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TTU111: Alignment of Interest ft. Alan Sheen of Dalton Street Capital – 2of2
2nd October 2019 • Top Traders Unplugged • Niels Kaastrup-Larsen
00:00:00 00:55:05

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Today on Top Traders Unplugged, I continue our conversation with Alan Sheen, talking about how and why he designed Dalton Street Capital’s investment strategy the way he did, and how it has performed compared to the market average over the past three years. Listen in to today’s episode to learn how Alan’s strategies are different from traditional managed futures, his managerial approach that enables employees to innovate, and what an investor should ask a potential manager when doing their due diligence.


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In This Episode, You’ll Learn:

  • Why Alan developed a hedging strategy based on volatility and liquidity
  • The connection between the Australian and US markets
  • Why Alan does not trade in US markets in his intra-day strategy
  • Why Dalton Street Capital focuses on Australiasian markets
  • Where Dalton Street Capital’s return profile comes from
  • Why Alan also trades in medium to long-term trend following
  • How Dalton Street Capital’s equity portfolio performs against the market average
  • Alan’s perspective on model decay
  • Why alignment of interest is important in an investment strategy
  • How Alan approaches market research
  • What questions should investors be asking themselves


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Welcome back to Top Traders Unplugged, where I continue my conversation with Alan Sheen, the Founder and Chief Investment Officer at Dalton Street Capital, a global systematic investment and research company based in Sydney, Australia.

I want to dig, obviously, a lot deeper into your strategies. I think the best place, maybe, to begin is with the absolute return strategy, since this is something that you had been running before, I guess, at Dalton Street. So, can you go back and tell us about how this came about and what the strategy is trying to capture?


The strategy is purely... The one that I mentioned before, this was my very first managed futures strategy that I designed. I didn't know it was a managed futures strategy at the time, and it was originally designed to hedge a basket of (and this sounds unusual, now that I repeat it, but this was the desire at the time) Australian equities over the trading day, in Australia.

Obviously, at the time, the asset owner that I was working for had a particular view, and didn't want to sell down the equity holding but just wanted to protect it during the day. Notwithstanding, I've since found out that more of the move in the Australian market happens overnight when it's closed. There's a huge gap overnight, but anyway, notwithstanding all of that.

So, I developed this hedging strategy and it was based on volatility and liquidity, because I thought, "Gosh, if this guy wants me to do a hedging strategy, all the traditional measures that I knew just wouldn't work: PEs, dividend yields, all these long-term factors were never going to work." That's when I was caught up with these guys called Quants, they were talking about the VIX, and I thought, "Well, this is interesting. Volatility and liquidity, there may be something to that. Let's have a look at that and see if this has some sort of (I hate to use the word but) predictive capability."

I guess another observation I had, particularly in Australia (and it happens all across Asia), is that the first thing that we hear on the radio, TV, or morning meeting (if you work for an investment firm), is that it's the same thing every single day, and that is, "What did the U.S. do overnight?" This is what I figured out when I was reading Kahneman and Tversky, and their studies on anchoring. For better or worse, that's what we hear first thing in the morning, and we anchor on that number.

You and I know that's an arbitrary number. It's completely meaningless. And there is a traditional view in Australia, "OK, the U.S. was up overnight, so, therefore, Australia will be up the next day. The U.S. was down overnight, Australia will be down the next day." It's very, very well known. I think I was told that very soon after coming into the industry, and I did a quick study. I thought, "Well, let's see what happens here." And, sure enough, a majority of the time, Australia would be down the day after the U.S. being down overnight. But, that was just the absolute index measure.

I found that there was very little predictive capability there at all, because as we know, the futures trade overnight, so there's no use me jumping in the next morning, "The U.S. is down overnight, well, I'll jump in short at the start of the day, the next morning, and I should be guaranteed to make money." As we know, that's probably already probably priced into the futures, and it didn't work very well at all.

So, that's when I started looking more closely at the VIX. I thought, "Well, this is a behavioral bias." Instead of using a priced based model, again, I had no real knowledge about trend following futures other than the classic saying that "the trend is your friend," but that was more so related to me in the sense of equities. I started doing some studies on the VIX and volumes. I thought that there has to be something there on a short-term basis. If we're anchoring, I need a behavioral index rather than a price index. To me, it was the volatility in volumes that gave that.


