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 Andrew Beer and I, Niels Kaastrup-Larsen, where each week we take the pulse of the global market through the lens of a rules-based investor. Andrew, it is wonderful to be back with you this week. How are you doing?

I'm great. Look, I'm all dressed up.

You're all dressed up today. Actually, you are. For those who will catch some of the short clips we're going to do, you're all dressed up. Last time I saw you, you were in a warm hotel in Greece. And this time you're looking very, yeah, very polished, I have to say.

Thank you. Not a funeral, glad to say that.

Before we get into all the topics that we're going to be speaking about, which are of course, great, as I always say, just wondering, it's kind of late summer, early autumn now. August passed without too many disasters. We're into September. What's been on your radar lately?

I think, actually, this is something we're going to talk about a bit more today. But I think the astonishing thing to me is, if you just take a step back in where we are today (and it's something we've talked about on the CTA space), if you'd gone back a year or two ago and said this is what's going to happen? These are the 10 big things that are going to happen. We're going to have this political upheaval. We're going to have assassination attempts of presidential candidates. We're going to have radical changes in policies, and threats to withdrawal from NATO, and wars flaring up, and a tariff war for the first time in a hundred years. You’d kind of list all this stuff you'd say like, oh my God, you know, what would the world look like? And I just looked, and the equities are up 55% over that period of time and nothing's broken. And so, I think there's been this… Now it may break. I mean, I'm personally of the view that you can't keep lighting matches, dropping them on a carpet and hoping that the drapes don't catch fire at some point. But it is pretty astonishing, just the resilience of this global system that we have. And of course, usually when I say something like this publicly, it means it's about to cause some massive market calamity. But that's what I've been thinking about.

Yeah, I mean, I agree and kind of on my radar. I've got a few things, and I know some of this will tie in what you said, just to some articles that I found. But of course, the first thing that's really on my mind as a Danish native is what's going on in Denmark right now with the drone activity this week and how it kind of, on one side, shows maybe the weakness of the Western alliance because we haven't really done anything to determine… We haven't been able to do anything to determine who is behind it. But at the same time, it kind of feels very surreal that, what I would consider a kind of a peaceful part of the world, we are now talking about the threat level being at heightened alert in all of the country, and drones flying across the airfields where most if not all our newly bought F35s are stationed. I mean, it really is incredible. It's an extraordinary world. Not necessarily a world that, unfortunately, I think will get any better anytime soon. And it's concerning. And that concern we can then translate into sort of the financial markets. Not that that's more important. It's always, of course, people safety, I would say before portfolio safety. But still, there were a couple of articles that caught my attention, and I shared them with you. And I know you have some thoughts on them because I think you were able to kind of tie this all together. And the first one, I don't know whether this is the right order to do it in, but the first one I wanted to mentioned was this article in DFT where one of our previous guests, actually two of our previous guests had lunch together. Both Robin Wigglesworth and JP Bouchaud from CFM had lunch together. And out came a very interesting article where JP talks about what he now believes to be not the efficient market hypothesis, but the inelastic market hypothesis, where essentially it's a theory that contemplates that $1 into equities. It doesn't just notch the price higher. I mean, you're just talking about how high equities have gone in this uncertain world. It really multiplies it. And I'd love for you to kind of give your thoughts. You may have read the article more closely than I have, to be frank, but I think you are able to kind of tie this into some of the things that you're seeing happening right now.

Sure. Well, first of all, I love the article. And just for anybody who's listening, so FT does these articles where they take somebody out to lunch and the article is half talking about the lunch, and where they're going, and what they're eating, and half kind of the conversation is around a topic. First of all, the two people sitting at the lunch, I don't know, Mr. Bouchaud, I know Robin reasonably well and I mean, you're talking about two incredible minds sitting at lunch. By the way, if you don't have Robin Wigglesworth's book Trillions, I think I have 30 sitting in my office. And the next 10 people who sign up and subscribe to DTU, you can text me and I will send you your free copy of Robin's Trillions.

That is an offer I will take you up on. So, the next 10 people who subscribe to something on my website, toptradersunplugged.com…

Okay.

…will get a book from Andrew, himself.

Free, run, don't walk. So, one observation from it (which we'll talk about as well), the guy's obviously unbelievably brilliant, you know, to be a physicist and write a play on the side. And I'll just tell you a funny story in that. In my career I've worked with people who are just so much smarter than the rest of us. And so, one of the guys that we built DBI with was one of these guys. He was a mathematics professor who then went to Wall Street. But it’s just sort of a funny anecdote about how smart this guy is. I took him to an opera last year. It was a Mozart opera in German. And they have these little things on the back of the seats in front of you where you can put it on, and you can see the lyrics in English or you can see them in German. And his wasn't on. And so I leaned over and I whispered to him, Matt, you know, you can put it on and you'll know what's going on. And he glances over at me, he says, it's okay, I memorized the lyrics. (laughter) Reading the libretto, he actually knew. And so, look, there are some people who's just minds are astonishing. And I think that gets back to the whole idea of efficient markets is that it's the tension between how valuable is a particular talent. And I've always had this view that if you can apply somebody who's got an astonishing talent, but there are certain areas where I don't care how smart you are, you're not going to make it that much better. If you are the very best executive in America running a steel company going through a 30 year structural decline, you're going to have a really hard time. You're the worst bitcoin investor in 2015 and you're a centimillionaire today. You're the worst investor in Miami real estate after the GFC or Dubai, and you're, you know, fabulously wealthy today. So, it is that tension between talent, which we know is not evenly distributed, and then also how that gets monetized and what's the worth of it. And this gets into a very emotional discussion for a lot of people. Now, what I think, with respect to what he's saying, it does dovetail… I think a lot of the orthodoxies; you've had generations of people trained around certain assumptions, and to be a sophisticated allocator was to be able to, not just talk about Fama, but be able to talk about a Black-Litterman model. And, in a sense, what he's saying is that we have generations of people who are trained reinforcing an idea that may be wrong. So, last geeky point, there was an amazingly important book written in the 1950s called the Structure of Scientific Revolutions. And it basically made the point that when you have an existing paradigm, it's very sticky because you have tons and tons of people who are trained in that paradigm. And part of their identity is their knowledge and expertise in that paradigm. And so, what you get, over time, is you get these things that contradict the prevailing view. But it's not until it reaches sort of a critical mass that the vast majority of those people will abandon the first paradigm and move to a second one. So, if he's right, then five years from now we'll be talking about markets in a very different way.

