In this episode, Adam Butler and Mike Philbrick of ReSolve Asset Management have

an in-depth conversation with Chris Schindler, a seasoned investment

professional. They delve into a range of topics, from the intricacies of

investing in tech and the dynamics of the credit market, to the complexities of

portfolio construction and the impact of market forces on investment

strategies.

Topics Discussed

•The challenges of investing in tech and the role of analysts in creating

crowding effects

•The importance of understanding the dynamics of the credit market and the

implications of holding credit right through maturity

•The intricacies of portfolio construction, including the importance of

diversifying across strategies, assets, and time

•The impact of market forces on investment strategies and the role of

benchmarking in driving investor behavior

•The evolution of the volatility market and the influence of large players on

market dynamics

•The concept of 'netting' in multi-strategy portfolios and its impact on trading

costs

•The challenges of attribution in multi-strategy portfolios and the importance

of understanding the underlying strategies

•The potential pitfalls of short-term investment strategies and the importance

of a long-term perspective

This episode is a must-listen for anyone interested in gaining a deeper

understanding of the complexities of the investment landscape. Chris Schindler

provides valuable insights into the nuances of portfolio construction, the

dynamics of the credit market, and the impact of market forces on investment

strategies, offering strategies to navigate the ever-evolving financial

landscape.

This is “ReSolve Riffs” – published on YouTube Friday afternoon to debate the most relevant investment topics of the day, hosted by Adam Butler, Mike Philbrick and Rodrigo Gordillo of ReSolve Global* and Richard Laterman of ReSolve Asset Management.

*ReSolve Global refers to ReSolve Asset Management SEZC (Cayman) which is registered with the Commodity Futures Trading Commission as a commodity trading advisor and commodity pool operator. This registration is administered through the National Futures Association (“NFA”). Further, ReSolve Global is a registered person with the Cayman Islands Monetary Authority.

Like in 10 years, if you had to build a portfolio and say,

2

10 years from now, this is the portfolio

I want, what would it look like?

3

And the key part of that statement

is you have no idea what the

4

world's gonna look like in 10 years.

5

You have no idea if you're gonna

like stocks more than bonds, if

6

you're gonna like commodities.

7

If you're gonna, you have no active, you

have no possible active view in 10 years.

8

And so that's the, and so think

of that as your definition of

9

passive, as your definition of beta.

10

Build the best portfolio you can that

you'd be happy having in 10 years.

11

And then think of active as everything

that you do between now and then.

12

Adam Butler: Okay, today everyone

is gonna be very excited to see

13

we've got Chris Schindler back in

the hot seat from Castle Field.

14

Chris, how you doing today?

15

How's Toronto?

16

Chris Schindler: not so bad right now,

one or two degrees better than last week

17

when it was about minus 10 and snowing.

18

So probably not quite as nice

as where you guys are, but,

19

Adam Butler: That's possible.

20

It's pretty gray here today

too, but no snow on the ground,

21

you'll be happy to hear.

22

Chris Schindler: Oh yeah.

23

Adam Butler: For those who

don't know, we've had Chris on

24

two or three times in the past.

25

They're always crowd favorites.

26

We both, we go broad and deep.

27

Chris's background we'll get,

we will obviously give a more

28

detailed background or bio for

Chris, worked at one of Canada's.

29

Major, public pension plans for, for many

years, ran their quant desk and has spun

30

off into his own, uh, quant hedge fund,

primarily trading global futures markets.

31

So, we're gonna cover a variety of

topics today related to his past and

32

his present and potentially his future.

33

And, um, so let's, let's start with what

34

Mike Philbrick: let's not, let's

not hide where, where he is at,

35

it's Castle Field, is that,

That's the name of the firm, right.

36

And, uh, where is there a website?

37

Is there, just let's get it

out there at the beginning too.

38

Chris Schindler: Uh uh, I mean,

there's a website that has, I believe,

39

a phone number and an email address,

and that's about it on it right now.

40

So, uh,

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Mike Philbrick: Very, very

42

Chris Schindler: very professional.

43

Mike Philbrick: Close there.

44

I,

45

love

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Adam Butler: The scarcity close.

47

Mike Philbrick: Yeah.

48

Adam Butler: So let's start with

what we're currently facing.

49

You know, it's funny because I think

50

We had this crazy concentrated

tech rally, actually.

51

It was kind of like this meme stock,

low grade, low quality tech rally.

52

and we're, sort of back in a

way to where we were there.

53

We don't have any specs to contend with

at the moment, but it, you know, we're

54

back into that, massively concentrated

technology oriented large cap rally that

55

we experienced for much of the 2010s,

56

So I thought it might be

useful to revisit that period.

57

You know, I think a, a lot of people

who've only been investing for the

58

last 10 or 15 years have only really

experienced an environment where U.S

59

and especially U.S, big cap tech.

60

Was really the only game in town.

61

Do you think we're back in that kind

of environment or do you think there's

62

gonna be a lot more opportunities

over the next decade than we

63

experienced in the previous decade?

64

Chris Schindler: Holy moly.

65

You guys come out swinging, eh?

66

so, uh, and, and I guess you don't go

back to twenty-tens, you can go wait, you

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can go back to the two-thousands or, you

know, the, the, the Nasdaq bubble when

68

you really wanna talk about concentrate?

69

I

70

Adam Butler: mean, it was,

that was interrupted, right?

71

For that

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2000 to 2012

73

period, right?

74

We had this.

75

Chris Schindler: in Canada, I remember

we, um, a huge problem for anyone forced

76

to benchmark to, to public markets

where, like a public market index

77

where, if you want to hold a Canadian

index, you have to have like 30 or 40%

78

of your weight in Nortel, you know,

and, and so, you know, it's, there's

79

obviously, a lot to this question,

and, do these environments show up?

80

They, yeah.

81

Like they obviously do.

82

Have we been through one?

83

We absolutely have been.

84

The future's a bit hard to predict, but.

85

But you can kind of point to some features

of tech that make it much easier, I

86

think, to explain how it can get so

concentrated and how it can get like what

87

looks bubbly at times I guess, as well.

88

and part of it I think has to do

with just, it'll be pretty hard

89

for someone to just say, I'm gonna

start up a new business and, and

90

turn it into a billion dollar show

and, you know, in a couple years.

91

But like, obviously with the infinite

leverage of technology, especially,

92

you know, online technology and,

and the huge scalability, you know,

93

you can create these huge potential

future businesses, uh, almost out of

94

like, it feels like out of nothing.

95

And, and, and they're so

hard to value and right.

96

Part of the problem with the NASDAQ

bubble was, everything looked reasonable.

97

Well, I dunno if stuff looked

reasonable or not, but you want, you

98

can imagine why this one company, if it

succeeds, could be massively successful

99

and could be massively valuable.

100

but the challenge was.

101

All 10 or 20 of them couldn't be.

102

and so you had situations where,

individually it might make some sense

103

if you didn't get a, a sense of the

context of the entire, space or sector.

104

So that's like, that's

part of the problem.

105

And we've seen that over and over

again where it, they, they can't all

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succeed because they're together.

107

They're, they're making a bigger claim

on future, economic growth or future

108

wealth that that is impossible to exist.

109

And so together, like, all these

valuations can't make sense and then

110

you gotta figure out like, does the

entire index have to re reset or do

111

you have to go after the individuals

and, and figure out, you know, which

112

ones will go, which ones won't.

113

Because it's, it's so easy looking back

to say, man, these were billion dollar

114

companies, but if they're the one in 50

survivors or if you got entire spaces that

115

just didn't work and went to zero, it's,

much harder to predict that going forward.

116

But, you know, and, and like, I

mean obviously that's the challenge.

117

you know, and I guess the other thing is.

118

Because a lot of these businesses,

and, and I understand, I'm talking

119

about more of the ones that we just

don't know what they're worth yet.

120

Because, because so many their cash

flows are, way out in the future.

121

They're kind of, well they're,

they're almost like a private

122

equity firm that's marked to model.

123

They don't have anything that really moves

'em up and down, you know, uh, you know,

124

on sort of, on the, on the day to day.

125

And, they're just based on

some future possibility.

126

And that leads to two or three

really weird price dynamics, which

127

can lead to this concentration.

128

The first one is when you like, know

analysts and, and, and, and I think

129

that there's a, a fair amount of

evidence that analysts tend to crowd

130

with each other, and strangely, the

more volatile and uncertain the stock,

131

the more they tend to crowd with each

other relative to the volatility.

132

They have this benchmark risk of

being benchmarked to their peers and

133

looking wrong relative to their peers.

134

And so you actually find that for really

uncertain stuff that's a really high ball

135

that they crowd even more and it creates

more of these crowding effects and you

136

get more of these sort of bubbly effects.

137

And, and so that's like part of it

and that leads to momentum, in these

138

names, which can really happen.

139

And that, and of course they drag

retail in along with them along the way.