Interesting, interesting, yeah, I have to say I haven't really come across a strategy, in our space, that doesn't focus on price first and foremost, so that is fascinating. Now, I guess the other thing that's unique about it, so-to-speak is the fact that you focus on just Australasia in terms of the markets. Even though my first inclination was if you were focusing on liquidity, why not trade the super liquid markets in the U.S.?


I tell you, if it worked, I'd be there doing it. I've tried to make this work in every asset class and in every geographic region, and it just doesn't work. This is a discussion that I had with Mike Adam, it is unique in this region that we... Again, I come back to the pseudoscience of investment. We're lazy. I hate to say it, but we really are lazy. We sit here, we hear the U.S. is up or down, and we go, "OK, problem solved. I don't really have to think about anything anymore."

I think the other unique feature, as well, is that we receive our input signal, we sample the overnight market, and we sample the markets that we trade. So, we trade six markets. We trade Australia, Japan, Korea, Hong Kong, Singapore, and Taiwan. They're the most liquid markets that we can find in this region.

So, we sample the overnight's volatility and liquidity, and we sample the previous day's volatility and liquidity. Essentially, that is what goes into our model, and it has an incredible ability to give us a probability of where the market is going to go. It's not so much where the market's going to go close to close; it's where it's going to go open to close.

So, we will enter all of those six markets at the start of the trading day. We give ourselves a certain amount of time to enter the market and be fully positioned. Then we hold our position for the entire trading day, and we exit at the end of the trading day. So, we go home every night without any futures exposure what so ever. Because essentially, what we're doing is we're sampling a day, and we're trading a day. That's the simplicity behind it.


Let me just ask out of curiosity here, the fact that you know the liquidity and the volume, so-to-speak, where do you get the direction from?


The direction, actually, is quite incredible. It comes from a common... I've tried a few different ways of trading this model. Because we essentially, when we allocate our capital each day, it's very, very simple. We trade a sixth, a sixth, a sixth, a sixth, and so on. We allocate a sixth of our money to each market. I've tried many, many models, a vast number of models to try and volatility weight, or index weight, or do something. I just quickly found out that I'm able to figure out which way the market's going to go on a slightly better than 50% basis, I'm just not smart enough to say which market is going to increase more than another on the day. Most days, I would say ( well, not 'I would say,' I know the numbers) over 65% of the time we're either long all six markets, or we're short all six markets. Then obviously, the remainder we could be long three, short three; long two, short four.

The direction actually comes out of the combination (so essentially it's a four-factor model). We have the volatility and liquidity overnight on the U.S. markets, and then we have the volatility and liquidity on those six markets. It's actually the combination of those numbers, or those inputs, that actually gives you a direction. It's quite incredible.

We run trend following systems as well, and, as you know, the hit rate on a trend following system is quite low. I think ours is maybe somewhere around 35%, 40% and everyone is high fiving each other. Where this model runs, on average (and we have ups and downs, of course), but on average it runs about a 56% hit rate with a very, very slight skew, whereas, obviously, a trend following system has a very large skew. This has a very small skew of about .16. It's actually the combination of volatility and liquidity that can actually provide you with a direction.

It is just a unique strategy, and whilst I mentioned the black-box concept, we do have an element of black box because we only have a capacity in this fund of five hundred million dollars. That's Australian dollars as well. Australian pesos, whatever you want to call it. We're having a bit of a tough time against the U.S. dollar at the moment. I think we're down around 67% or so. It's not a good time to go on holiday from Australia, but it's a great time to come to Australia on holiday.

So there is, I would say, I'm happy to explain 95%, 96% of what we do, but it's that four or five percent leftover that we keep to ourselves. With our trend-following system, we really do explain everything about what we do and even some of what some of us (and probably DUNN's the same), call proprietary. We're very happy to disclose what we do there.

I think it comes back to the concept of discipline again. I would, in some ways, and I say this facetiously, in some ways I'd be happy to print the rules on the front page of the Australian Financial Review, or the Wall Street Journal, and (I think someone said this before), feel very comfortable that 99.9% of the people will not make money out of it because they don't have the discipline to follow it.


Yeah, that's true. I've certainly come across that over many, many years. I also think that there's someone, I can't remember who said it, but when you have a strategy that is behavioral-based, you can actually be quite transparent about it because, the fact of the matter is, what makes it work is that it's so bloody hard to do. So, that's the trick.


er since Credit Suisse (since:


Absolutely, now, I want to stay with the other component you said, the other challenge, because it is unusual - the fact that you keep collateral in an equity portfolio rather than what the industry does normally, which is some kind of short-dated fixed income. How do you separate, when people look at your track record, how do you separate the two return wise? I don't know how, exactly, it's split, but can the collateral overshadow the actual trading results?


