Recorded live from the Cboe RMC floor in Munich, Cem Karsan sits down with volatility veteran David Dredge for a deep exploration of what truly drives risk. From the crash of 1987 to today’s era of correlation, Dredge reframes volatility not as fear, but freedom. Through his F1 “brakes” analogy, he reveals why protection enables performance, and how convexity builds resilience in an uncertain world. Together, they trace the arc from structured-product flows to demographics, fiscal repression, and the coming global “Hunger Games” for savings. A masterclass in compounding through uncertainty.



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Episode TimeStamps:

00:01:29 – Cem introduces David Dredge live from Munich.

00:03:28 – Dredge recalls arriving in Asia before the 1987 crash.

00:05:06 – The F1 brakes analogy—why protection enables speed.

00:07:45 – The “preserve and enhance” portfolio that defied 65/35.

00:10:57 – Rethinking 60/40 and the illusion of diversification.

00:14:33 – Cem on $500 trillion of correlated assets.

00:17:22 – Why covered calls lose to convexity over time.

00:19:14 – Misreading 2022: correlation, not equities, was the risk.

00:21:20 – When diversification fails, only convexity endures.

00:27:13 – Value investing in volatility—buying what others suppress.

00:37:48 – Euro FX vol: the paradox of cheap risk.

00:44:07 – Demographics and the quiet mathematics of decline.

00:47:46 – The “Hunger Games” for global savings begins.

00:52:57 – Lessons from 1997: FX and gold vol as survival trades.

00:56:11 – The anti-fiat portfolio—Bitcoin, gold, and long vol.

01:01:13 – Closing reflection on resilience as freedom.



Copyright © 2025 – CMC AG – All Rights Reserved

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Music: 00:00:03

(Music)

Intro: 00:00:11

Welcome to U Got Options, an exciting series right here on Top Traders Unplugged, hosted by none other than Cem Karsan, one of the sharpest minds when it comes to understanding what's really driving market moves beneath the surface.

In this series, Cem brings his deep expertise and unique perspective, honed from years of experience on the trading floor to candid conversations with some of the brightest minds in the industry. Together, they unpack the shifting tides and underlying forces that move markets and the opportunities they create.

A quick reminder before we dive in, U Got Options is for informational and educational purposes only. None of the discussions you're about to hear should be considered investment advice. As always, please do your own research and consult with a professional advisor before making any investment decisions.

Now, what makes this series truly special is that it's recorded right from the heart of the action on the trading floor of the Cboe. That means you might catch a little background buzz. Phones ringing, traders shouting as Jem and his guests unpack real world insights in real time. We wouldn't have it any other way because this is as authentic as it gets. And with that, it's time to hear from those who live and breathe this complex corner of the markets. Here is your host, Cem Karsan.

Cem: 00:01:29

Welcome back to another episode of U Got Options from the Cboe Floor. Today, David Dredge and I finally meet halfway between Singapore and Chicago in Munich, Germany at the Cboe RMC Conference. It's the one a lot of you guys have been waiting for.

David and I cover a wide ranging set of different issues from brakes in an F1 race car and how that's important for going faster, much like in volatility, all the way to FX and interest rate, volume and how those can really diversify your portfolio in the coming year. You're going to love this one. Enjoy.

Cem: 00:02:02

(Music)

A lot of you out there have been asking for David Dredge for a long time. He's finally here. One of my favorites, also a fan favorite. One of my favorites for a reason. We were just talking before off camera that, you know, with all the developments in AI and all the Growth.

I have a theory that, that as AI grows, intelligence itself will be somewhat commoditized. But true knowledge data sets, unique data sets will be incredibly valuable. And few people that I know have, have those unique Data sets like Mr. Dredge here. You have been everywhere for a long time.

I feel fortunate, much like I think our audience does, to get that knowledge from you on a regular basis, or not regular enough, but every once in a while, at least give us a little background for those that don't know you, kind of where you've been and how you got into the space.

Dave: 00:03:28

Okay, great to be here. Thanks for. Cem and I have been wanting to do something, but I don't get to Chicago and he doesn't get to Singapore.

Cem: 00:03:35

Yeah, we're meeting in the middle here.

Dave: 00:03:36

Met in Munich and it's fantastic.

So, yeah, I got the, the rare good fortune having grown up in Utah and went to graduate school in Berkeley and joined bank of America in San Francisco so I could stay close to home and not go all the way to a place like New York, which was so far away I couldn't fathom it. And after three months in San Francisco, bank of America sent me to Singapore.

Cem: 00:04:00

Yeah. What year was that?

Dave: 00:04:01

1987.

Cem: 00:04:02

1987. Something happened that year. What happened that year?

Dave: 00:04:06

, the first Monday of October: 1987

And when the biggest position in the, in the dealing room got stopped, everybody got stopped and everybody lost money, whether they were long or short, because the market just went like that as Hang Seng famously was down 50% in a day. So you can imagine what forward FX curves and interest rate markets were doing. It was quite a thing.

Cem: 00:04:48

We just had Hari Krishnan on for last episode here at rmc, and you've quoted him and not your most recent letter, the letter before. I know risk is not about predictability and it's about vulnerability.

Dave: 00:05:06

Yeah.

Cem: 00:05:06

And I think that's brilliant. I think that's a great intro to kind of Vol's place in a portfolio.

You know, a lot of us have talked about this, but few more eloquently than you about how, you know, how tail risk is really breaks. Yeah. Right. Talk to me a little bit about how you think about tail hedging.

And volatility, obviously, that's your, you know, where you and I both swim in a lot of ways. Convexity. Tell me how you think about it and how it fits in your mind in a portfolio.

Dave: 00:05:42

Yeah, I use the Formula one race car example all the time. The guy who wins the 40 lap race is the guy with the best brakes. Right? Right.

Yet it's very difficult to attribute the contribution of the brakes because the brakes allow everything. The brakes allow you to drive faster. The brakes allow you to test aerodynamics and engines and transmissions to explore.

And so I talk all the time, you know, and particularly with our investors, kind of the. The whole concept is build this stable foundation of protection so that you can explore. So that you can explore the upside.

You can search for that path to overtake the guy, to extend that compounding distance through time. And, you know, I was like, what am I dredgisms that people attribute me to? It's just math, right?

