Geopolitical tensions, inflation shocks, and shifting market regimes are reshaping the investment landscape. Marat Molyboga and Katy Kaminski joins us to explore why managed futures have historically performed well during periods of geopolitical stress and why investors often misunderstand the role of crisis alpha in a portfolio. The conversation examines inflation driven market disruptions, diversification, short term versus long term trend following, portfolio construction, and the behavioural mistakes that prevent many investors from capturing the full benefits of trend strategies. It is a wide ranging discussion about risk, uncertainty, and adapting to a changing world.

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50 YEARS OF TREND FOLLOWING BOOK AND BEHIND-THE-SCENES VIDEO FOR ACCREDITED INVESTORS - CLICK HERE

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Episode TimeStamps:

00:00 - Introduction and welcome to the Systematic Investor series

01:13 - Marat Molyboga's background and Efficient Capital's investment philosophy

05:29 - World Cup excitement, soccer stories, and thoughts beyond markets

11:36 - AI, market concentration, energy trends, and major macro headlines

15:16 - Trend following performance review and key market drivers in 2026

23:36 - Understanding crisis alpha and the role of managed futures in portfolios

33:24 - Diversification, portfolio construction, and avoiding investor mistakes

44:08 - Geopolitical risk research and its connection to inflation

53:01 - Why managed futures have historically benefited from geopolitical uncertainty

59:01 - Commodities, inflation shocks, and the mechanics behind crisis alpha

01:06:47 - The case for short term trend following and execution challenges

01:20:31 - Final thoughts and lessons for navigating an uncertain investment landscape

Copyright © 2025 – CMC AG – All Rights Reserved

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Welcome to Top Traders Unplugged. In markets success doesn’t come from predicting what happens next, it comes from being prepared for what you can’t predict.

In each episode we go deep with some of the world’s most thoughtful minds in investing, economics, and beyond to understand how they think, how they prepare, and how they decide, and the experiences that shaped how they see the world. No noise, no short-cuts, just real conversations to help you think better and invest with confidence.

Welcome and welcome back to this week's edition of the Systematic Investor series with Katy Kaminski and I, Niels Kaastrup-Larsen, where each week we take the pulse of the global market through the lens of a rules-based investor.

This week we have a very special guest, namely Marat Molyboga, Chief Risk Officer Director Research at Efficient Capital Management, who is here to discuss some of his recent papers as well as some of Katy's recent papers. So, there will be lots of things to dig into. But first of all, Katy and Marat, it's great to have you both here. How are you doing? Is summer starting to set in where you are?

Sort of. I mean, we're getting there. We've had a very cold year this year in Boston. We had lots of snow and for some reason it rains every weekend. But you know, it's beautiful on Thursday today.

Yeah. Remind us, Marat, where are you based?

Chicagoland. And as you know, in Chicagoland the weather is very volatile. It gets really cold in the winter, really hot in the summer. So, we're fortunate to enjoy the nice two weeks of the year.

That's good to hear.

Now, Marat, since it's your first time on the podcast, probably no surprise, I would love to see if you could just share with the audience a little bit of your journey into the CTA world. What kind of caught your interest back then and also how you ended up at Efficient Capital and put a few words maybe to what you focus on in your current role.

Sounds good. Well, as you mentioned earlier, my name is Marat Molyboga. I'm the Chief Risk Officer and Director of Research at Efficient Capital Management. The company has been around for over 25 years, and we have been specializing in building customized multi-manager solutions for institutional investors. We allocate about US$3.5 billion to primarily commodity trading advisors.

And as a firm, we believe that investment decisions that are based on rigorous research will lead to better outcomes. We also believe that we are human beings just like anybody else and we are susceptible to behavioral biases such as performance chasing and hindsight bias. And therefore, our CIO, Chad Martinson designed an investment process that is supposed to mitigate a lot of those biases.

So, let me give you a couple of examples. One, for every single manager we have an investment thesis that is regularly tested. Another example is that we measure and record our decisions and we measure their effectiveness. And we also rely on data to determine whether we have edges in certain areas.

For example, we've been selecting managers for over 25 years. At the same time, we recognize that we have no skill in predicting which one of 10 constituents of the SocGen Trend index is going to outperform everybody over the next 12 months. We’re also very competitive because we care about the performance of our investors. And Chad Martinson, our CIO, he always preaches about the importance of precious basis points that can help us improve performance for our clients.

A couple of things about myself, you might have noticed that I have an accent. It's because I grew up in Ukraine. So, if I say something funny, it's just because I'm a foreigner. That should be normal. My background is in applied mathematics. I am a nerd just like Katy. And I love talking to people like Katy and you Niels, because you guys are always asking deep questions about what investors truly care about. So, I love learning from people like you.

And also, I feel very fortunate to work with people at Efficient because everybody on the investment team is very competitive but also very competent and also very humble at the same time, which is a pretty unique combination.

Absolutely. Yeah. Good stuff. It's great to have you here. It's great to hear a little bit of the background as we get into a lot of hopefully detailed and deep dives today. Now, before we get into any of this good stuff, as Katy knows, and I know, Marat, we spoke about it just a few minutes ago. I actually love to start with something that has nothing to do with the topics that we're going to talk about and that is kind of things that might have come on your radar in the last few weeks or something you're looking forward to or whatever it may be. So, since, yeah, since Katy have done it many times, I'll give you the floor first. If there's anything in particular that you're finding interesting as we start the month of June.

I mean, this is a good question. I know we always talk about soccer, so I guess we can go there. But I was thinking about something funny that we were talking about yesterday over the lunch table at Alpha Simplex. We were talking about the World Cup, and everybody in Boston is talking about the World Cup and all the crazy things that are going to happen.

And one of my colleagues was mentioning that they're trying to extend the bar hours until 3:00am which, you know, I don't know about you guys, but that basically has zero impact on my life. But what was funny to me is that I was immediately thinking, like, who is going to work those hours?

Because everybody keeps talking about supply, you know, supply crunch and the job market and all this stuff. So, sort of a combination of things. I think things are going to get a little exciting here in Boston, and everybody is sort of wondering what the impact of this big event is going to be.

Absolutely. I have a feeling, Marat, that you probably were also thinking a little bit about soccer, as you would call it, as we head into exciting time. So, what are you thinking here?