140

and you can put that up against what

feels like almost a totally different

141

statement, but I think are they actually

kind of work together, which is the,

142

you know, when you have a Dispersion of

opinions on something just straight up

143

though, like, and, and I'm not talking

about like analysts all crowded here.

144

I mean like actual people in the

market who are betting actually

145

have a dispersion of opinions.

146

You know, like cap in sort of assumes

that everyone has a modest expectations,

147

but like, that's clearly not true.

148

And as soon as you allow for

heterogeneous expectations, you get

149

these sort of weird effects where,

the more uncertain the outcome,

150

the more the price gets pushed up.

151

And I don't know if you guys have seen

any of these papers, but I mean, these

152

are, this is sort of a, a, is this

making any sense to you or do you want

153

me to go into this a bit more detail?

154

Yeah.

155

So, imagine if you had a world where,

you know, there's a, there's some

156

people thought a stock was worth

101 and some worth 102, and some

157

were 103 and somewhere 99, 98, 97.

158

And you kind of think that in a perfect

world, it would settle up what the

159

average dollar thinks it's worth.

160

And we've had this conversation a lot

about privates because it really, really

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shows up in privates and in private

equity is the most extreme form of this.

162

The, the price doesn't settle what

the market thinks it's worth, the

163

price settles in what the most wildly

optimistic person's willing to pay.

164

So.

165

You know, if someone, if someone's

gonna buy a house and, and you know,

166

the market thinks it's worth a million

and some people think it's worth 800

167

and someone, and one guy goes, it's

worth 200 or it's worth 2 million.

168

It sells for 2 million.

169

It sounds more like, and, and so prices

push off to the right when you have

170

dispersion of opinion, when you can't

short the price back down to zero and

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the privates cannot be shorted back.

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So they go all the way to what the most

wildly optimistic person's gonna pay.

173

But if you have a world where you've

got more longs and shorts, or you have

174

a, a, not enough shorts to pull the

longs back, and we're always in a world

175

where there's a long bias, there's more

like there's more, you know, potential

176

long buyers and short buyers that a

dispersive opinion is going to bias you

177

towards the tails and to the right tail.

178

And so the bigger the dispersion of

like, like, I don't know, this thing is

179

worth, and some people think it's worth

nothing, something is worth a ton that

180

pushes you to the right as well and

creates a bubble in that space as well.

181

So you can kind of see how the massive

uncertainty of these things will result

182

in, in a, a bias high and momentum.

183

Which we see all the time.

184

and so, does it, so you can

push all that against Hmm.

185

It makes it pretty risky against, I

think like one other thing you have

186

to pay attention to and, and like,

look, there's always crazy issues

187

when you're doing market cap and

market cap waiting and people, people

188

have that as a benchmark, right?

189

And the challenge with market cap is

your benchmark meet is that it, it can

190

be an incredibly painful benchmark.

191

It's because if the, if the, if the

small number of names do extremely well

192

and, and you're anything other than

the, than the market you're going to

193

get, it it's gonna crush you at times.

194

And there are gonna be times when

you crush it because it does badly.

195

But it's, it's a really inefficient

benchmark in a lot of ways to

196

measure your performance against.

197

But it is, it is what people

do measure performance against.

198

And so you get these benchmark

issues associated with it.

199

and so like, there's, there's a whole

universe of quant and, and you know, how

200

do we think about alternative to market

cap indices, and think of them as, as

201

as processes and, and, and benchmarks

and, This is gonna go on, uh, uh, on

202

a total left turn, by the way here.

203

Um, but, uh, you know, I spend a lot of

time thinking about how do we alternatives

204

to market cap weighting because you do

get this massive concentration risk in a

205

small number of names and like, the most

naive alternative to market cap weighting,

206

which, which for sure eliminates

like, you know, any kind of mega a cap

207

bias is just to equal weight things.

208

And, it's actually like in the

very long term, a surprisingly

209

strong solution for equities is

just to equal weight All the names.

210

but it's, oh, it's shockingly naive.

211

and, and it's got, so we did

this, we, we, we ran like an

212

alternative to, to market cap weight.

213

We, we ran an equal weight and the

pro and there are lots of problems

214

with equal weight, but what it does do

is it says, I don't care what anyone

215

thinks this is worth, I don't care

what the market thinks it's worth.

216

I don't care.

217

I'm just gonna put $1 in each of

these things and, and, and so be it.

218

Now, lots of problems with that.

219

But one of the ones that always

bugged me about equating anything

220

was this definition of, well

what's the thing you're equating?

221

I mean, you could say like, imagine I'm

equating countries around the world and

222

I'm gonna put $1 in the United States

and $1 in Canada and $1 in France.

223

And then imagine the United States

breaks up into 50, you know,

224

independent little countries.

225

And that thing that used to have $1 in

you now go, now I'm gonna put $50 in it.

226

You're gonna bet 50 times as much

on the exact same thing, just

227

because of how it was defined.

228

And, and you have this problem

with equal weighting, which is,

229

I call the unit problem of equal

weighting, which was like, how

230

do I think about what's the unit?

231

Because it's clearly,

it's a definitional issue.

232

And if, if things come together, if

things split up, I'm gonna completely

233

change my weightings based on what

shouldn't change my weightings.

234

And that's like a big

problem with equal weighting.

235

And so market cap weighting, it's

got like a lot of efficiencies to it.

236

It's got a lot of, you know, like I

say, efficiencies, it's got theory

237

behind it that you can kind of stand by.

238

but at the end of the day, it's

people's opinions about things.

239

It's the whole market's opinion about

things, but the price does move on.

240

That Ecoweight's got this definition

of, of independent unit problem.

241

And so there's a subcategory

of things in between.

242

And, and so this is what we, this

is the sort of the three categories

243

of of alternative indices.

244

We created what we call kind of

like a fundamental valuator, right?

245

And a fundamental valuator is,

is is different again, because it

246

takes something about the companies.

247

And so like, you know, when Rob Arnett,

I, I think is a guy who's really

248

covered this a lot, but he would

say like, it's, it can be anything.

249

It could be a number of parking

spots in the parking lot.

250

It could be a number of employees, but

it's typically revenues or dividends or

251

cash flow or something that kind of speaks

to the size and he doesn't sell it this

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Mike Philbrick: more towards

a fundamental criteria rather

253

Chris Schindler: biases it.

254

And, and so, so if you think about

Ecoweight and Ecoweight's got one extra,

255

really, this is totally off fire now,

but it's got one really cool feature

256

Ecoweight, which has got like a cult, like

an energy capture or a volatility capture.

257

If you have a number of companies that are

equal-weighted and you always have error

258

terms, you know, like you have surprises,

surprise the upside, surprise the

259

downside and, and what a market cap does.

260

Or if you take an equal weight and you

don't rebalance it, then the companies

261

that get surprised, the upsides grow.

262

So they have, they have positive

shocks and the companies that have

263

negative shocks shrink, and you end

up over-weighting the ones that have

264

positive shocks and under-weighting

the one with negative shocks.

265

And, and if there's any

reversion to the mean.

266

And so if, if prices project those

further out, if there's any reversion

267

to the mean, then you've, you're kind

of backwards in what you'd like to do.

268

What you really want to do is buy

the one you expect to, to revert back

269

and you wanna sell the one that's,

that's had a positive bias and market

270

cap is the exact opposite of that.

271

So anytime you equal weight or anytime

you rebalance to a starting process,

272

you're gonna capture some of that, that

natural mean reversion and, and in fact a

273

huge, huge proportion of a lot of quant.

274

Alpha and value add is in

fact that energy recapture.

275

And so I think Rob is able to show,

I don't know if he showed this or

276

something else did, but you could take

like the inverse of his portfolios

277

and they also beat market cap just

because that energy capture is, is

278

pretty, is pretty helpful anyway.

279

But so one of the things that, the,

that any kind of fundamental weighting

280

does is that, you know, when the

fundamentals change, you buy more

281

or less, but it doesn't move the

price because of people's opinions.

282

Because the market's opinion and

projecting that into the future

283

'cause that projecting into the

future tends to cause issues.

284

So, and if he's never sold it as this,

I've never really seen it presented

285

this, but the reason I like, I like

this idea is if I took a company, I

286

split it into 10 pieces, I will still

have the same amount of weight in that

287

new thing, split up 10 ways that I

would've had the original and vice versa.

288

And so it's kind of an equal weight,

but it's an equal weight by size

289

or something a bit more fundamental

than just like this equal weight.

290

And, and between those, now you

start to say, how do I invest

291

in a, in a market that's got.

292

some very, very concentrated

companies in it.

293

And, and you have to think, take

a step back and say, if those

294

concentrated companies were in

fact a hundred companies that came

295

together, well maybe it's not so bad.

296

Maybe that is, well, you know,

like it's a quarter of the weight.

297

But, but if it was a massive conglomerate

that brought together, maybe it's

298

not as concentrated as I think

299

Adam Butler: Mm-Hmm.

300

Chris Schindler: but if it's a

single thing with a, with a small

301

number of risk factors just blown

up a massive size and go, that's

302

when I gotta be more worried about.

