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You're about to join Niels Kaastrup-Larsen on a raw and honest

journey into the world of systematic investing and learn about

the most dependable and consistent yet often overlooked investment

strategy. Welcome to the Systematic Investor Series.

Welcome and welcome back to this week's edition of the Systematic

Investor series with Graham Robertson and I, Niels Kaastrup-Larsen,

where each week we take the pulse of the global market through

the lens of a rules-based investor.

Graham,it is wonderful

to be back with you this week. How are you doing?

Very well, Niels. Great to be back. Yeah, I had a couple of busy

weeks traveling around, talking to lots of clients about

trend and outlooks. Hopefully something we'll be discussing in

a bit more detail today.

Yes, absolutely.

Itseems like, because I've been on the road

as well for quite a few weeks by now, it seems like we're certainly

in the busy travel season, which actually does lead to some

interesting observation about what our prospects and clients are

thinking about.

Andspeaking about thinking about, Graham, I’d

love to start with this question, which has nothing to do

with really the topics we're going to talk about because I think

we have a great lineup of topics that we're going to be tackling.

But I would love to hear, sort of from maybe your own personal point

of view, what's been on your radar the last few weeks?

Well, I guess it's hard to pass up what's going on geopolitically,

particularly what's going on in, in Ukraine and Russia and the

dynamics of the new president. And all that is happening, and I'm

sure we'll cover that and its implications for markets.

WhatI

found particularly fascinating is just how engaged people have become,

particularly, you know, my kids, for example. My kids are 20

or late teens, early 20s. And everybody's engaged, everybody's

interested. And I think that's a healthy thing. You know, it, it

may not be… It's controversial. What is happening

in the world is interesting. Things are happening. The new president

in the US is going about things in different ways and people

are looking at it and discussing it and I think that's

a good thing.

Yeah, I couldn't agree more.

Itwas also the thing that I had

put on my little radar was just the fact that the world is changing

in front of our eyes and it's changing a lot every single day.

I also have kids in their early 20s, both studying in Copenhagen.

And when you mentioned that, what it made me think about is kind

of two things.

Oneis that I'm kind of curious to know if they're

old enough to know the difference, if you know what I mean,

because they kind of grew up in a period where, I feel personally,

a lot of the changes in the way things work, not necessarily

relating to the new administration, but just things have

changed is really in the last couple of decades. I mean, after

the great financial crisis, both politically and so on, and so

forth, we don't need to go into all the details about that.

So, I was kind of thinking, do they really know the difference?

Do they understand the gravity of the change we're seeing in front

of our eyes?

Andthen the other thing I thought of and love

to hear your view on this, and that is, are we scaring them, so

to speak, are we making them...? I mean, because the youth

has been through a tough time with COVID, in many respects. Certainly,

in Denmark, where I follow the news flow probably a little bit closer

still, there's a lot of attention on sort of emotional health

and so on and so forth, especially among the young people.

AndI was just wondering whether this news flow coming out,

and certainly Denmark is very. The whole discussion about Greenland

and all those things, there are a lot of things going on where

let's say the noise is coming from the political scene is worrisome,

let's put it that way. So, I was just wondering, actually, how

they may be affected by all of this. I don't know if there's an

answer to it, but is that something you're concerned about,

your kids being worried about what's going on?

I think they should be worried about it. But the key thing to me

is that they're engaged, you know, it's not just passing them

by. And that to me is fundamentally important and good.

Whatelse I've found interesting is the way that this

information is now disseminated. It came up on a number

of occasions recently where historically you might look at some

interview of a politician where you'd get the message in whatever

way was being portrayed according to the party line. But

these days, it seems to me that the information is coming through

the medium of podcast.

Lookat the way, in the lead up to the elections,

that it was the podcast, it was the bros that were the medium,

and that really got across. And what's interesting there is that

the message is unfiltered, it's less disguised, it's less kind

of roll your eyes at what the politician is saying over, and over,

and over again. And I think that it's probably a good thing too.

We're getting to hear what people really think.

Yeah, that's true, that's true. Although, I will say also,

even in the podcast space, I am seeing some worrying signs that

it's just being taken over by certain interest groups, let's put

it that way, and losing a little bit of that kind of raw independent

voice which at least we try to keep up here on Top Traders Unplugged.

But there we are anyways.

Allright, so of course everybody

knows we're completely biased when it comes to trend following,

but at least they know that before they sign up for the episodes.

Speakingof trend following, it's been a little bit of a mixed

start to the year, I would say. There were opportunities in

some sectors for sure, like equities, but then kind of those

opportunities have been somewhat canceled out in other sectors.

Currency springs to mind, and maybe we see fixed income bonds being

caught somewhere in the middle.

IfI look at it from my vantage

point. Love to hear yours afterwards. I would say that, of

course, gold has been quite an interesting market, good for trend

followers, to some lesser extent silver. And, of course, now

there is a bit of interesting chatter around the shiny metal gold,

including suggestions that the US administration could reprice the

gold reserves.

Ithinkthey have like 8,000 tons of it and if

they mark to market that instead of the $42 per ounce which

I think is the official price, they are on the books for, of course,

whoopty, you would have billions of dollars that you could

lend against should you want to do that, like build a sovereign

wealth fund or something else. So that's kind of one thing that

I find interesting, and I'm sure trend followers have enjoyed

that.

Wehave a new ‘cocoa’, because last year it was all about

cocoa. This year it's all about coffee. So, we see some challenges

with the crop coming out for next year. I think the estimates

I saw were that it’s probably going to be lower by 4% or 5%, and

that's obviously sending prices somewhat higher as far as

I can tell.

