Harold De Boer is a Managing Director, Member of Management Committee and Member of Board of Directors at Transtrend B.V. Growing up, Harold’s interest in statistics grew out of his work at his family’s dairy farm, and expanded into the world of trading and managed futures. Listen in to learn about Harold’s unique perspective on the industry, his marketing philosophy, and some of the most important lessons he’s learned during his successful career.

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In This Episode, You’ll Learn:

• How Harold got started with statistics at a young age
• Why Harold’s first job as a mathematician was intended to be only temporary
• How that first job transformed into Harold’s work at Transtrend
• When the Turtles project was discovered by Transtrend in its early years
• How being bought by a larger organization did not affect Transtrend’s operation
• Some of Harold’s biggest lessons he has learned
• How his time on a dairy farm informs Harold’s approach to trend following
• What investors underestimate and don’t understand about managed futures
• The only thing that actually drives the markets
• How market dynamics changed as a result of the transition from floor trading to electronic trading
• Why Harold believes that Transtrends program should be called “medium-term”
• Why Harold believes positive alpha does not actually exist

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Niels

Harold, welcome to Top Traders Unplugged. We’re so excited and honored to have you with us today. Both Katy and I have really looked forward to hearing your perspective on many of the issues surrounding our industry and your firm in particular during our conversation. Before we get to all that juicy stuff, perhaps you can start out by telling us a little bit about your background and how you got involved in this industry. Then we might talk a little bit about the history of Transtrend as well.

Harold

I was born on a dairy farm. When I was a kid, I knew all the cows by name including their fathers and their mothers. As a farmer’s son, there’s only one job that you of course want to do and that is to become a farmer as well. My parents have four sons. Only one could do it. Most people thought that I was going to be the one that was going to do it because I knew all the cows.

I liked to look at how genetics works with cows, and why black cows and red cows can combine and when you can get a black one and a red one. That’s how I learned statistics, and that was before I had mathematics at school. From there I became better and better at mathematics.

I became a member of the International Mathematics Olympiad. Team. If you reach that level, then you kind of have to study mathematics and not something that makes you a farmer. So, I ended up studying mathematics.

In the last year of my studies, I was looking for a project to write my final thesis on. I had a professor who said, “You shouldn’t do that at university. You have to find a real problem in the real world, and you will see there’s always some mathematics in there.”

So, I had to write a number of letters to different firms. There was a dairy company that I wrote a letter to, and I could do something there. It was a very nice project, but I was thinking, “Hmmm, later when I grow up I will work on a dairy factory, so maybe now I should do something else,” and the other thing was with a firm that was a traditional trading firm.

They transported things. They crushed soybeans into soybean meal and soybean oil. They were transporting a lot of things. They were very big in palm oil, for instance. And they were thinking about using futures markets, not for hedging purposes, but for trading.

They saw all these firms becoming successful in their markets, and they were thinking, “Well, these are our markets, so if money is going to be earned in those markets then we should do it.” So that started the project, and the project was started with buying computers and getting data. That was how far they were.

So, when I came there, they said, “Well, we have computers, and we have data. We hope you can do something with it.” Well, for a mathematician that is a nice way to start. So, I ended up doing that, and I think, “That’s nice for a year or so, and then I do the real job in the dairy factory – that’s where my ultimate destination is going to be.”

Well, I’m still there. (Laughter)

The dairy farm has to wait. That was a research project, this whole project of what can we do with data and what directions are there? We pretty soon found out that the trend following way seemed to be the most promising way because it offered most possibilities for really diversifying things. You can apply it to many different markets and the more different the markets, the better it’s going to get.

That was, for the mother company, initially, a kind of issue because they were thinking, “We only want to do commodity markets because that is what we know a thing or two about. That’s our background.” Initially, we were trading palm oil and all kinds of commodities, but also some financial markets. But that grew into more and now, we trade all futures markets.

Niels

What time period are we talking about? What year?

Harold

1989 was when I walked in there. I had no beard then. (Laughter) But I did start shaving.

Niels

Right, excellent, excellent. (Laughter)

Katy

How did that morph into what you were doing at Transtrend? Could you tell us a little bit about how that evolved?

Harold

Well, initially we were doing these different things, and we decided that this trend following way was going to be the best direction. Then, after a few years, the leader of the project, the managing director of the mother company, he decided that he found it so interesting that he wanted to go further only with this part.

So, he bought out this part and Transtrend became an independent company in which we were also managing money, also, for others than the previous mother firm. So, that’s how it started. We were first aiming for Dutch investors, pension funds, and so on. But, in those years, they were not really interested because they were thinking, “But these commodity markets, and futures, and [this] systematic way, that sounds like something that’s impossible because markets are efficient so you cannot do something like that."