Absolutely, and we make it very clear to our clients where the money does come from, and also how it's different to your traditional managed futures manager, but also how it's similar. For example, looking at a number of managed futures managers, now, they carry what I would describe as maybe a long equity bias, if that's a fair way of describing it. A number of funds are carrying a reasonable percentage of long equity exposure.

. Oh gosh, what's an example?:

So, whilst it would have been wonderful to be running a cash collateral for that year, it was tough in the equity basket. I think, if you look at the equity basket that we run for the absolute return fund (because we manage just six Asia pacific managed futures or futures contracts), we do match that off with the equity basket. So, the equity basket is drawn only from those same six countries that we trade.

So, it's kind of a volatility matching strategy loosely, if I could put it that way. But then we have the advantage where we see that the payoffs are asymmetric. Our best year in managed futures is just shy of 100%, but our worst year in managed futures is still only single digit, off the top of my head; whereas our best year in equities was, that would have been '09 where the equities returned about 40%, and surprise, surprise, the worst year in equities was the year before when we were down about 40%. So look, you do have experiences where one really does cancel out a significant amount of the other.

We've had a great experience recently, which, it's only new to us, historically, if you look at our return profile, 2/3s of the return comes from the managed futures portion, and 1/3 comes from the collateral. When I conducted a study of a number of well known managed futures managers, over at least a similar period to where we've been running this strategy, so twenty-four years, I quickly discovered that roughly 2/3s of their returns come from the managed futures strategy and 1/3 comes from the collateral, or cash, or bonds, or whatever they're sitting in. I thought, "Oh, that's interesting." But it doesn't have the same correlation relationship.

Really, as I said, it was really just a happy accident that I ended up with this. I had no knowledge of any relationship between equities and futures. I didn't even know about managed futures when I started trading managed futures. Over time, I've quickly found out that in just normal market periods, the two are uncorrelated; in periods of extremely high volatility or extreme low volatility, they'll become negatively correlated.

So, for the last three years, our managed futures have had a very similar experience to most managed futures. We've been flat to down over the last three years. But what has dragged us through these last three years is that equity exposure. We find, I'm not so sure about off-shore, but the clients in Australia have been incredibly frustrated. Many of them have started allocating to managed futures, gosh, three or four years ago, thinking, "We're due for a crash, we're due for a crash." And, they've missed out on that equity upside. I've said, "Come with us, and we'll give you that equity upside and, hopefully, we'll pick it up through the managed futures when we do have that crash, whenever that is."


You know, I can certainly see that there's an interesting story, for sure. There's an interesting argument for investors because you're right, a lot of people find it hard to replace equities with something else like pure managed futures. So, yeah, I guess that's part of your uniqueness.

As you said early on, and I think that's really important nowadays in terms of how we should be presenting ourselves and marketing ourselves and that is just being very authentic. If this is what Al and his team are doing, that's what you're doing, and you're not shy to be different. I think that's really refreshing to hear. I also want to dig in a little bit deeper in the other strategy, which is a little bit closer to my home, which is kind of medium to long-term trend following, if I'm not mistaken. So, I'm interested in why you also have gone this way, because that's a lot more mainstream than what you do in the absolute return strategy. So, tell me a little bit about how that came about and what you're trying to do there, maybe something different as well, who knows.


So, the plan behind the business was to eventually run a minimum of three strategies. So, the first and foremost would be the one with the longest term track record, which is our absolute return fund. But that has a small capacity. The second fund is the fund that we can actually gather more assets over time. That is structured as a medium-term trend follower.

I had a number of chats and email interactions with a former guest on your program, Andreas Clenow, and, as I said to Andreas, we were talking about different strategies and asking me what we do and how we do it, I said, "Well, just create your own book, and you'll have, probably, 80% of it." The average holding period is six weeks, average loss period is two weeks, average gain period is ten, eleven weeks. We trade seventy-four markets at the moment, and we run with a traditional stop loss. In our case, we run a three ATR stop loss.

I guess if you think of what we're doing that's slightly different is we just run our own version of a correlation matrix, which allows us to modulate (for a better word) our risk size. So, our standing risk size, per trade, is twenty basis points, and by overlaying the correlation matrix, it could move it up very, very slightly, maybe to twenty-two or twenty-three, however, it will reduce it down into the very, very low teens. Really, that's what we're doing. It's backed by equities as well.