It's just simply about the positive effect to the compounding path of positive convexity. In your portfolio is your car. The risk is the vulnerability of your car. It's not a prediction of future unknown curves.

Make the car reactive so that you can explore opportunities and decelerate in risky environments, and that will fundamentally change your compounding path, which really should be the objective of anybody managing wealth. Their own or somebody else's.

Cem: 00:07:01

Absolutely. And you put some numbers to this in your most recent letters, by the way, if anybody gets a chance.

Do not miss the letters that David puts out on a regular basis. Not only deep, but incredibly eloquent and wide in their. In their reach. But you put some numbers on this and I'm not. Not do you disservice.

I'll let you speak to them a little bit.

But in terms of allocations and percentages and what kind of performance you can get through this type of an allocation, I know, you know, an 80% equity, NASDAQ kind of type allocation with a 20% volume type allocation versus what standard. Talk to me a little bit about some of those numbers and how you see returns and getting these outcomes in a real sense.

Dave: 00:07:45

Yeah.

I wrote a couple months back and in a paper titled Preservation of what is Something that I have sort of, sort of a fundamental premise that I've proposed around how sovereign wealth funds should treat their investment process. And our local sovereign wealth fund in Singapore has sort of the mantra to preserve and enhance.

I said, well, if that's what you were actually trying to do, wouldn't you allocate half of your Investment portfolio to preservation strategies. So I had proposed 25% in gold and 25% in long volume, explicit long volatility, loss mitigation and then the enhance.

Wouldn't you invest in exploratory world changing, productivity building, convexity on the other side. Convexity on the other side. Something that's going to make the world a better place.

That's going to solve the productivity issues, the demographic issues, the energy issues, whatever it may be. And then I just used it a proxy of that, you know, until you find somebody who can find those things.

Let's just use NASDAQ as a proxy for growth investment.

Cem: 00:08:55

Right.

Dave: 00:08:55

And amazing, that portfolio, that's 50, you would say. Well that's 50%, Dave.

Cem: 00:08:59

Seems unfathomable to most people.

Dave: 00:09:00

Too conservative. Yeah. Well, that portfolio outperformed their benchmark by 6x in 20 years.

Cem: 00:09:08

Crazy, right? 6x, yeah. Wow, that is a crazy stat. And what was their benchmark, do you know?

Dave: 00:09:12

Approximately 65, 35.

Cem: 00:09:14

65, 35. Stocks, bonds.

Dave: 00:09:15

Yeah, yeah, yeah. Basically 65, 35. Which you know, again, I think I said it that piece. I can't fathom why a sovereign wealth fund owns bonds.

Now in the case of Singapore, and I suspect many sovereign wealth funds, but in Singapore, the FX reserve manager, the monetary authority, owns enough bonds for the whole country and more. So why does this Harvard wealth fund additionally own government bonds? To me it doesn't make any sense. What is the point of that?

What's the innovation, the growth opportunity of that? It's just driving slowly is all it is.

Cem: 00:09:48

Yeah, Honestly, I know this is, you know, you're not a big believer in Sharpe ratios and I agree, you know, Sortino's maybe better but still not perfect.

Even just the US markets like: 60:40

60:40 is exactly the same Sharpe ratio, similar Sortino, no diversification benefit. You are just deleveraging, as you mentioned, kind of your long exposure, but without breaks. You're essentially playing with a slower gas.

And again, the reason that people use it so much is because the last 40 years it has helped a bit. But I think we all know that that is a function of a very secular outcome in bond markets.

Dave: 00:10:57

I say all the time when I'm speaking to people whose Job it should be to grow wealth for the people there are fiduciary for, you know, the biggest destroyer of compounding paths. The two reasons people haven't compounded one, poor risk mitigation.

Cem: 00:11:13

Yep.

Dave: 00:11:14

And two, bearishness.

Cem: 00:11:15

Yep.

Dave: 00:11:15

And the reason they're so susceptible to number two is because of number one 100 and they're driving slowly. Sharpe ratio which says that the risk management is to drive slowly.

Cem: 00:11:27

Yeah.

Dave: 00:11:27

To explicitly forego upside to probabilistically reduce downside and thus the creation of negatively skewed returns. And all the things that everyone's doing to say I've reduced risk by capping the upside. Well, that's not the right way to grow wealth.

The right way to grow wealth is to explicitly risk mitigate and pursue upside and turn negative return skew into positive return skew.

So I say all the time you want to own thin tailed opportunities where you're realizing upside volatility to compensate for the risk of downside volatility.

And you want to hedge with left tailed, fat tailed, fat tailed risks where you're there is no upside and you're capturing high fat tails to the downside.

Because the industry has used volatility at risk and said that levering suppressed volatility is an increasing risk which is what creates the fat left tail.

Cem: 00:12:26

Completely.

Dave: 00:12:26

Agreed.

Cem: 00:12:27

You don't talk about this as much but I also think that, you know, if you can achieve true diversification. True is the key there. You know, you can also preserve capital. I mean it doesn't get you the tail that way.

But the problem tends to be that true, that word is so rare, it is more possible now than ever. I mean there are strategies out there that are truly non correlated, not, not convex to the other side per se.

Dave: 00:12:56

Right.

Cem: 00:12:56

And, and that breaks role is critical regardless because there is so little scalability to a lot of these true diversifiers.

But that is the other tool, and I think you touch on that a little bit with the gold allocation there that you're talking about, you know, a stat that I put out there which I think is really, really critical.

Really important is we're now, you know, in a world where there's $500 trillion of correlated assets, the majority of assets and investment is correlated. What are those? Just to put names on them. Equities, bonds, private equity, private credit, which are just the same thing with leverage. Right.

Real estate, which you could argue is also incredibly correlated to those same inputs. So this is 500 trillion on the other hand, up from just three years ago, about 5 trillion a non correlated about 15 trillion.

All of these have tripled essentially. And I don't think people connect that all these things are related.

The reason they're tripling is because quite precisely people are waking up to this idea that you have that's so important that you have no non correlation. You have no true diversification and you have no tail in any way. You have no brakes.

Everybody's driving without brakes and nobody really cares about that. If they're on the racetrack and the racetrack hasn't been wet for a while or Right. Like they've been. It's very predictable.