So, the group we were aiming at was not really interested. [However], somehow some people from the US and some others recognized our performance, and then they became interested. So, that’s how it started.

Niels

So, the late 80s is, of course, kind of the same time that the Turtle project finished in the US. Of course, there are some managers who were even before that. Were you aware, or when did you become aware that there was an industry actually trading futures? How did that come about?

Harold

Our project started with a guy who had to buy computers and buy data and he traveled to the US and bought all kinds of books that were written in those years – so from Kaufman, and Welles Wilder. Those books are from those years and of course, he also found out about the Turtles, and so it was known to us that trend following existed and that there were some trend followers doing very well. So, there were some basic rules about what a trend follower should do.

There were three things important in trend following: you should always use stops, you should always be in the market, and you should always trade the same size. Those were the basic rules in those years. We looked at it, and we said, “Trend following is good but you should never use stops, you should not always trade the same size, and you should not always be in the market.” The philosophy was OK, but the basic rules were wrong. So, that’s how we started.

Niels

Interesting, interesting. So, in those early days how many of you were inside discussing, debating, looking at these books, and reading the books?

Harold

Four people, four people. But that was nice because the four people did everything. In those years, I checked the data; I did research; I installed drives into the computer; I repaired the coffee machine; [and] I entered the orders and called up the brokers worldwide. That was the early days. It was four people, and most of us were doing almost everything.

Niels

Right. How long did that period last before, you could say, Transtrend started to slowly evolve into what it has become today? I remember Transtrend stories [as being] a little bit different from other managers who were privately owned for a long time and so on and so forth. I remember you guys on a different path that you chose.

Harold

Yeah, but we were… The ‘90s was when we were slowly developing. But of course, the 90s was a period when the stock markets were rising almost constantly. So, outperforming the stock index was almost impossible. It wasn’t really going that fast, but the interest was growing slowly. We were thinking that if you managed one hundred million, that would be a lot. Is it possible? Because we saw some managers that reached one hundred million and weren’t able to do so [successfully]. In the 90s somewhere we reached that level.

Niels

You got bought, didn’t you, you got bought by a bank at some point?

Harold

Niels

Do go on and feel free to tell us more of that evolution, but I’m also interested in learning about how does that change a firm becoming part of bigger and bigger organizations, maybe even with foreign ownership and so on and so forth?

Harold

That had minimal effect, because Rabobank owned Robeco but did almost nothing with that. They just owned them, and they did some projects, but they really were not involved a lot. And Robeco also kept pretty much at a distance. In the US we work together in the sense that they have a presence in the US, so the US fund is a typical Robeco fund – in which Transtrend acts as the trading advisor. Apart from that, we go our own way; we do our own thing.

Robeco recognized that a thing like Transtrend could work if it works differently. It’s another investment style, and you should not commingle that with all kinds of ideas that you have in stock markets, for instance, or fixed income.

Katy

So Harold, you mentioned those three rules and how you disagreed with some of them. What are some of the key things that you think are the greatest lessons that you’ve learned along the way? It’s been a long ride, so what are some the things that have been an epiphany or aha moment over time? What are the greatest lessons as a long-term…?

Harold

In the early days, for some reason, the traditional US CTAs were pretty volatile. This, maybe, also had to do with trading the same position whatever volatility there is in the market, this type of thing. We took a different step in that, but also many other European CTAs did. So, in those years, you got this more smooth performance from CTAs - most of the CTAs in Europe. Later on the US CTAs kind of moved in the same direction.

Basically we were looking at risk on the portfolio level, instead of individual positions. The traditional US way - everything that you read about it - was trading a market, trading a position in the market: we are trading gold, we are trading silver, or we are trading the Aussie dollar. You traded a market, and all these trades together made a portfolio. We had much more of a top-down approach.

We said “No, we want to trade a portfolio, and we don’t have to look at things like whether it’s a stock market, or whether it’s a commodity market or a currency market. It’s not relevant at all.

If there is a trend in oil, that oil trend can manifest itself in the oil futures, but it can also manifest itself in oil companies - stocks of oil companies, or in currencies of oil-rich countries, like the Norwegian Krona, and so on. So you have to get rid of this idea of how much are we going to give to interest trades, how much are we going to invest in currencies. It is totally irrelevant. It’s about how you invest in a trend wherever the trend is. So, that was a somewhat different approach than maybe many, especially in those years, had - looking at trends instead of looking at allocation to different markets and markets as part of a cluster.