So, in this case, because we're running the seventy-four individual contracts model instead of looking at the MSCI All Country Asia Pacific as the pool that we draw our equities from, we draw our equities from the MSCI World Index. So we have, instead of twelve thousand stocks to choose from, we have thirty-five thousand stocks to choose from.


So, with the actual collateral, do you invest in individual equities, or do you just do ETFs, or how do you actually do the collateral side?


I've looked at this many, many times. The easiest option is just to stick it in ETFs, or you could pick up a MSCI World ETF, what are they charging these days? Four basis points, six basis points, that would be the easy way to go. However, we have a quant model, or a factor model (for a better word), and that selects and ranks stocks, and we have used that model. Well, I've used that model since the late nineties, and whilst I can say that I was the architect of our original absolute return futures strategy, using volatility and liquidity, I can honestly say I stole the equity model. I stole it from the well-known book, Security Analysis, by Ben Graham and David Dodd.

This is another aspect of human behavior, and this is what Ben Graham observed in Security Analysis, and interestingly I just read it again at the start of this year. In my mind, it's an enjoyable read, again. That probably is a little bit more insight into my personality than anyone else's.

He's very clear where I think most people know Ben Graham from the point of view of Warren Buffet. OK, Ben Graham, he's a fundamental investor, he was Buffet's mentor, as I think it was, Columbia University and gave him the only A+. Ben Graham and, obviously, David Dodd, the co-author, do talk about, I think it's, seven or nine rules which incorporate quality management and moat around the business and franchise.

But, towards the end of the book, there are two very, very interesting takeaways. One is that Ben Graham says, essentially (and I'm paraphrasing here), "If you're a little bit shy, and you don't like meeting people and getting out and talking to people, just use these three factors to select your equities, and you'll receive the returns of all those seven or nine factors anyway." That was one.

The second part, which really worked well for our futures model as well as the equity model, is, again, I'm paraphrasing here, "Beware the man who approaches you with a very complex algorithm to invest in equity markets, or any market what-so-ever." That really stuck with me.

So, I just stole his model, and it's been working really well since. I think, on average, I think the index, if we bought an ETF, I think our average yield would be somewhere around two or three percent. The yield of our portfolio is closer to five or six percent, and I think, on average, we've outperformed the index by somewhere between three to five percent per annum.

t's funny, actually, when, in:

As I explained to the clients, with both funds, is I said, "Look, if you want to allocate to a managed futures manager and a deep value manager, well, you'd have to allocate, say $100 to one and $100 to another and pay fees on both. Where all you need to do is allocate only $100, and we'll take care of both for you." Believe it or not, managers can actually perform well in both asset classes.

When you think about what we do, Niels, and what DUNN does, we're looking at, I think, fifty or seventy-four asset classes that we're managing (for a better word), and we seem to manage those OK. I think people lose sight of the fact that (and it comes back to the principle of engineering) if you have principles of investing (like if you're building a plane or bridge), and if you follow those principles religiously, you should have the desired outcome that you're looking for.


Absolutely, I'm also interested in your general view, obviously you run two very different models, but you can go outside your own models in general, but I'm interested in this idea of model decay. I know we talked about a lot of the principles behind what you do and what the managed futures industry does is based on human behavior, so we don't think, necessarily, that that will change.

However, I've also come across a lot of people in the shorter term space who definitely say that they have model decay and that they need to continue to develop new models in order to keep up. What's your sense on this? Is this something that you need to also do on your side for any of the things that you do?


ss the term model decay since:

Every behavioral strategy we look at, and obviously, the main ones are the volatility and liquidity strategies that we look at, they are the trend following strategies or momentum strategies. Whilst we can go for many years, which was evidenced in the, I think it was AQR that conducted the century of trend following, say over two centuries of trend following. Then you had another guest on your program, Alex Greyserman, and Katy Kaminski, what was it, 800? I'm probably getting it wrong.


I think they went back 800 years for their book, yeah.


Yeah, and it's clear, it's very clear, there's no question about it. I always say, "There's a reason for sayings." There's always the joke about the mother-in-law being an absolute dragon to deal with. It's because most mothers-in-laws are dragons to deal with. When you're talking about, "Trends are your friends." That's because that's where you can make money. But you have to put up with your mother-in-law, and you have to put up with periods of (what's the better word) underperformance in our strategy. That's how you make your money. You muscle through it. You muscle through Christmas with your mother-in-law. You muscle through the tough periods in our strategy.