There's not a lot of, well, guess what, you know, 22 showed that there's a little bit of water on the tracks. And we're going to take this metaphor all kinds of places.

Dave: 00:14:33

Yeah. You know, I say all the time one of another dredgism. You know, history alone is a very poor measure of risk.

Cem: 00:14:40

Absolutely.

Dave: 00:14:41

Because it only tells you what did happen, not what could have happened. So yeah, the simple analogy I use all the time, two guys climbing up a cliff face, one has a rope, one doesn't.

Well, financial market back testing would say if they climbed at the same pace, they had the same risk. Well, obviously one has a lot less risk if it's raining the next time they climb. And logically the one with the rope could climb faster.

And that's the whole point. Again, get the protection and then take advantage of it and go out and find that convexity to the upside.

Go out and pursue the, you know, cut off the, the unrecoverable. To pursue the unimaginable.

Cem: 00:15:16

Well, and not just that. I mean, I think we both know actually a big, I think core thesis of how you trade is, is often the least.

What seems historically the least likely is reflexively often the most likely. You know, people are rarely fighting. Everybody's fighting the last war. Right. And it's generally not hedged for the war that hasn't happened.

Dave: 00:15:38

Well, the reason things are correlated in the downturn is because of leverage. Because the financial system allows leverage to accumulate based upon assumptions of low volatility as low risk. Right.

And so when, you know, super senior tranches of subprime CDOs are the biggest risk of the financial system is when they're priced the as though they're the least risky. And it's that application of leverage regardless of the strategy. Which is why, like you said, homes are positively correlated.

It's because they're levered and you know, private credit's possibly correlated because it's levered. And so when that leverage or deleveraging happens, stuff that looked like low correlation, all of a sudden isn't low correlation.

And what you find in most of the, you know, traditional, what I call sharp world strategies optimizing to a Sharpe ratio, you have low correlating faux diversifiers that are only low correlation in good markets, which is destroying your compounding path. And they turn out to be higher correlation in bad markets.

I mean, one of the worst measures I see, and you know, and I see this far too often, people talk about averages. Average is meaningless, the average means nothing. The average expected return is meaningless. The average correlation is meaningless.

And when we talk about convexity or concavity in an investment structure, really we're talking about correlation, right? So if you're convex, you have increasing correlation in good markets and decreasing correlation in bad markets.

But most investment portfolios that are structured to a Sharpe ratio optimization have declining correlation in good markets and increasing correlation back. They're concave. And that creates what in our world people would call volatility drag, which is a destroyer of compounding paths.

And yet that's really the. It's just math, right? It's just as simple as that.

Cem: 00:17:23

Yeah, you actually make a point.

We're here at the CBOs RMC conference, but that the CBOs put cover strategy talk to me a little bit versus our short volume strategies has dramatically outperformed. I know people don't refer to that.

Dave: 00:17:36

Right. I don't want to upset anybody.

Cem: 00:17:38

No, no, I think it's fair.

Dave: 00:17:39

But you know, we go through, you know, presentation after presentation, not just here, but everywhere we go of the benefits of volume selling or covered calls or volume premia harvesting, et cetera.

And I always like to show, and I'll show at the conference here, the CBOE's volume indices that show the buy right covered call index performs here and the put right index performs here and the buffer index perform here and the put protect index which buys the puts and owns the underlying risk is here.

Cem: 00:18:08

Right.

Dave: 00:18:08

And my good friend who I'll be on the panel with tomorrow, Jerry Hallworth, how are you? Makes it so clear those options are non recourse leverage.

And so you can underwrite the risk selling the option or you can take on the non recourse leverage and own the risk.

Well, obviously if the compounding path is most significantly determined by the biggest ups and biggest downs, that put protect always has more potential upside and less potential downside than the other strategies.

So through time, not only does it perform better, but always had the chance to perform even better, which we don't generally recognize when we measure historical performance.

Cem: 00:18:47

Tough question. How do you offset an issue like 22? Right. And what happens when you have.

Let's just imagine a scenario, right, where we just have, you know, stair steps down for a year or two or three or four. Right. And we lose 80% that way. So, so maybe a convex kind of instrument doesn't really pay the way as a function of time.

I mean, you know, how do you think about those diversification there and offsetting risk?

Dave: 00:19:15

We're hedging in what we do for people, we're hedging correlation risk. And everybody's portfolio is exposed to correlation.

And most people that we talk to, pension funds, sovereign oil funds, are very good at managing the risk that they're measuring. And they measure risk as equity fx, interest rate, credit and commodity inflation.

S and P hedges didn't work in: 2022

And interest rate hedges worked really, really good.

Cem: 00:19:56

Right.

Dave: 00:19:57

And of course in: 2021

Cem: 00:20:06

Absolutely.

Dave: 00:20:06

So you simply need to have the discipline to, and the sort of agnostic nature to own the convexity where it's expressing the, the lack of capital protecting the implied leverage in that risk.

Cem: 00:20:23

Right.

Dave: 00:20:24

And so you just need to follow the opportunity of where cost efficiency exists and stop thinking that you can guess what the risk is going to be and go and hedge that.

Cem: 00:20:38

Absolutely. I think it's so well put. That's a, that's a hard question, by the way. I hope everybody out there understood that.

I mean the reality is it's, it's in true convexity, speed of move and liquidity crises. That true tail is the only thing to buy.

Dave: 00:20:54

Yeah, right.

Cem: 00:20:54

And you have to have that in your portfolio if you want to cover vulnerability. As we said, that said, there are other risks in the scenario that aren't tail and those need to be. Well, there are different kinds of tails. Right.

They are to your point, you know, a non correlated outcome you can actually cover through diversification entail through that non correlation aspect. I think that's so important.

Dave: 00:21:21

And of course, you know, everybody should be managing the risk they're managing. Right.

So you know, people should be good at constructing the risk they want to take in their equity sleeve or in their emerging market sleeve or whatever that is. But in between those sleeves, the residual risk is correlation. The assumptions people make around diversification is always what lets them down.

And I hear, you know, day after day about, you know, some pension manager's expertise and how they construct and manage their risk. And without fail, the thing they're not measuring or managing is correlation.

And the thing that always explains their relative performance to a hoped for compounding path is going to be the, the concavity of their core, their correlation relationship to their target.

