On this episode I continue my conversation with Marty Bergin, the owner and President of DUNN Capital Management, Grant Jaffarian, Portfolio Manager of the Advanced Trend program at Crabel Capital Management, and Mike Boss, who is a Director within the Capital Introductions Team at Societe General, where we cover all things trend following and some of the differences to short-term trading.
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Welcome back to Top Traders Round Table, a podcast series on managed futures brought to you by the CME group. You are listening to part two of my conversation with Marty Bergin, the owner, and president of Dunn Capital Management; Grant Jaffarian, portfolio manager of the Advanced Trend program at Crabel Capital Management; as well as Mike Buss who is a director within the Capital Introductions Team, at Société Générale.
We estimate that, just in terms of our execution infrastructure, we’re talking about having to support it with several ten million dollars, multiple ten million dollars worth of investment in executional loan. That doesn’t really speak to all the other costs around data, client relations, office space, etc.
So, to break even with our trend following product we’d have to run in the vicinity of four billion dollars at our fee structure to break even at the fee level we’re charging for this product if that’s all we were, was a trend follower.
Sure, Marty I know that you have a unique approach, as you already mentioned, to the way you charge fees. So I’d love to hear your perspective to this new breed of products and of course, as Grant already said, a lot of them were really created to capture, in a cheap way, returns from trend following, and therefore competing against trend following managers specifically. So how do you view this development?
Well, so I have to ask myself where did the low fee products really derive from? And, you know, it’s basically large managers who have the capacity. They have the AUM to drop the incentive fee and just charge the management fee.
Then you ask yourself, what’s the motivation? Is the motivation to continue to make outsized profits? Or, have they found that their AUM has come to such a size that it’s difficult for them to make the same type of money they have in the past, and now it’s about asset accumulation. The Wintons of the world… I mean it doesn’t take a genius to do the math - what a one percent management is on thirty billion dollars. That’s paid annually, whether you make money or lose money.
So when you talk about low-cost, you have to ask yourself, what does low-cost mean? I consider what we do as low-cost because we don’t charge a management fee. But nobody would say that our incentive fee is low. We charge a twenty-five percent incentive fee. If there came a time where our returns were not competitive both on an absolute... because, at Dunn we’ve always been competitive on an absolute return basis. Trend following by its nature (at the bare bones of it) is an absolute return strategy. But it’s never been known as a real strong risk-adjusted strategy.
So, what all our research in the last ten years has been designed to do is increase the risk-adjusted returns. So we look at both of those, and if there comes a time when I’m not competitive at a twenty fifty percent incentive fee, then I’d probably ratchet it back. There’s a lot of pressure on us to offer a management only, fee type product. But, it just doesn’t seem right to me.
If I could just go back to you Grant, what’d the incentive for a firm like yours, if I can be so bold to ask? To offer a flat-fee product - I know you said you have combinations, but still, what’s the incentive (just to pick up on what Marty said) to really produce that great return when you’re being paid the same? Whether you do it or not?
Yeah, well, you know, Crabel is an interesting shop. We’re an interesting dynamic of a heavy research focus; and yet, for the most part, we’re relatively ego-free as a community at Crabel. We’re, however, that said, we’re extremely competitive folks at the end of the day.
We want to make money for our investors. Our founder was a professional tennis player before he became a professional asset manager. He still plays competitive tennis, very competitively. You know we’re just a competitive group.
Now, one of the issues we always had, which is fun for us, but our flagship multiproduct that runs about two billion dollars today has no correlation to anyone. We have peers in the sense that there are other short-term systematic traders. But, when our investors call, they’re not saying, “This manager did X! You did something plus or minus X!” That doesn’t make any sense because we really don’t have any correlation to anyone, which is exciting.
However, the idea of having a product that has a peer group that’s not only expansive but has been around for decades; that has direct mandates from the world’s largest pensions and endowments who really need the exposure; a product that puts us in a position where our entire team can look at the returns, really, on a daily basis and say, “How are we doing?” Gosh, that’s exciting!