303

And so we start to think again, which

is like, how do I determine how many

304

effectively independent companies

are in that company to get a proper

305

sense of how concentrated it is?

306

And, and, I'll just say those are,

there's a lot of topics in that, but

307

just say like, is there a fundamental

reason why tech, and especially tech with

308

earnings that are being projected way

out of the future is way harder to value?

309

Like Absolutely.

310

Does that result in trending

and possibly higher prices?

311

Look that, that then have to correct

and, and disappoint going forward.

312

Like probably, does that mean that.

313

Google.

314

Is Google a single factor

or is it a conglomerate, or

315

how do you think about it?

316

I think you gotta get a little bit

deeper before you say, is this, this

317

is a massive tech concentration.

318

'cause Google's not really

Google's a tech company, but

319

it's also an advertising company.

320

It's also, it's, it's a media company.

321

I mean, maybe it's a bit more, maybe it's

not quite as concentrated as it feels.

322

Adam Butler: Well, some of them

are more concentrated than others.

323

I mean, obviously Microsoft is exposed

to virtually every sector of the economy.

324

It's a massive global conglomerate.

325

Same with Google.

326

Nvidia reminds me more of like

a Nortel or JDS Uniphase, right?

327

I remember JDS Uniphase with their

optical switching and you know, everyone

328

assumed that the internet was gonna have

optical switching, and that was gonna

329

be the, tech that everyone settled on,

and JDS Unified just went to the moon.

330

You know, it's these kinds of concentrated

bets on, on these narrow tech,

331

outcomes that become especially risky.

332

Right.

333

But I mean, just from an advisor

standpoint, how do you manage this

334

and manage client expectations?

335

It terrifies me to see investing in global

cap weighted U.S equities above 60% of

336

global cap weight now, and seven companies

worth, you know, up almost 30% of U.S.

337

Equity valuation.

338

Like it's just a.

339

You just have this sort of, you're, you're

going on this massive amount of faith

340

and taking this huge concentrated bet.

341

If you don't, you risk

being totally left behind.

342

If you do, then you're

taking this concentrated bet.

343

It feels like a no-win situation.

344

I mean, how do big asset managers

deal with this, especially when

345

they're benchmarking against peers

on a year-in-year-out basis, like it

346

seems like it's just a hard problem.

347

Chris Schindler: Yeah.

348

And, and, the, challenge, and I, you know,

and I don't know how you break it, but the

349

problem with it is, is the benchmarking.

350

At the end of the day, if you are always

going compare someone to something,

351

then they are always going to have

to look somewhat like that thing.

352

And, and you've, and instead of being a

maximum share ratio investor where they're

353

trying to make as much money for, as, you

know, as much, much return, for as much

354

risk as possible, you've forced 'em to

have a different definition of risk, which

355

is, their tracking error to the benchmark.

356

And, and their optimization becomes

return over tracking outta the

357

benchmark, which is a fundamentally,

like, much less useful thing.

358

Uh, and, and it's much

less useful for you.

359

And I say like when typically I say

you're looking for managers and I

360

think you just have to get comfortable

with, I mean, if a manager's properly

361

a long, short space, they should have

no beta anyway, and you shouldn't care.

362

You literally should just say, I've got

my, you know, and, and whether I'm talking

363

about as a portfolio constructor, how much

of this stuff do I want in, in my beta?

364

Separate that question out for a second.

365

Say, let's say, let's say I've somehow

made that decision then for my managers.

366

I, I should give them the right benchmark

and I should give them the right risk

367

definitions and the right governance.

368

And so that, so that this

doesn't affect 'em at all.

369

They have a good stock pick over here and,

and, and they should make it regardless

370

of what the beta is and is doing.

371

Now, that's, that's, that's a pie

in the sky kind of nice statement.

372

It, it typically doesn't go that way.

373

But even for, you know, even if you're

saying like, I still, I'm investing my

374

money in this beta, what do I do about it?

375

And, and it's funny because when we

first started looking at this and how

376

to think about waiting countries and,

and I think we're doing this research

377

in the early two thousands and the,

and, and the country that really stuck,

378

stuck out in the history, you know,

the last 20 or 30 years was Japan.

379

'cause Japan in the late eighties had had

what looked exactly like the US does now.

380

It was a massive portion of MSCI

and of course it got super expensive

381

as again, there was all the tiger

funds and everyone was, was, was,

382

was just throwing money into it for

15 years and it got so expensive

383

and then, and then it just broke.

384

And it broke, and if you were MSCI

weighting Japan, you got crushed.

385

If you had, you know, underweighted a

bit, you did well because you had a very,

386

very large concentrated exposure to a

relatively small subset of the universe.

387

And, and I think over the very long

term, these moves tend to punish you

388

and you tend to want to disparate

because, because there's the, there's

389

always the mixture of the fundamentals

and then the market mania behind it.

390

And, and the market mania behind

it is the, is the piece that always

391

over-projects and, and any market cap

weighted, which is a mixture of the

392

fundamentals and the market's projection

of that into the future is, is almost

393

certainly gonna lead to over-projections.

394

The problem is, can you survive in

the short run long enough leading

395

against that to, to prove your thesis.

396

That's the tricky part.

397

Mike Philbrick: it's, it's the

combination of, of this, overvalued

398

market and a strong trend, right?

399

So, and this is where it gets

really dangerous because when the

400

overvalued market trend turns and

increasingly you get that larger

401

and larger spikes in volatility.

402

Where the dip is bought until such time,

it's a 25 or 30% and the dip isn't bought,

403

or it's only bought up 10 or 15, and

the trend is now changed and different.

404

And the world of investors is

always sort of slower to pick that

405

up in, in the final trend change.

406

And then you have this exposure, this

overexposure to the largest market

407

just by the market cap chasing.

408

And you have the risk unwind and, And so

that's, you know, the valuation side of

409

it is important, but man, when the trend

is strong, it's a really hard problem.

410

Chris Schindler: yeah.

411

And, which I guess when you're

saying the trend is strong girls

412

and the values, you're just, you're

also, to put it another way, you're

413

just saying the behavioral side

414

Mike Philbrick: Right.

415

It's that, it's that, it's that

momentum that, you know, that punching

416

fist through the, the, the enthusiasm

that continues and as long as it

417

continues, the valuations don't matter.

418

I mean, it, it's expensive.

419

It's not as expensive it's ever been.

420

It's not as expensive as Japan was, and we

don't know if any of those are even limits

421

on how expensive something could co become

in a, in a strongly trending market.

422

Chris Schindler: Yep.

423

So, uh, and that's exactly it.

424

And, and so then you end up with, you

know, sort of various forms of this, which

425

is like, look, you can stay along the

trend, but you've gotta be aware that the

426

more crowded it gets, the, the quicker and

sharper it can turn back on you because

427

there's, because there's like a growing

liquidity build up and there'll be a

428

growing liquidity rush on the way out.

429

I, I think, my guess is a

lot of players get that.

430

I don't know if the retail side sees

it as clearly, but I think a lot of

431

players get the growing riskiness of it.

432

But there's always that.

433

Yeah.

434

But you have to keep playing

while it's still happening.

435

And, and it's very, 'cause it's

just so painful to lean against it.

436

So, uh, and this, it all comes down

to it's a benchmarking problem.

437

Adam Butler: Did you ever

438

Mike Philbrick: a doubt.

439

Adam Butler: did you ever do any

work internally on, um, the, double

440

exponentials, like as the, as the

curve approaches a certain level

441

of criticality and the fractals

and all that kind of stuff?

442

I forget the name of the

French, mathematician who was

443

mapping all of that and you wrote

444

Chris Schindler: a way

445

Adam Butler: paper April.

446

Chris Schindler: it?

447

Mike Philbrick: or what?

448

Adam Butler: He, one of.

449

Mike Philbrick: Mandel.

450

Mandelbrot.

451

Is

452

Chris Schindler: Mandelbrot would be one

of like the fractal guys, but, but yeah,

453

so the, um, I mean, yeah, that's, that's

a big, so when markets go parabolic, the,

454

the issue is always is, is you know, like

it's the same definition of anything.

455

It's like a bubble is really easy to

see after the fact, after it's popped.

456

Um, it's very, very hard to know

if this thing that's running up,

457

is that the bubble yet or is it

the peak, the bubble, you know?

458

And Jeremy, Grantham, GMO has done

a huge amount of work on trying

459

to just, you know, he's, he's

basically all bubbles being revert.

460

But the, the challenge with that is,

after the fact, yes, all bubbles being

461

reverted because you kind of defined it as

a thing that went up and came back down.

462

It, you know, Microsoft or Apple,

just like, are they bubbles?

463

Well, it's hard to say.

464

They just, they kept going

for like 15, 20 years.

465

And, and so, I mean, maybe at some

point in, in the far future you'll

466

be to look back and say, yeah, yeah,

they were bubbles, they mean reverted.