Well, as somebody who grew up in Ukraine, I have to be a fan of soccer because outside of studying, everybody just goes outside, kicks a soccer ball. Unfortunately, I did not spend a lot of time as a kid. I don't think it was coordinated enough, but I really fell in love with soccer. My own kids started playing in kindergarten, and we've been following soccer since then. Two of my girls have already retired at the ages of 7 and 10 when they reach those ages. But my son, who's 16, is still playing, and as a family, we love watching soccer.

I think the reason I'm really excited about the World Cup is because it's pretty amazing to see so many talented people who are taking pride in representing their country and they really care about the result. I think that sometimes when you watch professionals, it's not the same level of passion that you see. In the World Cup, it's just such a passionate environment.

I think there are some very unique things happening this time. For example, there are three players: Lionel Messi, Cristiano Ronaldo, and also the Mexican goalkeeper, who are playing in their sixth World Cup, which is pretty phenomenal. And the Mexican goalkeeper is so good that there's a rumor that he has six fingers.

And I decided to fact check that yesterday, so looked it up, and I found out that was actually a false rumor. So, I need to apologize for bringing this up. But he's just so good that people come up with all sorts of rumors about him.

That's amazing.

And I am pretty excited to watch, you know, the US of course, but also there are so many fantastic teams like Spain, and Portugal, and France, and Brazil. I'm pretty excited about Morocco because they made it pretty far last time, and I'm hoping that this time an African team will make it farther. But my biggest concern about this World Cup, to be frank with you, is that I think that it could have been so much better if two teams made it. I think that Ukraine and Denmark would have made all the difference. So, I'm really hoping that they're going to join the World Cup next time.

So, my household is happy. I think Niels didn't want to talk about this, but that's fine.

Yeah, no, of course, we feel very, you know, disappointed that we didn't make the World Cup.

Norway is in it, too. Don't forget Norway.

Yeah.

Yes.

Yeah. Yeah. We'll find other teams. I mean, I guess that's the beauty of also being Swiss, is that I have another team in my backup to support, so it helps.

But I was more interested, actually. I mean, there are two things about the World Cup that, when you talk like that, Marat, I'm interested in. One is, I don't know at what age you moved to the US, but I'm just thinking, was it a difficult thing to learn to call it soccer when we all know it's called football?

It took me a while. So, I think, actually I came to the States when I was in high school. It was a high school exchange program. And I remember going to high school and using the wrong words for everything, and one of those was football. So, when I say, hey, I like playing football, people looked at me like crazy because I was this skinny kid who was 135 pounds and they could not imagine me enjoying playing the game. So, yeah, it was quite an adjustment for me.

The other thing, when you bring up the World Cup, the one thing, and I don't know the details of it, but from what I hear (and I was in the States only a couple of weeks ago), people talk about it, at least sort of the man on the street, so to speak, and that is the ticket prices, it just seems like they're completely out of reach for many people.

And I think that's a shame because I feel that these big events that kind of brings together the whole world should be accessible to as many people as possible and not just in front of their television. But, you know, for whatever reason.

Now, I appreciate you both thinking about the World Cup in your ‘what's been on your radar recently’. I found a couple of other stories that I thought was kind of interesting because you know, for example, AI is still something many people talk about. And I just read that apparently Amazon's voice AI shopping assistant, running on Alexa, is converting now shoppers 3.5 times better than if they were doing traditional search. I thought that's quite interesting.

That is cool. Nobody wants to spend time doing that.

It's interesting to be converted like that by an AI bot. Anyways.

Can they make a bot to make our email more searchable? I don't know, for Microsoft?

I think AI should do the pitching for managed futures going forward. If it can convert people at three and a half times the speed, that would be interesting. The other thing I found was interesting… These are just headlines. This is more kind of some of the macro stuff we're going to be talking about. But I saw that Google has gone from a company that used to do stock buybacks and now they're issuing $80 billion worth of stock to fund AI CapEx. So that's a big shift. You know, it might be a subtle thing, one company doing it, but you know, one factor of keeping equity markets going has been certainly stock buybacks I would imagine.

And then the final thing… actually two things more… three things more that I saw. Again, these are just headlines, but I find them interesting. It says here, this is, I think, for Bloomberg or someone like that. For the first time ever, wind and solar generated more electricity worldwide than natural gas. That was for the month of April, by the way. I thought that's kind of interesting. Suddenly we have something that is an alternative perhaps.

And then a couple of weeks ago I had a really interesting conversation with Hari Krishnan and Cem about passive and the impact of passive based on a new paper that Hari wrote with Mike Green and another gentleman. And I noticed that now 10 companies in the S&P 500 make up 40% of the index. So, I thought also wow. I mean that is definitely a lot.

And then of course the other thing I've been vaguely following, let's put it that way is just this SpaceX IPO, and the headlines, and the stories, and all of that good stuff that comes out from people who read the perspectives, I guess. All very interesting stuff.

Anyways, let's talk about something that is even more riveting and that is trend following. So, let's do a quick update and see where we are. So, we're recording in the very beginning of June. So, I thought maybe we'll just focus on initially the month of May.

So, the month of May was quiet but positive. BTOP 50 index was up 31 basis points, the index is up 10.25 for the year so far. SocGen CTA Index up 23 basis points, up 10.5 for the year. SocGen Trend 26 basis points, up 10.4 for the year. And the Short-Term Traders index is up 5 basis points in May, up 5.3% so far this year.

All very aligned. Not a lot of divergence there and it's all very well. Now, of course, within that kind of performance there were certainly some, you know, different contributors. Some sectors did a lot better than others. Equities were the clear leader, I think.

Well, you should probably know this much better than I do, Marat. I have a much narrower lens than you do. But anyways, it looks like equities were the main winner with a little bit of base metals, a little bit of currencies perhaps. But there were also some losers, mainly from energies that sold off during the month, and maybe also some of the bond markets, and maybe even some of the softs.

Yeah, this year has been super interesting to be a CTA. I mean, wow. It's always these really difficult environments where things are good for trend. Right? And what was really, to me, was that in the first quarter of the year where it was a risk on trade, where it was equities, it was the FX trade. Those are the two things.

But the last thing that I saw that's interesting is that, at some point, the world started to see through the conflict, and the equity risk on trade came back. And so, you started to see equity trends profitable again, particularly in April. May has been a little bit back and forth, and then you saw the energy trade start to fall apart and come back in. And then I'd say the thing that has been the most annoying asset class, which is typical, is fixed income where we've kind of had stops and starts, where the question is really going to be about hey, do we really have higher for longer? And we can talk about that a little later because I'm very fascinated by that. But it is not an easy asset class to trend because there's too many dimensions.