So there are ancillary benefits way beyond the revenue we generated. Make no mistake, we’re making (generally speaking) one in zero, and that’s very, very helpful. We maintain an extremely expensive operational budget to do what we do, particularly around execution and research. It’s useful, but it’s pretty exciting to have a product that we can actually compare, and that really feeds the competitive nature. It’s exciting!
Niels, can I pipe in with a question? Something in my tours... quite surprised, by the way, good amount of emphasis - I keep hearing pension and endowment, and that’s been a good part of my time visiting some of these folks... and almost shocked to hear… okay there’s a three-person investment team, you know looking after eight billion dollars, and oh, by the way, we did our own simple trend models, and we run it in-house. To me, it was kind of jaw-dropping, and I’m just kind of curious of… and that’s relatively recent to both of you. What are some of the pitfalls of that? Is that a bit naive? Just thoughts, yeah.
Well it’s not that recent, I mean people have started moving that direction ten years ago. One of the largest allocators in the world actually took their trend following in-house. And for the first few years of that experiment, they actually outperformed the market place. It always works until it doesn’t, and when it doesn’t, it’s usually a bad ending. I really believe there is no question anybody... you can take a high school student and give them a text book and they’ll design a trend following system.
The problem is in the risk management of the trend following system. You know the worst drawdown is always there to be beaten by the next drawdown, and that’s just the facts of the world, and it can be pretty painful. So I think it is naive, and, you know, a lot of people fool themselves in their research because data mining is a big problem. A lot of people don’t even realize that they’ve data-mined and come up with this wonderful system until they run it themselves. And, maybe it works for a while, but when it doesn’t, it’s a hard lesson and an expensive lesson.
Well as Oscar Wilde once said, “Imitation is the sincerest form of flattery that mediocrity can pay to greatness.” So maybe that is what’s going on! (all laugh)
Mike, from where you sit, who’s winning the battle between the low-cost products and the traditional trend following products? Or can they actually exist happily together?
I think they can coexist, I mean, we’re definitely seeing that. Some of these public mandates (which are again public, you can go to the websites) you can see that there’s RFPs. Unfortunately, those RFPs tend to be with at least a ten-year track and two billion AUM. So, it does eliminate quite a few of the players, and that’s kind of unfortunate. I think in my view, and I would say it’s always kind of been that way, it’s always been very steep, but it seems even steeper now where the AUM goes to those with AUM.
A quick side not is Société Générale launched a CTA Mutual Fund Index, which is both single and multi-manager. I think it was at the beginning of last year. I would say the interesting part of that is we took the top ten that are open for investment (that were willing to share returns with us) and all top ten said, "Yes, we are." I thought the interesting part there was the largest is, whatever - at X billion. I think you guys know who, but the tenth largest is just one hundred million. So it’s kind of very, very concentrated in very few hands.
It’s a very difficult market. We just got into the mutual fund market a year ago, and I have been ecstatic at the fact that we’ve raised one hundred million dollars in a year. Which you know I look at all the other guys out there, and there’s a lot of shops that have gotten involved, and they just can’t get any traction whatsoever. You’re exactly right; there are a few big players that basically gobble up all the money.
It’s a twofold process you’ve got to have returns, and secondly, you have to educate the RIA community on what managed futures does. As an industry that’s something we don’t do very well. We really need to do a better job of letting the public know what it is we do and why it’s an advantage to them.
The idea that a person has to be a qualified investor to get access to this type of investment is just ludicrous to me. Everybody at every level should have access to this, and they should have access at a reasonable cost. That’s part of the problem with the mutual fund space is it’s just too expensive to really make money. The risk that’s being taken… all the risk is on the investor, right? He’s the only one taking risk; everyone else is getting paid. So, that's the real problem.
I just want to go back to the point brought up before about some big institutions or investors trying to set up their own internal trend following approaches. Of course, we’ve seen some… we could say we’ve seen some lacklustre returns in the trend following space in the last few years. Is there any link between more and more people getting into trend following and returns - maybe not being as strong as they used to be? Which is an argument you sometimes hear when you deal with investors. I don’t know Marty, do you have any view on this? Or have you seen any evidence of this?