467

But, but it's, it's, I don't

think it's quite as obvious.

468

And, and so he tries to fight in

bubbles relative to fundamentals.

469

But the, the problem is they mean

revert or the fundamentals catch up.

470

and it's one of those two,

471

Adam Butler: The story always need

to have a plausible outcome where

472

the fundamentals could catch up.

473

I mean, there's very good narratives

around why, you know, meta Google

474

NVIDIA, Microsoft, deserve these

ultra premium multiples, right?

475

The new story is AI and all the

compute that's gonna be required.

476

In 2000, it was, it was internet and

switches and all that kinda stuff.

477

In Japan, it was their six

Sigma manufacturing process.

478

They were gonna completely

dominate global tech, manufacturing

479

and auto manufacturing.

480

And, you know, that all got swept

up in their, in their banking sector

481

and, and the real estate sector.

482

You know, I remember in

483

in Tokyo was valued at a.

484

Higher total valuation than

all the land in California.

485

Right?

486

Like, and there's a plausible

reason for this every time, right?

487

And, there's this potential every time

for this time to truly be different.

488

You know, maybe, fast takeoff AI actually

does, mandate this kind of overvaluation,

489

maybe software, you know, uh, mark

Andreessen said Software eats the world.

490

Maybe this is the time when

software eats the world.

491

Like there's always gotta be this

plausible explanation in order

492

for the markets to rise to this

kind of bubble level, right?

493

Chris Schindler: Maybe, but then you,

I, I, it's like, unless there's, unless

494

it's also a, an incredible, like just

creator of mass wealth for everyone.

495

You, you can't, you can't plow this one up

because it's potential ability to grab the

496

ability and still keep these gut there.

497

There has to be like once again,

you gotta add all up what, like

498

those growths require what kind of

earnings and what kind of cash flows

499

and what kind of percentage of the

total world pie at some point you go.

500

Does that make sense?

501

Because if they're claiming two x

of what it it will ever be, then

502

no, those things don't all add up.

503

It's just the question is like, one

of those 10 may be correctly valued.

504

Maybe that goes even bigger.

505

But, but that's, I mean that's obviously,

yeah, there's, there's always a story.

506

Uh, there's no doubt

there's always a story.

507

and it has to make a bit of sense.

508

It can make a lot of sense.

509

The, the, the, you know, and we, we

all heard the stories, like all the

510

way through, like through the, through

the years and through the decades.

511

We've heard the stories.

512

I mean, I guess NFTs had a story.

513

I, it it doesn't necessarily mean that

they're gonna hold their wealth when

514

the story moves on to someone else

515

Mike Philbrick: The, the other thing

is the initial conditions can, they're

516

important and they're different.

517

Right?

518

1990, you had a significant

earnings contraction, yet

519

the market did not go down.

520

The early nineties, the

S&P kind of sailed through.

521

Whilst earnings were contracting, I

mean, yields were high and they, it

522

looked over the recession almost.

523

And so you also don't know what

the initial zeitgeist of the

524

market is when you go through

the, through the transition.

525

There's so many dimensions to this.

526

It's, it's

527

Chris Schindler: Yeah.

528

Well, yeah, it's, it like, no doubt.

529

and I think, you know, like, especially

when Japan peaked in 89 and, and I

530

mean, I'm gonna make up some numbers,

but I think like 15, 20 years

531

later, it's stock market was down.

532

I can't remember, like 90% in, in like,

like it was so much in its real estate

533

market was down ninety-five percent.

534

It was, it was just

unbelievable crushings.

535

Mike Philbrick: It's only

approaching those numbers today,

536

Chris Schindler: yeah.

537

Yeah, it's just

538

Mike Philbrick: but it's.

539

Chris Schindler: and, and, you know,

and, and, I think like from like

540

2000, 2010, I think Japan's earnings

growth was faster than the U.S.'s.

541

like it's starting points really matter.

542

And, and whether or not, and you're gonna

see this lots of times it's like, and,

543

and you think about, you know, like risk

parity stocks versus bonds and you go

544

like, like if you just went, like imagine

you just, you make some magic statement.

545

It's like they both should have

the same sharp ratio over time.

546

And maybe that's true,

maybe it isn't, who knows?

547

But like, you know, if this guy

runs off at a sharp of one over the

548

last 10 years, it's either getting

ahead of itself or catching up.

549

And I don't know if you really

know, because at the end of

550

the day I mean, who's to say.

551

But, uh, or maybe a bit of both and,

and it is either getting in front of

552

itself and you should sell it or it's

catching up and it's a good deal.

553

and I, I guess that's kind of

like a risk-parity statement.

554

It's like if you were, uh, if there, if

the only two things you could invest in

555

in the world were stocks and bonds and

you had 'em, would you care if this one

556

happened to take from this one and then

this one happened to take from this one?

557

If you have both of them, I guess

you're, you're probably kind of fine.

558

so if you have the world and the world is

taking from here to give to here, as long

559

as you've got a well diversified basket,

maybe you don't care as much, um, as,

560

as, as, as long as you do that, right?

561

Adam Butler: then you've got periods

562

makes, makes a bit of a mockery of

that stock bond diversification, right?

563

Like this, you know, own

some stocks, own some bonds.

564

The idea is the bathtub.

565

There's always a drip into the bathtub,

and so the level always rising,

566

whether it rises more into equities,

that doesn't really matter versus

567

bonds because you own them both.

568

But when the, you know, that bathtub

sort of contracts, the levels contract,

569

then, you know, you've got stocks

and bonds both losing together.

570

Right.

571

Which is why stocks and bonds,

the, the two-legged stool

572

typically doesn't, balance Right.

573

You gotta add that, that third leg.

574

Chris Schindler: Yeah, I mean, at

least I, I and I, I guess that, so the

575

statement there was like, if stocks

and bonds were the only two things,

576

and you had, I guess, a world where you

couldn't lever and delever, obviously,

577

when we first started our risk parity

work, I mean, the very first thing

578

we did is went, stocks and bonds are

dangerous, like hugely dangerous.

579

And, and, and that would be a crazy

dangerous risk parity process.

580

and, and assuming correlations are

static and either zero or negative

581

is also massively dangerous.

582

And so, you know, if it, it's gonna

require some dynamicism and it is

583

gonna require some dynamicism on risk

and correlation measures, and it's

584

gonna require other stuff because

you, and I think I presented this

585

a while ago, to you guys I know I

586

When the last thing anyone in the world

587

stretch your mind back and remember.

588

But it was like people were still kind

of freaking about deflation at that time.

589

And the last thing anyone was

thinking about was inflation.

590

But, but it was, it's just all it

is, inflation is always a risk and

591

discount rate shocks are always a risk.

592

And, and so building a portfolio

that's resilient to, to inflation

593

shocks and discount rate shocks,

Inflation shocks is easier 'cause you,

594

because you can put some other stuff.

595

You've got some, you know, some

gold or some break-evens or

596

some, you know, commodities.

597

There's things that you can put together

to, to get a decent attack on inflation.

598

I just can't write shock, you know,

that, that's, it's self distinct

599

from growth and inflation shocks

is much harder to defend against.

600

because, you know,

601

Adam Butler: We just haven't

had very many inflation shocks

602

over the last few decades.

603

So, you know, hedging against inflation

or owning assets in the portfolio that

604

are designed to do well during higher

than expected inflation shocks has kind

605

of made you look silly for a long time.

606

You get these sort of periodic spikes

where it, pays off and then you

607

go through these long stretches of

sort of this, you know, or at least

608

you have over the last few decades.

609

Gone through these long stretches

of disinflationary growth and, you

610

know, any I, any effort to diversify

outside of stocks and bonds kind of

611

makes you look silly for a long time.

612

And then, you know, you get this, you get

this spike and, and that sort of pays off.

613

But it's just the investors haven't

had much experience with that level

614

of diversity paying off over the

horizon that they've been managing

615

money or had money invested in markets.

616

So it's hard.

617

Chris Schindler: Sure.

618

totally right.

619

Um, to that, I guess I would

add a couple things uh, and I

620

can't remember what I presented.

621

Uh, I should probably would've rechecked

my old podcast before I, I came on.

622

But, the, um, inflation, uh,

so something like a breakeven.

623

While, while it should respond

and it responds to a certain type

624

of inflation shock over a certain

timeframe, which is not necessarily

625

what you're, you're always worried

about, probably has a negative expected

626

return over time, though, as a trade.

627

And, so if you think about the things

that, like that you mentioned where

628

you go, I, I want to have a positive

expected return because I want it

629

to contribute to my total portfolio.

630

And, and yeah.

631

Like it's gonna be spiky

at the right times.

632

And then how do you build something that's

inflation sensitive that has more of a

633

smooth, positive return over time while

still covering your inflation shocks?

634

And that was the big, I think, you

know, sort of effort in saying,

635

first of all, when we, when we built

our inflation sensitive asset class

636

against all sorts of pressure to

say like, why, why would we bother?

