfolio, which has a pretty consistent 0.6 equity beta. So, I mean, it came from, I suppose… The reason for writing a paper emanated from, I suppose, those investor questions. I have been running a portfolio like this for my own money for a while and have had some queries around that. So, I wanted to set it out in a framework as well. But I do think we're at a point where investors are looking for an alternative framework and an alternative approach but haven't formalized that yet. So, this is really setting out to achieve that.

Okay, so I mean, quite a lot, even in that little introduction, so to speak, quite a lot to dig into. But I know we have a lot more to cover, but a few things that kind of came to mind as I was hearing you talking about it. We often talk about this regime change, and we often talk about the changes in the absolute level of say, interest rates, for example, but even also the correlation change that we've noticed, which, obviously, you can go back 125 years worth of data, and every time interest rates go above 3%, 4%, the correlation tends to go positive. So, it's obviously nothing new. But there's one thing that I wanted to ask you, and I don't know if you've done any research on it or just maybe your gut feeling, because I think what we don't talk so much about are actually the changes in inflation and inflation expected changes. Meaning going from this stable, predictable inflation to this more unpredictable inflation environment. To me, that strikes me as being quite a large challenge, not just in ordinary business planning and all of that but also in the investment world. And oddly enough, I think that, although it may not show up this year, it could well be something that I think trend following tends to do better in those kind of environments where inflation may not be high but it's not stable at least. So, I don't know what you think about that.

I have a few things to say on that. One is, given that we've already had this inflation spike in 2021, 2022, consumers, market participants, everybody's more sensitive to inflation now than they were five years ago. It wasn't a talking point in 2020. So now, if you do get higher inflation, people remember we had this before. So, there's an increased risk of inflation expectations being de-anchored. And this is something the Fed has talked about. They've said they don't see it as a risk, at the moment, given that unemployment is rising, but it is something that they see as theoretically something to be aware of, the fact that you've had that inflation episode means there's a heightened sensitivity. And obviously what's the big talking point in the US at the moment? It’s all about affordability. Prices have stayed high even though the inflation rate has moderated. So, I think that's one thing. In my paper I do look at instances where inflation was 1 percentage point above its 2-year average and 1% below. And as you say, trend following is the one strategy that very much stands out when you get those inflation surprises. So, I think that's definitely part of it. And I think, as we've touched on earlier, the inflation fighting credibility has been squandered somewhat. I mean it was hard won, Volcker, Greenspan in that era, but now we're at risk of throwing it out. And the reason central bankers fought so hard for independence and lower inflation was because once it became embedded in the system in the ‘70s, it was so hard to wring out. So, I think that's a very big risk, that complacency.

Another question, you mentioned the total portfolio approach, which we've talked about the last few weeks on the show because of the changes happening at CalPERS. Is there a large difference from the way you think about it in your adaptive approach rather than the total portfolio approach? And if there is, is there a way for you to kind of narrow that down and say, well this is how I see this being a little bit different to what they're doing over in California?

Yeah, well actually it's something I looked at (I'm referencing the paper). The portfolio I run, this adaptive portfolio, it basically is equivalent to kind of using a 60/40 as a benchmark, but with about an 8% tracking error, whereas CalPERS are looking at about a 4% tracking error versus their benchmark, which is I think 75/25. So, I mean, I suppose it shares that philosophy or you can view it from that total portfolio perspective, but obviously with a lot more flexibility around… And obviously the 60/40 isn't a benchmark. I'm just looking at the historic performance relative to that. So I mean, the issue with total portfolio, I mean, I think it's a good development, it's all positive. It makes sense. I think it really just reflects the shortcomings of how large institutions were set up previously and how they did strategic asset allocation. But to still start off with a reference portfolio, where does that come from and what justifies that? You know, it's still kind of embedded in old ways of thinking up to a point, albeit it gives them a certain amount of flexibility. But you could have much more flexibility to deviate from that kind of reference.