Well, I don’t know that I’ve seen evidence of it, it has to play a part, though. I mean the more people you get occupying the space, the harder it is to move the money around. But I have to believe that the poor returns that the industry, as a whole, has seen since the credit crisis is more attributed to the control of the economy by central banks and orchestrated effort by central banks around the world who control the flow of money. Which, hopefully, we’re starting to see that decorrelation come back into the market place, which is going to be really good for trend followers and managed futures as a whole and the number of opportunities that become available will be greater.
Sure, what about the short-term space and, for that matter, the trend following space seen from your eyes Grant, what do you make of this recent period? Is there any link?
It’s… as Marty indicated, I think it’s difficult to know with certainty. On the short-term side, it’s unlikely a function of asset growth in short-term trading because it’s just so challenging to trade in a twenty-four-hour hold duration with any size. The number of round turns we do... you know we’re probably amongst the biggest five futures traders in the world (maybe even the top three, it’s difficult to know for sure), but none of the others that populate that count of largest are asset managers. Their all high-frequency trading firms.
So we have a decent body of data to suggest that it’s difficult to pile a lot of money into those time frame strategies. The point there is I don’t think we’ve seen meaningful growth in short-term systematic trading because it’s just so challenging to pull off.
So there? No, I think what we’re talking about instead is generally a long-term, low volatility period, of course, with some volatility spikes here and there. But, for the most part, absolute volatility has been relatively low globally for some time. That’s been challenging. We love markets to be a little spicier. We still haven’t had a large number, for instance of, let’s say, S&P days that opened or closed more than one percent higher or lower. The percentage of those days as a function of all days is really quite low. We love to feast on those types of days in our short-term trading.
So, I think there it’s less an asset growth question and more of an absolute volatility question. In the trend following space, the interesting dynamic that you see is the larger a trend follower gets, typically, the lower their volatility profile gets; and the more they prefer to move into other markets. And the reason that’s relative to your question is because perhaps, on the face of it, institutional asset managers, in the managed futures and trend following space, in particular, have grown. It may be that they’re trading footprint has not, which is unfortunate for investors because you theoretically pay more for less.
From an assets trying to be plowed into these strategies, it also becomes difficult to justify that the assets have really grown in the managed futures space. I don’t think that they necessarily have in the trend space. We certainly have an experience in slippage. We run our entire trend following product, in terms of our back test, to what we are actually in the market at about fifteen, sixteen basis points and that includes exchange cost, clearing, and execution. So it’s very, very low, we have not seen that change very much, even in this year.
So, from an ability to hit where our model suggests we should get filled, etc., really no impact. So, what are we looking at? Well, we’re talking about obviously an election year this year; we’re talking about a tremendous amount of government intervention over the last… really post 08’ really. So, relatively sharp or clear indications of risk on/risk off sort of situations and absolute low volatility. Most of which suggests that it’s going to be difficult for trend followers to make money.rse, we did have big moves in:
A side question to that guys: you know we’ve been in this thirty-year cycle of lower interest rates, which I think with a roll curve always... mostly being positive meaning positive carry in interest rates. Let’s just go with a "what if." If we start going the other direction, how challenging is that going to be for shorter to longer term trend followers?
To tell you the truth this comes up all the time. This assumption that long-term trend following has basically profited because of the thirty-year bull market in bonds is just crazy in my mind. There’s definitely an interest rate advantage when you’re doing managed futures but… I mean if we went into a twenty-year bear market, I can’t think of a better thing for our industry. I mean it would be a windfall.
The fact that we can bet on the price falling just as easily as betting on the price rising, makes it very simple for what we do. I don’t know about the short-term space, but I would imagine the short-term space wouldn’t be affected whatsoever. It doesn’t care if the market is going up or is going down, I mean just like us.
Marty, but you fight carry if you’re going to be short interest rate futures. I mean if we reverse the trend and rates, say for the next thirty years, and rates went all the way back into low double digits or higher, theoretically, you don’t make money. As a trend follower being short interest rate futures, you just don’t. Because you have to pay the carry, right?