Niels

Where did that idea come from? As you say, a lot of the people, a lot of the early pioneers were not doing that. I know, and I completely agree, that the European industry probably overtook the US, and certainly in the terms of the view of the institutional investor because of that different approach. So, I think it’s really key to understand where your realization came from. Was that by looking at other European managers? Or was it just from reading more books, or just from your own…?

Harold

Looking at the markets - just look at the markets and see what’s happening. That’s the basic principle. Reading books is nice, but you don’t learn that much from books because the markets are changing. They are changing constantly, and you see what’s happening in the market. And if you look at the markets, it’s logical.

If I say, it is oil companies, and oil currencies, and oil markets; if I say it everyone will realize, “Well, of course, it’s logical.” But somehow many people are so fixed on, “OK, we do it top-down, or bottom-up or whatever.” Instead [of considering] what’s really happening, asking why, what is this?

It’s much like the way I looked at cows, for instance. They also go in a certain direction, and you don’t look at the movement of one cow. If one cow is moving a different way he’s sick.. You have to look at the whole flock of birds, or the whole herd of cows, and then you see something. Then you know which ones belong together and what is driven by another thing…

That’s the way of looking at markets. It’s not much different from the way you look at animals because markets are driven by the kind of animal that is very popular in the world here - we are sitting here with five of these animals. (Laughter) So, we humans drive the markets. Looking at it, in that sense, I am the farmer that is looking at the cows, but different cows, and they produce different milk.

Niels

Sure, sure. I think when people look at our industry, and I think certainly there is, in recent years, maybe from some types of investors this notion that trend following is easy, right, so we shouldn’t pay for it very much. We should just use replicators, etc. etc. I don’t want to go down that path right now, but I do want to ask you what do you think investors underestimate the most about what we do as managers? What do you think they underestimate the most?

Harold

One thing is that we are constantly doing something else. This whole idea that it is easy is just based on doing historical research and doing the same thing... I’ve seen research that goes back a hundred years. While this seems very nice, think about this for a second. ,So eighty years ago you sent an email to Japan, and they will execute the order that you’ve just recommended from the data you’ve just received by your computer or something? It’s impossible!

The world is changing, constantly changing. So, that’s a very important thing. So, there is no existing CTA, [which has] existed for a long time that has constantly been doing the same thing.

You mentioned the Turtles earlier. The Turtles, especially Eckhardt, also said, “There is not one line [of code] that I haven’t changed.” Many people said about the Turtles, in the early days, that the ones that didn’t succeed were the ones that couldn’t stick to the rule. But that’s wrong. The ones that did succeed were the ones that knew how to constantly bend the rule to adapt it to the changing world.

Those were the ones that succeeded. In that sense, Eckhardt was the best Turtle because he knew that, as the one that was leading the project, [it was important to] constantly keep on doing that. That’s the whole thing.

The idea that there’s just a simple formula that you can use and keep on using, that’s not right. Especially in the last years, a lot of things have changed. Sometimes it's underestimated.

If CTAs didn’t have this characteristic of doing well when stock markets are coming down, the performance of the last, what is almost ten years now, is not really something that people want to be invested in. It’s something else. It’s the idea that when stock markets come down, they will do well. Now, that’s not even automatically the case.

But [that's not the case], because there have really been structural changes in the markets. A few of them are very relevant and are there to stay. A very simple one is that floor trading has been replaced by electronic trading. That’s not going to revert.

This has led to completely different market dynamics. All kinds of things that used to be the case have changed, for instance how an opening works: an opening on the floor was an equilibrium that was reached already without trading. Brokers were calling around and saying, “Well there’s a lot of buying coming in, and because they heard buying coming in, they were willing to sell.” So, a kind of equilibrium was reached before the opening bell. Then it started, and it opened at a certain value.

But now orders come in electronically; these orders do not communicate with each other. So what happens is that the equilibrium process starts at the moment that the orders are flying in and are responding. So there are a lot of markets where this happens, but just take the normal US stock markets: very, very regularly, in the first minutes of the day, the whole daily range is set. There’s no equilibrium before that.

No, now it just happens at that very moment because an equilibrium has to be found. That’s a completely different microstructure that is not going to change. This is going to be there for a lifetime.

It can come back if regulations are changing again, in a few years time, maybe it will grow, but this is gone, this is definitely gone. This has a big impact.

Another one [which fundamentally changed], we really underestimated its effect: maybe you’ve heard the story Demystifying Managed Futures, this is an academic article. There’s a line in there that says that all of this is without taking trading cost into account, without [taking] transaction cost into account, because the markets, in this article, are some of the most liquid markets in the world.