Thenwe have the widow trade which is interesting

as far as I can tell. For those people who may not know what

I mean by I say the widow trade. The widow trade is something

that has been used to describe trying to go short Japanese government

bonds for a long time, because every time you tried the BOJ would

basically make you pay through its central bank policy. But there

are some signs that things are changing.

Yieldson the Japanese

10-year bonds have gone up from being negative 25 basis points

to now positive 1.44%. And we've seen an interesting push higher,

since around September of last year, in terms of yield, which means

that being short JDPs, now, is actually something that has made

a little bit of money for trend followers as far as I can tell.

And, of course, depending on what kind of exposure the manager

would have.

Andthen within equities, even within equities, it's

also been, I think, a little bit concentrated in just a few markets

as far as I can tell. The DAX has done well, which may come as

a surprise because people think of Germany struggling, which

is true, but actually the DAX index is made up, as far as I know,

of a lot of multinational companies that are making money at

the moment.

Andalso, things like Hang Seng seem to have had an

interesting move, a bit of noise in the last couple of months,

but also a bit of movement that could be captured from a trend

following perspective. So, those are some of the things that

I'm seeing at the moment.

Graham,love to hear what your observations

are on trend.

The gold one is a fascinating one. The gold story is one side,

but of course the other consequence is what happens to the

treasury market as a result of an issuance in the treasury market.

And again, that's where trading all the different markets

that we do globally is particularly interesting.

Youlook

at the effect of one market and what should that do to another

market and you can capture trends in lots of different ways.

So, you mentioned a few. There's a couple of other ones I

would mention as well.

Imean,to me you covered equities,

the fact that European equity markets are on fire this year is

amazing given the noise that's coming out of all the tariff talks

and whatever. Again, breaking this link between economic news and

market prices. It’s fascinating.

Andthen there's the

European energy markets. It’s very difficult for traders like us.

Last year they were quite range bound but you've got very low

inventories, you've got very cold weather. I mean, certainly,

as I found out this week, traveling in the Nordics and Holland,

you know that very, very cold weather coming through. Low inventories

plus little wind means little supply from the German renewable

networks.

Andthat just pushes up the price of European energy markets,

whether it's natural gas or power. There are hugely different

dynamics going on, which is music to our ears in a sense. Lots

of things going on is good for us, I would argue.

Over at our firm, we don't trade European energy other than

Dutch nat gas. Tell me a little bit, if you could, just tell

me a little bit about some of the opportunities that we now have

today, as managers, to capture some of these moves in European energy

markets. What kind of markets are you thinking of here and how

do you even access them? Because I imagine they're not really

futures based just yet. Or maybe they are.

Some of them are futures based. What I guess you find with

some of the futures based markets is if you look at an exchange,

the liquidity perhaps doesn't look great, but there's liquidity

off exchange that you can potentially capture. Some of it is

OTC, over the counter which, on first sight, people think OTC

equals a liquid. That's not necessarily the case. The way I like

to think about it is you just have to work a little bit harder,

roll up your sleeves in order to trade it. So, you might need a

little bit of human intervention to execute it.

Youmight

need to have some kind of ISDA arrangement perhaps in the background

to trade it. So, it's a little bit harder, but you can still trade

it. But there are some big liquid markets out there that you

can capture.

Historicallyyou've seen some quite

independent behavior from some of these markets. When we know the

effects, someday a central banker stands up can affect big liquid

macro markets, but you'll have a situation with some European markets.

NordPool, I think I've mentioned, is one of my favorites

there where the thing that drives the price of a Scandinavian

hydroelectric market is weather patterns. It's how much rain

is falling. So, the trends you get in those markets are just completely

diversifying to what you get elsewhere.

Soagain, if diversification

is the name of the game, and I think it really is for a trend following

strategy, the more diverse price sources, price drivers you

can get, the better potentially it is for a trend following

strategy.

Now I know you guys have been, and when I say you guys, for those

who don't know, but I refer to AHL as one of the pioneers, not just

in our industry, but also in the alternative market space, you

have a very successful fund in that space. Can you, I know we didn't

prepare for this, but I'm just curious because I don't have any

firsthand experience with this, can you talk a little bit about

maybe some of the other alternative markets that have been

interesting as well? If so, because again, it's not really something

I follow to a great extent.

I can give you a couple of examples there. So, the thing about

the alternative markets, it's a Very broad term. But essentially

you could view it as not a classic futures and FX market, which

are relatively straightforward to trade from a trend following point

of view.

So,you might be talking an OTC market, an interest

rate swap for example. One that maybe immediately springs to

mind is something like Swiss interest rate swaps. So, there isn't

a Swiss fixed income futures market, it’s certainly not big enough.

But last year, for example, the Swiss national bank opened up

the prospects of going subzero rates again. And that's something

that of course would drive up the price of those instruments. And

that's something you could potentially capture if you're able

to trade, let’s say, interest rate swaps relative to the classic

futures markets.

Soreally, it's about just allocating or getting

markets in there that you can't particularly trade anywhere

else. Opening up your price sources, opening up diversification,

really was something I always find (I think I said this when we

previously chatted) that the diversification or the spread in

returns you can get from trend following managers, despite us all

really trading trends. Right? Theoretically, it’s quite a simple

thing to do. You buy something that's going up and you sell something

that's going down.

Butwhen you start to figure out, okay, how

long does it have to go up, how long does it have to go down,

which markets are you talking about, how are you measuring it?