Now, one thing that maybe we could try and let's see what you think about this. And it kind of ties into kind of this active versus passive debate where clearly people like Mike Green thinks that this is really distorting the markets. And of course, what Bouchaud is saying is that, yeah, we've had this tremendous… I mean. what determines more what goes on in markets are the flows, And so, one day if these flows turn, things may be very different, and we may experience something that we haven't experienced for quite a while. But before we get to that point, we have seen, as you pointed out, I mean, despite all the uncertainty, we have seen an enormous amount of upwards market movement in equities. And if we go back of course to the GFC, I can't remember how many fold now we're up from 666. Now we're at 6,000 plus in the S&P. So, I mean, that's extraordinary. And maybe we can kind of slowly tie it in, a little bit, to what we will talk about later on today. Do you think that if they are right about this other hypothesis, so to speak, where inflows multiply the effect of where equity markets are going, do you think that that has also had an impact on, say, performance opportunities in some of the strategies that you and I follow more closely in the alternative space and maybe have impacted change the landscape there? I know we're going to talk about multi strategy funds later on, but again, I wonder whether we are looking at something where we built kind of new avenues and people now are thinking, oh these are fantastic strategies but they're kind of built on a unique time period where markets were behaving somewhat differently than they may do over a longer period of time. Do you know what I'm trying to say here?

Yeah, well, I mean, I think the easiest way to look at it is 60/40 portfolios. I mean, 60/40 portfolios were, basically, one of these self-reinforcing paradigms. You know, I don't think anyone's ever figured out who actually came up with it. So, all of a sudden, it's just 60/40. And then enough people say it. I mean there's this great Lenin quote that, if you say a lie often enough, it becomes the truth. But then there was positive reinforcement, it kept working. And if you'd done it in 1990, then you wouldn't have seen the same negative correlation or zero correlation of stocks and bonds. You weren't going through the mother of all bond bubbles. And so, it reinforces, and reinforces, and that was basically the cornerstone of every asset allocation model. And this decade it hasn't worked, not because equities haven't gone up, but because bonds have had an 80% correlation to equities, and they went down in 2020 when they were supposed to protect. So, the problem, when you have these things that challenge a paradigm, is that people don't really have a playbook because they've sold everybody, not just on their portfolio, but they can't really go back and say, sorry, we were wrong about stock and bond correlations. And so, everything in our business model is basically we have to, basically, tear up the playbook. So, whether it's passive, whether it's these things, what you're seeing is, what you'll see is clearly a big impact on lots of different active strategies that seek to make money in the markets. And, and it's not going to be evenly distributed. You know, equity long/short was everyone's favorite hedge fund strategy in the 2000s. By the end of the 2010s it had faced years, and years, and years of underperformance. And that could be something where just passive has killed a strategy. On the other hand, managed futures, which we both love, showed in 2022 that all of these allocators out there who are deliberately slow, part of what they've told their clients is don't change your mind fast, you're likely to be wrong. We're not going to change our minds fast because we can't time the markets. That was a really bad decision when inflation started to come back. And so, what it did was it presented an opportunity for CTAs to make a decade of alpha in one year. Yes, I think it has an impact. I think it's very hard to say that it's necessarily going to have the same impact on everybody over some period of time. And the impact it's having on people in five years may be very different than it is today. If money starts to flow out of passive funds, and we get a 10 year bear market, everyone's going to love short sellers again. Find me an allocator who can name a dedicated short seller today. So, the world changes and we must adapt.

Yeah, well, speaking of adapting, and that was the other article that I noticed that sort of hit my radar was from the institutional investor. And that is a big change in kind of the way a very large, perhaps the largest institutional investor think about portfolio construction, namely CalPERS, as they now, essentially, want to stop thinking about putting strategies and investments in buckets and they're going to adopt the total portfolio approach. Which, I'm not an expert in per se, but one of the things, what the article describes, and it talks about the total portfolio approach, is a strategy where every investment is judged by its contribution to the entire portfolio goals, not just its own asset class. Now, I may misunderstood that sentence completely, but what I'm thinking is, well, if that's the case, that really fundamentally changes. If they're going to be true to this, they're going to look at the strategies and say, okay, what kind of contribution can you actually provide us with, and so on, and so forth, then a lot of the strategies, that on their own might not look very appealing (say, managed futures, for example, or trend following or whatever), suddenly becomes very attractive because of its contribution to a portfolio. So, I'm not saying that this is what they're going to do, but I'm just suggesting that if that is true, if my interpretation is true, then it's going to change the landscape in terms of how favorable some strategies will be. And, of course, then if the largest institutional investor in the world is making a change like this, well, then maybe there will be more following along that way. So, that's what I find interesting about this article. Even though this might take years to really trickle down to what you and I deal with. But you never know.