This doesn’t say anything about the writers of this article; this says something about the academic world. Because if you were to write something like that twenty years ago, it was impossible that it would be accepted.

Because writing that you could trade without market impact is… There’s only one reason why markets move, and that is because of market impact.

Apple stock doesn’t rise because Apple is selling more iPads or because they have a very new iPhone that everyone is after. That is not why the price of Apple stock rises. Apple stock rises only because people are buying Apple stock. Probably they buy because they see that the iPhone is doing well, but the stock only rises because of market impact. The only thing that drives markets is market impact.

So, an academic world that accepts articles that say that trading can be done without market impact… It’s like saying sailing can be done without wind or something. It’s completely impossible. The fact that such articles have been accepted; that the academic world has changed such that they allow articles saying that there is no market impact means that more people believe that markets are something that you can trade in, you can do things in, and it has no impact.

The fact that people believe that, also means that more people are doing that. So, if you want to understand a flash crash in which a mutual fund is selling twenty-five thousand contracts of mini S&P – [which is], I would say, one of the most liquid markets in the world - without regard to price and time, as the CFTC found out… Of course, such a thing has a huge market impact.

And these impacts you see constantly But if more people are believing that you can trade like this, then it doesn’t function anymore - you get different dynamics. If people are trading and a lot of money is going through markets, understanding that with what you are doing, you are part of the market and you move the market, it’s a different way of market dynamics, than when there’s a lot of money coming in and flying through the markets with the idea that, “I can buy, I can sell, and there’s no impact.” Then the impact is the biggest.

Low volatility with a deep drawdown means you’re not doing what an investor is supposed to do. An investor is taking a risk and gets a risk premium for it. You get volatility, and get the return. It can be negative, it can be positive. But if you have deep drawdown with low volatility there can only be one thing that you’re doing, and that’s paying a liquidity premium - paying a premium instead of receiving a premium; being afraid of volatility.

That’s what you saw happening in the performance of Transtrend and some others as well. It’s the result of markets that are changing, and we were thinking: “OK, let’s add more markets and automatically the program will do well.”

But no, it had the opposite effect; the volatility was coming down instead of better performing and performing better from it. We had to adjust because markets have been changing. And that means that if you are adjusting, and you are looking for volatility again and bring it in the program, only then do you have a chance of performing again. That’s very important.

Katy

So around when was this that you made some changes to the program, or did you do some research in this area and then come with some adjustments?

Harold

Niels

I’m curious about this. I think it’s very interesting what you shared here. There have been studies done by some firms and obviously, Katy, you’ve written a book about this where, I think, kind of the conclusion, rightly or wrongly, but the conclusion is that these strategies have worked even if we go back a hundred years.

But when you talk about these changes in the markets, I’m thinking well over a hundred years markets must have been changing many times. Also, in fairness, there are still trend followers who have made very good money in this period. I agree, as an industry, it’s been challenging, but there are people that have done well.

So, I just wonder whether… I’m interested in this thing where you say these changes are so fundamental that they’re never going to revert, which is true, we’re not going to have floor trading again. But I’m just thinking does it really matter if you’re a long-term trend follower whether you have floor trading or electronic trading, or is it more, specifically and maybe as we’ve seen, certain types of trading, certain timeframes that have really suffered? What is your view on that?

Harold

The hundred year thing is a nonsense story because it’s all fictive trading. There are no futures that existed for more than a hundred years. The technology did not exist, programs did not exist, and even instruments did not exist, so that’s just Hansel and Gretel - that’s a fairy tale. It has nothing to do with reality.

The only thing that counts is real trading. So, how long have there been real life managed futures traders around? Not a hundred years. There have been futures for agricultural markets only. So OK, you can write stories going back a long, long time but that has no meaning.

The kinds of changes that are in the markets… So if you look at the real performance, then I do agree that the somewhat slower programs are less sensitive to these changes than the faster programs. I recognize that. The problem is that the faster programs, generally, are not so good when there’s a big reversal in markets, and when the stock markets are turning downwards.

So, you can be doing well with a slower program, and have less problems with this, but still, then the problem is there that when stock markets are coming down, you’re probably not going to do very well. Another way that people can do well is put some kind of long equity premium in there - some kind of long equity bias.

In the past few years, we’ve seen some of that; that may work and in itself there’s nothing wrong with that. But again, the hard thing is to find a way to keep on doing well with these changed markets without giving up the big advantage of doing well when stock markets are turning down.

So, that’s a choice. So, we choose not to become slow. We want to have this ability to profit from declining stock markets when it happens. You need speed for that, and of course, always, some styles are better in some environments, and other styles are doing better in other environments. But, in general, you will see that the volatility relative to drawdown that the relationship is changing. I do think that the best ones are the ones that prefer higher volatility.