These things introduce huge variations in trend following strategies

and you can get some up and some down over the same kind of timescale.

Andthat's been quite evident, I would say, this year in particular,

if I look at… We're fortunate at AHL, we trade a range. We trade

anything from, you know, tens of markets all the way to kind of

hundreds of markets and all have different characteristics.

Butwhat

was very evident, particularly post the US election, let's say December

last year and January this year, the very biggest liquid markets

really nicely trended, particularly in a relatively slow

point of view. So, they've been doing relatively well.

Morerecently,

and I'm going back over the last couple of years, diversification

hasn't necessarily played out. That was certainly the case, I would

say, in 2022 when we had some big moves in markets. But year to

date that diversification has a little bit…

We'vetalked about

the European energy markets and those three factors coming together,

the low inventories, the cold weather, and the lack of wind to

power the renewables has really driven those markets higher.

So again, it's been fascinating to see what differences

those different effects can play.

Now,we know in the long term,

when we run a simulation, diversification tends to play out

in the short term kind of anything goes, which can present

a few problems to those of us who are explaining the strategy to

investors, but it keeps us on our toes.

Just staying at this theme just for a second more, some of our

good friends in the industry, and I think I'm referring mainly

to Florin Court here because we had them on the podcast a few

years ago. They obviously came from AHL and were kind of one of

the pioneers to go and say we exclusively focus on alternative

markets. And so that was very interesting.

NowI remember, well,

I think I remember from the conversation that there was some

suggestion that maybe, at least back then, alternative markets

in their view were trending better. And I've always had a little

bit of a struggle with that concept because I was thinking, why

would they necessarily trend better? And when I looked at the

data, it didn't look to me like performance was better in the

long run, but it was different.

Andthen I know some of

our other friends, who I probably can't name right now because

I haven't had their permission and they haven't been on the podcast,

so, I can't use the source, but what I can say is that they did

a presentation a while back, because they also trade alternative

markets, and they concluded that actually they don't trend better,

they just trend at different times.

I'mcurious as to how you

think about alternative markets from your side. Do you think

that they have some inherent benefit or advantage to developed

markets or whether it's kind of more, what I believe, that they

just tend to do things differently at different times and

therefore they can add some diversification?

Great question. So let me answer it in a slightly different

way. To me, performance of a trend following strategy is a lot

to do with the diversification that you can get out of the individual

markets.

Themaths basically says all things being equal, if everything

is completely uncorrelated, your Sharpe ratio increases with

something like the square root of the number of markets. You can

get a 0.1 Sharpe up to 1 Sharpe by trading 100 completely

independent markets.

Onthe face of it, if you can access a broader

range of price drivers from alternative markets, you should be

able to get a higher Sharpe ratio in the long term. And then

if you look at the futures and forward side of things, you do tend

to see a bit higher correlation, particularly with macroeconomic

events. It seems to be the case that the big liquid futures

markets were more susceptible to, let's say, what a central banker

might say. These two observations kind of come out, I

think, when you look at the properties of them.

So,I guess where

your question comes from, if you look at the Sharpe ratio of alternative

markets, it tends to look better in the long term, I would

argue, because the diversification is better. And that's

me kind of dodging your question about do they trend better,

but the performance tends to be better in the long term.

Butthe

classic futures markets seem to have a lower long-term Sharpe

ratio. But that crisis alpha property for which people really

look to are strategies that tend to come out stronger.

Andif

you look at the big sell-offs in risk assets in 2008, and even

more recently in 2022 when we had the big inflation spike, you

know, it was evident to us that that was really coming through

in traditional markets. And what we think is relatively appropriate

here is asking investors the question, what are you trying to

do?

Areyou looking for something that has perhaps a long-term

Sharpe ratio, a steady performance independent of markets,

or are you looking to trend crisis alpha properties?

Andspecifically,

with regard to the latter, you could make the case of well, if I

want to insulate my risky asset portfolio to a crisis, you

probably won't be trading the kind of instruments that you'd have

in that risky asset like S&P is a classic example. Treasuries

is an example.

Goingback to my case of Nord Pool, you're not

intuitively going to be insuring yourself or protecting yourself

from a sell-off and risk assets by investing in something

like a Scandinavian hydroelectric power contract. I think

the intuition is there. So, it kind of depends what you do.

AndI

think it might be a case of greater diversification with alternative

markets as opposed to they intuitively innately trend better.

I've heard it both sides, but that's probably the way I would look

at it.

Okay, very good actually.

So,my follow-up curiosity about

that would be given the fact that there are these benefits that

you mentioned, and obviously not just you, but other people as

well, alternative markets in the CTA world have been around now

for a few years, right? It's not ‘new new’ anymore. You were the

pioneers as far as I remember, but others have joined since.

So,my

question is, do you see any signs of an area which, I assume,

liquidity is obviously not going to be the same as on the developed

markets. Do you see signs of some level of crowding?

Crowdingis

not exactly the word I'm looking for, but let's go with crowding,

that there are simply maybe a few too many people trying to extract

that benefit now using more or less same techniques, and in a world

where liquidity could be a challenge from time to time, not

in all alternative markets. I'm fully aware of that but it may

also have a little bit more cost associated with it now than

compared to when you guys were doing it more or less on your own.

Great question. So, let's see if I can remember them all so I can

unpack them.

Sofirst of all, I think we need to be careful in

terms of liquidity and the connotations of that. So, the alternative

markets, if you look at them on a market-by-market basis, they're

not necessarily smaller than futures markets. They're harder to

access, but not necessarily smaller. So, I think that's an important

point.