Well, first off, from your mouth to God's ears, that people then say, I really want things that behave differently from other asset classes, I'm going to value those more highly and make those a more important part of my portfolio. Because as I've written about, the allocation to managed futures, relative to all these other hedge fund strategies, is preposterously small from a statistical perspective. But that's also a segue into another fun quote, which was either Disraeli or Mark Twain, which is that there are lies, damn lies, and statistics. And so, when I read something like that, I say, okay, that's great, you're moving to factors, you're moving to something else. Really, how are you going to decide what those things are going to be over a long period of time? And so having spent time with a lot of people who build models for a living, they torture the data until they get the answer that they want. And so, back in 2000, if you were building an asset allocation model, I think small caps had outperformed for years, and years, and years because of the small size factor. And as this has been noted, there are a lot of issues with that data, etc., etc., etc. And yet nobody, that I'm aware of, had an inequity portfolio, in the 2000s, that was all small cap equities and a tiny percentage of large cap. So, what happens is they come up with these long-term assumptions and they start with historical data, and then they extrapolate it out, and what you find is, right now, the only equity you want to own is the NASDAQ. Why would you own anything else but the NASDAQ? But they're like, no, no, no, it wouldn't be prudent to put a lot of our money money in. And they start thinking about, you know, Robin Wigglesworth is going to write an article on us about how we were the fools who went all-in on AI at the turning point. And so, what they do is that they then make judgments on top of it. And so, what you end up with is they kind of haircut assumptions for things that look too good recently, and they kind of assume mean reversion on other assets. So, look, I am all in favor of continuous evolution of this, but it's going to be a judgment call on their part in terms of what they like and how they look about it. And again, this probably precludes CalPERS from ever giving us a meaningful allocation. But I think what it sounds to me like is, guys, you were all in on a model, a paradigm, that didn't work for various reasons. It has failed to predict this decade. And again, calPERS, has had bad stumbles. They used to have a $4 billion absolute return bucket. But making 4% on 1% or 2% of your portfolio didn't mean anything, and it had a lot of people saying that I'm shutting it down. But, to me, the more honest answer is we thought we had a solution for how the world worked. And we made all these long term predictions about various asset classes and how they're going to drive, and we structured this massive portfolio that matters immeasurably to hundreds and hundreds or millions of end investors. And we made a very big mistake. And, at the very, very peak of the bond bubble, we basically decided, in the beginning of 2021, that a very meaningful portion of your portfolio would be in something that mathematically was going to have difficulty earning a return over time. It's very hard for people to go back on their prior narratives with investors. So, I think a lot of what you're seeing, in the wealth management and the model building space, is rather than staring headlong into the issue, which is (what was it Niels Bohr said, predictions are difficult, especially about the future, or something) that what you're seeing is people kind of coming up with a new paradigm that sounds good. Now this is happening across the US wealth management space where a lot of people who sold or built their business on 60/40 have now introduced a 20% diversifying bucket, the reason of which is bonds have not worked the way they were advertised to work this decade. I mean, you've had correlations have gone to 0.8 negative, volatilities have doubled or tripled, they went down during 2022, in many cases they've been earning less than cash. So, what they've done is they've introduced a new category they can talk about but without kind of really explaining why they got there. And I understand why they do that, but that was my reaction when I read the paper. Again, knowing almost zero about what they're talking about at a granular level, but I've been to this rodeo before.

All right, well let's move on to our usual segue which is of course kind of a quick trend following update. And my own trend barometer finished at 36 yesterday. That's a bit weak still, despite actually the data looking pretty good. And you know, so far September is kind of turning out to like one of these sort of maybe a ‘September to remember’, as I think Earth, Wind and Fire once sang about, simply for the fact that if it could close in a positive territory, it would be four months in a row for the SocGen Trend index. And we haven't seen that since January through April 2024. So, it's been a while. So, I'm kind of hoping that that's where we are heading to me, at least where I'm sitting. Maybe you have a better view in terms of your replication strategy. It seems like it's kind of the usual sectors, right now. It's the equities and it's the precious metals in particular that are helping with a few supporting acts from the commodity side in terms of driving performance. Interestingly enough, again from my vantage point, despite fixed income being maybe where the focus has been in terms of the fact that the Fed pivoted, to some extent, by lowering rates, it seems relatively well behaved and kind of quiet in terms of P&L contribution in the trend following space. Let me run through the numbers and I'll give you the floor, if you have any comments on current attributions or whatever. But BTOP50 is up 2.81% so far this month. So, it's pretty flat now, for the year, having been in negative territory for quite a few months. The SGCTA index is up 3.5% or so, and now it's down only 3% for the year. The Trend index is up almost 5% for the month as of Tuesday I should say, down 3% for the year. And the Short-Term Traders Index is also up 1.5%ish, but still down 5% so far this year. Now, of course, the traditional markets are doing really well, continue to do well. MSCI World up 2.5%, up almost 17% so far this year. The S&P US Aggregate Bond Index up almost 1% in September, and up almost 6% so far this year. And, of course, the S&P 500 Total Return up 2.85% in September as of last night, up 13.95% so far this year. Any overall thoughts? I mean, obviously you will have different contributions, etc., etc., but you kind of know what's going on from the work you do. Is there anything that stands out to you in recent months in terms of what managers are doing, exposures are changing, or anything like that?

Well, I'll say it in general. So, I had a funny call from one of our investors who reached out to me near the bottom of everything, and he said, what do you think about this? We talked about it. And he said, what's your answer? And I said (I won't say it here because for all the children listening to your podcast), BTFD, basically. I said, you know, I said, we've just known this strategy for a long period of time. It can be rattled, but then it turns around and pivots. So, what was so hard about August and Liberation Day was not just the inflection. It was the inflection…

You mean April, April and Liberation Day.