It's like, when I think back to my sporting days, I often say, "I'm not very good at many things. There are probably only two things I'm good at now, and that's value investing in managed futures." But when I was younger, I wasn't the greatest natural sportsman, but I had a mentality about myself of not stopping. I always think of the Forest Gump movie where he scores the touchdown and keeps running through the cheerleaders and out of the stadium, and that was very much my mentality, hopefully with a slightly higher IQ, of course.

It's just muscling through, and you have to have the where-with-all, and you have to be aware of what you can take, as well. I spent many years as a cyclist, as a track cyclist, that was one of my chosen sports, and how fast you can go around that track, to some extent, is how far you can lean over in the corner. We all know the only way to find out how far you can lean over is to fall off. So, I had no problem falling off. The bottom of the track or the top of the track, and once you hit that point, great, I know how far I can go. I found a lot of people where too frightened to fall off. Maybe that comes back to that Forest Gump IQ again, I'm not quite sure Niels.


You know, as they say, actually, which is another reason why rules-based strategies are worth considering is that scientifically it's proved that when we are under stress we lose, I think it's thirteen percent of our IQ, and therefore, it's nice to have something to hold onto and not make very important decisions at a lower level of IQ. So, yeah.


I agree with that with my military training, as well. People talk about military or army that they're dumb or they're not creative in their thinking. No, absolutely not, these are rules that when you're in the height of war, you can't think of any greater stress. I still remember periods, I spent a lot of my time in fast jets and some unusual situations whereby it was extreme stress.

You do have that feeling of your life flashing before your eyes, and my response was to follow what I had in front of me because these were principles of aerodynamics, in that case, that will take you out of the very uncomfortable situation that you're in. To the point where, for me and a lot of the time the pilot, there's no looking out, there's no looking up trying to figure out what's going on, you just look at the true source of truth, which is your instruments. To me, that's systematic trading, that's technical, that's the very essence of following what you have rather than looking around and wondering, "Oh, I wonder what the market is going to do today. I heard that the U.S. was down tonight, or I heard that the dollars moving, or Trump's going to Tweet something." Follow the rules.

What concerns me the most, particularly in our industry, is when people say, funnily enough, I think the loudest calls of the death of trend following was the end of last year, almost, then we've had this wonderful year. I'm thinking, "Gosh, if you're not going to invest the way (of course this sounds like a commercial for us), but if you're not going to invest the way we do in a systematic manner, well, good luck with anything else, because it's not repeatable.


Yeah, yeah, going back to that story about the military and the engineers having to go on the plane after they fixed the engine, I'm not so sure they do that in commercial airlines, but I do like the concept.


It would be worthwhile introducing it. In alignment of interest, it's funny, we do talk about it because fees are, obviously, a discussion all the time and alignment of interest. But the literature is very clear, and I'm sure you've come across this as well, Niels, the literature is very clear that the higher fee-charging managers are the higher performing managers on an after fee basis.

There's a recent study here, in Australia, by, it's called the CSIRO, which is a research institute at the Monash University, and that was only done a couple of years ago. It's reinforced a number of previous studies that you really need to go for the managers that are charging the higher fees. It's very, very clear, based on the empirical evidence.


Yeah, so how have you stayed balance on fees? How have you balanced it on your side? I'm not a big fan of these cheap replicators or flat fee products, so we're on the same side of that, I think. What's the fair balance nowadays?


It's interesting, I was just speaking to a former colleague of mine at Credit Suisse. They're not at Goldman Sachs, and Goldman Sachs are doing a number of replication products, and I asked to see the returns, and he was kind enough to show me the returns and where the returns came from.

I must admit, I wasn't surprised that one, they underperformed on an after fees basis; two, they missed most of the big runs that we've seen recently: natural gas, emissions (gosh, there's a couple of others as well), coffee recently. They picked up the bonds, that was OK, they picked up the STIRs as well, but those big outliers like emissions and natural gas, they just didn't capture them. It's as simple as that. That's one, two, I have to question when an established managed futures manager decides to offer a lower fee product. Are you receiving the best work? Are you receiving the best ideas? I don't know, I don't have the transparency into those firms. We certainly don't do it ourselves, but I just think of it as a business manager, where am I putting my best ideas? Where am I putting my best staff and applying the research?