Andcertainly, we view the trading or the size that we would

have in any one market for an alternative market in exactly the

same way that we would do a futures market. So, I think that

would be the first point to make. It's not necessarily giving

up liquidity.

Imean,even outside of alternative markets, a

smaller futures market will probably get a smaller size within

your portfolio, all things being equal. So, that'd be one thing.

Thesize of the industry. I think you were right with your question.

If that was becoming an issue, you might pick it up in terms of

transaction costs increasing, but you don't necessarily see that

and you get independent…

Weobviously measure internally the

size of a market in which we gauge our position. But there's also

independent surveys that you have on credit derivatives and interest

rate swaps, and they showed that these markets are actually growing

as well. So, you can kind of glean from those whether or not perhaps

the space is getting too big. And we certainly don't think that's

the case.

Andmaybe the final point, and again, your question alluded

to it. Does liquidity necessarily dry up in times of stress?

I mean, CDS is almost the poster child for that not being the

case. A credit derivative, when times get stressy, what you

often see is the demand for insurance. And credit derivative,

to some extent, is insurance from your credit risk.

Thatdoesn't

dry up. If anything, the size of that market tends to grow at that

point. All good questions, and it's something we actively monitor,

but we don't think these are significant causes at the moment.

Final question on this, and I really appreciate you sharing your

insights here because we didn't specifically plan for this,

but in the alternative space, at least in my view, you would include

crypto. And I get a lot of questions personally from people

who ask whether we are considering crypto. And, of course,

you could say from a return stream point of view it's an interesting

non-correlated market, and so on, and so forth.

ButI did notice

that even at this stage, where some of the cryptocurrencies have

become very well established, you have even got ETFs on those markets,

we had a little bit of a crypto crash earlier this month where

Ether dropped like 20% or more over the weekend in one day.

So,to

me, the exit liquidity risks that, what if you had to trade on

that day? I know you couldn't even trade futures on that day, but

some people may trade it in other ways. Is this something you

just simply…

AndI don't know if you can answer this question,

of course it's more of a research question, but I'm sure you

could. Is this something that you just simply have to kind of take

into your analysis saying yeah, this could happen. So, we take

that into consideration when we price positions or calculate positions.

Or is this something that may even surprise, a little bit, your

research team when they see that in a relatively established

crypto market like Ether, that suddenly you have a 20% drop in a

day.

Great question. I guess as always you just have to weigh up

the risks with the opportunities as well.

We'vegot

fairly well established futures markets on I guess Ether

and Bitcoin 2017, off the top of my head, something like that.

So, fairly big and fairly liquid. What's certainly apparent

to us as traders, and this is not us expressing any fundamental

opinion either way, which I'm sure Rob Carver would be very happy

to hear about. But you know, you just have this complete missing

idea of value within there. It's been, you know, over the years.

You know, obviously we're, we're bounded at zero on one side,

but where's the other end of that spectrum? Is it, it used to

be 100, and I hear people talking about 200, who knows where

it is.

Butthat is, to a trader, particularly a trend following

trader, that is just a wonderful thing to hear. Trend following

strategies love bubbles. And anything where there is just very

little idea of fundamental value has this propensity to form

bubbles.

Andthat's something that we absolutely love. So yes,

there's definitely opportunity there and risk there as well. So,

I guess your classic way to look at the risk side is well, how

do we diversify?

Andof course you diversify across as many future

strategies, futures markets as you can, I mean broadly too their

investor appetite comes into it as well. Even though we can say

we think it's potentially a great opportunity set, some people

just don't want to trade it and that's fine. We have to accept

that.

Butyou know there are other options too. You can, you know,

there's decent liquidity in a lot of the coins now, as well. And

that's something that we can, we can look at and try and diversify

some of this idiosyncratic risk that you mentioned. But I think

to us the opportunity set is fabulous there, but very cognizant

of the fact that some people just don't want to be exposed to

that, and that really limits where you can put these things into.

Yeah, no, absolutely, great stuff. Thank you so much for playing

ball on these questions. It’s very, very helpful and I'm sure very

interesting for our listeners.

Nowlet's get back to the normal

programming and that is talk a little bit about what trend following

is doing at the moment and then we're going to get into a question

which actually I think will be quite interesting for people to hear

and then we'll get into some topics that you brought along.

Froma

performance point of view, first of all, my own trend barometer

finished at 30 yesterday which is weak, on the weak side. But I

think also, people should always remember that it is using

somewhat shorter term timeframes so it's more in line sometimes

with the Short Term Traders Index which is pretty week so far

this year. But still, anyways, it can be tracked every day on the

website. But it's at 30 right now.

Performancewise, and this is

as of Tuesday since we're recording Thursday so we don't have

the Wednesday numbers yet, but I think yesterday was a little bit

of a down day for the industry. But as of Tuesday BTOP50

was up 56 basis points for the month, up 1.78% for the year. SocGen

CTA index pretty much flat, up 11 basis points for the month, up

73 basis points for the year. Trend index making 41 basis points

in February, up 56 basis points for the year. And the Short

Term Traders Index, as I mentioned, struggling a bit, down

30 basis points and down a quarter percent so far this year.

Comparingthat to the traditional world, MSCI World up

1.83%, very strong despite everything that's going on in the

world, up 5.37% so far this year. Even 20-year bonds, the S&P

US Treasury bond index for 20-year plus is up 68 basis points

so far this month. That surprises me a little bit actually.