Sorry, April. What did I say? August.

Yeah.

Sorry.

Yeah.

It wasn't just the head fake. It was the double head fake. And what happened, at least from what I saw, was that, you know, it's always funny when you're talking about people today because the whole space has been having a great run, and it's recovering from a very tough period. And nobody wants to say it out loud because nobody wants to jinx it.

We'll be saying it very quietly today.

But basically, what's so fascinating about this space is, when it seems to detect something early, and when it detects something early, and what I think it detected early, it was the ‘let it run hot’ trade. And so, if I'm talking to somebody about the underlying position in our portfolio, in June, when everybody still has post traumatic stress disorder from what had happened in April, it felt reckless. The exposures felt like, are you not paying attention? Are you not watching? Are these guys not watching the news? Because it was starting to embrace the ‘let it run hot’ trade in September. And then I had people saying, well, it's going to work. You know, it's going to flame out in August or September. It hasn't. So, this is an example where managed futures got behind, broadly speaking. And I say ‘let it run hot’, which means, you know, Trump is going to jawbone the Fed, or they're going to then keep rates lower than they should. That's going to, you know, drive up equity valuations. So, you know, if there's a bond market tantrum, it's going to happen latter, not now. And, you know, it's probably great for gold and crypto. And I would just remind everybody that it's the first time I think we've had a president who's massively short the US dollar. So, just take that into consideration. So, they've done it, and it's been working, and I think that's great. It's what the strategy is supposed to do.

Okay, let's move on. Before we get to your topics, I actually had a question that came in. I don't remember if I actually sent it to you. I should have done that, but it's a very simple question. It's from Michael, and Michael wrote, my question for Andrew is about pair trading with his replication product. He says, why shouldn't I sell Andrew's product when it's outperforming single managers and buy single managers and then vice versa. So essentially, you know, because as we know, one type of strategy sometimes will outperform and then vice versa, and so on, and so forth. So, that's his, his question. I'm not sure how he would buy the single managers and how. It doesn't explain that. But, any thoughts on this?

I think it's a little bit like, so my argument would be, well, first of all, I don't know when we're going to outperform and underperform, so if Michael has an answer to that he should call me.

I think it's just based on whether you are outperforming, which you are at the moment. I mean clearly this year you've done much better than many single managers.

Yeah, look, I mean we were outperforming earlier this year, and we outperformed by more, and then we gave a little bit back, and now we're outperforming more again. It's extremely unpredictable. So, I don't know how… But the structural problem is that, historically, having done this now for 10 years is, is we have about a 300 basis point efficiency advantage. So being short us and being long single managers historically, and it's even worse if you're talking about investable things like mutual funds or UCITS funds where you're talking about more than 300 basis points of outperformance over time, that's going to be a very costly short. And so, if I knew structurally when I thought we were going to outperform or underperform in advance, and you'd have to get that timing very, very right. But it's interesting. So, you know, people used to talk about replication as something that could hedge, use it to hedge. You can short DBMF, right. So, you could buy five well known mutual funds in the US and short DBMF against it and you'd lose 300 basis points on average or more. And so, I'd be very curious to hear ideas around it. But I don't know how to solve those two points from a timing and shorting perspective.

Let me do a follow up question on this. Just something I thought about as you were talking and about this sort of idea. From memory, and again, I don't want it to be sort of taken as something that's super precise but from memory, when I look at kind of your evolution in terms of performance, and I probably, from memory, normally look at it back from when it was launched I think in 2019 and then comparing it to the index from time to time, I do see these periods where clearly you move away from the index to the upside. But then there will be a couple of times over that period where you kind of come back and you kind of meet again, and then you go off again, and so on, and so forth. I think that's what he's kind of referring to. But my question is more have you noticed whether there are certain environments where you move away from the underlying index and then there are certain environments where you actually see, yeah, but when we go through these type of environments, that's usually where we then tend to move closer to the index again, and so on, and so forth. Is there anything that you've noticed that describes those periods?

We know it after the fact. So, we know that there are two periods of times, and you and I talked about this, in January and February of 2023, so, we underperformed. We gave up a lot of outperformance from the peak in 2023 through around mid, sorry, peak of 2022. Because, remember by the peak in 2022 we were outperforming in part because of the absence of incentive fees and stuff, 600, 700, 800 basis points.

Yeah.

And then when the markets reversed, we gave that back and then we had a… When we had an underperformance, it's because of one of two things happening. Either we miss trades that are generating a lot of excess returns for the hedge funds, which, which is natural. I mean you would expect that. And, as you and I talked about, In January and February 2023, we didn't have the Mexican peso, we didn't have the front end of the Canadian interest rate curve, we didn't have the Nikkei, we didn't have softs, we didn't have a lot of different things. Now, the bet that you have to make is that there's going to be a period of time where a lot of idiosyncratic trades statistically are working at the same time.

Right.

80% of non-core trades are working at the same time. And it's going to persist for a month or two.

Yeah.

Good luck. It's very, very hard to predict. The other is at very sharp inflection points.

Right.