It's an interesting topic, and it's something that, obviously, has been quite evident in our industry for the last few years and I'm sure it will stay there. Yeah, I guess you get what you pay for, often in life, and I think with our business, it's kind of the same.

I also want to, before we start to wrap up our conversation, I want to touch on research. Research is always an interesting topic, of course. So, I'd love to hear a little bit about your research process. Obviously, you've got a good team that you've been with for a while. There's this debate that often investors want to see you evolve, but they don't want to see you change, so how do you think about research in general?


Sure, and look, I'm happy to send you my chart that I've done, Niels. I probably wouldn't distribute it too much further. I just did a simple chart, again, of managers who have been managing portfolios for twenty odd years like we have. It's just a simple bar graph of their funds under management, their staff numbers, and their returns. Also, as well as I can figure out, the Ph.D.s they have.

As you know, asset allocators love to know how many Ph.D.s you have. I think, "Gosh, what are those fifty Ph.D.s doing there? I just can think." There's a guy with a background in astrophysics, and then there's another guy with a background in extra-galactic astrophysics because our universe wasn't enough for him, he had to go outside of that. I'm thinking, "Well, no, no, it's the mentality of, again, it's like my lawyer friend, "I argue because I'm a lawyer." No, no, you became a lawyer because you argue.

So, they're the sort of people that you're wanting to bring into your firm. You don't need someone with a degree in extra-galactic astrophysics, or, in our case, we're all a group of engineers, quantum physicists, mathematicians, computer scientists. Gosh, no, we don't need that, we don't need that horsepower, we need the mentality. We absolutely need the mentality.

In fact, one of our employees, one of our staff members (and all of our employees are also partners in the business), their father runs quite a large fundamental investment shop. He was very keen for his child to work with him, but it was very clear to the child, who studied a science, that it's probably not the way I'd go about thinking about investments. So, we were fortunate enough to pick that person up.

It's interesting, we're always asked that question, how can four people compete against a large firm of four hundred people? I just look at the numbers. I just show them the numbers and say, "Look, we've been running this strategy for over twenty years. The maximum amount of people that I've ever had on the strategy was five, including myself, running a trend following system alongside that most of the time, as well.

Those same five people were working alongside that, and I said, "Look, at the returns." It's very, very clear that what happens is once you generate more fund, and therefore employ more people, or it could be vice versa, you employ more people to generate more fund. You go from running a fund to running a business. I'm completely OK with that. You have to make that decision in your career or in the aspect of your business.

It's interesting, for example, with the absolute return fund, people say, "Oh, you've been running this for a long time. What sort of enhancements have you done to this over time?" And I say, "Well, we basically haven't done any. This is a behavioral strategy, and in the last twenty-four years, I haven't seen my own behavior or other human's behavior change to the extent that I want to be changing the strategy." That doesn't mean that we haven't done thousands upon thousands of optimizations, or whatever you want to call it, to see if there's a better way of running the strategy. But at the end of the day, we get in on open, we get out on close. There's not a whole lot of ways to do this strategy.

Trend following, on the other hand, yeah, look, we look at everything from, should we be only managing contracts in six markets? Should we be doing it in twenty markets? Should we be doing it in two hundred and six markets? Again, it doesn't make a whole lot of difference. The research we found is, should we be running on a fifty-day breakout, a twenty-day breakout, a hundred and twenty-day breakout, a cross-over strategy?

It's incredible, as you know, with DUNN and your own experience, they all generate very, very similar returns over time. I guess maybe the faster moving stuff, probably not so much now, the sort of five and ten-day trend following strategies, we've found that there's been a little bit of decay there. But, again, we're only talking about thirty or forty years worth of research on these strategies. We could be having a bit of a tough time. As we know, bonds have been going one direction for thirty years or something I think it is now. Japan went one direction for thirty years. We really need a lot more data on that.

I have a very simple (I guess) management philosophy as well, and it's a bit of a crude statement that my father used to say. Dad studied for many years to earn his qualifications, and then, within three years, they promoted him to management, and he said, "I did all that study to become a clerk for forty years." And I said, "Well, how did you deal with that, Dad?" And he often said (it's a bit of a crude statement), "I'm not going to hire a dog and bark myself." I let people do the job. I hire people who are competent (and look, it's a military term, and he uses it), tell people what needs to be done, not how to do it, and they will amaze you every time with their intellect and ingenuity.