It's up 1.15% so far this year. And the S&P 500 Total Return

up 1.8% in February, up 4.64% this year.

Allright, let's move

on to a question that came in from Rick and it goes I think a little

bit into sort of the structure of how the trend following managers

look to extract the trends, so to speak. How do we do it? And I'll

read the question in a second. But also, I think it allows us to

talk maybe a little bit about the history of how some of this may

have evolved.

AndI will say to you, Rick, appreciate the question,

but of course I don't think Graham and I can claim that we know

enough about what our competitors are doing to give you

any reliable data in terms of the breakdown. But let's deal with

it one by one.

Youwrite, “The SG trend index (and I think it's

the trend indicator that you're referring to), utilizes the

20 and 120 day crossover as a trigger and has some nuance sizing.

Here are my high level questions.

Isa crossover system

typically the primary tool for trend?” (And when I read this as

moving average crossover, that's how I read the question.)

So, I'd love to hear your thoughts about this because from

my memory, I think actually that AHL in terms of the CTA, (here,

I'm going back to the original, so to speak, AHL with David,

Marty and Mike) they were maybe some of the first people to

use moving average crossover.

Idon'tknow if you know this or

not, Graham, but that's just how I remember my conversation with

them many years ago. What would you answer, whether it's the

typical primary tool for trend following?

So, I guess back in the very early days, I think the original

signals were kind of binary. It's on if it's going up, or it's

off, or it's minus one if it's going down. And I think the natural

progression from that kind of binary signal is something that's

a little bit smooth, something that moves gradually into positions.

And I think a classic moving average crossover will give you that

kind of response.

Yousaid it in your introduction. We don't necessarily

know what everybody's doing, but I'd be surprised if that wasn't

happening in a lot of trend vol managers analysis. And the indicators,

as far as I can remember, uses one crossover, the 20/120 day to

represent the index or it best fits the index over a number of years.

So, I think that's where that comes from.

Interms of what I said

earlier, we need to be a little bit careful there in terms

of the huge dispersion we get in trend following managers who are

using all these different techniques for looking at trends

in all these different markets. Even with a consistent approach,

trend following approach, that dispersion is absolutely huge. So,

we need to be a little bit careful if we're boiling it down

to one tool this 20/120 day. But more broadly I'd say moving average

crossovers or something similar. They're one of many tools

that we use to look for trends.

Othersinclude, you know,

breakout models where you effectively form a channel around

a better price and then if the price moves upside, on the upside

you go long, if it moves in the downside you go short. People

also look at back returns. There's lots and lots of different

ways to do it.

Evenwithin moving average crossovers, for example,

there's lots of design choices you can use. Do you use a fixed window,

you know, that 20/120 day that the trend indicator uses, you know,

is that just a constant window constant, 20 day constant, 120 day

average? Or is it some kind of weighting towards more recent observations

which might make more sense to make you a little bit more reactive.

Whateverthe case though, the beauty of a system like that is that

they're smooth, they're incremental and any kind of positions

that you put on through moving average crossover type models they

don't hit the markets hard and they incur relatively small transaction

costs. So, they have lots of advantages.

Yeah, no, definitely, because actually Rick goes on to ask whether

the breakout models are also used and what's the typical split

of crossover versus breakout models, so on, and so forth. So,

of course, you and I don't know the split. We can certainly

confirm that they're both used.

ImeanI can say from my point,

at Dunn, we actually started using volatility breakout. That's

back in the early ‘70s. We never used moving averages. But then

later on we added, as you say, more continuous systems like a lot

of people would call time series momentum, which by the way

AHL has a wonderful YouTube video called AHL Explains.

Andit's

very well explained, actually, by one of Graham's, I think maybe

former colleagues now, about how time series momentum and other

of these signal generation methods are used. So, Rick, maybe

you want to go and check that out as well.

Butthen I dug a little

bit into sort of the archives and I found, from books, and I don't

necessarily agree with the timing of this, but it was interesting.

So, some people would say that breakout systems can be dated back

all the way to the 1800s with David Ricardo and his kind of rules.

There are some quotes that we've used in the trend following

industry for many years about, ‘let your winners run and cut your

losses short’, dating back to that era. I think it was like 1789

or something like that.

So,some people claim that breakouts

have been around for a very long time. It may be true, I don't

know. Then there were people talking about sort of Dow theory

as also a kind of a breakout dating back to the 1900s, which may

be true.

Thereis this article, I think actually it's something

I came across on Michael Covel's podcast many, many years

ago. I think he had an article of this show dancer called Darvas,

I forget his first name, who made a lot of money, not from dancing,

but actually from using what became known as the Darvas box. So,

when prices broke out of this box or range, I guess, he would follow

them and apparently made a lot of money there.

That'sback from

the 1950s, this article. So, that's been around for a while. Then

you have these channel breakouts that you refer to Donchian

Four-Week rule as a concept. I found some references back to 1960

about that. Something called the Dreyfus 52 Week Rule, also 1960.

Andthen of course the Turtle Traders, which most people listening

to us will probably be aware of, which started out, I think in

1984 and lasted for a few years. Later on, according to the

sources I could find, you had Bollinger Bands, which is more volatility

breakout and average true range.

Butall I can say is that

at least at Dunn, and I think also maybe people like Campbell and

others, who date back to the early ‘70s, this was volatility breakout.

So, that certainly came before what these sources had found.

AndI

also think that there are fractal, Bill Driess who also had

been on the podcast and who's unfortunately retired now, good for

him. He was using some fractal analysis, I'm not entirely sure how

to describe that. But he also dates back to the mid to late ‘70s.