And look, inflection points play out in a couple of ways. So SVB happens, and we like everybody else are very short treasuries, and it happens, and three days later one of two things is going to happen. Either it was a head fake, like with the end last year and things will revert and we'll be fine. We'll underperform by a day or two or three days and then we'll come bouncing back or it'll keep going. And when it keeps going, we will be de-risking that position faster than actual funds. And so SVB was one of those things, a very sharp inflection point. And a week later it was the regional banks were going down, and a few weeks later it was Credit Suisse is going down. And so, you went, in a four week period of time, from rates are going up, inflation is back to, my God, we're going into a global banking recession again. So, we'll underperform. The math of it, though, is the underperformance is not 1000 basis points. The underperformance is a couple hundred basis points here and there. So, the periods when we tend to outperform are periods when those non-core trades backfire, or risk management backfire. So, the outperformance this year, I think what's sort of interesting about this space is that nobody has a really good explanation as to why the drawdowns, among a lot of single manager funds, were as bad as they were...

Okay, but that’s not really what my perception is of that, actually. I think there's a very simple explanation to it, if you don't mind me sharing.

Yeah, please.

I think that, again, if we look at these large managers that you track also, that are in the index, we must assume that they have a tilt towards the financial sectors because that's where they can get the liquidity and the size and there’s nothing wrong with that. But then if you look at the actual market movements the last 14 months or so in equities, in fixed income, and in currencies, I would argue that there have been two, three, big reversals in all of those sectors within the last 14 months. And some of those, maybe not with equities, maybe you didn't go short at any point in time, but you certainly went from being fully long kind of thing to being almost flat, and then almost fully long again, and then down again. And then in fixed income, I would say, it's been a very large range that has forced many managers to go from quite large long positions to quite large short positions, then back long and then back short, And then with currencies, to some extent, the same. So, to me at least, as an observer of these things, I would say that it's a little bit of like the, what do you say, the perfect storm for large managers who are maybe tilted towards financials, that you have all those three sectors being challenged by big reversals within the same timeframe. That is how I perceive what's going on. So, to me it's actually not a surprise that it's been a difficult period. And then you have those that are more diversified where smaller market contributions, or where smaller markets, like the commodities, have been able to mitigate some of those losses. And some people, you know, as I said, a lot of managers are coming back now to kind of flat and slightly positive performance. And then of course we can't forget about, you know, speed of models. Of course that will have an impact as well. But to me, I just think that it's rare that you see these three financial sectors being so difficult at the same time. And I think that's just the explanation. But maybe it's too simple, I don't know.

Well, we've all been living through whipsaw hell, right? And it feels like, as soon as you take your eye off one thing, a bomb goes off somewhere else. I'm making, I think, a slightly more nuanced point which is, I think that if you had gone to the beginning of 2025 and said we're going to have a really chaotic year with a lot of noise and other things like that, and you said what should do better in 2025? [Would it be] a simple replication-based model that is going to be a little bit slower and, again, not capture really interesting trades that may present themselves in a lot of different markets, or single manager hedge funds with hundreds of instruments, vol controls, risk management, short-term models, etc.? You know, there is US$100 billion of professional money that would have made a bet on the latter, not the former. And it hasn't happened. And so, to me, and I'll be in Stockholm with the heads of some of these firms in a few months and if I make it out of there alive, it'll be…

Well, I know the people, they'll be gentle. They'll be gentle. Andrew.

(laughter) I'm quick. I bet I can get out of the room faster. So, to me, again, just thinking about it, when things do badly, there's often, in the rest of the hedge fund world, very clear storytelling around it. Like, we lost money because we believed in this thing about the company that proved to be wrong. This is how we change our mind. This is how we do our decisions. What my impression is, is that, at least when I've had conversations with people about it, it's kind of diffuse. It's like, well, the models are short, you know, we timed it bad, we rebalanced this at the wrong… It's a lot of little paper cuts that resulted in a fairly deep wound across the industry. And just again, so I've been thinking about this convergence. And I wrote this paper, not paper, I wrote an article in Hedge Nordic earlier this year, basically talking about the awkward statistical fact that 80% to 90% of ETFs are outperforming the average mutual fund or hedge fund in 2024 and 2025 by a lot. And again, that's not supposed to work. And so, I've been thinking a lot about, is there a structural reason around it? So now, I imagine it's right after Liberation Day and you're focused on commodities because you've got a lot of concentration. But now, imagine a fund that has added position number 298, and they made the decision to invest in it because, well, let's look at the underlying liquidity over time. Well, on certain days it's not something we'd want to trade but you know, but we can ease into our positions and we're going to be intelligent about it. But in a period after Liberation Day, the liquidity might disappear in that market. Now you've got a vol control red light that goes off because that thing is whipsawing much more than something else, or you've got a short-term model that now wants you to get out of everything quickly. So, in a four or five day period of time, you may be selling 100 different positions, or buying back 100 different positions in markets where there's thin liquidity. And again, you're talking about the larger firms who are going to have a larger footprint in those markets. And so going back to the Bouchaud point, now take that argument and collapse it down to the microstructure of hundreds of markets that themselves, It's not just that you're trading with other people who trade like this, now you're also trading with prop desks who can smell blood in the water. And so, when you're getting out of position number 298, did you lose two points on Tuesday closing your US$8 million position? And would you, five years ago, when you thought about including position number 298, would you have included it in your portfolio knowing there could be a day where you lost 200 basis points just trading It. So, I've been waiting to hear those kinds of stories and I haven't heard them. So that's what I mean about, and I could be totally wrong on this, it could just be a combination of these factors, collective factors as you described. But I think this has been going on since the beginning of 2024 and I think there are structural reasons around it and rational reasons why people have done this. But I'm just not sure whether we're going to look back in five years and say these things didn't work as well as people thought they were going to work.