637

The answer is because it's

a risk and it could happen.

638

And, and so.

639

Whether or not you think it's

gonna happen, let's call that

640

your alpha on this whole thing.

641

But, but, you know, portfolio construction

at the, at the portfolio level is just,

642

I want to build things that are resilient

to a variety of outcomes, regardless

643

of who thinks what's gonna happen.

644

I call that like a data

portfolio construction.

645

And, and even then you

say, what's inflation?

646

And, and, and everyone's got a different

definition of inflation, right?

647

An economist might say it's a CPI

or, you know, wage inflation, or they

648

might say it's monetary inflation.

649

A lot of 'em will say it's

monetary inflation is the

650

correct definition of inflation.

651

you know, it, it obviously, as we saw

in the seventies and, you know, the

652

late sixties or even early eighties,

inflation can be driven by commodities.

653

Um, and it's, so I call

a supply side inflation.

654

And, and if the price of commodities like

go up by four times, well yes, that's

655

going to be massively inflationary.

656

If it's persistent and

it's across the set.

657

and so for each of those different

definitions of inflation, you

658

actually have different basket

of assets to, to handle them.

659

And so for monetary inflation,

like what, what's your, what's

660

your best defense guess?

661

Monetary inflation.

662

I don't know.

663

There's like, there's a variety

of things you can think about

664

from real assets to gold.

665

Uh, you know, if it's, if it's,

if you're looking purely at a

666

definition of something like CPI,

then maybe a real return bond or, or

667

a breakeven is a better focus on that.

668

If you're looking at like a source

of inflation from the energy side or

669

from the ags or from commodities in

general, then obviously commodities

670

are the best source of that.

671

You know, we built a, a very broad

basket inflation-sensitive set of assets

672

because we thought inflation can be,

there's lots of different definitions,

673

there's lots of different, causes, but

that the reason you care about inflation

674

and the reason you need this, this asset

class is because in general inflationary

675

shocks have a deleterious effect on most

of the other assets in your portfolio.

676

And so there's gonna be times

when your other assets get hit,

677

especially your bonds get hit

by inflationary, like unexpected

678

inflation, but so do your businesses.

679

And so, you know, if you think of your.

680

Your equity in your businesses and your,

you know, are, are, are generally exposed.

681

You need something to protect you.

682

And then the real question is, well,

how do you build something that

683

protects as well as possible, but

still has a positive drift to it?

684

And so that's where like, that's where

we kind of built a quant program or a

685

systematic program that does that, right?

686

And you can start to think about if I

got these, like, what am I trying to do?

687

Is I'm, I'm trying to cover

inflation, but I'm also trying

688

to get the positive risk premiums

and drifts in the commodity space.

689

Well then you gotta get, you

gotta dig a, dig a bit deeper than

690

just going along a couple things.

691

And that once again, requires a

bit more expertise, a bit more

692

specialization, and a bit more

leverage and a bit more like effort.

693

But ultimately I think something

like that can be really, really

694

helpful for a lot of investors.

695

Adam Butler: Yeah.

696

I mean, before we

697

Chris Schindler: to, once again, like

if, if, if you thought your bathtub

698

was just stocks and bonds Yeah.

699

You're, you're gonna get,

like, you're gonna get exposed.

700

the, the risk parity world is really

like, it's that statement of like, if

701

this just money sloshing around, then if

somehow you could own a bit of everything.

702

Uh, then in that world

maybe you're kind of okay.

703

Um, but then, then that goes

like, well, that's great.

704

Money's sloshing around.

705

And, and, and every single

investor's wants to get that alpha.

706

Like, I want to time that I want to

add value by getting in front of that

707

sloshing or avoiding the sloshing or,

you know, and of course that's what all

708

active and macro and everything is, is

trying to time the flows of money around.

709

And it's like, yeah, stocks

and bonds and commodities.

710

If you got that, if, if somehow

that flows your entire path, that's

711

great, but I'd still like to capture

some of that energy between them.

712

And, and that's where, you know,

I think a lot of the fun is.

713

Adam Butler: so speaking of Alpha and

trying to generate it, we spent a lot

714

of time, you know, debating where the

greater, if inefficiencies are right and

715

the more sustainable inefficiencies are.

716

And we chatted a little bit

about Samuelson's dictum on

717

this program, a few times.

718

And, you know, whether there's a,

a greater opportunity to generate

719

alpha through security selection

or in, in the macrospace, just in

720

terms of hedging inflation risk.

721

Like I.

722

Do you think it's, it's conceivable to

be able to manage inflation risk through

723

more effective security selection?

724

Like, can you just select a diverse

basket of equities and or credits that

725

make you more or less resilient to

inflation and you don't need to have

726

that third leg of the macro stool?

727

Chris Schindler: huh.

728

That's interesting.

729

Um, so Samuelson's dictum, that's

the microefficient macro inefficient.

730

Adam Butler: yeah, yeah.

731

Chris Schindler: I mean that's a, that's

an interesting statement and I think

732

it's one of those things that, um.

733

You know, I, I lemme just like quickly

sort of say about inflation, I would,

734

I would kind of think of, uh, what you

just said there is like, if I stock

735

pick correctly, can I, can I create,

like can I, can I cover inflation

736

from credit and stocks as opposed

to having to go into commodities?

737

Like Yeah, I mean there's probably

some inflation sensitive equities

738

and, and, and I think, you know,

you, you could probably find things

739

that have some inflation sensitivity.

740

you know, is that, is that going, is

that something you would add to your

741

basket of inflation sensitive assets?

742

Yeah, probably.

743

I think you have to be careful and

this is, um, you know, this is just an

744

alpha beta separation statement, but

you go, like, if, if you think of like

745

portfolio construction as I'm gonna try

and build my portfolio and, and I think

746

of past and we've had this conversation

before, like what's passive, like

747

nothing's truly passive, you know, and,

and what's beta and, and my definition

748

of beta like goes all over the place.

749

But if you say one definition

of it is like it's gonna do

750

what it's gonna do regardless

of what anyone expects it to do.

751

And, and so if you put money in it, it

doesn't matter what you think this is

752

gonna do once, if you just, if you just

leave it, it will, it does what it does.

753

Um, that definition of, beta,

well, if you go, I'm gonna put my

754

betas together to try and create

the best beta portfolio possible.

755

There's obviously some active decisions

there, but let's say there's like,

756

you know, a not as much timing,

then you need pieces that interact

757

with each other in a nice way.

758

And, and if you're leaning on your ability

to see the future and, and stock pick

759

correctly to cover your inflation risk,

that's, that's a little bit different.

760

That's, that's, that's like saying

like, if I could see the future properly

761

and I can call winners and losers,

then I don't have this risk because

762

I'm, because I can see the future.

763

And it's like, well, maybe

you do, maybe you don't.

764

But that's active management and

you're now relying on active management

765

to cover your inflation risk.

766

And I would say you, you

should do that as well.

767

But when I think about how pieces of

my portfolio interact and portfolio

768

construction the way, and this is how we

sold it to our board, and I think it's a

769

really interesting thought process when

you talk about your, portfolio, your beta.

770

And we said, what's the portfolio

you wanna have in 10 years from now?

771

It's like, not over the next 10 years.

772

Like in 10 years, if you had to

build a portfolio and say, 10 years

773

from now, this is the portfolio

I want, what would it look like?

774

And the key part of that statement

is you have no idea what the

775

world's gonna look like in 10 years.

776

You have no idea if you're gonna

like stocks more than bonds, if

777

you're gonna like commodities.

778

If you're gonna, you have no active, you

have no possible active view in 10 years.

779

And so that's the, and so think

of that as your definition of

780

passive, as your definition of beta.

781

Build the best portfolio you can that

you'd be happy having in 10 years.

782

And then think of active as everything

that you do between now and then.

783

So like I'll have a view over the next

month or the next two months, or the next

784

five years and start to layer on that.

785

But your center point, your starting

point should be that thing that, that,

786

that is the most, Unaffected by your

view of the future, because your view

787

of the future make it, make those

bets and, and, and decide how much

788

risk to put in that bet based on how

much, how confident you are in your

789

ability to see the future and do that.

790

But, but just understand that,

that you could be wrong and you

791

might not see the future right.

792

And you might not have that ability.

793

You might not be as good

as you think you are.

794

You might be better than you

think you are, who knows?

795

But, but, separate those two pieces

out and build the best beta you

796

can and that needs assets that

interact well together regardless

797

of your ability to call the future.

798

And then, and then if you want to

try and add value through active

799

management, absolutely do that.

800

And if you think part of that value

is alpha and part of it is inflation

801

protection, however you wanna

define that, for sure, go for it.

802

Size it, right?

803

But separate those decisions there.

804

Mike Philbrick: And the, the nice side

effect there, Chris, the way you explain

805

that is now you also have something

to measure your active bets against.

806

You have this, un, let's call it unbiased,

do no harm allocation of beta assets.

807

That you will have today and have in

10 years, and you're gonna make active

808

bets, you know, against that, or add

additional diversification to that.