Sothat's kind of what I found in terms of the history of these

things. Feel free to add anything, Graham.

The only thing I'd say is one, I'm incredibly impressed about your

expansive knowledge about the history there.

Well, I've been around for a long time, unfortunately. I date

myself, Graham.

Well, I was going to say, I mean, I remember reading, I think

it was Reminiscences of A Stock Operator, which I've just been

looking up Lefevre. I mean, that to me was one of the earliest

instances I saw of people talking to me. It didn't say trend,

I recall, but it was clearly what it was. And that was absolutely

spot on. It’s just really interesting to see how people got

it from very early days.

Reading the tape, I think is how they described it.

Great book, well worth the read. And also, Anthony Ledford,

who is the author of our little videos that you mentioned.

He's still around, actually. Still around, still going strong,

and still very able to get across relatively complex ideas in

a nice easy manner.

Yeah, they're wonderful. They're absolutely wonderful. I think

I had them in my resource section for a while on the website,

linking to you guys, because I thought there was no point in trying

to replicate that because they were done so well.

Anyways,now we're

already 42 minutes into our conversation, and only now we're

going to get to the best part, which is your topics, of course,

Graham. So, I'm going to let you lead the way. I know you've got

a few sort of big ones. And feel free to dive as deep as you

want and then I'll try to keep up with you.

Right, okay. So, I think there were two predominantly on my agenda.

Thefirst one, which I'm calling ‘the taxi driver problem’,

and then the second one, which we'll touch on later, talks about

the recent events around DeepSeek and implications on defensive

equity strategies. But let's talk about ‘the taxi driver problem’.

Asyou're probably aware, when you travel a fair bit, you get to

hear, you get to talk to a lot of people, and it's a really good

way of finding out what's on people's agendas. And clients, at

the moment, it's very difficult to beat a dominant performer

in an index.

So,the Mag 7 being the classic case in the US

driving everything. So, you might hop into a cab in the US and

they'll tell you how well they've done being long the Mag 7.

And of course, they were in there before they took off.

Andif

you were in Copenhagen, you might have the same issue with your

cab driver talking about Novo Nordisk and how they've been in there

since they've exploded, and done really well. So, you know, you've

got these classic problems where very well-known entities do

basically make the average man in the street do very well. And it

presents problems for investors who try and diversify across

lots of different assets to try and protect themselves in the

long term.

It'svery hard to get it right in the very short term.

So,I guess the most often question, the most popular question

we're getting from clients at the moment is kind of, I'm underperforming

the Mag 7, for example, what can we do about it? I mean, to be

clear, it's a very tough problem.

Hereis a very large component

in a very large index, already overweight, that's performing ridiculously

well. And it's very hard for a stock picker to beat that. You know,

the largest components are the ones that are performing best. It's

very hard to figure out how you beat that.

Andone thing that

people are gravitating towards is a portable alpha solution. I know

lots of people call it different things, but essentially

what we're doing here is saying, okay, well let's separate

our stock pickers problem into a kind of beta part. You're just

trying to perform in line with the index; with an alpha part, which

is a kind of long short stock pickers problem.

Andthe stock picking

aspect of that is very hard because the largest components are

doing well. So, I guess the portable alpha framework would say,

well, let's separate the two. Let's accept that you want your equity

beta in there, but can we port that alpha problem somewhere else?

Can we take it potentially out of that pure equities domain, and

can we put it somewhere else?

Iguessthe obvious area, particularly

with this podcast and the subject matter is, can you put it

in quant strategies? Can you put it in multi strategy funds? Can

you put it in trend following just to diversify away from that

pure equities framework and diversify your alpha sources?

So,we

see portable alpha strategies coming back on people's radars. It's

something that you have to think about very carefully. Margin

management can be very tricky. You've got to make sure that your

alpha strategy isn't drawing down at the same time as your beta

strategy, clearly, which I guess from a trend following context

at least should be beneficial. Typically, when your beta portfolio

is drawing down your alpha, if it's trend following, tends to do

quite well via this crisis alpha property.

Soanyway, it's an

avenue that we're seeing increasing interest from clients

and it really is started quite often from a Mag 7 type problem.

Anddoyouofferstandardizedsolutionsforthatorisitalwaysacustomizedsolutionifpeoplecomeandsay,yeah,Ineedyoutohelpmesolvethatproblem,ordoyouhaveproductstodaywherepeoplecanjustsimplybuyfrom,youknow,anequityindexplussomekindoftrendontop?

And do you offer standardized solutions for that or is it always

a customized solution if people come and say, yeah, I need

you to help me solve that problem, or do you have products

today where people can just simply buy from, you know, an equity

index plus some kind of trend on top?

We've certainly found it to be fairly bespoke problems from some

larger clients. As it stands, that's the kind of problems that

we're solving. But clearly there are potentially opportunities

there to look for commonality across other investors to see what

might be more broadly acceptable.

So, when I think about that, because obviously it's also something

that I come across, and this portable alpha, although it has found

itself getting a lot of publicity in the last couple of years,

it's certainly not a new concept. I remember working on this

back in the ‘90s. So, it just comes and goes.

Funnilyenough, it

always comes back when equities are doing really well. And

we have to come up with a solution as to why we're… How can

you participate in trend and not feel you're underperforming all

the time?

Butseriously, it also obviously has a very important

function because it is a way for giving people the solution they

need in a package that they want, essentially. And so, I do think

it's very valid. And often, I'll come to my question, because

often we think about this as, oh, trend should be combined with

equities. That we can help you diversify away from equities.