So, just for me to understand your point here, to be clear on that, your point is that some of these larger funds are too diversified, so to speak, and the trading cost of trading smaller markets, it does have an impact. Whereas, I would generally say, and you know my view on alternative markets, I'm not a big… Well, I certainly will just say it's different. I wouldn't say it's better. I've never believed that. But it's different, I agree with that. But my point is just that I think, and having been in this space for 35 years, my observations are simply that there will always be times where you're going to have certain sectors of your portfolio doing well or badly, just from the normal way of marketing movements and, obviously, monetary or fiscal policies, whatever it may be, there's going to be an impact and that's just how it behaves. But over time, at least it's our belief at Dunn, that all markets has the ability to trend. They obviously don't trend at the same time, nor would they be in non-trending environments at the same time. So, yeah, you're going to have periods of time where you get drawdowns because you know nothing is happening and whereby maybe being in fewer markets and having a longer time frame, like replication, is just simply a better way of doing it. But that's just a snapshot of say (as you point out) maybe ‘24 and parts of ‘25 that's been a period like that. Okay, fair do. But there's going to be a period of time where having more sectors, for example, will be better. So, I don't see that as a necessarily conclusive evidence, in my opinion. It may be what's going on right now. So, I don't dispute that. But I think it's hard to conclude that it is a permanent change because I've seen this happening before. Even though replication has been around for a long time. But just the difference between certain managers would suggest that, yeah, you could have the kind of “wrong” lookback period for your models. Or you could have just, as you said, a lot of markets in your portfolio that just weren’t really trending well at that point in time.

Okay, but I mean, let's go to an extreme example. And my partner gave this in a speech in Paris when he was talking about this. Let's say the Copenhagen housing market trends upward over time. You know, it trends up and then trends down, trends up and trends down. When thinking about that, how do we trade that? We're going to look for the trend on the way up, then we're going to sell all our houses. Once we see the trend reversing, since you can't short houses, we're going to wait for the bottom, and then we're going to buy them again, and do it all over again. If getting in and out costs you 10% to 15% between brokerage commissions and everything else, there may be a trend, you still don't want to try to do it from an invested perspective. And so again, having talked to a lot of very, very, very serious quants about how they approach it, there is always this question of, it sounds great, can you implement it? When high frequency trading came around, people could make staggering amounts of money on unbelievable returns on US$5 million or US$10 million, and the returns disappeared at US$30 or US$50 million. What I've seen in the industry, again as an observer, when we started looking at replicating the space that back about 10 years ago, the talk at the time was about bringing down slippage costs. It was a badge of honor to be able to say that you had brought your slippage cost down from 400 to 200 basis points. Now if you'd asked them at the time, and that's with simpler portfolios and more liquid markets like what you do. Now you ask them at the time, okay, what do you think about trading 300 instruments, not 70? What do you think about that? So, take again the Liberation Day example (and this is where I keep looking for the story). Okay, so, part of my portfolio is a very short term model and I'm very long equities going to Liberation Day. Trump basically, equity markets collapse over the course of the next week. And so now I'm selling my equity exposure, I bring it down flat. It goes on for another few days. I've actually flipped to short at that time. Then he head fakes everybody again. The markets go back up. So now I'm covering my short. And then, three weeks later, I'm now back to being long again. And thank God, I'm starting to embrace the ‘let it run hot’ trade early. So, if I'm doing that in the S&P 500, I mean, it's, it's annoying, and the timing of the rebalancing and everything else may cost you, may hurt you, but it's understandable. Okay, now I'm doing that with, I don’t know, pick some esoteric equity market where I'm doing it. So all of my point is, there are a lot of great ideas, but the question is, are they implementable? And usually when you're looking at it, you're not saying… Like, look, private credit, nobody's worried about the fact that they don't mark private credit to market during good times. They're worried about if defaults rise and you get all of a sudden, a sudden 25% markdown approach. So, everybody evaluates these things on the very worst day that can happen. So again, I'd love to hear what your guests have to say about it it feels structural to me. And you're right, we won't know. Some of the guys who are down more have become roaring back. They're still down but you've definitely seen a rebound across the space. That kind of reinforces my argument though. Talk about Bouchaud, I mean, talk about the liquidity that's coming into the markets right now; YOLO, fear of missing out, you know, like ‘let it run hot’. And so, that recovery is not necessarily a sign of long-term high expected returns. It may be just benefiting from a sharp influx of liquidity into areas where you happen to have exposure.

Yeah, I certainly don't disagree with any of that. And I do think that it is so important to stress that trading liquid futures on exchange, relative to off exchange, and illiquid stuff, that's certainly our belief as well. So, we don't disagree on that point. But I do think it's Interesting.

I would love to have one of your very best PM of one of these funds. And I'd be so curious to hear their responses, live, to a question like that. I don't scratch the surface in terms of their knowledge of the underlying space and how they build their models. I'm observing things that I'm seeing, and it's pretty widespread across the space.

Well, let's put it out as a challenge. If there's one in these large CTA firms that's been around for…

To beat the daylights out of me here, on TTU. (laughter)

Well, that's been around for a long time, and do include alternative markets, if they're up for it. They're invited to the next recording with Andrew in six, eight, seven weeks, and we'll talk about this because it is an interesting point. We're completely not started yet on any of the main topics you sent along, so I'm going to let you decide where you want to go. We have some stuff about ETFs versus mutual funds, and we have something about multi strats. We have about 15 minutes time, so I'm going to let you drive, so to speak, and I'll try and follow along and maybe I have a comment or two along the way.