Last point I will point out, given where we are right now, it is very interesting that the trends are sort of at odds in a way. Right? You have this AI growth trend combined with short views on fixed income, AKA higher for longer, because of the inflation uncertainty due to oil prices and a potential pass through of energy shocks. And you still have long views on energies, base metals. So, it feels a little bit like a hedge trend environment, like they're a little bit offsetting.

And the correlation structure we're seeing right now is very different from typical environments where energy is negatively correlated on average with equities, and bonds are positively correlated with equities. So, we're in a very weird macro environment and trend just loves that because it's wild, it's moving and things are changing. So, I think that's my kind of synopsis of where we are as of year-to-date.

Yeah. So, Marat, what are your thoughts?

Yeah, I want to put it in perspective a little bit because if you look at June of last year as an industry, we experienced the worst drawdown ever and that was really brutal, it was really difficult. But I think we've seen a pretty incredible run up since July of last year and I think I've been very encouraged and it's really nice to see that investors are finally talking about managed futures potentially being a bigger portion of portfolios. I think there's a bit more excitement because it was really challenging to go through that tough period. And I completely agree with everything that Katy said about this year and May.

But just to kind of give you a little bit more of a broader perspective on the CTA universe, we tend to look at the CTA universe in terms of three groups. We're looking at long-term trend followers and, actually, we have a couple of subgroups that we use internally. Then we have short-term managers and then we have diversifying strategies.

And what we find is that those three groups actually tend to perform pretty differently in different environments. Like for example, last year was a pretty bad year for short-term managers. But what we're seeing this year is that all three groups are performing well and actually there’s pretty similar behavior overall. I think all the groups are benefiting primarily from equities and commodities, and fixed income tends to be a more challenging sector.

So, a couple things about May. So, in May, our experience was that we saw that short-term managers were actually the best performers, whereas trend and diversifying managers kind of struggled a little bit relative to short-term managers. I have a thought about why fixed income could be so challenging, Katy, and I think that it's really the challenge of the Fed being in a difficult situation.

Yep. I agree.

If you go back about like six, seven months ago, there was expectation of multiple rate cuts this year and now the Fed is talking about potentially even hiking rates because of inflationary concerns. And I think those are pretty difficult factors for trend followers to digest when you look at the fixed income market.

I would agree. I think there's this push/pull between sort of Fed wanting to have lower rates and there's a push for that versus the inflation uncertainty and the risk that the bond market could really sort of be at risk because of inflationary pressures.

Let me just quickly mention, also, so now we're only a couple of days into June, but so far so good. Actually, my own trend barometer has recovered quite a bit, was a little bit weak towards the end of May, went down to I think to the early 30s. We finished yesterday at 50. That indicates a better environment.

And if I look at the numbers for the indices as of the 2nd of June and I think yesterday was a fairly quiet day by the way, the BTOP 50 index is already up 1.25% in June. SocGen CTA index up also 1.25%. The same for the Trend index by the way. And the Short-Term Traders index is up about 7 basis points so far in June.

In the traditional world, MSCI World is down in June 34 basis points so far as of last night, still up 10.32% so far this year. And the S&P 500 down 34 basis points, and still up 10.89% so far this year.

Before we jump to our topics, just a little bit of housekeeping in the sense that we did actually receive a long question for today's conversation, specifically for Katy. Rod wrote in, and that's very kind, we appreciate that.

But unfortunately, Rod, these questions are too specific, they're too product oriented for us to be able to deal with for regulatory reasons. So, I will find another way to perhaps help you out with some answers. But in any event, we do appreciate you taking time to write in.

All right, let's jump into some of the main points that we've been going to be covering. And as I mentioned, it'll include both papers that… and I should say, interviews and papers that you've been involved in, Marat, and also papers you've been authoring, Katy. So, it's going to be super exciting.

The first one I think that we wanted to discuss was not so much a paper, but actually an interview that you were involved in, Marat, that relates to Frank Fabozzi, from JP Morgan, if memory served me right here, what I'd love to do is, if you could give us kind of a little bit of a short rundown in terms of what were the topics that you discussed, why are they important, how did it even come about that he wanting to interview about this?

And then I might have one question or two. Katy might have one question or two. I don't know, we'll see. But let's start with that and then we'll see how we go.

Sounds good. Niels, I want to go back in time a little bit. I consider Frank Fabozzi to be a good friend. He and I wrote a couple of papers together. We're actually working a couple of other papers right now. And a couple of years ago I wrote a book about hedge funds Called Your Essential Guide to Quantitative Hedge Fund Investing.

It primarily covers portfolio construction and fund selection, but also it had several chapters about diversity and inclusion where I interviewed thought leaders who are either women or minorities. And when it came to thinking about somebody to write about managed futures and Crisis Alpha, Katy was the obvious choice. So, I'm really grateful that she helped me with that. But at the time I needed somebody to write the forward. So, I asked Frank and he kindly agreed to write the forward.

And we've been talking a lot over the years and last year he approached me, he told me that he was working on the special issue for the Journal of Portfolio Management (he's the editor of the Journal of Portfolio Management). And the special issue was supposed to be about multi-asset investing.

And he said, Marat, I think that investors would benefit from learning about how trend following and managed futures can help their portfolios. And I quickly agreed. To me it was a no-brainer. I think there's such a huge gap between all the potential benefits of managed futures. Katy wrote the whole book about those benefits: this pretty attractive long-term performance of the asset class, but a pretty significant crisis alpha that's very unique to managed futures.

But the gap is, despite all those benefits, we're seeing that the AUM of gappy investors and managed futures is still relatively small when we look at relative to other hedge fund strategies. And as I was thinking about it, I realized that I think there are some three main obstacles to why this gap exists.

And one of those is that I think investors don't always clearly understand the role of trend following in their portfolios. And the second reason is that, unfortunately, investors make some common investment mistakes, and the problem can be fixed. And finally, it's important to understand what the optimal way is of accessing the asset class.

So, in my interview I tried to address all three areas. So, let me jump into the first one. I think that generally people understand that trend following provides crisis alpha. But in my opinion the best way to understand this asset class is in terms of the risk mitigation framework introduced by Meketa. This framework recognizes the growth factor is the most significant factor that drives performance of institutional investors. And they suggest mitigating this risk factor with this so-called risk mitigation strategy which has three components.