Cem: 00:22:08

Amen.

Dave: 00:22:08

So they're not getting the best years in their, their correlation is letting them down in the worst years. And so it's how you deal with that. And dealing with that means going out and finding. I use the forest fire analogy.

It's not your diversification solves the problem that lightning striking a tree doesn't blow up your portfolio. It's if that fire spreads through the interconnection of leverage in the system, dry brush between trees, that's the problem.

And that's what hopefully guys like us, guys like you are there to help with by saying, well we've got some idea where the endogenous risk is because we're on the other side of the leverage buildup of volatility selling.

Cem: 00:22:47

Absolutely. And I think to you and I, you know, diversification is table stakes and that's why we end up talking so much about kind of volume.

But I do think, you know, most people today, even at least on a non institutional level are not even getting the diversification part. You need to do both. Right.

You need true diversification, you need all the 10% returning strategies that are all non correlated with each other, that are one sharp, that together are too sharp. Right. Or sort, let's say sortino.

Dave: 00:23:16

Yeah.

Cem: 00:23:16

To kind of better clarify. But, but even so you have to somewhere along the way have that when the correlation eventually does go to one.

Dave: 00:23:26

Yeah.

Cem: 00:23:27

When the, the, you know, the bigger fire blows through things that you are protected as well. And I think it's the pair that is so powerful. Right.

Dave: 00:23:37

Yeah. You just, everybody needs to be conscious of where they're exposed to implicit or explicit leverage. Right.

And the left tailed nature of that, that again so destructive to the compounding path.

And you know, nothing drives me crazier than people constantly foregoing the upside while maintaining downside exposure because they probably probabilistically it won't happen and that's just a destructive path through time. And you know, I wish fiduciaries weren't allowed to do it with other people's money and somehow reward themselves with compensation.

But it is almost generically how the fiduciary industry works.

I mean, banks are obviously notoriously short tails with bounded upside collecting compensation for themselves and socializing losses when things go wrong. And it's.

Cem: 00:24:32

Yeah, it's structural. I mean, not to get in any way political or anything, but like the reality is that short termism is one of the biggest drivers of convexity.

You know, if we are always going to do what's good today, tomorrow, it creates momentum to recent outcomes and eventually undoes itself.

Dave: 00:24:49

So, you know, back to the race car analogy.

If you know, as is generally the case in the fiduciary industry, if you're optimizing one lap at a time in a 40 lap race, you're going to target the average lap speed and sell the straddle.

Cem: 00:25:02

Yeah.

Dave: 00:25:02

But if you optimize back from the terminal 40 laps, you will see that the difference in the compounding path is the fastest and slowest parts of the track. And it's going to say by the straddle.

Cem: 00:25:13

Right. And buying when a person slides off the track or you know, has to change two tires because, you know, and.

Dave: 00:25:18

So it's, you know, again.

And I wrote about it a little bit this month quoting a lady, Judith Roden, who wrote a fantastic book called the Resiliency Dividend, that, that resiliency has a lot more benefit. And she's talking about city planning. Right. Than just saving you from the flood because it allows you to grow and develop and innovate.

Well, the same with an investment portfolio. That resiliency allows you to explore the unbounded upside potential of the investment universe, which is where growth truly, truly comes from.

And so put really good brakes on your car and go learn how to drive. Go learn that you can do a lot more than you're doing. Trying to anticipate what the future curve is and taking your foot off the gas all the time.

Cem: 00:26:06

Right. That idea is so powerful. I think some people, everybody, I think once they hear it's like, oh, I get it, that's so important.

But how do you deploy it other than just buying puts on the S P or whatever. Right. That's, that's a bit of the trick. Right, because, because it's not always and often it's not the equity index. Right. That you want to, to own.

I know you in particular play across the board and, and part of why I love our discussions so much whenever we get to have them is, is, you know, you being in Asia particularly, getting to play for a long time now, FX and interest rate, Vol. Commodity, you know, all that, whatever comes your way.

I think you're telling me you, you had a big trade in, you know, the Filipino currency not, not too long ago.

But, but the point is, you know, give me a little bit of perspective on some of the areas you, you have found fruitful, how you think about going forward, how you could get convexity outside of just equity tail. And I'd love to dive into kind of some of the more practical parts.

Dave: 00:27:14

Of we call ourselves value investors in convexity. Value in volatility markets is the same as value in any markets. Supply and demand. And it's all about price.

Everything you hear me talk all the time, everything's price. The only signal we care about is price.

And what drives that price is the supply of volatility through what's commonly known the structured product world, which is getting ever bigger in the US and Europe, but has been very big in Asia for a long time, not least of which innovated by my old baker's trust business back in the very, very early 90s. And what drives that supply build up again is the flawed risk and accounting methodologies in the sort of food chain of market participants.

And so the, the buyers of the structured product, they're getting the enhanced yield in some form through embedded short volatility through with a credit intermediary bank that's measuring the risk of that embedded derivative using a value at risk methodology, potential credit exposure, and then passing that derivative on to a sophisticated global derivative bank who's using some sort of option pricing model that's measuring value at risk and two standard deviations and stuff.

So you've got this entire food chain of guys who are accounting for the enhanced yield of the repackaged option premium as calendar year accounting revenue bonusable and not accounting for the tail risk of the embedded derivatives in this food chain of how they've been constructed.

And so quite naturally the supply will very quickly overwhelm the demand of the people who are buying the options that are recycled into the market, who have to account for the cost of those options but don't get generally the look through to the risk benefit of owning that tail that the other guy is not recognizing.

Cem: 00:29:09

Right.

Dave: 00:29:09

And so you get massive supply and demand imbalances on occasion more often than people would imagine in places where, you know, if the entire pension system if obviously famously right now, if the Taiwanese insurance companies aren't accounting for the residual tail of the embedded Bermudian swaptions in their massive portfolios of 50 year, 5 year call callable note structures. And they're calling all the enhanced yield annually accrued on what they've booked as a five year duration to the call day as, as bonusable profit.

Well that's going to crush the demand for volatility on the other side, right? And then inevitably something comes along.

In this case interest rates go up and all of a sudden the stuff that they've been allowed to value by local Regulation as a five year duration bond is a 50 year duration bond because it's not going to get called like it did every other year up to that point. And now you've got a problem.