So, I think what I'll do is I'll leave aside the... I mean you can read the article if anybody is interested in the ETF versus mutual fund or hedge fund world. If you can't find the article, ping me on LinkedIn or something and I'll send you a link to it. So, I think the really interesting thing is multi strats - multi strat hedge funds, and these things show up in the news a lot. Costas Mourselas, at FT, wrote a great article on it recently. Nishant Kumar is the high priest of writing articles on this space. and I think it actually dovetails with Bouchaud, and it dovetails with a lot of other things, and passive investing, and everything else. So, a couple of observations about the multi strat hedge fund space. First of all, what these guys are doing, from an investment perspective, is cold fusion. It is high temperature superconducting. They are running hedge funds with enormously high cost structures that are generating returns that are staggeringly consistent and valuable for investors. So, just to throw out some numbers. In 2020, right through the midst of COVID, they had the worst month I've been able to find was down 6% in March, which was not terrible. But again, if you're talking 5x leveraged funds, that means across your portfolio you're down 1% when the world basically collapsed. So, they're up 13% in 2020, 9% in 2021, up 2% in 2022, up 6% in ‘23, up 11% in ’24, and up 8% year-to-date.

Which index is that you're quoting, by the way?

So, by the way, the very best data is the Pivotal Path Multi Strategy Hedge Fund Index. It's published by Pivotal Path. Connect to a guy named John Caplis - C A P L I S on LinkedIn. The reason it's the best data out there is because he gets his hedge fund index data from the institutions like CalPERS that actually invest in hedge funds. So, he has the best data and gives you the most accurate picture.

Right.

Now again, these things, depending upon how you look at them, might have a thousand basis points in fees before clients get paid. And so, there are a lot of articles on this space that are talking about how this is a disaster waiting to happen. And it is, by the way, it's very, very bizarre because clients end up paying… You can hire anybody at any price and your clients will end up paying it. And I've written on the space, by the way. About two years ago, I wrote something basically saying that I thought the risk of this space was not that they're going to blow up, but the risk is basically dead money over time. And in 24 months I had been dead wrong on that. But also, equities have gone up 55% and bonds have gone up like 8% a year. So, I think this is not really the time to be able to tell that, but it gets back to the point about how inefficient markets are. And I'm going to segue - kind of a little bit of a weird segue. In 2003, I started a commodity focused multi manager firm called Pinnacle Asset Management. It was initially a fund of funds business. It evolved into a commodity fund because we had first mover advantage doing that. And the guy who ended up becoming the CIO and is now the billionaire genius behind the business, which I've been out for a long time, but he had this theory that if he could find a guy who was the very, very, very, very best trader in a very esoteric commodity market, you know, the guy making markets in options on, I don't know, you know, like some like power trading business or something. Or, there was this guy who put up the most ridiculous numbers in the hedge fund industry named John Arnold, who had a firm called Santoris. He'd been making, I don't know, US$600 billion a year or something in Enron trading, like two contracts. I mean, so Jason's theory was that, at the time when you were talking about putting somebody into the business, so somebody who had no hedge fund, no business to speak of, shows up and they say, like how much money do I need to get going? I need US$50 million to start. I'm going to put up US$5 million in my own money. The thing at the time was to use the US$50 million, you could give them, as a cudgel and say, fine, well you're going to do it at half fees or we're going to get a stake in your business. And Jason's very contrarian view was that guy with that talent, with that competitive advantage, is not going to do 200 basis points better than the established guy. He's going to do 30 a year for his first three years. And as long as he agrees not to go to US$500 million in six months, I don't care what we pay him. Two and a half and twenty, fine, take it. I mean I'll give you the money in two weeks, set up in a managed account. And he was absolutely right about it. And plus, what he did also have was liquidity. So, it was kind of an early version of the multi manager model. He could see all their positions, etc. So, in a sense what you've seen, with multi strat hedge funds, is they're not hedge funds anymore. This is like the proprietary trading desk at Goldman Sachs where you have better information, you're the first call on things, you have better financing terms. And so, what they're doing is when they're setting up the compensation structures, they're setting them up like a bank. Banks used to pay 55% of revenue and they had a lot of less attractive business in it. 55% of revenue was basically compensation. So, you're doing the same kind of thing here. Now, a second observation is that everybody's jealous of what they're doing. I mean you are talking about $50 billion funds that are leveraged and they're mysterious. So, a funny story is, my favorite restaurant in New York, I go to enough that they give me one of the power tables in the front. Another guy gets a power table, that same power table, whenever he wants, It is the Angliter. And I'm friends with the matriarch. And I said, look, I just want to tell you, if I am halfway through my appetizer and he walks in, I am fully expecting you guys to pick me up and throw me into the bag and give him in the table. Because there is a difference in talent in this world. And this guy is… what Ken Griffin has done with his business and with the Citadel Securities, it's LeBron James. There is talent out there. And what Bouchaud is talking about and what Pinnacle is a counter example to, is the idea that the markets, broadly, are very, very efficient. And that comes from the fact that the incredibly talented guy, parts of the markets are weak efficient, at least weak efficient. So, picking large cap stocks in the US, and getting paid 100 basis points for it, you're probably not going to do better than 100 basis points, over time, statistically. But what the multi strats are basically doing, the philosophical underpinning of it, is we can find a guy who can go out and raise a $500 million hedge fund. And he's distracted. He's dealing with investors. He's explaining what he has to do. He has to hire people, and pay them, and monitor them. It's LeBron James running the NBA, the draft picks, and the business, and hiring, and having the towels washed, and whatever the hell he's doing. And so, the bet is basically we can take that guy and give him an incentive structure where he is not sleeping for the next five years. And if he makes US$500 million for us, and we pay him US$200 million of it, our clients are better off, we're better off, and he's better off. And so that, in a sense, is absolutely, utterly fascinating. Now, let me pause for a second because I know you spend a lot of time thinking about the space, and then I have an interesting segue as to where it doesn't work.