Niels

How do you define, you say slow, fast, how do you define that and how would you describe your own speed, so to speak, in the markets?

Harold

I think we should be called medium-term. We’re not really short-term. Every position can change every day, but that doesn’t mean that it does change every day. It can even change more than once a day, but that doesn’t mean it happens. Well, a little bit sometimes it happens that we buy, and a little bit later we sell again when the market is booming like that. But, normally the positions are in there for two weeks until two months - that is kind of the average. So, I would say medium-term.

Niels

How different is that from… before the changes you made?

Harold

That has not changed, that has not changed, no.

Niels

Oh, that has not changed.

Harold

The structure of the program has changed but we didn’t want to become slower. We want to be less sensitive to short-term uninformed price moves, which can be pretty large nowadays. So you never want to react in the wrong way to any short flash crash or that kind of situation.

So, you want to be insensitive to that, without becoming slower. But if you are slower, then you are automatically less sensitive to that. So, there’s the advantage there. But I think, ultimately, because this new dynamic is continuing, you will see that also by being slower, without taking good care of execution, you will earn a little bit less.

This all has to do with how people look at the world and look at things like an alpha and beta. One of the popular topics now is that trend following is now just a type of beta. Yeah, I completely agree. I think in investing there is only one ultimate source of return and that is risk premia.

You have all kinds of different risk premia that you can profit from in some kind of systematic way. If it’s not a systematic way you don’t have to program it, but if it’s not a systematic way then it’s a coincidence. So, everything that can be done systematically is, in some way, a risk premium for all kinds of different types of risk. There are easy types of beta (long only stocks, for instance, is an easy type of beta), and there are harder to catch types of beta.

Where the difference is, is this idea of what alpha means. For me, alpha is the inefficiency of getting the beta. For me, there exists no positive alpha. All positive alpha that I see presented here and there is always model misspecification alpha. So, you didn’t put the real beta factors in, then you seem to get alpha, or there’s no linear correlation or relationship whatsoever. It’s always model misspecification.

There’s no real source of alpha. The only alpha is negative alpha which is the result of inefficiencies in getting the beta. And the easy to get types of beta result in (almost automatically) less negative alpha than the harder to get types of beta.

So what we are doing is we are delivering a type of beta, but the markets are [changing somewhat]. [This] means that if you don’t change anything, then, with the same beta, you get a little bit more negative alpha. You will see it in execution, for instance, and it has to be just very little.

If you look at correlation, you won’t see it. But if you just lose .1% every day in execution, it sounds like nothing and you don’t see it, but after 250 business days that’s 25%. So no strategy is good enough to be able to lose .1%. And .05% is still 12.5%. It’s very easily realized by just a [few] more changes in the market dynamics.

[If you don’t] take care of it well enough you get this negative alpha.

Another important thing about this negative alpha – looking at the model this way, instead of thinking of alpha as positive – is what the real alpha adepts call portable alpha. Portable alpha is a great term but it is a typical academic concept.

Because the idea is that alpha is positive, and you can place positive alpha on positive alpha on positive alpha and you get better and better returns. But if the real alpha is negative, portable alpha means you add a negative number.

It means that you have been trying to catch some kind of risk premium and you want to do it as cheap as possible. By doing it cheap, you miss something. So, you have a higher negative alpha, and you think you can compensate for that by adding some alpha. But, alpha means you’re adding someone else that tries to capture the same beta, and it has some negative alpha as well. Maybe less than the other one, but it’s still more.

So, instead of building up more and more alpha, you’re digging into negative alpha [deeper and deeper] and end up with more inefficiencies. Inefficiencies cannot be compensated for by other inefficiencies.

So, this model of positive alpha should be forgotten. People should concentrate on, “Which beta do I want to grab, and how do I make sure that I lose as little alpha as possible with it,” instead of how do I get positive alpha, because that’s something that you cannot get.

In that sense alpha is comparable with health, health doesn’t exist. What’s health? It’s only the lack of diseases and the lack of accidents. If you look around before you cross the street, then you stay healthy. If you do not look around you will be overridden, and then you potentially die, it’s not good for your health.

But, you cannot compensate for that by saying, “You know what, I’ll cross the street without looking, but once I am at home, there is my portable alpha. I’ll just watch television very good for an hour and - look - everything is alright again.” That doesn’t work. So, health is something that doesn’t exist. It’s just a lack of diseases and a lack of accidents. That’s the same with investing. Positive alpha doesn’t exist. You have to avoid the negative alpha, and that’s what we strive to do…

Ending

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