So, I let my staff go and do what they want, my performance review, people say you should have management meetings once a month, or whatever period of time. I have an annual performance review with them, and it lasts a good two and a half minutes, two and three-quarter minutes, and I just ask them what are you doing that you enjoy? What are you doing that you don't enjoy? What do you want to do more of? What do you want to do less of? It's quickly done.

You just hire people who have the competence, the intellectual curiosity, and the personality to fit in with the other team members. I've been very fortunate that that sort of management has worked with the sort of people that I've employed. It's always a little bit more difficult when you inherit a team. I inherited a team of forty staff, at one stage, when I was the Chief Investment Officer of a large organization here in Australia, and that was a little bit more challenging. But once they realized that you believe and trust in them, a little bit like your children. They'll try, every now and then, to test you and see how much Dad will put up with, but like your children, you let them go, and you let them go, and you let them make their own mistake. Then they'll come back and go, oh, OK, this guy is being completely reasonable. I'll work within the bounds that appear to be in place.


Yeah, absolutely, something I also wanted to gauge your thoughts on, again, a topic that comes up and has been quite present, I think, in recent years and maybe still at this time, and that is the term "crisis alpha." I know you mentioned Katy Kaminsky, I think, who coined the phrase. We love her on the show, of course. I have to say, personally, it's a challenging term for our industry, because I think it has lead people to believe that we are a hedge rather than an uncorrelated return stream. But I wanted your thoughts on this "crisis alpha" term, in general, what do you think?


I think, ultimately, I have no problem with the term. I don't have too many problems with a lot of terms; it's just the definition of the term, that's all it is. It's like volatility, or standard deviation, or vol, what's the definition of what they mean? I was fortunate enough to meet the person who (for a better word) invented vol and took it to J. P. Morgan, I think it was. The whole idea behind vol was a fourteen-day risk measure. Gosh, I don't know anyone using it as a fourteen-day risk measure. So, it's the definition.

So, when I heard the term "crisis alpha," and a lot of our clients or potential clients started talking about this crisis alpha, and why weren't, for example, when was it, the last quarter of last year, people were wondering why we weren't up when the markets were down, and what happened to the crisis alpha? I think you probably heard a few people say, "Well, yes, if we were correction alpha, you'd be quite within your rights to be annoyed." We've yet to see a crisis for some time.

I'm OK with the term as far as what a person's definition of it is. That's my takeaway. The broader question is the correlations. I don't know if you've had this experience, Niels, but we have it all the time. You can explain non-correlation many, many times to the same people, and when you meet them again, they describe negative correlation to you again. And you say, "I'm pretty sure I remember the conversation we had."

I think it comes back to that (and I know this is going to sound like I'm trying to be intellectually superior, but that's not the case), it's just a simple fact of principles of investment. We just don't seem to have the principles of investment behind us. We have a lot of disparate opinions and a lot of people who just listen, read in the media, listen to colleagues, and not think and do their own research.

Interestingly enough, we've been asked a lot, recently, because, like most managed futures strategies, we do a little bit of when volatilities high, and we've had a lot of people coming to us and saying, "Oh, volatility is high. We're at record high volatility." I'm going, "My gosh, where are you hearing this?" [And they respond,] "Let me send you the article." I've had many articles sent to me, and there's absolutely, in every article, there is absolutely no evidence for the statement of increased volatility.

I often just send them the VIX chart, the simple answer. This person is swearing that volatility is at all-time highs. Again, it comes back to definition. What I did uncover is that there is an area of volatility that is at almost highs and that's cross-sectional volatility, in Australia at least. Obviously, the volatility between stocks and an index. I thought, "Ah, OK, somewhere someone has found out that cross-sectional volatility is high, and people have just taken that as volatility is at all-time highs." Why are you guys making huge amounts of money and why haven't you been doing it for two years, two and a half years that cross-sectional volatility has been high?

But we'd expect that, wouldn't we? You're saying that some of the largest companies in the world, Apple and the like, are probably up ten percent on a day, or down ten percent on a day, where, showing my age, when GE and Exxon (other than an oil spill or something), you would never contemplate these companies moving ten percent up or down on a day. A three or four percent move was a massive move. So, it's kind of specific to definitions. So, if I hear the term crisis alpha, I say, "Well, what's your definition of crisis before we start the conversation."