So you have massive, just like you have famously in the hold to maturity books of US banks, massive unrealized losses on these things that have never been correctly accounted for and are not capitalized. And so you've got this long workout thing and you and I have talked about it for years. My, you know who's going to buy the bonds?

Because the guys who bought them, what I call rational accounting man, as opposed to they're not making an economic decision about the 30 year investment value of long duration bonds. They're following accounting rules of their bank and annual bonus cycles and they filled up on these things at really, really bad prices.

You know that no rational person managing their own retirement saving, no rational person in the UK is going to five time lever gilts with their own money at a zero yield. But pension funds regulated to do so happily do so and then have to get bailed out.

And so that creates this, you know, massive fat left tail and these structures of things that end up attracting leverage that literally have no uptail, right? Only have a downtown and massive leverage. And that is where opportunities flow hopefully into our world.

Whether that's an FX or credit or commodities or equities and indices, single name products, whatever it may be that volume supply us.

We've had a great week here talking about and hearing about, you know, the proliferation of volume selling strategies and ETFs and what's happening around the world, which is just, I, I wish I brought a bigger bucket to fill up as we were here.

Cem: 00:31:39

Yeah, I always find it amazing that I remember the first time I think we talked, I, I remember asking you about your signal. I'm like what's your signal? How do you decide where. And you know the answer is price, price when, when people sell it to me at a.

What seems like an irrationally low price, inevitably you're getting close to kind of the, the bottom right. And, and before too long a lot of situations that turns in is the best thing to buy.

Not just because it's cheap, because reflexively it actually undoes itself.

Dave: 00:32:13

Yeah. And so remember for us, we're always working for the benefit of our investors.

So our investors have freed up capital from ineffective diversifying strategies to get something that's very explicitly diversifying convex negative correlation so they can go and take more participating risk.

And so as that's getting cheaper and coming and we're becoming more effective, more asymmetric in our potential protection, they're benefiting in that rising market. And then of course our challenge becomes to grow and maintain that sensitivity. You think about, you know, strike sensitivity is the market go.

If I buy a bunch of 30% out of the money options, long dated options, the market goes up 30%. There's not much sensitivity. So how are we maintaining sensitivity?

How are we maintaining duration and expanding the potential convexity through time as they're benefiting from the superior compounding path of carrying more participating risk, more upside convexity?

Cem: 00:33:12

How do you think about. I mean one of the challenges of that is, you know, a scenario like Korea, right.

Where we saw dramatic volume compression for honestly decades, forever. It was by far the cheapest fall available for a long time. The problem was.

Dave: 00:33:31

Yeah.

Cem: 00:33:32

I mean you could hold that against a long book and the long book would make money, but then into a decline, often it wouldn't perform. How do you deal with those situations? Given sometimes just dramatic supply demand imbalances from a structured product perspective. Because yes.

To your point, when things get cheap, often not always. Right. There's no, there's no complete cheat code. There's.

But often it, you know, you get that quicker than you think renormalization and value from it. But there are times, oh yeah.

Where you can sit on something that's cheap just because of the supply and demand imbalance for, for forever and not really get the convexity you need.

Dave: 00:34:09

Yeah.

Cem: 00:34:09

How do you think about that? It's something that we all.

Dave: 00:34:11

Yeah.

Cem: 00:34:12

You know, nothing's perfect.

Dave: 00:34:13

This is the challenge for us. And like I said, we very much consider ourselves bottom up value investors in convexity, which sounds weird. So we're tracking that supply.

So if something's percolated up that's created a Vega supply that's coming to us. We're trying to understand what's generating it, how much is it getting done, who's doing it, how are the banks managing it, how are they hedging it.

And, and you know, we low doesn't mean cheap. Right.

Cem: 00:34:45

And I think that's critical. I just want to make that so.

Dave: 00:34:47

How we build layers of convexity in our portfolio is really based upon how effectively we understand the supply and demand dynamic.

Cem: 00:34:58

Yeah, it's critical. Just want to touch that. That's, that's a bit of my world. As you know, like I, I.

Cheap is, is important and I agree with you often, at least in a relatively normal functioning set of markets that can ultimately undo itself.

But there are situations, particularly with structured products that are not levered, that are not as concentrated in the sense that they are distributed over large sums of people that are hard to force a re by effect or a release of that volume. And we're starting to see that here in the US I say here not.

Dave: 00:35:33

New about some stuff that we've been working on lately. You know, we started aggressively actively working on this 22 months ago and printed our first trade last month.

So it took that long for the accumulation of structured product activity and hedging activity and spreading of that risk across other market participants that we're willing to take it on in different forms.

That maybe we wouldn't be willing to take it on until it finally gets to us in the form that suits our book and how we want to diversify our book and how we want layers of convexity and how we want potential highly asymmetric risks and we'll pass on things for a really, really long time because it's not yet what we would consider good value. That's the job in a sense. That's the active management part.

Cem: 00:36:28

Yeah. I love your ability to be patient. Right. And I think it's so important to let it come to you. And only that combined, I think with your.

You're fortunate enough to get a lot of, to see all the things right. And at the right moments, I think that's really pay dividends for you guys.

Dave: 00:36:45

Yeah.

The decades of being in that food chain and knowing the participants and working closely, we have really unbelievably tight relationships with our derivative counterparty banks. And we're working with them day in and day out across global derivative markets.

And they know if they've got volume to sell, we're happy to talk about it and try to figure out how to do it. Likewise, they know if they need to buy it back, we're probably a good place to go because we own it.

Cem: 00:37:11

Yep.

Dave: 00:37:11

And in those difficult times, when times are difficult, you know, finding a seller can be tricky. That's the point. So it's good to Know who owns it if you need it.

Cem: 00:37:20

Right. You get the liquidity too, when you need to get out, which is key.

Dave: 00:37:23

Yeah.

Cem: 00:37:29

Talk to me a little bit about, I mean, I kind of know this from our conversations over the last couple of years on and offline, but talk to me a little bit about where you found convexity the last couple of years. Walk me through maybe some of the stories and things that have come across your desk and the opportunities to the extent you're willing to share.

And let's then talk about what you're seeing now and what you see going forward.