It has first responders, second responders and third responders. So, the first responders are strategies such as tail risk or low vol strategies that are supposed to quickly respond to sudden market drops. Like for example, if there's a 10% to 15% market drop in equities, those strategies are going to benefit from this environment.

As you know, trend followers are the second responders, and as such they benefit from prolonged periods of market dislocation that last quarters to years. And finally, there are also diversifiers. And those are the strategies that tend to provide uncorrelated returns with the goal of improving long-term performance of risk mitigation strategies.

So, what I see sometimes, which is really frustrating, is that investors get so disappointed with CTAs where they don't perform great during the weekly market sell off, but they're not designed for that. This environment is perfect for the first responders whereas CTAs are going to help during periods that last quarters to years. And therefore, I find Meketa's risk mitigation strategy is very, very effective at explaining the role of trend following and managed futures in global portfolios.

So, the second issue is common investment mistakes. We're all humans, we're all susceptible to behavioral biases. And what I find, as the two main mistakes that investors make, is performance chasing at both manager level as well as the industry level. At the manager level, I think it sounds very reasonable to look at which managers have done well over the last three years and make sure that their assets are large enough. And that strategy seems reasonable. I'm going to sort all the CTAs, pick the brightest and the largest, and I'm going to invest a lot into those managers.

But we've done a lot of research on that, and two of my colleagues, Joel Handy and Lorent Meksi, wrote a paper that was published in the journal Wealth Management that shows that when this strategy is followed, using the constituents of the SocGen index, the performance is poor because of low performance persistence of CTA returns. And therefore, performance chasing at the manager level is a poor strategy.

As you well know, another typical mistake is that investors often get really excited about CTAs right after a crisis. And it takes time to make investment decisions. It might take a year or two to finally make a decision to invest in CTAs. And then since the environment is pretty normal, CTA's performance is just okay. It's not great. They're not expected to make double digits every year.

And therefore, over time investors get disappointed and they conclude they don’t need managed futures in their portfolio. Their portfolio is fantastic without the protection of managed futures, and they decide to deallocate right before the next crisis. And because of this unfortunate pattern or performance chasing, I don't think our industry has as many happy investors as we could have.

And finally, the last question is what is the best way to access our asset class? We've done a lot of research on that and we believe that a multi-manager approach, that's diversified across managers and timeframes and access through managed accounts is the optimal way of accessing our asset class. There are many reasons for that.

We've done a lot of research that shows that diversifying a portfolio across managers, using equal risk allocation and also trying to diversify it across time with volatility targeting, it improves risk adjusted performance. It also provides more consistent crisis alpha.

And by going with a diversified multi-manager approach, investors are able to overcome this high idiosyncratic risk and get more consistent crisis alpha. What's also special about our asset class as you know, is that managed accounts allow scaling higher Sharpe ratio portfolios up, to accomplish high returns at the desired level of volatility. And this is very different from the typical fund of hedge funds that deliver fantastic Sharpe ratio but are unable to scale those up to deliver attractive returns.

We've done a lot of work with Meketa. I think we're very aligned conceptually about the best way of accessing our asset class and also, they like the research we've done to see how it adds a lot of value to the investors. Because of that we've been partnered a lot with them.

So, kind of to summarize the three main points we're trying to make in this paper are that one, it's important to understand the role of managed futures as the second responders within Meketa's risk mitigation strategies framework; two, it's important to overcome the common mistakes of chasing performance at the manager and the industry level. And finally, we believe the best way to access managed futures is through multi-manager portfolio with managed accounts.

Katy, I've got a couple of things, but I want to let you go first. If there's something that you wanted to probe in a little bit in the paper or if there was any other thing or thoughts you had.

I mean, I don't have anything to argue against in this paper. I just loved it because, honestly, I haven't seen such a very concise and structured overview of our entire industry, and sort of things that we do, and expectations, and so I thought it clearly was well thought out and very inclusive of all the key topics. So, I just hope that more investors read that and sort of get some more background on managed futures.

I also love… I guess you can tell that Marat and I have known each other for a long time, and so a lot of the things that he says just resonate with me in so many ways. And you mentioned one of my favorite points and I think Niels is probably going to ask something similar to this but I love how you talk about the concept of approximately right, as opposed to precisely wrong. It's something I actually say to some of my colleagues all the time.

I'm like, you can get the nerdiest formula and do everything, but you'll be precisely wrong as opposed to, as a CTA, it's really about finding the approximately right solutions and well thought through decisions and everything we do. And so, I think it's a great article and so I hope everyone reads it.

Yeah, absolutely, people should read it for sure.

Now, a couple of things I wanted to ask you a little bit and, by all means, correct me if I read the interview wrong, but you seem to take a little bit of a swipe at QIS strategies, if I'm not mistaken, mentioning that they're often just based on backtest and as soon as you start running them, performance is not quite the same.

But I'm sure, and maybe you could even say the same about replication strategies, that they kind of come up with an algo, and they replicate, and they backtest that, and they say oh yeah, this is how we're going to do it. Maybe you could even say that about multi-manager firms saying, oh, we take all these managers, we do a backtest, and they look good together.

And maybe you can even say that about the managers ourselves where we say, well we try these models, and we backtest them, and we see if they work, and so on, and so forth. So, was there a specific point that I didn't catch that makes, for you, QIS stand out a little bit more than others? Or how should I read that part of the conversation?

Well, thank you, that's a fantastic question. So, I've been efficient for a long time, but for about four years of my career here I actually was working for a subsidiary of the firm which was a short-term trading strategy. And I spent many years working and developing trading strategies. I learned a lot about the challenges of in sample and out of sample backtests, and I have a lot of empathy for managers because I think it's very, very difficult to develop strategies that are going to perform well out of sample.

And I think it's very easy to come up with a backtest that performs well. But as you know, it's really unlikely that that backtest is going to perform well going forward. And, to me, the biggest difference between asset managers and QIS strategy is that asset managers have to put their stamp of approval on the given strategy and they put their reputation on the line. Whereas, with QS strategies, banks typically offer hundreds or maybe even thousands of strategies, and they let you pick any one of them, at the same time their reputation is not on the line, and therefore, I think that QIS strategies are much more susceptible to overfitting issues than asset managers.