809

And now you can actually measure whether

your steps were in fact a creative

810

or were they Dilutive to the actual

long-term returns of your portfolio?

811

Chris Schindler: percent.

812

And, and, and, and you're exactly right.

813

And that was a huge part of the push

for creating that, we call it the

814

theoretically optimal portfolio.

815

And, and you never quite get to it because

you have constraints and you have, and

816

you're not ever 10 years in the future.

817

You have, you know, and you have

a starting point and you're trying

818

to move from there to something.

819

There's, there's a lot to that.

820

But that's, if that's your center

point, that, then you can measure your

821

distance from that and you can start

to justify your distance from that.

822

And, and that starts to really be your

act, your set of active decisions.

823

You have to start justifying why

you are no longer what, what and why

824

you're not going in that direction

or why you're leaning against that.

825

And, and, start to think about how much

active risk you're taking in, in those

826

active decisions relative to that data.

827

It's a really, really helpful starting

point and it's a much, at least from

828

my opinion, 'cause this is what we

kind of, you know, put in place.

829

It's a much better benchmark portfolio

than almost anything else you can define.

830

Like, this is, like, we talked at

the beginning about the challenge of

831

benchmarks and if you're, if you have

your, your CIOs responsible for, for

832

investing at the total fund level and you

give them a benchmark that's 60 40, then

833

it's gonna be really hard for them to be

anything that's like too far off of 60 40

834

because you've made that their benchmark.

835

And now that their definition of

risk is tracking error to a 60 40.

836

And if you say your benchmark is the

median manager or the median pension

837

plan or the median, anything that's

gonna look a lot like a 60 40 or an

838

80 20 or it's gonna, you know, at

the end of the day, they, once again,

839

they're centered around something.

840

That isn't necessarily the,

the, the right starting point.

841

And you go, how do we ever move off

of that paradigm and how do we move to

842

something better if you're always getting

benchmarked back to that paradigm?

843

And, but then the question inherently

comes, well then what's, what do

844

you want your benchmark to be?

845

and that becomes a, a really

tricky question, but you say

846

like, look, this is a good center

point to start thinking about.

847

And, and, and you have to be

careful that it's, that it's not

848

too pie in the sky theoretical.

849

Like if you, it can't assume that you

can do certain things that you, you

850

can't, in reality, like, like a leverage

requirements or, you know, assets,

851

there's not enough real return bonds on

the planet to do what you want to do.

852

It's like, well, that's

not a fair benchmark.

853

So it has to be like, you know, it has

to move back to reality a little bit,

854

but like, as a, benchmark construct that,

that you sort of say like, I can measure.

855

And, and, and, and I guess the

one other way you can think about

856

benchmarking yourself, and this is

like also super weird, but we also

857

put in place a little bit, was.

858

Benchmark each year to

the start of that year.

859

So, 'cause I'm just trying to break the,

compare myself to the rest of the world

860

or do what the rest of the world's doing.

861

And now you can say, if I'd held the

portfolio that I started with for the

862

entire year versus what I actually

did, I could not measure my changes to

863

some arbitrary starting point, which

is just as arbitrary as anything else.

864

But I can start to like, once again, focus

in my alpha without contagioning it with

865

someone else's definition of alpha, which

is in their starting portfolio, which

866

is, which becomes my beta unfortunately.

867

And I, I don't want my beta to be

someone else's alpha as my starting

868

point because, because that really

messes up the whole decision,

869

Mike Philbrick: N nothing, nothing more

dangerous than having a false premise to

870

start the whole discussion of, oh, 60 40s

your benchmark and beat the media manager,

871

and that that premise just contaminates

every other decision down the track,

872

Chris Schindler: Yeah, absolutely.

873

And so portfolio construction at the

total fund level is, it's hard enough

874

as it is, but, understanding the, oh

Everything is affected by your benchmarks.

875

Like everything.

876

And, and so trying to break the paradigm

of, or like the worst thing if you're a

877

CIO is some other team that's not you.

878

Like a risk group creates your benchmark

and now you're like, well, who's the CIO?

879

Because the most important set of

decisions, the asset allocation,

880

maybe even the amount of risk you're

taking have been, ab like have been

881

taken over by a different group.

882

And, and, and now you're just

a, like a long short TAA around

883

someone else's starting benchmark.

884

And like, I believe the CIO should

own the total portfolio, should

885

own every major important decision.

886

And so, and, and you can really

see, the challenges of that.

887

But at the same time, you're a

board member, you go, oh, like what

888

are you completely unconstrained?

889

And so then you can start to define,

well here's a, here's an alternative

890

benchmark, or here's the definition

of risk, which is how much movement

891

from where we are comfortable

here to, to the end of the year.

892

Like, and, and, and we were just trying to

come up with alternative benchmarks that.

893

gave you the flexibility you needed to do

the right things without giving you too

894

much flexibility to, to cause unmitigated

895

Mike Philbrick: do the wrong things.

896

Chris Schindler: So,

897

Mike Philbrick: The CIO's dilemma is

just getting more and more, uh, complex

898

and uh,

899

Chris Schindler: it, absolutely is.

900

That was a, that was a big part

of the challenge was, was breaking

901

that, breaking that benchmark.

902

Adam Butler: Yeah.

903

Another irony is that the fact

that everybody is benchmarked to

904

something is the, you know, a big

reason why a lot of alternative

905

sources of return exist, right?

906

Like, you know, if, the true definition

of risk is tracking error and not

907

the deviations and the value of the

overall portfolio, then that is going

908

to drive behavior that is aligned with

minimizing tracking error, not aligned

909

with minimizing total wealth variance

and that produces the opportunities that

910

alternative managers, many alternative

managers use to generate their returns.

911

So, you know, you don't, you don't want

everybody to become enlightened and,

912

and abandon their benchmarks because

then it has the potential to, to kill

913

the goose that that lays the golden

eggs for many alternative managers.

914

Mike Philbrick: But,

915

Chris Schindler: Yeah,

I wouldn't say it's it.

916

Yeah, you're absolutely right.

917

It's, it's definitely one of the sources.

918

It's, it's probably not the only one,

like benchmarking, but it's definitely

919

one where, and you could kind of like

just argue, you know, as, I guess we

920

have in the past that it all comes

down to anti-crowdedness, right?

921

Like, it comes down to when you have a

bunch of people following some set of

922

rules or some process or some benchmark.

923

Whenever, whenever too many people crowd

into, into any particular area, the prices

924

get bid up and, you know, if the cash

flows aren't affected by that crowdedness

925

'cause why would they be, you know,

the, the, the prices get bid up and the

926

cash flows the same and returns fall.

927

Like crowdedness is always gonna

result in, in, lower Sharpe ratio.

928

Because at the same time is that, you

know, the returns fall, the risk goes

929

up because the possibility of that

crowd all trying to lead together at the

930

same time becomes significant as well.

931

So crowdedness of which benchmark

hugging is a major one, uh, is a

932

significant source of potential

alpha if you can, if you can avoid or

933

take advantage of that crowdedness.

934

so all of that to say, you know, if we,

if we backtrack and went, inflation and

935

we can come at it from the alpha side,

we can come at it from the stop making

936

side and, and whether or not, I know you

kind of started with inflation or, or you

937

even sort of went back and said, look,

are we, are we micro or macro efficient?

938

I don't know.

939

Like these, these are, these are

interesting questions because like in

940

one sense it really does look like,

we have massive examples where we've

941

been incredibly macro and efficient

over the last 20, twenty-five

942

years to the point of so obvious in

hindsight, and maybe for many people,

943

super obvious at the time as well.

944

and so, so you might argue them for

microefficiency and, and like, and I

945

guess microefficiency, it's got one other

thing going for it, which is like, as

946

human beings, if you think about it for

a second, like everything that we, like

947

all of our senses are, are really good at

relative, but terrible at absolute right?

948

Like, like I go, like, if, if you

asked me what stars brighter in the

949

sky, I could say That one's brighter.

950

But you know, or what's bigger,

you know, or what sound is louder.

951

I can, I can do relative really well.

952

And that's what our

senses are built to do.

953

We're terrible at absolute.

954

I could not give you like any sense

of it, how bright that that is.

955

And in fact, even our relative senses

are like log scale and you know,

956

like what seems like twice as loud

to us might actually be 10 times.

957

Adam Butler: Mm-Hmm.

958

Chris Schindler: More decibels and

the same thing with brightness.

959

And, so like, so we're quite

good at saying A versus B.

960

And so if you think of like micro

as a whole series of like, you got

961

specialists focusing on a small number

of stocks and you're stock picking

962

and you're going a whole series of A

versus B and doing some sort of ordinal

963

rank, that's probably what we're most

comfortable doing as humans, right?

964

And, and so we probably are very

confident in our ability to do that.

965

And we probably are quite good at

orderly ranking things, but then you,

966

I guess, like you got a bunch of things

that might even be ranked correctly,

967

but when the whole picture, the

absolute piece can just be miles off.