Whatabout

bonds? What about trend as a, I wouldn't call it a bond replacement

because in Europe… So, you and I deal with, well, I don't know about

you, but I deal with mostly European and non US investors.

Andso,

for them it's not necessarily the S&P they're worried about or

the DAX as such, but it's the 80% or the 60% bonds they have in

their portfolio. And of course, we don't know what's going

to happen in the future, but it sounds like what's happening in

this new world order, that it's not going to be cheaper for

countries to defend themselves. So, you would think that

there's a lot of bond issuance coming one way or the other.

So,maybe

the real risk is not being invested in private companies, but

it could be being invested in government bonds, to some extent,

from a yield perspective. I'm not talking necessarily about a default

perspective, but just from a yield perspective.

So,is that something

that comes up in your conversations of saying, well, Graham,

could you help me find a solution where I could maybe replace

some of my fixed income exposure with something that could

work well regularly?

Yes. So, the crisis alpha framework is typically referred to

in terms of equities. And I think the reason for that is you've

had some very well-known equity market falls in the last 25

years. I mean equities, you look at MSCI World has lost about

half their value, twice since 2000. You know, the tech bubble bursting,

2000, GFC 2008 and then, of course, you've got Covid. MSCI World

I think was down about 30% in that period.

So,you've had a few

instances where trend following has been able to shore

those credentials in fairly recent memory. Certainly, as long

as I think Dunn has one of the longest track records around, we've

been around for a few decades as well. We can see that in the track

record.

Theproblem with bonds has always been, at least until recent

memory, you've had to go back an even further time period to see

it. You need to go back to the ‘70s to see inflation really taking

off. Bond crises have been relatively few and far between, with

one exception, the recent one, 2022.

AndI think that really has

been, from talking to clients, that's been the kind of wake-up period

where people have thought of bonds as, oh yeah, as soon as equities

go down, bonds will go up.

the case, and it's definitely rekindled interest in a dynamic strategy

like trend following where you can be short bonds, you can be short

equities. And if you're looking to bonds as defensive, or

as you quite rightly said, if you're slightly worried about the

US repricing its gold and all of a sudden not needing to issue

any Treasuries and what happens to treasury markets? I think

it's quite possible that people might be looking for alternatives

to that and I think trends and other strategies with defensive capabilities

could step in and fill that hole.

So, I have another related question to that. Obviously, we know

that interest rates came down for about 40 years from ‘81 through

2020, thereabouts there. Of course, bond yields have picked up

after Covid. Now they've come off again to some extent, but they're

a little bit higher than they normally were.

Now,my recollection

is that after the financial crisis and when rates were really

low and short-term interest rates were about, you know, zero

or negative in Europe at least, investors weren't really looking

for double digit, mid double digit returns or volatility for that

matter. Now that it's changed, do you think, I mean from trend followers,

that they were quite happy for lower volume type strategies?

Andso,

I think there was a general deleveraging in our industry compared

to say the ‘90s and the ‘80s leverage and volatility came down.

And if you look at, say, the UCITS space, there is a little bit

of a range in terms of volatility. But I'm just curious

whether you think, now that we have a little bit more volatility

in say fixed income markets, we have higher rates, do you think

that investors are actually now looking to their trend followers

to also deliver a bit more. They want a little bit more juice

from what we do and they're not really looking at these low vol

alternative products, so to speak?

I think that question really depends an awful lot on individual

investors. I hear some people will be dyed in the wool. Something

that's low volatility is all that we're looking for.

Imetan

investor yesterday who had completely the opposite view to that,

actually. You know, given what you said, given what's happening

in the world now, we want a little more juice out of this. And

I guess, from my point of view, the beauty of a trend, but

quant strategies in general, is their flexibility. You can do

a 5 vol strategy, you can do a 10 vol strategy, you can do a 20

vol strategy. It's just the turn of a dial. It doesn't really

change anything.

Thevolatility of markets doesn't

scare us. I'll go back to Bitcoin as an example again. You've

got an asset class that trades on or around about 100 vol. It doesn't

bother us at all. It just means that we need a smaller amount

of it to generate a certain level of risk.

Andthat's just the

way that we look at markets in a day-to-day basis anyway.

Yeah, absolutely.

Now,in the interest of time, of course, I know

you're a busy man, you had one other sort of main topic you wanted

to discuss and maybe we'll have time to. I'll throw in a couple

of thoughts at the very end but I certainly don't want to miss

your last topic for this conversation so, feel free to take

over again.

Great, thank you, Niels.

Yes,so the second topic was about

defensive equities and explicitly about the news that we

had on DeepSeek that came out on the 27th of January. So, just

to recap, this was a Chinese company coming up with a new large

language model which could be done much cheaper than previously

thought.

DonaldTrump called it a wakeup call for US companies.

Marc Andreessen, who was the co-founder of Netscape, referred

to it as a Sputnik moment.

I'mgoing to go off on a tangent

given that you've displayed your knowledge on history there.

So, I looked that up. It was a lovely analogy. So, the Sputnik moment

goes back to 1957 when the USSR launched Sputnik 1 and showed

the US just how far ahead they were. And it turns out that NASA

was founded the following year. So, things happen on the back

of that. So, I thought that was quite a cool link there.

Butcertainly,

judging by subsequent price moves, I think a lot of the Mag 7

components there just bounced back. That Sputnik moment doesn't

seem to be playing out too much at the moment, but the context

that was particularly interesting for us was regarding

defensive equities. By that, I specifically mean long/short quality

or QMJ as our friends at AQR first talked about it in 2013.