Got it. Okay. Okay, cool. Thanks for clarifying that. The other thing that I took away from the article or the interview was that you mentioned some concerns that you have, if I remember correctly, about using mean variance optimization. And I was wondering if you could explain what that is, in the first part, just so that all our audience follow what you mean. Maybe briefly mention what the alternative to using a mean variance optimization would be and then, if I read it correctly, why you are skeptical about that methodology versus the alternative, so to speak.

So, I call inverse optimization a beautiful theory with ugly results. I've spent a lot of time trying to make it work for our portfolios. When I was right out of school, I really liked that optimization because the approach seemed very obvious to me and it seemed really powerful. And the reason why I liked it so much was because it takes a very complex problem of building a portfolio into just having to estimate the vector of expected returns and the coherence matrix. So, for me, as somebody who was a mathematician, that sounded really exciting because it was an easy problem to solve.

At the same time, what I found was that it just did not work. And at the high level, the reason why it doesn't work is because it heavily depends on your ability to predict the future. And, as you know, the future is impossible to predict. And because of that it falls apart. Out of sample performance isn't good, portfolio weights are very unstable, and therefore, for all practical purposes, I don't think that inverse optimization can be successfully used to manage portfolios.

I think there are a lot of other approaches that would be much more promising. I do believe that the best principle to use in finance is the principle of diversification. I believe it truly is the only ‘free lunch’ in finance and therefore I think using equal risk approaches is much more attractive.

Sometimes you may want to make some adjustments when you recognize there could be different clusters of strategies. So, you might need to tweak this eco-risk approach with some maybe top-down frameworks. At the same time, I believe that those techniques are much more promising than any extensions of inverse optimization. I also believe that what investors often also miss is that you can also diversify it across the dimension of time.

For example, when you develop trading strategies, it seems obvious that you might want to use volatility-based position sizing. Right? And what it does effectively, is you are volatility targeting those positions. And by doing that you're able to diversify your bets across time. And what we show in our research is that those same ideas can be applied at the portfolio level and they can further improve performance.

So, kind of like summarize it. I don't believe that inverse is a good approach. I think it's a beautiful theory with results. And I think equal risk allocations that are intelligently tweaked are much more promising than inverse optimization.

Katy, as another quant, any thoughts on this?

So, I love that you brought that up because, to me, it was very fascinating coming from academia where it's like all these complex stochastic calculus models and none of them actually worked for real people. And so, I think that's why I think this is very important when you're thinking about portfolio construction. But that paper was really a seminal paper to say, hey, uncertainty in finance is too high for the complexity and the precision that we have to estimate a lot of these things.

So, we need to focus on what we can estimate. And we can estimate correlations a little bit. Maybe, on the margin, we can estimate volatility pretty well. But that's it. So, use that and use it with caution. And so, I like that you brought that up in the article as well.

Super, good. Well, let's pivot a little bit, although we're going to stay with trend, of course. But I would say, even though I have been doing this for a long time and so have you guys, I think probably most of our careers we haven't really thought about how does this strategy, how does this industry get impacted by what goes around in the world? Because generally speaking was a pretty peaceful world with sporadic and very precise risks from a geopolitical point of view. Now, that's all changed in the last five years.

So, I love the fact that you, Katy, have been busy at the typewriter and produced another paper about geopolitical risk and managed futures. My only disappointment is, when I prepared for our conversation, I looked at the wrong paper. So, I'm completely at your mercy for you to take us through the gist of the paper. And Marat will actually, probably have some points and questions. And I'll do my very best to catch-up along with all the audience.

No problem. Niels, like, honestly, I always say this, but I really like this paper the best. Like, I loved it, it's so fun. And it's basically, it's called Navigating Geopolitical Risks and sort of from the perspective for managed futures.

But let me tell you why I wrote the paper. So, I had this client, and this client said to me, Katy, we really want you to give a talk, in Portland, Oregon, on managed futures and geopolitical risk. And I was like, oh, that's a hard one, sure. Because when someone asks you to give a talk, and it's like you go back to the drawing board and you answer it. Right?

So, what happened is that I actually have been working with some research and following some of the geopolitical risk research and I just dived in and I was amazed by some of the cool things we can do. And I think this paper is really exciting because, A, it tells us about what to expect, and, B, it gives us some data, and tools, and things, to measure how much geopolitical risk matters for us and is it changing? So, this paper is, like I said, one of my favorites because it is so relevant right now, and all of us are thinking about geopolitical risk.

What is hard about geopolitical risk is, what does that mean? Right? We talk about it, we read articles about it, but when I turn to the academic literature, they, of course, have been thinking about it as well. And they have come up with some tools, and some ways to measure, and understand geopolitical risk. So, I want to just give you a quick summary of that literature because it is so relevant.

What's interesting is that they have also started a literature of measuring geopolitical risk. And how they do this is using LLMs and using dictionary methods based approaches. And then there was even a paper that came out in March, that hasn't been published yet, that uses AI to not just measure these geopolitical risk events, but also to classify them more in sort of specific context by reading millions and millions of periodicals over time.

So, what is really cool about this database or this data is that it's on the web, so anybody can download it and play with it and look at it. So, it was great for me because as soon as I saw it, within five minutes I could download the data. And I said, “Oh, wow, look at geopolitical risk in March, it's so high, etc.” And so, I want to just give (before I go into the results when we messed with the geopolitical risk data) one other point about this is that this data is very granular. It's not just a series. It covers all different countries around the globe. It covers the difference between the type of geopolitical event: whether it's oil based, whether it's a threat, or a realized action. So, the threat of an action is very different, for example, than the actual action, an invasion, for example.

So, if you go and you Google this, you can figure out in five minutes you can download the data. So, I just want to summarize some of the findings in the current literature that I think is important. And I can take a breath for a second if you want to ask me a question before I talk about our analysis. So, here's the three main corollaries that I have found, or at least are summarized in the literature.

So, when you use geopolitical risk data, which is basically a measure of how often terms related to geopolitical risk are mentioned in the media, okay, and when I say media, it's print media, it's the Wall Street Journal, etc., it's the Washington Post, etc. What they find is that, when we have higher geopolitical risk, there is a heightened perception of disastrous outcomes. We have an increase in risk aversion, which can make risky assets seem more risky than they usually would be. And finally, there is generally lower consumer confidence, which could potentially reduce growth.