968

And I think as humans we're probably

no good at the absolute piece or, and,

969

and so without something to anchor

that absolute two, it, it probably

970

can go off, in extreme distances.

971

Adam Butler: Well, here, here,

here's, we sort of came at it, right?

972

We came at it from the

perspective of, two dimensions.

973

One is, portfolio agility, right?

974

the big players out there.

975

just don't have much ability to take

major bets, take major tracking error

976

against their policy portfolio, right?

977

Like taking major, equity overweight

versus target or major credit overweight

978

or duration overweight versus target

carries a lot of risk, whereas taking,

979

you know, maybe there's more tolerance

for risk within the, you know, individual

980

asset classes, And then there's just

the agility, like you're, you're

981

swinging these massive portfolios

around, you just don't have the, the

982

ability to move quickly enough to take

advantage of, of many of the macro

983

or micro inefficiencies that exist.

984

Right?

985

So, sort of taking a down one

level, I would argue kind of 99%

986

of all cognitive and computational

energy focused on investing.

987

Is within the individual silos, right?

988

So you've

989

got the equity group and

you've got the credit group.

990

You've got the, the

991

rates group, you got the

992

Chris Schindler: There's no way

the equity group can tell you

993

equities versus a commodity.

994

Like, it just doesn't, the

question makes no sense.

995

And so there, you know, I think

there's, there's probably another thing

996

that, that leads to microefficiency

as well is the stat art players like,

997

the ability to build a long, short

basket in ARB that is infinitely more

998

powerful than the one sided ARB of just

trying to sell something you think is

999

expensive or buy something you think

00:49:05,101 --> 00:49:05,391

Adam Butler: yeah.

00:49:05,551 --> 00:49:08,056

'cause you can hedge the beta

within the security space, right?

00:49:08,056 --> 00:49:10,756

But there's nothing to, there's,

nothing to hedge against directly in the

00:49:10,881 --> 00:49:12,256

Chris Schindler: and a, it's much slower.

00:49:12,256 --> 00:49:15,226

It's much lower breath,

it's a much riskier bet.

00:49:15,256 --> 00:49:18,646

It's one of those things that you, you

have to trust that a bunch of other people

00:49:18,646 --> 00:49:22,186

are gonna come in alongside with you

over time for it to work on your behalf.

00:49:22,651 --> 00:49:25,831

Whereas like in a Stata player, you

can, like, you can almost do it yourself

00:49:26,101 --> 00:49:29,881

if you know, so, and it's got a, it's

a very, very different risk profile.

00:49:30,137 --> 00:49:33,677

so I think like there's a lot of reasons

why you could think of micro-efficient.

00:49:33,857 --> 00:49:36,527

I can also say like, the last three or

four years, like the micro-efficiency

00:49:36,527 --> 00:49:39,504

argument seems to have like, you

know, if you get too many people,

00:49:39,894 --> 00:49:42,654

uh, you know, you've had a lot

of craziness, uh, uh, intraday.

00:49:42,654 --> 00:49:45,774

I mean, like, think about, I think much

of the market's changed in the last

00:49:45,774 --> 00:49:49,374

two or three years with, you know, we

were talking about the, the retail,

00:49:49,374 --> 00:49:52,584

like player just coming and doing

some crazy, you know, meme stocks.

00:49:52,584 --> 00:49:55,134

But you also have like, like what's

happened the last three years.

00:49:55,134 --> 00:49:58,374

It's like, I don't, I don't know how

many day traders are still playing with

00:49:58,374 --> 00:50:01,314

cash equities versus the ones that are

just playing with like, like massive,

00:50:01,344 --> 00:50:02,994

massive size of one day options.

00:50:03,534 --> 00:50:07,104

And the the ability for a small player

or a small set of players to come in and.

00:50:07,507 --> 00:50:11,767

significantly move the

market is, is changed a lot.

00:50:11,772 --> 00:50:14,722

And, and like these, I I don't know why

these things are like, it blows my mind

00:50:14,722 --> 00:50:17,242

that these, these are legal because

it just, it feels like if someone came

00:50:17,242 --> 00:50:19,822

in and fat fingered the market to the

size of the amount of manipulation,

00:50:20,092 --> 00:50:23,092

that's a market manipulation because

you just hammered the market that hard.

00:50:23,097 --> 00:50:26,392

But if you went to 10 dealers and you

bought, you know, enough of these things

00:50:27,052 --> 00:50:30,442

and then, and then just nudge it, then

suddenly you've got a whole bunch of other

00:50:30,442 --> 00:50:34,429

people buying aggressively on your behalf,

bracing each other and, potentially

00:50:34,429 --> 00:50:37,566

slamming way more into the market than,

you would ever do as an individual.

00:50:37,571 --> 00:50:41,329

And, and you've, just, you've given

like this incredible weapon to, to

00:50:41,329 --> 00:50:44,542

a small number of players and it's

been really disruptive at the micro

00:50:44,572 --> 00:50:47,162

and at the macro level, uh, you know,

over the last two to three years.

00:50:47,162 --> 00:50:49,922

And so you can really see like,

I mean that's changed a lot.

00:50:50,264 --> 00:50:50,354

Adam Butler: Yeah.

00:50:50,354 --> 00:50:52,904

I mean, you could, you could almost

corner the gamma market the way you

00:50:52,904 --> 00:50:55,634

could, you could, you could corner

the silver market back in the.

00:50:55,716 --> 00:50:56,916

In the eighties, you

00:50:57,081 --> 00:50:58,071

Chris Schindler: Oh, you absolutely have.

00:50:58,071 --> 00:51:01,274

I mean, and, and like, I mean the

the whole I mean, vol is, is such an

00:51:01,274 --> 00:51:04,394

interesting asset class, but it's changed

so much in the last three or four years.

00:51:04,737 --> 00:51:08,554

you know, you've got dealers now who are,

who are stuck, you know, short calls, like

00:51:08,554 --> 00:51:10,144

massively like in the market right now.

00:51:10,144 --> 00:51:13,327

And, and so, and the same way as,

you know, like when, when you still

00:51:13,327 --> 00:51:16,867

think about the and this is, I think

fundamentally, and I think big pension

00:51:16,867 --> 00:51:17,827

plans kind of get this wrong too.

00:51:17,827 --> 00:51:21,127

And they go like, I'm being very, I'm

being a good, I'm being a good player.

00:51:21,127 --> 00:51:24,667

When I, when I, buy a big put because

I, you know, like if the market crashes,

00:51:24,667 --> 00:51:25,897

I make this money on the other side.

00:51:26,107 --> 00:51:29,151

And what you don't realize is

an option is not really a thing.

00:51:29,317 --> 00:51:30,907

you know, you buy equity,

you bought a thing and you

00:51:30,907 --> 00:51:31,777

kind of know what you've got.

00:51:31,777 --> 00:51:35,137

But an option is kind of a

promise by someone else to

00:51:35,137 --> 00:51:36,427

buy and sell on your behalf.

00:51:37,027 --> 00:51:39,127

Because when you buy an

option with a dealer.

00:51:39,457 --> 00:51:42,391

You know, they have to delta hedge

it and so on the other side of that

00:51:42,391 --> 00:51:45,211

trade, if you're, if, if the dealer's

on the wrong side market starts to

00:51:45,211 --> 00:51:49,141

rise and they have to buy to cover

that, that, you know, the deltas that

00:51:49,141 --> 00:51:52,741

runs away from them, they become a

massive accelerant into the market.

00:51:52,746 --> 00:51:54,241

And same thing on the put side.

00:51:54,241 --> 00:51:56,701

And so if the dealers get stuck on the

wrong side of that trade, which they

00:51:56,701 --> 00:51:59,221

do all the time now, like this is,

like, this has been the last three or

00:51:59,221 --> 00:52:00,301

four years, this has been the story.

00:52:00,701 --> 00:52:04,031

it, it's just, it's just quite an

incredible, force in the short term.

00:52:04,031 --> 00:52:07,931

And it can be an incredible short, and so,

so you can, you can really like see a lot

00:52:07,936 --> 00:52:11,291

of market movement when the dealers are on

the wrong side of their gamma exposures.

00:52:11,524 --> 00:52:14,134

now they, they've started to reprice

it and they started to figure it out.

00:52:14,134 --> 00:52:17,224

But, but it's, it's been a real change

in the market because, I mean, for

00:52:17,224 --> 00:52:21,304

the longest time ever it was, you

know, it was priced by puts and, and

00:52:21,309 --> 00:52:24,964

you know, as such there was this like

strong negative correlation between

00:52:25,024 --> 00:52:28,321

the VIX and the S&P and p and like

that has gone positive at times.

00:52:28,321 --> 00:52:31,417

And, and, and, and the whole

relationship between, you know,

00:52:31,417 --> 00:52:33,457

vol and market moves is growing.

00:52:34,042 --> 00:52:35,962

And, and these one-day

options are super interesting.