Dave: 00:37:49

of similarities between that: 1995

And how similar I felt about what's been going on 23, 24, 25, where you're getting this constant rise of equity markets but volume all over the world, and yet the volume supply keeps coming and jumping around.

So, you know, last year, and we talked about it on the call last year, very much the volume supply that came that we found most interesting convexity was in FX space. And it was, you know, prolific around the world.

But most specifically euro and euro related euro, sterling euro, Swiss, euro related pairs, just massive amount of volume supply. Now, turns out that was a pretty good thing to own in the early part of this year. And then I thought it would, you know, it was gone.

But then by middle of summer it was back again.

Cem: 00:38:59

Right?

Dave: 00:39:00

lows of convexity In March of: 2024

And so I find that I always say it's, you know, just turns out as a general rule, whatever's the cheapest thing turns out to be the thing that's the biggest risk.

And, you know, if you read what my good friend Russell Napier, various people are writing about France, you could get an impression that Europe's pretty risky and yet one of the cheapest convexities in the whole world two months ago was euro.

Cem: 00:39:35

I love FX too, because it doesn't have as much of this structured product, structured compression as much. There are other things driving that make things go too far, but I generally.

Dave: 00:39:46

But it is very massively driven by structured products. But that's driven by corporate treasury businesses. So it's importers, exporters, monetizing through option selling.

Cem: 00:40:01

Not as distributed. Right.

Dave: 00:40:02

They have of either higher or lower currency. And so it's very concentrated and it's quite smart in a sense. It's not a bunch of retail guys. That's exactly. It's professional treasury books.

Big treasury books. Obviously the scale of this stuff dwarfs many other volume markets and so that, you know, creates opportunities.

And as always, like everything, as the volume gets compressed, the leverage inherent in these strategies goes up.

Cem: 00:40:29

Yep.

Dave: 00:40:29

And so because you know, lower volatility is less risk to add more leverage and because the volume gets compressed, the returns on them gets lower. So to meet return hurdles, turns of leverage and duration extensions get built into it, which then eventually helps it find its way to us.

But increasingly, and what's been talked about a lot here, you know, we've become increasingly interested in a lot of the structured product flow which has been very, very heavy in Asia.

And increasingly I, I'm learning more and more heavy in the US is on, you know, there's been a big shift away from index sort of auto callable worst of products into single name.

Cem: 00:41:08

Right.

Dave: 00:41:08

Worst of auto callable products. And obviously now we're getting ETFs on auto callables.

And, and all of you know, the, the explosion of call selling ETFs and bus per ETFs and all this stuff is providing convexity into the system which eventually gets recycled and then hopefully over time, you know, some of it'll find its way to the little old me in Singapore.

Cem: 00:41:29

Yeah, yeah.

It sounds like you're increasingly interested, you know, slowly building, you know, part of your book here in the US too, which is, which is interesting.

Dave: 00:41:41

Obviously we'll go where the supply is.

Cem: 00:41:43

Yeah.

Dave: 00:41:43

And you know, if the behemoth, that is the Asian wealth management, private banking, retail client machinery that has more lifetime experience in auto callables than any other market in the world decides they want to do max 7 auto callable structures. Well then, you know, and then that triggers the next guy and the next guy.

Well, eventually that's going to be where volume gets compressed and where leverage builds and where correlation risk builds. And that's exactly the kind of stuff we're interested in.

Cem: 00:42:12

Yeah, but similar to what you said before, I mean you have to be careful to not get stuck just S and P or something where it could just remain somewhat compressed due to a massive set of supply. You kind of have to find that spot where you can get convexity and Leverage where it could turn dramatically.

Your point about fx, which you mentioned again almost a year ago now, which very much kind of played out, was tied to this view, that it reminded you, if I, you know, correct me if I'm wrong, of 97. Right. And like Asian flu and Russian ruble crisis and all the things that, that, that drove that period.

I agree in terms of kind of liquidity being pushed into the system. Right. That was right after Greenspan lowered the natural state of unemployment and drove what essentially was a bubble. Right.

That, that went to: 2000

We, you know, Russia had just collapsed or, you know, and we were, you know, the US was global hegemon, interest rates are heading down sec like secularly more. Right. Than just cyclically. You see a lot of the opposites now.

And a lot of those things for me, and for me talk about this remind me of, not to mention the political side of things, remind me much more of a 60s and 70s.

We're kind of getting a confluence of like this more structural bubble that's driven by all the liquidity and everything we've talked about, but paired with a structural, you know, I don't want to say fourth turning, but.

Dave: 00:43:48

Right.

Cem: 00:43:48

Like there are these elements that are driving this confluence of both this big kind of 60s, 70s structural populist rebalancing, deglobalization, global conflict, all the things simultaneously to all those flows kind of hitting there what feels like a coming terminus at some point.

Dave: 00:44:08

It is a unique environment. And everybody says that. But again, you know, my sort of number one obsession is demographics.

And I always say you can't talk about anything, any country, any economic scenario without talking about where that bulk population cohort is.

And I wrote in my note a couple months ago that you should end every economic related conversation with this addendum, add on and for every year going forward there will be fewer taxpayers and you really start to understand the challenges around and the uniqueness around. When we say, well this is like deja Vu for 95 to 99 or like the 67. But you say, wait a minute, where was that bulk population cohort?

And so I have this conversation all the time.

I was one of the early guys talking about fiscal dominance and financial repression, that financial repression isn't the solution to our current problem. Financial repression is how we got here.

al repression basically since: 2000

Cem: 00:45:31

Right.

Dave: 00:45:32

And sort of you would argue that.

I would argue the Greenspan put inflation targeting was very much, let's break the trade off between employment and price stability by claiming that asset inflation isn't inflation and driving growth and the population drag on growth through what, the fat.

Cem: 00:45:50

Yep.

Dave: 00:45:51

And so I really think that that's driving a lot of this wealth segregation issue.

And because we've financially repressed, we've pushed so much wealth into that cohort that's now moving into retirement just as we have fewer taxpayers coming up behind them.

Cem: 00:46:06

It's just more leverage to the long just.

Dave: 00:46:08

Right. It's just, I mean if you think.

Cem: 00:46:09

About it, it's one thing to say, okay, everybody's longer has greater, you know, average retail exposure to equities is at all time highs. But what people don't also realize is how leveraged everybody is structurally just by the number of people who are driving demand.