So, all these seem very, very consistent with what we're thinking about today, given how much all of us who read the news are feeling about this as well. The one other research area which is… I was shocked to see that this actually published in January. There was a paper also including Iacoviello , who has the data on his website with three other co-authors, in January this year, where he looks at geopolitical risk and its link to inflation. This is extremely important to all of us today because this data goes back to… Because periodicals have been around. So, they can do the data back to then. And basically, what they were trying to understand is what are the macro effects of geopolitical risk after the fact? So, when you have increased geopolitical risk, like World War I, World War II, other events in history, what happened?

And they show that geopolitical risk, and increases in geopolitical risk, is often followed by an increase in inflation. And sometimes, historically, that's two to three years of heightened inflation. So, they also show that this eventually is often paired with lower growth, supply disruptions, increased military spending, growth in money supply, and decrease in international trade. This is their findings. It felt like I was reading today's newspaper. That's what we're dealing with right now.

So, this literature was just very interesting to me because it gives us an idea about history rhyming. Right? Because I think, as trend followers, we often say history doesn't repeat, but there's a lot of rhyming. And I think, when you look at this literature on geopolitical risk, which is much more analytically driven, of course I like a data study, not just a qualitative statement, it gives you an idea of what kind of things we might expect.

And I really do think we all know it intuitively, but we know that during a period with increased geopolitical tensions and geopolitical risk, we're going to expect very different asset class behavior, we're going to have different levels of risk aversion. And so, I think for me, this paper was a great roadmap of how to think about investing over the next three to five years.

Any questions before I go into the results? Because I just talked for a long time.

Well, I'll give the opportunity to Marat if he has any question at this point. Do you have anything you want to…?

Well, I'll make a couple of comments. So, one comment is that I love talking to Katy because I think she's always trying to answer tough questions that investors are really wrestling with and she's very brave. I think those are really difficult questions to answer. And two, clearly we live in a crazy world. I think even this year, with all the conflict that's happening with Venezuela, Iran, potentially Cuba, and I saw in the news just last week the US and Chinese militaries held a meeting in Hawaii because they talked about how to improve communication to avoid miscalculations. So, I think that the largest militaries in the world are worried about potentially going to war with each other.

But I think what's also interesting about this particular paper, is that it gives new insights about trend. We all know that trend performs well during periods of financial crisis, but to me, it's not really obvious why trend would perform so well during periods of high geopolitical risk. And to me, this whole link that Katy is making, geopolitical risk leads to inflation, to me, that's a really interesting link that can explain why trend following would perform well during those environments. So, I'm really fascinated by that.

Yeah, let's jump into that.

So, maybe let me tell the results and then we can kind of circle back to some of the other work that people have done related to this. I mean, clearly this paper was focused on understanding what is geopolitical risk, how can you measure it, and how do strategies and asset classes respond to it? I mean, it's not a long paper, but it gives a roadmap to perhaps further research.

And what we did find during the largest increases, because geopolitical risk is funny, it's not very stationary. Like it's low and then it blows up. So, you know, nothing is going on and suddenly you have an invasion. So, it's a complicated time series to deal with.

And so what Yingshan and I ended up doing is we looked at, okay, so when there is the biggest increase in geopolitical risk, meaning like we went from things are good to, oh, this is really bad, we found that equities tended to be down, fixed income tended to be down, energy tended to be spiking (oftentimes during those times). And the US dollar was generally up for the last 25 years, because we focus on the period since the SG trend.

So, if you look over a longer period, you might see something different for the dollar. You might see something different for energy, I think, and equity and fixed income. That makes sense because that is consistent with an inflation shock coming. Right?

And then when we looked at investment strategies, interestingly enough we found (and not surprisingly) hedge funds tended to struggle a little bit during these periods, consistent with the literature on beta expansion, etc. Equity market neutral was pretty much neutral, which would be consistent. But managed futures tended to have very positive returns during higher geopolitical risk. And that, to me, is very intuitive because if, you know, things are changing and there's stress in the system because we're multi-asset, it’s not necessarily an equity story per se. It could be commodities. The strategy has tended to adapt well to a stressful environment. So, that was very consistent with what we found.

And the last thing I'll point out, and then that's sort of the last conclusion in the paper is, we looked at sort of a sorting of geopolitical risk with the biggest increase, biggest decrease, and in the middle. And you actually see that CTA smile. Right? When nothing interesting is happening managed futures is kind of flat. When something interesting is changing, either getting much better or much worse, then we tended to do better. So, it was consistent with that sort of crisis alpha type story. But it's not really an equity focused strategy. Right?

It's like there's geopolitical risk, it's expanding, or it's contracting and changing things, and we like that. Everybody's happy and we're all buddies, go buy your equity portfolio. And so that was interesting.

And when we looked at the extreme moves, you found that equity actually wasn't one of the bigger contributors during these periods. So, timing the equity moves during these geopolitical events is hard. And that would make sense right now. Look at try and think about trading equities in the recent conflict. That would be difficult. It's been not a clear trend per se. And so, that was interesting to see as well. This isn't just like an equity timing story.

When geopolitical risk hits, it's really about the big moves in commodities and fixed income, likely due to the increased probability of inflation around geopolitical risk.

Super interesting when we think about what makes then kind of trend following this perfect… Well, we know it's a good crisis alpha strategy, but now we could also add the term geopolitical risk strategy, maybe. But what is it, specifically, that we think that makes it that, so to speak. Meaning, is it the… because I remember the original definition that you came up with, Katy, which I think a lot of people have forgotten, actually. But is it the adaptability of the strategy? Is it the fact that it's so diversified, had lots of commodities in it as well? You know, is the fact that it has no bias in these accounts or some of the original themes that went into it?

And I don't know if you looked at it, whether there was one theme that was more dominant than others? The reason I asked that is that… And I don't have any evidence of this because it's something I remember hearing. And I wonder (I might attribute this to the wrong person), but I wonder whether it could have been your co-author, Katy, Alex Greyserman, that may have done the research once. I don't know, but I seem to remember someone saying that, oh, if you go back and look at crises in general, and we have to say that a geopolitical risk doesn't necessarily mean we're going to get an equity crisis. We haven't had one this time around so far. But I seem to remember that when you go through the data and you look at real equity crisis, you already alluded to the fact that yeah, we're probably going to lose money in equities, but actually the most consistent sector or sectors that seems to perform well during these crises comes from the commodity side of the portfolio.