Right, but if you look at the 70’s, we’re probably the only long-term trend follower that was around during the 70’s in which you had a long period of raising interest rates. We made a lot of money during that period.
Yeah but, sure, but you have to overcome the carry.
Well but you're not… interest rates don’t just affect the bonds. So it’s all the other associated markets that also react to that interest rate, and if you’re not necessarily making as much money in the bond as you were on a thirty-year bull market, you’re still making money there. But your currencies, all the commodities, gold, energies, all these other markets are moving also. The movement of the interest rate effects everything. I mean that’s… I’m still convinced that all that we’re doing is trading interest rates, and every other market is affected by the same thing, that’s interest rate.
Yeah, that’s the clarification I was looking for because to suggest that it’s easy to short interest rate futures and make money in rates, is likely not going to be accurate if the speed at which rates change is equivalent in reverse as we’ve seen in thirty years. So you’re not going to make money in interest rates as a trend follower. It’s not going to happen. It’s flat.
Mathematically you can just reverse it, you can flip the carry, and it’s clear, but theoretically you should find tremendous opportunity in the other three sectors, and I don’t disagree. And to be clear, and this is maybe a controversial statement, trend following… and I kind of hinted at this, really trend following is carry capture -the vast majority of the time, except for crisis alpha (you know, the ability to flip and take advantage of crisis moments).
So, what you do have is a business that does not leverage money, of course. We use very little capital to actualize our positions, which means the vast majority are suddenly able to earn interest on deposit because we’re not using it. You may not make money on the directionality of rates but now all of a sudden you’re earning, essentially, carry on your cash. So, you have that benefit, which you… it’s easy to forget that looking back in the 80’s, and 90’s the Turtles did great, yeah, but ten percent plus of those returns were essentially interest on cash?
Wow! That’s nice! What other space has the ability to accrue that type of return? Everyone else is deploying leverage for the most part. So, there’s this tremendous give and take there. I think Marty’s right, theoretically, you see a lot of volatility elsewhere, so you make directional profits. You’re not going to make money being short interest rate short futures. I don’t think so.
Well the other thing you have to remember is interest rates don’t go up lockstep. So, even though we’re in a thirty year bull market, there’s a long period of that time when we were short interest rates in our positioning. The same will be true on the other side of that. Of course, we’ve been long interest rates for five years until just recently. Four years ago I sat in front of a room saying, "Who would have believed that we were long interest rates last year?" I mean that’s crazy!
We’re still long and I still think it’s a bad position and we’ve made… you know we’ve made a lot of money being long interest rates when nobody thought we should be long interest rates. Because we’re systematic, the market will dictate… everybody in this room is systematic, so it doesn’t matter what we think, nobody cares what we think, it’s all about the market and the prices and we react accordingly.
Nielsing is being done in December:
Oh wow, what a year! I think it goes to show what you think you don’t know. We were at a new high in July which, what anther great year we were having and boy just think it’s the last two months have really come off. I think we’re in a transitional period. I’d like to see what everybody else thinks about that. You know everybody has been waiting for bonds to finally turn over and interest rates to go up. I mean are we in that transition where we’re moving from lower rates to higher rates? I don’t know, but it seems like we are, and I think that’ll be a good thing for the industry for the future.
Nielsat about your take-aways from:
Well, I mean it’s hard to talk about, purely from an investment perspective, given the amount of, I think, fear that the world is exhibited across various elections. Whether it’s Brexit or our U.S. election. It made it very difficult to trade. There’s no question, that level of uncertainty.
We’ll see. I think typically we’ve seen technological leaps that happen every so often and they’ve accelerated over history. It seems like a very grandiose statement to conclude a podcast; it’s just I think the world is somewhat poised for a relatively massive technological leap to potentially save us from an overindulgence in cheap money, essentially, that has flooded the market place. We’ll see.