Ithinkin previous chats that we've had, Niels, I've mentioned

that that worked particularly well in recent years when trend has

struggled in typical flights to quality like the Silicon Valley

Bank Crisis 2023, and we had Yenmageddon when that big carry unwind

happened in Q3 last year. Long/short quality a cash equity

strategy, where you go long high quality stocks and short low

quality stocks, that did remarkably well.

So,we've seen it

as a really nice partner for trend following strategies. Trend,

I always think about lines of defense. Trend requires sustained

sell-offs, typically, to work, to exhibit these crisis alpha periods,

typically, I guess, of the order of weeks to months. I think

long/short quality stocks tends to be a bit more immediate

and sits in the middle of something like let's say a long volatility

strategy.

So,it's something we've been looking at quite closely

to sit alongside trend following strategies. But I guess

why it's relevant is that a few people have said, well, if you

look at quality stocks at the moment, you tend to find that they're

often dominated by technology stocks, software and services, semiconductors

and equipment. What would happen in an environment where the

tech sector sells off? Is a long/short quality stock strategy

going to struggle as well?

AndI guess this links into the DeepSeek

episode the 27th of January. That's clear that was linked to a

fairly big sell-off in tech stocks, but we didn't necessarily

see a sell-off in that factor. So, that was reassuring. I think

that was on our radar in the last couple of months. But it kind

of makes sense as well.

Evenwhen the tech bubble burst,

2003, you saw long/short quality strategies, at least in simulation,

do okay. So, it's kind of nice to see, more recently, in a very

sudden market move, like we saw on the 27 January, that this,

at least for now, doesn't seem to have been an issue. So, I think

that was the main point I wanted to raise with that one.

Yeah, it's funny, the whole DeepSeek event obviously happened,

as you said, the first Monday of the week of the big alternative

investment conference in Miami that I was attending, actually. And

there were a few nervous faces in the morning of that day when you

looked around, but it all turned out not to be too big of an

issue.

Thiswas great.

There'sone thing I maybe wanted

to sort of leave people with as a thought because you mentioned

it already when you talked about this thing about value. Now,

I forget the exact wording you were using earlier, but the way I

think about it is that we do live in a time right now where there

is, in my view and others, there is a disconnect between the

price and what we define as value or what we used to think about

as value.

Andyou talked about it in terms of Bitcoin, where value

is very subjective. What is it worth? Some people say it's going

to be worth millions and some people say it's going to be worth

zero. So, value has become very subjective in many ways. And

I completely agree with that, I think we live in a world where

we see some crazy price moves and crazy assets, as well, being

priced.

AndI was thinking about this, and I think, well, if

we're in a world where there is less of a connection between value

and price, wouldn't it be a good idea to just focus on price?

Because that's the one thing we do know, because we have it in

front of us on our screens every second.

Andso, in an odd way,

because of what's happening, even though it's not good news necessarily,

what's happening around us, but in an odd way I think it might

present more opportunities for strategies that are just focusing

on price, like trend following. But there may be others

as well.

So,it's not always nice to be optimistic at a time where

the world seems to be falling down around you but I do feel that

there are some opportunities for these type of strategies. And

maybe more so, that there is a bigger understanding, and recognition,

and acceptance, by investors that maybe they need some of this

in their portfolios if they haven't got anything. And maybe they

need a little bit more than what they have right now.

Notthat

I think that there is a lot of massive changes in inflows to our

industry right now, but I certainly feel, from my travels,

that there is a bigger openness to have these conversations

compared with a few years ago. Don't know what your thoughts are

because you travel as much as I do.

I would agree. I think maybe, to quote a friend of the pod, Andrew,

who says about trend following, Mr. Market is your portfolio

manager. You know, let's see what's happening in the price, not

necessarily what's in the value. And there's just as, at least,

if nothing else, a different way to look at things. And I think

that's really quite relevant right now.

Yeah, it is indeed.

Allright, well, great stuff. Thank you so much,

Graham, for preparing, and coming on, and sharing your knowledge.

We'll, obviously, have you back in a few months when the weather

is a little bit warmer. And so, I already look forward to that.

Ofcourse, for those of you listening and you want to show a

sign of appreciation to all the prep work that Graham did, go

to one of your favorite podcast platforms, leave a rating,

a review of this episode, and give him some nice feedback.

Wetalked

about crisis alpha a fair bit. I'm glad to say that next week I'm

joined by the queen of crisis alpha, namely Katy, who'll be here

to talk about maybe even a new paper she's been working on. So that's

very exciting news, I think, for all of us.

Andif you have some

questions that you want to ask Katy, you can email them to info@toptradersunplugged.com

and I'll do my very best to, one, remember them and also make

sure I put them in front of her as best as I can.

FromGraham

and me, thanks so much for listening. We look forward to being

back with you next week and, in the meantime, as usual, take care

of yourself and take care of each other.

Thanks for listening to the Systematic Investor podcast series.

If you enjoy this series, go on over to iTunes and leave an honest

rating and review and be sure to listen to all the other episodes

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Ifyou have questions about systematic

investing, send us an email with the word question in the subject

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we'll try to get it on the show.

Andremember, all the discussion

that we have about investment performance is about the past, and

past performance does not guarantee or even infer anything

about future performance. Also, understand that there's a significant

risk of financial loss with all investment strategies, and you

need to request and understand the specific risks from the investment

manager about their products before you make investment decisions.

Thanks for spending some of your valuable time with us, and we'll

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