00:52:36,142 --> 00:52:39,952

Uh, they really transform things, but like

I, I would say that they're taking a ton

00:52:39,952 --> 00:52:42,262

away from Microefficiency as we speak.

00:52:42,262 --> 00:52:45,082

um, you see how the stat-art guns

are able to pull that together?

00:52:45,864 --> 00:52:47,994

Adam Butler: So, Sorry,

Mike, you had looked like you

00:52:48,044 --> 00:52:50,169

Mike Philbrick: Oh, I, I think you're

gonna transition, just like I was

00:52:50,169 --> 00:52:52,959

thinking, the same thing you've got

if you're transitioning to sort of

00:52:52,959 --> 00:52:55,209

strategies and changes in the market

00:52:55,284 --> 00:52:58,224

Adam Butler: Yeah, well, I wanted to talk

more broadly about diversification, right?

00:52:58,224 --> 00:53:01,344

Like, we, we've done a lot of

that on, on previous episodes.

00:53:01,344 --> 00:53:02,994

I, I wanted to really round it out, right?

00:53:02,994 --> 00:53:08,291

So, once you sort of, we talk about

stocks, bonds, and inflation, hedge

00:53:08,291 --> 00:53:13,804

assets, I, I'd love for you to kinda

rank for me, right, like, what are, what

00:53:13,804 --> 00:53:18,829

are some of the other alternative betas

or, premia or whatever that, and I know

00:53:18,829 --> 00:53:20,449

it's always a co a continuum, right?

00:53:20,454 --> 00:53:24,369

From, beta alpha and, you know, you've

already talked about that a little bit.

00:53:24,369 --> 00:53:29,589

But, but how would you kind of rank, where

would you wanna start as you're adding.

00:53:29,802 --> 00:53:33,882

You know, completely different flavors

to the portfolio in terms of what

00:53:33,882 --> 00:53:36,102

big players can actually allocate to.

00:53:36,339 --> 00:53:39,759

you know, with the actual dollar

size of these premia are large enough

00:53:39,759 --> 00:53:43,539

for a sufficient number of players

to actually be able to participate.

00:53:43,809 --> 00:53:46,749

Like how would you think about,

adding to the diversification

00:53:46,749 --> 00:53:48,069

of the portfolio in what order?

00:53:48,069 --> 00:53:49,539

If you could, if you could rank

00:53:49,559 --> 00:53:49,779

Chris Schindler: Huh.

00:53:50,521 --> 00:53:51,391

so I guess there's a couple.

00:53:51,511 --> 00:53:55,411

So, so first of all, there's the, there's

the diversification into assets and

00:53:55,411 --> 00:53:57,271

there's diversification into strategies.

00:53:57,271 --> 00:54:00,234

And even then I would say that

inflation-sensitive, it kind of has to

00:54:00,234 --> 00:54:02,214

be in between an asset and the strategy.

00:54:02,214 --> 00:54:05,154

I think if you, I think like what you

described as if it was just assets,

00:54:05,154 --> 00:54:07,614

then it doesn't do what you needed to

do and people aren't gonna stick with it

00:54:07,614 --> 00:54:11,574

because it's, yeah, it'll spike, but we're

talking like once every 10 years or so.

00:54:11,574 --> 00:54:13,584

You need it and then you look

like a loser for nine years.

00:54:13,584 --> 00:54:16,069

But if you can get strategies that,

that, that actually make money over

00:54:16,069 --> 00:54:18,499

time and give you that protection,

you're miles ahead just 'cause

00:54:18,499 --> 00:54:19,609

there's so much easier to stick with.

00:54:19,609 --> 00:54:19,789

And.

00:54:19,994 --> 00:54:25,887

And so, the alternative assets to stocks

and bonds are obviously, you know,

00:54:25,887 --> 00:54:27,537

credit and, and then the privates.

00:54:27,537 --> 00:54:29,727

And, and we, and that's a

totally separate discussion.

00:54:30,357 --> 00:54:31,797

Adam Butler: But are

they alternative assets?

00:54:31,797 --> 00:54:32,847

Like do we even need to go there?

00:54:32,847 --> 00:54:38,277

Like credit's, you know, credits short

ball at your, it's capital structure?

00:54:38,277 --> 00:54:39,091

Like, I don't know.

00:54:39,091 --> 00:54:39,781

I've argued on.

00:54:40,376 --> 00:54:45,236

Many, many podcasts and in, in

many papers that credits not

00:54:45,236 --> 00:54:46,616

even really its own asset class.

00:54:46,646 --> 00:54:48,656

And is private equity any

different than equity?

00:54:49,721 --> 00:54:52,721

Chris Schindler: so I, uh, I've also

made the exact same argument with credit.

00:54:52,751 --> 00:54:56,501

I mean, we, when we first tried to look

at bringing it in as an asset class

00:54:56,501 --> 00:54:59,831

at the portfolio level, like once you

cover, it's got an equity risk, it's

00:54:59,831 --> 00:55:02,321

got a fixed income risk, it's got a

credit risk, and it's got a shortfall

00:55:02,326 --> 00:55:03,551

piece, it's got the illiquidity.

00:55:03,791 --> 00:55:07,601

And once you take those pieces out of

it, like as an asset class, it doesn't

00:55:07,601 --> 00:55:08,861

bring anything to your portfolio.

00:55:09,101 --> 00:55:12,131

But it's actually a very cool asset

class in its own because it's this.

00:55:12,476 --> 00:55:14,696

It's not exactly risk parity,

but it's a nice mixture of

00:55:14,906 --> 00:55:16,106

four different risk premiums.

00:55:16,106 --> 00:55:17,336

So it looks pretty good on its own.

00:55:17,666 --> 00:55:21,056

It just doesn't bring as much as people

think it does to a, to a total portfolio.

00:55:21,296 --> 00:55:24,656

But it's a, but it's a really

big universe for value add.

00:55:25,226 --> 00:55:27,956

And so there's a, there's a lot of room

for value add within credit, and I think

00:55:27,961 --> 00:55:30,116

there's a, there's a lot of, so, so is

00:55:30,181 --> 00:55:32,396

Adam Butler: I think, you know, the,

the opportunity is to, is take a

00:55:32,396 --> 00:55:33,836

little away from the equity, right?

00:55:33,836 --> 00:55:35,096

And, and add a little bit to credit.

00:55:35,096 --> 00:55:36,956

Acknowledging the credit

gives you some of that equity

00:55:37,286 --> 00:55:38,156

Chris Schindler: I mean, from a factor.

00:55:38,161 --> 00:55:40,526

So this is, this was like, you know,

this is once again going back to the

00:55:40,526 --> 00:55:43,316

work we're doing at teachers, at the

portfolio level, but like from a, we tried

00:55:43,316 --> 00:55:46,196

to get things into a factor perspective,

and once you transform into a factor

00:55:46,201 --> 00:55:50,512

perspective, you go, like if your factors

are either call it growth and inflation,

00:55:50,512 --> 00:55:54,406

you can call it stocks and bonds and,

and some short ball and some illiquidity,

00:55:54,706 --> 00:55:57,529

then you've mostly just defined credit.

00:55:57,859 --> 00:56:00,619

you know, you've also come pretty

close to defining most of the factors

00:56:00,619 --> 00:56:01,849

that are in your privates as well.

00:56:01,954 --> 00:56:04,302

and so, you know, when it comes down to.

00:56:05,374 --> 00:56:07,024

A little bit of a timeframe.

00:56:07,264 --> 00:56:10,474

Uh, you know, privates are,

like they are diversified.

00:56:10,474 --> 00:56:13,504

Like they literally, like, they're

definitely diversifying in the short term.

00:56:13,504 --> 00:56:18,051

So if you look at your one year, uh, you

know, model privates, they look, they look

00:56:18,051 --> 00:56:21,741

really uncorrelated because they're lagged

and because they're smooth and the smooth

00:56:21,741 --> 00:56:23,451

means you get to make up their valuations.

00:56:23,456 --> 00:56:27,474

And, and in some cases you really just

make up the valuations and they're

00:56:27,474 --> 00:56:28,824

lagged because it doesn't matter.

00:56:28,974 --> 00:56:30,534

They, they're not in real time anyway.

00:56:31,074 --> 00:56:34,427

And so, you know, those two

effects are incredibly helpful

00:56:34,432 --> 00:56:36,084

for CIO in the short term.

00:56:36,301 --> 00:56:39,961

They're probably not that useful

for a sponsor in the long term.

00:56:40,321 --> 00:56:43,591

And so that's a, that's, I call it like a

classic agent management mismatch because

00:56:43,591 --> 00:56:45,751

the CIO gets paid on return on risk.

00:56:45,751 --> 00:56:48,991

And, you know, anything that cuts risk

that significantly and recently is

00:56:48,996 --> 00:56:50,941

doing boosting returns is super helpful.

00:56:51,157 --> 00:56:54,067

but it's not necessarily really accretive

to the portfolio in the long term.