That's a fair point. Let me finish off with a couple of more general, maybe, but also something that might lend a little bit to the listener getting even more of your personality out while we have our conversation here. You know, it is always hard, I'm sure. And I don't think, necessarily, that the jobs of investors have become easier. It's really hard to decipher between managers and so on, and so forth. So, in your opinion, what are some of the better questions investors should be asking, both themselves, but certainly also managers right now?


Yeah, so what I find is that a lot of investors are, actually... I don't know if they're afraid, or they don't want to offend the manager, but I think they should be asking more personal questions. Whilst we run systematic strategies, at the end of the day, we are still human. We have the ability to override, change, enhance (for a better word), our strategies. We don't have to follow these strategies in any way.

So, I think it's very important to ask some personal questions. That example I told you about the cars, the high-performance cars, that's a significant difference in the performance of managers. So, I would be asking my manager, or my potential manager everything from, yeah, what car do you drive? What do you do in your free time? What sports do you play? A simple one for me too is, when you gamble, let's say you go to a casino, do you punt on the horses? Is there any proclivity there to take unmeasured risk?

I still remember, when I first, having spent so much time with an asset manager. It's a little bit like working in a library, and it runs quite considered (I guess for a better word). Then, when I joined Credit Suisse and I was walking through to the bubble, the glass room that the prop traders worked in, I had to walk through the trading floor, I would have to say that every third or fourth desk had the horse racing guide on it. I thought, "Whoa, so, these people are advising fund managers on what to buy and sell? This is incredibly concerning."

And look, part of it is probably my own proclivity to gambling as well. I've actually never gambled a dime in my life. It comes from my background. Unless I can measure the odds in some way, I would never put money on a horse race, or put it on a table at a casino, or anything like that. I know a lot of people do, when I say that, they say, "Well, hang on, you gamble every day, don't you?" I say, "No, it's your definition of gambling. I certainly trade and invest, but if I wasn't doing the research, I'd call that gambling." I think, really, you need to ask the personal questions. What car do you drive?


That's a good insight into how you think and also, again the importance... and of course, behind every model there's a person, so we definitely need to get the personal side as well.


And also, I think you need to ask about ego as well. I often tell people, as a fund manager, is your ego more attached to being the largest fund manager or the highest performing fund manager? Yeah, I think that's a really simple question because, at the end of the day, our egos drive so much of what we do, and so much of it is unconscious. So, do you want to be the highest performing or the largest manager?


Or both, you never know.


Or both.


So, let me finish off before you completely lose your voice here. Let me finish off with something that I've only tried with a couple of people, but I think it might be fun to hear. So, it's kind of you finishing this sentence, if you can, and the sentence goes, "I know I'm being successful when...

When do you feel you're being successful?


Well, I often think, as parents, people say, "What do you want for your children." I'm supposed to say, "I want them to be happy." That's a terrible goal. That's an absolutely terrible goal for your child because you have very little control over your happiness in many situations. So, when I look at success for my children and therefore myself, I think, "Do I have a purpose? Do I have a purpose in my life? Am I pursuing that purpose, and do I feel as though I am meeting the goal of what I think that purpose is?"

For me, my purpose in my professional career is (looking at my ego) generating the highest returns for clients to allow them to achieve a greater quality of either life, or retirement, or whatever it is that they're looking for or what they want to do with their money. I look at that with my children as well. Some people say, "Oh, you don't want your children to be happy?" I have no doubt that if they have purpose and they're achieving or pursuing that purpose, and maybe not even achieving anything great, but if they have purpose, I have no doubt that they will be happy and they'll have greater control over their happiness as well. Just being happy, to me, sounds like a very arbitrary desire for your children, and obviously for yourself as well.


Absolutely, purpose is very important. On that note, let's wrap up this fascinating conversation. Al, thank you so much for being on the podcast and for sharing your thoughts and experiences with me. It's been fascinating to hear your views. As I often say, I think it's so important that practitioners, like yourself, share these ideas because when ideas become conversations that lead to action, that’s when real change happens.

I hope you were able to take something away from today's conversation onto your own investment journey. If you did, please share these episodes with your friends and colleagues, and send us a comment or leave us a voice mail to let us know what topics you want us to bring up on the upcoming conversations with industry leaders in the rules-based world of investing.

From me, Niels Kaastrup-Larsen, thanks for listening and I look forward to being back with you on the next episode of Top Traders Unplugged. In the meantime, go check out the show notes for this episode and all of the resources that you can find on our website.


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