Yeah, the other final thing, and then I'll let you dive even deeper into your paper, but the other thing that I noticed that you bring up early on in your paper, and that is this, that you use the words ‘traditional’ and ‘alternative’ and then you reference them as being the labels we've become used to. And I don't know if you intended to do it or whether it's just me reading into it, but I think there is room to really question what traditional is in this new environment. And if you and I, which I'm sure we will in 10 years time, be talking on, on Top Traders Unplugged, maybe we have a completely different.\ narrative around what is traditional in a portfolio. So, I don't know if you intended to open that debate, and feel free just to jump in where you want to go in terms of your…

I mean, I think it's absolutely a valid point. The point I was making is sometimes you put a label of ‘alternative’ on something and then people assume that means, okay, it is very diversifying. So, the point is, you know, you've got assets like private equity, venture capital, they're alternative growth, they're not diversifiers. So, you know, we talk about, and again, public versus private. There is this almost a kind of insinuation that the private is diversifying. But no, it's not. It's just a private expression of the same risk that you're getting in public markets, just it may be better or worse, but it's in a private… So, that's why I think, you know, you can have too many labels. So, I've brought it down to growth, diversifying assets and strategies. But the threshold to be regarded as a diversifier is higher. And then I suppose I see adaptive strategies as a unique form of diversifiers that have that flexibility to tilt in their risk posture. But I think one of the things I wanted to talk about in the paper is not just the mislabeling, but why, as well, investors struggle to hold these pure diversifiers. We've talked about it before. JP Morgan Asset Management and GIC have done a study on if you are optimizing a hedge fund portfolio by itself on a standalone basis, you get a different outcome than if you optimize a hedge fund portfolio in the context of a broader, traditional portfolio with bonds and equity. So, if you construct it on a standalone basis, you get more into convergent, market neutral, long/short equity, equity market neutral type strategies. But you're already picking up factors that you already have in your traditional portfolio. Whereas if you take a total portfolio perspective, I guess, it naturally points you to the pure diversifiers, which are things like global macro, trend following. They’ve actually added commodities as well. I know David Dredge, our friend, has a lot of work in this, extending it to volatility as well. So, I think that's one thing, this kind of behavioral bias of viewing the portfolio in isolation or viewing the hedge fund bucket in isolation and not thinking about it in the context of the overall portfolio. But to your point, I think something that we will see a shift in is we tend to think in terms of buckets like equities, bonds, multi asset. But now we're increasingly seeing hybrids where you'll have portfolios including traditional assets, but also alternative strategies - some with leverage, some without. So, how do you classify these? What's the right classification? And I think that's something that, you know, the current labels maybe don't account for. But coming back to the point, to kind of the behavioral question, I think another reason why we've seen an under allocation to these strategies historically is because of the capital constraints. Because for a lot of people, if you want more risk, that naturally means more equities just to get the volatility up. But as soon as you have the flexibility to use futures for leverage or to allocate to high volatility strategies, that changes that. And don't forget, Markovitz optimization was based on the idea of you find the best risk adjusted return, you blend based on the best asset allocation, that's what you do first and foremost. And then you decide the level of risk. Do you need to borrow to lever up or do you de-lever to find out what level of risk? So that has been somewhat lost, in the industry, towards this just blanket, oh, you want more risk in your portfolio? Well, that's an 80% equity portfolio. You want less, that's a 40% and that's not the way it should be. So, part of what I address in the paper is, one, about building balance resilience, and then about thinking what's the right risk level. And I think when you take it from that perspective, it's easier to see the merit of having diversifying adaptive strategies. And another shortcoming here is people often judge these strategies from the perspective of the last 15 years when we've had a fantastic equity bull market, which, based on current equity valuations you'd say, well, returns are probably going to be less going forward. So, I think there's a, a number of factors there. Go ahead.

Yeah, I was just going to ask, and just maybe in a sense putting what you just said, trying to put it into the context of what we discussed earlier in terms of the global macro. I mean, what do you think the result is (if I can put it that way) of this structural under allocation to the, let's call it, true diversifiers or the strategies that are adaptive? Given where we are today, if you're going to characterize what the consequence (maybe the consequence is a better word) of that under allocation is, as we sit in, towards the end of 2025, given all the global macro forces that are at play, what do you think the worst consequences might be?