You combine that with clear fear and anxiety that we’re seeing across some of the most developed countries in the world. Particularly around issues like immigration and it sets up for some pretty interesting impacts on the financial markets. It’s a shame it’s been tough for us to trade this year. I think we’ve all learned from it. I think there’s no question, particularly on our short-term side, the number of new concepts that we’ve been able to include. We've probably had about twenty percent alpha turnover, perhaps, in our multi-product. That’s a general idea, but the reality is it’s been ample ground to get better, and we hope we’ve done so.
Sure, Mike any take?
You know not to sound mellow dramatic, but moments of pure joy balanced by sheer terror this last year. (laughs) So, very, very challenging including from a banking perspective as well. But you know, I think all of us in this room would say if you could predict that next year’s going to be an awesome year for CTA, I mean who can really do that? We really can’t, that being said, we have a new administration coming in and maybe a little bit more of a laissez-faire attitude, and maybe a little bit more "let markets be markets," and I think that can be a good thing.
Sure, so far, and we’re coming to the end of our conversation. I’ve been asking all the questions, but I also spoke to you about maybe you all had one or two questions that you would like to ask each other to change things up a little bit, so who wants to go first? Who has some interesting questions that they might want to raise? Yeah, Mike?
I’m going to throw it out to the both of you, it sounds real sexy you know, machine learning, we’re going to have the machines… what are your views on you know machines deciding what the best strategy… is there merit, is there alpha, or is it an intellectual exercise?
Alright, I guess I’ll take at a stab. It’s ridiculous for somebody sitting in my chair to try to answer that question authoritatively, what do I know? There are a lot of smart people deploying tremendously bright ideas in quant learning and metadata concepts, etc.
One thing that we have always focused on at Crabel has been the intuitive nature of our system development, and we’re one hundred percent systematic, but the reality is every line item we have, in terms of our individual systems, has a reason to be. And you can sit with our researchers, and they’ll tell you why it makes money.
That said, recently we added a team that we believe to be on the forefront of what’s happening in signal processing and machine learning. The learning curve there is tremendous. Getting involved with early stage manager start-ups over the last several years, I’ve seen a number of very brilliant people come out of Silicon Valley and other places and flounder with technologies that were incredibly adept at pricing various other sort of pricing structures outside of the markets.
It’s challenging because it’s absolutely impossible to know what the market’s going to present you with next. Now after five to ten years for some of these guys, I think we start to see some unbelievable work. We’re not yet at the ten-year mark, I think generally, so it’s going to be very challenging. I believe my answer is likely to change in three to ten years. It’s just not there yet.
Well, so we’ve looked really hard at this space over the last five years, and we have vetted, we’ve talked to, we’ve even traded with some people doing this, and I agree with Grant, we’re not there. I mean the intelligence level of the people doing this stuff and what they’re… the technology involved is phenomenal, and it’s incredibly fascinating, but we haven’t seen anything that works. Not over the test of time, so it’s not worth the risk at this point in my mind.
Yeah, one other antidote having I think some interaction with what’s happening in the prop trading community… I’ve heard, and this is purely anecdotal, that there are generally thinking two different ways to approach, for instance, high-frequency trading. This is not necessarily talking about whether you’re a passive or aggressive market maker.
One is to develop thousands of machine learned concepts, throw them against the wall, see what works, start allocating more of your capital on an intra-second basis to the ones that work. But the most successful HFT firms out there, and the ones that are garnering (I suppose) the most momentum, and putting some of the others out of business, still derive all their methodologies around intuition, which is stunning. I mean here the shops that theoretically we, all here, do extremely well and make money every day. I think the very best ones are still deploying logic that’s intuition based. So, that’s pretty interesting.
On that note, Marty, Grant, and Mike thank you very much for sharing your thoughts and opinions on managed futures. I really appreciate your openness during our conversation today. And to our listeners around the world, let me finish by saying that I hope you’re able to take something from today’s conversation with you as you continue your own investment journey and if you did, please share these episodes with your friends and colleagues and send us a comment to let us know what topics you want us to bring up in the upcoming conversations with industry leaders in managed futures. From me, Niels Kaastrup-Larsen, thanks for listening and I look forward to being back with you on the next episode of Top Traders Round Table