I think the stat is that the top 10% of the U.S. drives more than 50% of all consumption in the U.S. now that is a record up from 33, 34% just 20, 15 years ago. That's a wild stat that we've been, you know, that distributionally that's happened and we haven't even talked about the political effects.

Dave: 00:46:46

Right.

Cem: 00:46:46

I mean, you know how I talk about the populism. Right. And how much that's driving the fiscal dominance.

But like, you know, this administration now is actually, despite publicly kind of talking about going that route, they're actually zigging away from it partially because I think Besant et al are fully aware that there's no way out. There is no way out. You, you cannot rebalance inequality and not pay the piper. They borrowed from the future.

Now I say they, it's not this administration, it's many administrations, it's going back forever.

Dave: 00:47:19

This is a standpile that's been building.

Cem: 00:47:21

For a long time. Impossible situation.

And if you really want to give the political, the populace what they want, and particularly the younger generation, who's seen the greatest effects of this, who had 40% of the wealth creation, household formation. Right. Of baby boomers, all the stuff we've talked about, you can't do it without hurting markets and bonds. And so.

So no better time for convexity, no better time for diversification.

Dave: 00:47:48

Yeah. You know Obviously I get to speak to pension funds all over the world. And so people will ask me, you know, back to where you started.

Risk is about vulnerability. What are people exposed to? Well, certainly if you speak to pension funds in this part of the world, they're exposed to inflation. Right.

These guys are still way bond heavy.

They've been debasing the savings of their population as that population's moving into retirement with higher cost of living because of the surge of inflation that this has created. With a smaller tax base, you know, who's going to have less savings because they have to pay more tax and a higher cost of living.

It's a, it's a negative feedback loop. That's really, which is literally what we talked about in January.

Cem: 00:48:30

Right.

Dave: 00:48:31

Can, you know, the Scott Bessant with his333, can they reverse that feedback loop? They looked like they were going to try and it's not too hard. Yeah. And now you're back into this negative feedback loop.

And, and so my Hunger Games analogy where there's this ever growing competition for every scarcer supply of savings to fund people's debt. And now, you know, Germany, where we're sitting, is mass, you know, has removed their own debt cap and is going to increase their issuance.

And, and, and France is, you know, doesn't have a sustainable path that anybody can describe anywhere. And, and you know, how, how France is going to avoid the necessity of capital controls, I can't see.

Cem: 00:49:10

Yeah.

Dave: 00:49:10

How they can't trap savings and hold it in France is very hard to fathom. So this problem is, you know, obviously, you know, famously China is going to lose 600 million working age population this century.

Well, find me a historical precedence to explain how that works. I don't know one.

Cem: 00:49:27

No, I mean, I think you can't think about this without really saying it's turning into economic warfare. Because you said Hunger Games. Right. That's essentially the same thing. You know, there has to be if there's no way out, right?

Dave: 00:49:42

Well, yeah, yeah.

Cem: 00:49:44

Somebody's going to die on the way out the door.

Dave: 00:49:45

Who's going to be the last guy issuing bonds to the last guy with savings.

Cem: 00:49:48

Right.

And I think you really have to think about that at this stage in the game because if you don't think the Fed is going to go, do you know, Project Twist? I mean they've already announced it ultimately, like they really have almost gotten to that point. Next, you know, you're kidding yourself.

They are going to try and keep the long end of the curve higher. They've actually added, as there was a couple people on the Fed now talking about it as the potential third mandate. I mean, that's crazy.

But the reality is most people think, oh well, they're big enough, they can do it. So why would you. Don't fight the Fed. Why wouldn't you, you know, True. Except in this situation, we're talking about long duration.

And when you start talking about 10 or even 30 years, you can try the Fed. This is one place where the Fed might be outmatched, which is ultimately, at least in the long run.

You know, you can't keep real rates negative to the extent that will eventually be necessary. If you do it well, document it will drive a structural inflationary loop.

I mean, if, if I can buy something, I borrow money at 3% and inflation's 5% a year, guess what? I'm gonna go borrow a lot of money at 3% to buy more of that stuff. That's. And guess what?

Then it no longer goes 5%, then it's 7% and then it's 9% and.

Dave: 00:51:06

Then it's, you know, ever since they innovated QE, the biggest opportunity cost in an investment portfolio has been owning bonds. You should own everything else, obviously.

And it strikes me they have very little choice but continuing that, in which case owning bonds isn't going to grow wealth. The guy selling the bonds explicitly telling you he's trying to debase them.

And so again, they're playing this forever game of trying to bring demand from the future to today, knowing that there's going to be fewer taxpayers in the future. And that is inevitably flawed and must be a bad solution. But nobody thinks to the second order effects of these things.

And it seems to me this thing could keep going. So back to what you said, be convex.

Own stuff that benefits from the asset inflation that they so desire and own stuff that protects you if it goes wrong. Right.

Cem: 00:52:00

It probably just, you know, prognosticate a little bit. I mean, it probably to your point, in a hunger game scenario, first hits overseas, right.

You know, maybe it's France, maybe it's, you know, but the point is those things are, you know, I think starting in the US is unlikely. Right. They're gonna, they're gonna crowd out as much as they can. They're gonna try and push, you know, as the bully in the room, the risk overseas.

that: 6882

You know, it wasn't equity volume that actually paid off long term. You had some short term opportunities right throughout that period. But what really, really paid off is FX fall, obviously interest rate Vol. As well.

Precious metal ball. I mean the most convex instrument both in terms of performance and in terms of total volatility was actually gold.

Dave: 00:52:59

Yeah.

Cem: 00:53:00

And it's behaving a lot like that. Yeah, 100%. We talked about that years ago by the way. You and I did a lot like that now. Yeah, yeah.

And I think it's fair to say that that's probably not over given the risks out there.

Dave: 00:53:12

You know, again, in the part of the world I sit, reserve managers have been building reserves which if you think about what that actually is, it's just qe. They're just printing money and buying somebody else's bonds. They own enough bonds and they know that they're getting debased in this bond ownership.

So they quite logically have been, I assume.

Of course, obviously you can see the numbers shifting at least some of their ownership now, particularly as we've had a very weak dollar that results in more intervention accumulating reserves, which results in more diversification into something other than the bonds that they already own way too much of a la gold. And you've seen what's been the result of that.