I think the obvious consequence is what you see in portfolios is a concentration in assets to a risk factor exposure that is tilted towards growth and stable inflation. So, as I point out in the paper, if you take your typical institutional portfolio that you often see, say whether it's a US endowment or pension fund, and they've got exposures across public equity, private equity, venture capital, private credit, maybe some hedge funds, but they might be more multi strats or equity market neutral, and then they've got credit, etc., they might have 10, 11, 12 buckets. But actually, if you break it down into how much of the portfolio is linked to growth, it could be 80%. In risk terms it could be more than 90%. Then how much of the portfolio is prepared for higher inflation? Well, they might have some real estate and commodities, and over the very long-term equity should be able to withstand inflation. But, as we saw in the 1966-‘82 period, we had high inflation but equities got derated amid much more macro volatility. So, I think the consequence is that it comes back to the Howard Marks quote that you've mentioned there. Assuming things will always be this way, that we've had this long trajectory of disinflation and steady economic growth. But the issue isn't just the change in the bond equity correlation, so that's a key point. It's that the tail risks are underpriced, that there's what are the scenarios? Obviously much higher inflation I think is obviously a clear risk. And I spoke to Maurice Obstfeld, former IMF chief economist, and he was blunt saying that when a major economy like this US started behaving like an emerging market, runaway inflation is the obvious risk. But also, if you get a boom like that and then if they eventually then hike on the brakes, you could get an asset deleveraging, deflation. And that's something that definitely portfolios are not prepared for. So, I think it's those tail risks that are the obvious, and it's not just those types of institutional portfolios. If you look at a typical wealth management multi asset portfolio, it's always kind of the same, you know, 50%, 60% equities, 20% fixed income, some hedge funds but not enough, small amount of gold. So, it's about rebalancing portfolios and reorienting them coupled with using the tools like leverage.

So maybe you could give us a brief overview. So, what do these allocations look like in your view? (And of course this is obviously hypothetical returns.) When you've gone back and you've done your research, what do the returns look like? How are they different? Let's put some numbers…

So yeah, I mean from a balanced perspective, in the framework that I set out, I have 40% of the exposure in growth assets, in risk terms, and 20% in diversifying assets, in risk terms, and 40% in adaptation adaptive strategies, in risk terms. And the reason for that is it is a growth-oriented portfolio over the long-term, but with diversification for enhancing the risk adjusted returns, and then a high allocation reflecting the changed macro environments and the risks I've been talking about. Actually, the portfolio outperforms the 60/40 going back since… I look back since 1990, it outperforms quite a decent amount in total returns when you compound it over time. The benefit comes from the notably lower drawdowns you see in the portfolio because the adaptive strategies have that ability to respond during the major crises such we've seen 2000, 2002, 2008. And that's where you get the long-term benefit from a compounding perspective. Because in those tougher times the drawdowns are limited. And then when markets recover, you can compound then from a higher base. Whereas obviously equities suffered a 50% drawdown in the financial crisis. Something similar, maybe not as strong 2000, 2002, 60/40 was down, whatever, depending on the level of duration, anywhere between 20% to 30% in 2022. So, it's in those environments that really impacts your long-term compounding. By having that balance and adaptiveness it helps mitigate those drawdowns and compound at a higher level. So, that's one important point. I mean, the second important point is that the strategy doesn't outperform in every period, not even in every five-year period. So, 2015 to 2019 was particularly good for 60/40 obviously was the years when bond yields went to their lowest level. So it's not about building a portfolio optimized for any particular scenario, but it's one thinking about what makes sense for the next 10 years when you don't know is it going to be good for equities, bonds, gold, or trend. We don't know which one of those the environment will favor, or will it be runaway inflation or not, or just a return to secular stagnation, but balancing all of the risks and building in sufficient allocations to strategies that can respond. So, ironically the approach has done better historically, even during that kind of disinflationary period. But you would expect it's a more robust methodology for thinking about the future outcomes.

Yeah. The other thing that I think is quite important, if you think about it with a very large lens, the stability in the returns that you show will, I think, be even more important going forward, given the fact that we have such a large generation of people who are getting very close or in their phase of retirement. So, because the worst thing that can happen as you enter retirement is that you get a big drawdown in your portfolio. So, that, in itself, I think makes it very relevant for people to take a closer look. I'm sure they can get many more details if they engage with you directly, Alan, in terms of how do we get these wonderful returns? If we were going to make a few conclusions, and of course do not forget to tell us where they can download the paper. I'm sure there's going to be a long delay because it's such an exclusive announcement on the Top Traders Unplugged podcast. But it could be ready right after people listen to this conversation, of course. But before we get to that. What should the main takeaway be from people who have been listening to us today, would you say from this new way of thinking and building portfolios? And is it something you would consider setting up so that people could just buy that ticker from you?