I don't actually have a lot of thoughts about what you said. I think it's some interesting insights that you share. I am impressed/surprised, and I have nothing really to base it on. But I also see that if too much money, you know, flows into kind of the same types of businesses, like maybe we've seen with private equity, again, without being an expert, at some point, things are not necessarily going to work as well. And then people might add additional leverage or whatever they may do, and you start having some fairly hidden weaknesses and dangers building into that business model. Because I imagine, to some extent, and maybe you can confirm or deny this, and that is the risk management teams that are allocating the money to these sub parts, to a large extent, they're buying P&L curve. So, the more successful you are, the more money you get. And at some point it's like, okay, so I don't know… There's a little bit of risk in that approach.

I agree. The logical thing is, you can't, you cannot keep… So, you know, is pod number 300, by definition, less attractive than pod number 20? And look, I don't know the Ken Griffins, Izzy Englanders, Bobby James’ to have conversations with them about that. I would be more than happy to buy them lunch if they would spend an hour.

At your power table.

But they're proving it wrong. If I told you five years ago, like pre 2020, that you had US$50 billion of capital, leveraged five times, and we're going to go through the kinds of market gyrations that we've seen, the kinds of regime shifts, and you told me that not a single one of these funds had not only not blown up, but not had anything approaching what would be deemed to be a catastrophic drawdown, and they had generated hundreds and hundreds of basis points of returns over cash as they're paying higher and higher fees to do that, it sounds impossible. And again, to keep parroting Bouchaud, that's exactly this idea of it shouldn't work, but it does, so why? And I'm very sympathetic to it because a lot of people said replication shouldn't work and does. So, I'm very fascinated with the why.So, the interesting about it is that it works but you need the hedge fund structure for it. And when you compare it, then, to the mutual fund world where, about 15 years ago, people started to try to develop the plug-and-play one-stop solution. Why do you do anything multi strategy or multi managers? It’s because you're trying to outsource it to somebody who knows what they're doing to be able to balance the right strategies, pick the right managers, you know, come up with the right implementation around it. And so, you then say this basic Idea of we're trying to give you diversified exposure to a diversifying return stream has been an embarrassing failure. The entire space has done less than 3% per annum, after about a 200 basis points in expenses, over the past 10 years. And so, there's this kind of musical chairs of people kind of like going from one fund that's working well to another fund. Back to your point about people chasing hot dots. And so, to me also, the fascinating thing about the hedge fund, the multi thread hedge funds, is you can't do it outside of a hedge fund model. And you can't do it if clients have the ability to withdraw their money every quarter. So, in a sense what they built are these… They built companies. They built these trading engines. And again, talking to people who run the underlying strategies, what's sort of fascinating about it is you kind of get the impression that they're worker bees. They have no idea what happens to layers above them in this organization. They're fabulously wealthy worker bees. They don't have great job security. A guy told me of being down 3% one year, and he goes back to his office and in fact all his stuff is sitting in boxes and he's being escorted out the door. But boy, I mean you talk about motivation and hunger for these guys, and when it works, they become fabulously wealthy. I was in Miami a couple of years ago and somebody, they told me a story about Citadel moving its headquarters down to Miami. And my two favorite stories were, somebody, as a representative of Citadel, apparently went around to the three top private schools, and said yeah, we need 200 slots because they're moving these hundreds of whatever people down to Miami. And the other one was that two of the brokerage firms had basically signed agreements where they had to show Citadel any houses that were US$10 million or more within 100ft or something, or 100 meters of the water, 10 miles up or down the coast. And so again, these are staggering money making machines. By the way, I have no idea if those stories are true, but they're too fun not to talk about this legendary thing that we see going on. So, in a weird way, like I'm somebody who's very critical of fees. Like I think you're way overpaying a multi strategy mutual fund manager 200 basis points if he's giving you 3% a year for 10 years. On the other hand, I think if you're paying 10 points for guys who basically have found a way to generate a 4 Sharpe ratio, take 2 of the Sharpe ratio to pay everybody, and everybody has private jets and US$50 million homes. I think that's pretty great.

Yeah, it's a fun paradox, I have to admit. Okay, well, I think we've done it as much as we could today with the time allowed. I really appreciate the insights, Andrew, and there are definitely some topics that we will need to continue. We'll see if we'll be joined by someone on the alternative markets front next time. You never know. And let me just remind you of Andrew's offer, and this will be the first 10. This is up to me to do the judgment here, but the first 10, after I published this episode on Saturday that opt in to something on the Top Traders unplugged website. And by the way, you can't use funny names that are not real, well, for two reasons. One, I usually delete them anyways and two, if you want the book, we need your details and I will forward that the details to Andrew and he will send you one of Robin's books, I think it was we talked about.

Michael, the emailer, gets a complimentary copy if he can tell me.

Yeah, Michael, yeah, if you're listening to this and you haven't sold your DBMF just yet, then you should send me your details and Andrew will thank you with a book as well. So very generous of you and of course super fun conversation as usual. And I hope that you will go to your favorite podcast platform and show some love for Andrew and all the work he puts into these conversations, and all the insights, by leaving a rating and review. Now next week I'm going to be out traveling so Alan will sit down with Cem, who I know has been traveling, meeting some very interesting people in both Las Vegas and over here in Europe and they're all coming out as the U Got Options series continues. So please send me your questions if you have any questions for Cem and of course you can email them to info@toptradersunplugged.com and I'll do my best to get them to Alan. So, from Andrew and me, thanks ever so much for listening. We look forward to being back with you next week. And in the meantime, as usual, 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 valuable time with us and we'll see you on the next episode of the Systematic Investor.