Cem: 00:53:57

Yep, there's. There's about 25 to 28 trillion dollars of gold reserves. About 22 of that is in vaults untouched, will likely never be touched. Right.

And what's interesting is that total value, which is now, let's say 27 was nine just three years ago. But importantly, much like a venture capital, you know, offering it like there's a little bit of float, there's not a lot of float.

Dave: 00:54:30

Right.

Cem: 00:54:30

I mean there, there was maybe 1 or 2 trillion, which is now probably 5 or 6 trillion. Right. So you know, as a diversifier to the 500 trillion sitting on the other side, I mean, talk about a supply and demand imbalance.

I mean you could go look at crypto and that's why crypto's also tripling. It's now kind of come along for that ride.

Dave: 00:54:50

I talk about a thin tailed instrument, something where, you know, it has downside moves but you get rewarded with a massive upside tail as well. Right. You're not cutting that off at all.

So you know, whether it logically makes sense or not, it's been a great reward for people willing to participate in upside tales.

Cem: 00:55:09

Yeah, I think the flexibility and portability of it obviously Paired with its association to the entities that are getting the most, you know, we have $125 trillion wealth transfer that's happening in the next 20 years. And, and the people that are getting that money believe, and that's all that matters.

Dave: 00:55:27

Right.

Cem: 00:55:27

That it is a store of wealth and importantly, it is portable as well. So both of those I think have, you know, it's crazy to say after, you know, not just a triple in three years for both.

Dave: 00:55:37

And they both have exactly what you were saying.

And something that our mutual friend Mike Green off, he talks about a lot in the world of passive, you know, the marginal dollar in that, because so much of that is locked up and not tradable. So the marginal dollar keeps driving this sort of supply and demand, huge uptale and keeps going, which is the same.

Cem: 00:55:57

Thing that happens by the way, in the Mag 7 and Venture.

Dave: 00:56:01

This is Mike's point about passive.

Cem: 00:56:02

It's literally the same exact thing. But now you're actually talking about diversification as well.

So it's incredibly compelling to be able to get some diversification and get that convexity in those products.

Dave: 00:56:13

One of the sample portfolios that sometimes we show we call the anti fiat portfolio, which is Bitcoin, gold and long Volt. And that's outperformed, you know, less risk, more return than, you know, any traditional portfolio for the last six years.

Cem: 00:56:30

Yeah, and it incentive wise as well. I mean if you just think about those that are pulling the reins. Right.

sees it. That's what happened: 1968

People don't realize the equity market went nowhere. So people felt less pain, it was less volatile because it was a world of nominal illusion.

Dave: 00:57:02

But I'll come back to my previous point about the demographics.

So in a sense you got away with that and came out the other side because that population bulk, the pig and the python, was just going into their peak earnings, peak tax paying, peak saving, peak investing period. Now they're stepping out of earnings, savings investing period.

And so now shaving the coins, intentionally creating nominal growth through inflation to offset growth drag through population decline is probably a really, really bad idea. Is an increasingly bad idea as the pig moves through the python. Right.

And so I have this conversation with some good friends who will point out how well financial repression worked in the post World War II era. The yield curve control of the 50s. And I say, but where was the pig in the python?

Very different to today and the financial repression today, then when you financially repressed and the high government debt that was driven up during the war to fund the war, contrary to the austerity through the depression and the war of the private sector allowed a crowding in of private sector borrowing as the government shrank and debt to GDP declined to the financial repression. But we've been financial repressing for 25 years and debt to GDPs are higher than they've ever been and growing.

So in a sense it's not working and doesn't strike me that it will work when every year going forward there's fewer taxpayers.

Cem: 00:58:29

Right.

Dave: 00:58:29

king age population peaked in: 1995

So they're way, way, way ahead of everyone else.

s and early: 2000

Now you're going the other way and you're having this massive disappearance of working age population around Japan, Korea, China, where I spend most of my time. And it's an interesting dilemma.

Cem: 00:59:23

at the big picture, you know,: 1929

People think of that as the Great Depression. And you know, the amount of losses that we saw, you know, from a nominal perspective, obviously are massive.

And some of the biggest, probably the biggest in history in at least the U.S. but what most, most people don't realize is that decline in real terms, that period is almost identical in real terms to what we saw from 65 to 80. 83.

Dave: 01:00:03

Yeah.

Cem: 01:00:04

That really one's a deflationary environment, one's an inflationary environment. Right.

And, and I think, you know, a lot of that is a function of a much stronger fiat now Federal Reserve, who's able to shave those coins and manipulate the situation in a more palatable way. Palatable, right. But the outcomes are the same.

And I think it's Corey Hofstein, my friend, who says, you know, risk can, much like the first law of thermodynamics, you know, risk cannot be destroyed. Right. It cannot be created. It is only transformed, much like energy. Right. And so you can. It can move, but.

But the pressures are there, the risks are there, and it really is a function of time.

Dave: 01:00:51

And. Well, how that comes back to where we started. Right. Optimize your portfolio to the divergences from the mean of the expectation. Right.

Because that's what's going to drive the compounding path. And that's what this nature, the population demographic thing could result in one of the greatest deflations we've ever seen.

Or they can continue what they've been doing and result in ongoing greatest inflation we've ever seen.

Cem: 01:01:15

Right.

Dave: 01:01:16

But the average will mean nothing in that.

Cem: 01:01:18

Correct. It's all about real.

Dave: 01:01:20

Average is meaningless.

Cem: 01:01:21

I agree. And the average is.

Dave: 01:01:22

And it's the divergences that you need to be resilient to. And that resilience going back to the rate will come from having good breaks.

And by having good breaks, it frees you to explore the other side of that district.

Cem: 01:01:38

Absolutely. Whether that's in currency or whether that's interest rates and inflation or whether it's nominal returns in markets. I couldn't agree more, David.

Every time. It's better than the time before. I thank you for joining me today. Wonderful to finally do it in person here in Munich.

And I look forward to doing it many more times in the future.

Dave: 01:02:01

I'll get to Chicago one of these days.

Cem: 01:02:02

Oh, I can't wait.

Dave: 01:02:03

Thanks. Take care.

Ending: 01:02:09

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Cem: 01:03:56

Sam.