So anyway, I'll throw out the question again whether you looked into why you believe and I often also love to hear your thoughts, Marat, about why you may agree with Katy's findings in saying that geopolitical risks and trend following, or managed futures, a kind of an interesting match.

Yeah, this is a good question and that's kind of why I did look at the asset class contribution in this paper. One of the challenges with any sort of crisis alpha or sort of drawdown analysis is going to depend on the time horizon. Right?

So yeah, I think, you know, and it's interesting, Marat, and I were talking about this maybe a few weeks ago, because he had asked me a question about this paper. Since this is a monthly frequency, you're not going to see trend being able to capture that tech bubble.

You're going to see a shock or a move, in certain asset classes, that would be commiserate where the type of risk that a geopolitical risk induces. And that's why the research was interesting because it gave me some fundamental thoughts on what trends might occur during a geopolitical risk. Right?

So, when there's a geopolitical risk shock, usually you end up with supply or demand shocks, or different shocks, specifically, supply probably as well in some area of commodities. And we can compare what happened during the Ukraine invasion versus say this particular shock in the sense that that was a shock but it was more in Nat gas, and food, and etc. The shock this time has been an energy shock.

But commodities is a place where we feel that pain during a geopolitical because it's something we all share. Right? And so, I think that's why commodities is a place you're going to see.

I do think fixed income is also interesting because fixed income is very vulnerable to inflation induced commodity shocks. So, those two are more obvious. With currencies, it depends. And for equities it's going to depend on whether or not these shocks are enough to affect growth. And that's why the market this time hasn't hit growth. So, I think trend as a strategy is well positioned to deal with change in the macro environment.

Geopolitical risk is just an indication that the macro environment is changing. And I think I kind of had the same view as when you have equities down, it's also kind of a different macro environment where it shows that things are changing and reconsolidating and it's a period of stress. So those are stress, but a different type of stress I'd say.

Okay, cool. What about you, Marat? What are your thoughts about this?

Well, I think what Katy says makes total sense. I think that the inflationary story, I think, is very intuitive. I think geopolitical risk causes inflation, and inflation causes moves in the markets that tend to be profitable for trend. For example, when prices go up, inflation is high, commodities go up. So, there's going to be a trend in commodities. When fixed income goes down, because of inflation, you can try to capture those trends.

And there was a mix for a lot of hedge fund strategies, but there were two strategies that stood out. One was loan only commodities, and the second one was trend following.

So, even though our studies were done, I guess, for different horizons, I think that in our case we're seeing that inflation, whether it's driven by geopolitical risk or some other factors, those environments will be profitable for trend following strategies. I guess my question is for Katy.

I wonder whether she would get even stronger results if she goes beyond a one month horizon and look at quarterly, but maybe even annual horizons in her research. Because I think trend is not as good, necessarily, at capturing quick events. But if geopolitical risk induces new trends in the markets, it might take a while for the strategies to capture those. So, I'll be really interested...

I think you just gave us a new paper to write, Marat, because you know, I think we'd have to look at…

But I do think you would see that. And so, the difference between a shock and a persistent event, you're going to include things like the World War I, World War II, the Great Depression. It'd be very interesting. But you definitely need long time series if you're going to talk about those horizons.

Yeah. But frankly I feel like even with what you've done already, I think the implications for investors so obvious. I think it’s pretty clear that trend is their friend. Whether they're worried about the crisis, whether they’re worried about inflation, whether they’re worried about geopolitical risk.

And I think also, from an allocator perspective, I see a huge case for diversification. I think Niels mentioned the importance of commodity trend. I think that is so true. If you are worried about geopolitical risk, then commodity trend is actually going to help you a lot during those environments. So, you need to be well diversified. So, I think that the implications of your research are really important, thank you for your work.

That was a fun one. It was a fun one.

Well, before we wrap up, let's dig into one more important point and that is actually that if we try and connect kind of Katy's world with the geopolitical risk world, meaning crisis alpha and geopolitical risks, you actually kind of addressed this in a paper that I think is very recently published last month in Pension and Investment, Marat. And that specifically suggests that shorter term strategies, I think specifically you mentioned short-term trend following, might actually also be worth considering now that you mentioned earlier that you have been working on short-term strategies for quite a while. I'll be careful with my pushback, but I might have a little bit of a pushback. We'll see.

But do you want to briefly talk a little bit about what you found and what you looked at?

Absolutely. And Niels, I want to be careful because I don't want to overstate our findings because I think that, even in our paper, we talk about some of the areas that we need to be careful about. I want to give you a little bit of a story behind this paper.

As I mentioned earlier, a lot of the times we see that investors have one or two trend following managers. We believe that we make a case for an investor to diversify to maybe 6 to 10 hedge fund managers, that's huge success. Because I think they're able to overcome so many potential issues and they're going to capture crisis alpha more consistently.

At the same time, what we've seen over the years is that, even 10 years ago, we'd have clients who come to us and say, well, can you actually increase our crisis alpha? And we'll say, well, you might want to consider short-term managers.

And there was a really fun project, I remember tackling about 10 years ago, about what is the optimal allocation between long term trend and short-term trend if you're trying to maximize crisis alpha? So, we had to deal with those questions a lot over the years. And then a couple of years ago we ended up writing the paper, academic paper, in the Journal of Portfolio Management. And then we wrote a piece this month, or last month, to talk about the importance of short-term trend.

So, let me just talk about three main findings of the paper. So, the first finding was that we found that short-term trends is able to increase the long-term performance of trend following strategies. So, if you add them to long-term trend, medium trend, short-term trend improves long-term performance without sacrificing crisis alpha. Which is a really important finding because I believe that most investors choose to invest in our asset class because of crisis alpha.

But then we wanted to understand why is that? Why is it the short-term trend is able to improve the performance of trend strategies without sacrificing crisis alpha? And what we found was that short-term trend was really effective at offsetting some of the losses that were experienced by long-term trend strategies during early transition periods.

But then we also need to be realistic. And as you know, when you look at shorter-term strategies, the impact of transaction costs, market impact, and all execution related and implementation related issues are so significant. And therefore, in our paper we wanted to understand how sensitive were our conclusions to implementation costs. And actually, what we found was that the results are extremely sensitive.