Yeah, I mean, I think first and foremost it is a proposed architecture, a proposed framework for thinking, to challenge, I guess, the consensus around the traditional labels, etc. So, I mean, that was part of my motivation for sure. So, to think more in terms of risk terms, not just notional allocations, to think about the building blocks that are available in terms of futures, or return stacked type products, or portable alpha. And to think about if you can combine adaptive strategies within a portfolio, you can overcome some of those behavioral biases that make it difficult, for practical reasons, for investors to hold them. So, I think that's really the call to action, I guess, to investors. So, the paper will be on the Archive Capital website, ArchiveCapital.IE. So, I have been heavily motivated to get it finished, cognizant that we would talk about it today. So, it'll be on the website from when this is released. And yeah, I mean, I've had some interest in this approach, so it's certainly something that we're exploring in terms of executing as a strategy. So, you know, certainly keep tuned. We may have more on that in time.

Fantastic. Good stuff. Now you mentioned, just before we wrap up completely, you just mentioned in passing, you know, return stacking or portable alpha strategies. And I couldn't help reading briefly a note on LinkedIn by another great industry participant, Corey Hofstein, who, and I'm not an expert in this area, it's not an area that really affects me directly, but it has become very popular, these return stacking, portable alpha products. And then he mentioned that a small change in name or labeling by the likes of Morningstar could potentially have quite a large impact on these products. I don't know if you read the note that Corey wrote, but it has something to do with how some of the authorities rank or, how should I say, view these products when you use “leverage”. And if you put the word leverage into the labeling, then that becomes a problem for many platforms to even carry those products on their platform. So maybe you have a better way of describing what I was trying to say here.

I just had a read of it, as you sent it to me. It sounds like I hadn't been aware it was an issue. So, Morningstar have come up with a new category, it seems, for products like return stacked products. I think it's levered multi asset or something like that, which we all know the label leverage can have negative connotations for some investors. Even though there's leverage in lots of places. You get operating leverage from certain companies, you know, it's not an issue. You get to different degrees, you know. What I thought was fair, from Morningstar's perspective, is I do think the labels need to be reconsidered, but maybe something like unconstrained multi assets might be a better reflection of what these types of strategies seek to do in the sense that, you know, multi asset traditionally, in the European sense, would be more often long-only, you know, long equities, bonds, property, etc. Once you start to integrate alternative strategies with traditional assets, you're getting long and short dynamic exposures and leverage. So, I see that as being more unconstrained multi assets. So, that's my suggestion for Morningstar.

Just again, listening to you talking about that, going back to our very first part of our conversation with the company strategy, which we know is not really known for being an IT company anymore, but actually a 3x levered version of Bitcoin, as far as I know, I mean, I could be wrong about the leverage amount. But anyways, I wonder how Morningstar classifies that? Is it just classified as an equity or is it classified as something with leverage, which I'm pretty sure people would say that's probably what's going on in here. Anyways, interesting, an interesting post that Corey had about that and the “kind of uneven treatment” of some of these products, perhaps, when it comes to labeling. Well, I think that wraps up a wonderful conversation, Alan. So first of all, let me just encourage everyone listening to really show their appreciation for not just you writing a paper that they should go and read, but also just all the preparation that goes into these conversations. So, you can do that by going to your favorite podcast platform, and find the podcast, and leave a rating and review and say, of course how great Alan is as a co-host. And in fact, he's so great that he's going to come back next week and he's going to host the show along with Mark. He's going to be joined by Mark because I will be traveling to Florida next week and so yes, that's going to be another great episode for people to tune into. I think that's going to wrap up what we had planned for today. Thanks ever so much from Alan and me. Thanks ever so much for listening. We look of course forward to being back with you next week. And as usual, as always, in the meantime, take care of yourself and take care of each other.

Thanks for listening to the Systematic Investor Podcast series. If you enjoy this series, go on over to iTunes and leave an honest rating and review. And be sure to listen to all the other episodes from Top Traders Unplugged. If you have questions about systematic investing, send us an email with the word question in the subject line to info@toptradersunplugged.com and we'll try to get it on the show. And remember, all the discussion that we have about investment performance is about the past, and past performance does not guarantee or even infer anything about future performance. Also, understand that there's a significant risk of financial loss with all investment strategies, and you need to request and understand the specific risks from the investment manager about their products before you make investment decisions. Thanks for spending some of your vaccines valuable time with us and we'll see you on the next episode of the Systematic Investor.