So, if you don't invest in execution, if you don't choose to invest in co-located servers, if you don't invest in specialized algos, the edge that the short-term trend can provide can quickly go away. And therefore, the only way to provide an edge in short-term trend following is if it's complemented by very significant investments in execution infrastructure to reduce execution costs.

So, kind of to summarize, we believe that short-term trends can improve the performance of trend following strategies without sacrificing crisis alpha. It's really driven by their ability to offset early losses of trend following strategies during transition periods. But execution is essential in order to capture the potential benefits of short-term strategies.

Yeah, that's great. Now as I said, I did have some thoughts about it when I read it. And I think it all depends on kind of what eyes you look through. And of course, I am completely biased since my career has been spent in the long-term trend following space. So, that's kind of the first disclosure I should make, I guess. But nevertheless, here are my thoughts about it.

I've always felt, and I've said this many times on the podcast, that I think when we use the words ‘trend following’, especially the word ‘following’, I have struggled to find any managers, and even when I look at internal research data, that supports the fact that it's profitable over time. Certainly, when we just change the lookback period on a basic trend model from a research point of view, we find that generally they end up losing money over time.

However, what I've also observed, and this is a, you know, just an observation, objectively, I guess, maybe also inspired from my recent conversation with Toby Crabel, that we interviewed, maybe also with conversations with Nigol from Quest Partners, whether it's because of that success and the massive inflows that you saw in shorter-term strategies following that time, those kind of strategies have not really done so well in the last five years or so. And we've seen again that, you know, AUM has adjusted down as a consequence.

Neither did short-term, from memory at least, at least compared to long-term trend following. So, I was kind of thinking, as you were talking right now, I wonder if it's because the crisis have become different. Because, oddly enough, if the crisis is too short, like a V shape, like a liberation day, for example, or something like that, then the short-term guys can't handle it either. Right? Maybe it's actually better to be like a replicator who's so slow, if I can put it like that, that they don't even blink and the crisis is over and they just stay with the position.

So, I cannot say exactly why I make the observation about this, but something has changed in my mind about the effectiveness or maybe just the challenge of being short-term in recent years. So, those were kind of my observations, Marat. So, I'm not disputing your findings. I'm just saying, from a practical non-quant point of view, I see other things happening around me in the space. And when I talk to people I have a lot of respect for in that short-term space, they acknowledge the challenge that they have faced in recent years.

Niels, I think you are raising really important points and you might be surprised. I'm not going to push back on a lot of what you're saying.

No, no, no, no.

Okay. So, I want to be… And frankly, I wrestle with a lot of the questions that you're asking. Like at some point I remember thinking about, hey, does it even make sense for us to invest in short-term managers? And the reason for that, because I remember looking at the performance of the SocGen CTA Index and it wasn't great. Right?

And I had to wrestle with the question, well, if you look at the performance of our short-term managers, they've done so much better than STTI. Is it just luck? Right? So, we had to wrestle with those questions.

So, I want to say a couple of things. So, one, I do believe it is extremely difficult to make money. Okay. And so, what we find in our studies is that the more different managers are from being long-term trend following, the higher their mortality is going to be. Okay. Short-term managers have higher mortality than long-term trend followers.

What we also find is that if you look at diversified strategies, mortality there is even higher. And it doesn't necessarily mean that we should not invest in those segments of managed futures. We actually find that we're able to build much better portfolios because we leverage those. But those are not easy categories to find good managers. They're very, very difficult. So, I would say it's hard to find good short-term managers and it's even much more difficult to find diversified strategies. Okay.

So, another point is, when you look at short-term managers, your point of them not just running a short-term trend, it's a completely valid point as well. So, a lot of managers use some, for example, better recognition techniques to generate returns. Right? So, it's not just purely short-term trend.

So, I would say, when you're looking at short-term traders trying to build successful businesses, either way they have to constantly look for ways to make money because it is so challenging. And I know that you mentioned Toby Crabel. He probably talked about the challenges of decay. Right? Signal decay.

Actually, one thing Toby said was quite interesting, and I'm going to quote him incorrectly, so I apologize for that, but people should go back and listen to the conversation that we published, I think last month, with Toby. But what he was saying was his observations were, for example, that, and I think he was referring to if, in the old days, when a market opened higher it usually finished higher like 64% of the time. And now he says it's like 56% or 58%. And he said, that's, percentage wise, seems like a small difference, but it makes a huge difference if you're trying to be like a short-term breakout. And of course, he wrote the book on open breakout, and he says there's not even an open anymore. I mean, so things have changed. Right? So, maybe it's all part of small things.

Katy, in being conscious of time, I still would love to hear your thoughts quickly, but we have gone long because we've had great things to talk about. But I'd just love to hear your thoughts maybe on this topic before we wrap up.

I don't think anybody is disagreeing because I think short-term is such a broad term that it's just defined so differently. We talk about trend following being defined differently by different people, but once you go to short-term, there are so many different things you can do in the shorter short-term that you go, the harder it is, because the transaction costs and other things.

And I think, you know, what I did appreciate with this paper is it is consistent with something that Alex and I found where we're just looking at, you know, the reactivity question. Right? And so, when you're trend following, even if you're following, you're more reactive at following when you're faster.

I think there's a lot of dependency on what you define of trend following for short-term because it's a huge space. So, it has a lot of things to offer, but it's also hard to navigate.

Yeah, well, on that point, I will just say that in the short-term, we have to wrap up our conversation, but in the medium and long-term, we'll be back with more conversation as we continue to explore this wonderful world of CTA and trend following.

Now, before we wrap up, I hope that a lot of people got really a lot from Marat's work and the paper that Katy just published. And to show your appreciation, head over to your favorite podcast platform, leave a rating and review. It's so important that we get more people to understand the space, and that's one way of helping us do so.

Next week I will be joined by Andrew Beer, as well as a guest we've had on a few years ago, namely Eric Crittenden, from Standpoint, that's going to be a fascinating conversation because we're going to address different types of things, but I think we might also touch a little bit on maybe some of the challenges about transaction costs and how we think about these things. So, I really do hope people will show up and maybe also send a question to Andrew or Eric. They're wonderful people to answer whatever question you may have, [email protected] is the email to send it to. But maybe be careful making it too product specific because we may run into some compliance concerns, as we did today with the question we got from Rod.

Anyways, from Katy, Marat, and me, thanks ever so much for listening. We look forward to being back with you next week. And until next time, take care of yourself and take care of each other.

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