In this episode, Niels hosts Yoav Git to explore inflation risk, bond fragility, and the changing role of trend following in a world defined by supply shocks and declining trust. Drawing on recent research and market behavior, the conversation examines why traditional bond allocations struggle during inflationary regimes and how commodity trend strategies may offer structural resilience. The discussion spans geopolitics, deglobalization, energy markets, fixed income autocorrelation, and the limits of forecasting macro outcomes. Rather than predicting inflation’s path, the episode focuses on portfolio construction that can endure multiple regimes. What emerges is a disciplined argument for robustness over precision in an increasingly unstable global system.

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Episode TimeStamps:

00:00 - Introduction and series context

01:08 - Inflation back on the radar

02:38 - Recent podcast influences and inflation narratives

06:56 - Geopolitics, trust, and market fragmentation

08:52 - Commodities, volatility, and supply driven moves

10:48 - Trend performance and early 2026 conditions

11:30 - Fixed income, FX, and emerging market trends

17:26 - The all weather portfolio problem

18:18 - Bonds, inflation regimes, and correlation breakdowns

22:39 - Commodity trend as a defensive building block

27:01 - Are markets signaling higher inflation ahead

30:04 - What commodity trend really means

33:35 - Institutional resistance to commodities

43:51 - Allocation stability versus macro forecasting

45:23 - Fixed income trends, carry, and autocorrelation

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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 Yoav Git and me, Niels Kaastrup-Larsen, where each week we take the pulse of the global markets through the lens of a rules-based investor.

Happy New Year, Niels. Yes, trend has been actually quite good this year or starting, at least, this year. And we're going through a couple of big projects in, in Gresham and it's very, very busy. So, it's a very busy start for the year, but a very good one.

Yeah, always exciting. Excellent. Good. Well, we have also quite a few wonderful topics to discuss thanks to what you brought along. So, we'll be tackling them in a few minutes. But before, as usual, we do that, I'm curious to hear what's been on your radar the last few weeks since we caught up last time.

Well, actually, I'm going to talk a little bit about work because inflation has been on my radar. So, I'm going to plug TTU.

Oh, wow.

I've been listening to Mark Blyth on interviewing with Alan, and also Bill White who spoke a week previously. And actually, to be honest, it gives me a bit of trepidation because following them, these are two beautiful podcasts, really, really good. Both talking about inflation, about structural problems with US debt, or UK debt in the case of Mark, and two very different points of view.

One of them is a much more social, what is the social impact of inflation, from Mark, and a much more conservative sort of Fed type of outlook on inflation from Bill White. But really, really interesting. So, in fact, I listened to it last week. I ordered Inflation: A Guide for Users and Losers, by Mark Blythe, and I've been reading it all night until about 3am last night. So, a lot of fun there. It's really enjoyable.

Yeah, I mean, I completely agree. I think Alan did a wonderful job and the guests were just superb. I mean, Bill White I knew of, of course we've had him on before. Mark was new to me. I have to say I really enjoyed it.

And when I look at the comments that we've had and the engagement we've had on that episode, that is just a sign of how much I think it kind of touched… and how his style actually touched people.

Absolutely.

So, I completely agree. These were wonderful conversations.

We've got a lot of really great guests coming up, by the way, in the next few months that I already know of. So, I would say, stay tuned.

My daughter studies economics and maths and she was listening to him, and she said, he's really good. And I said, you know, maybe I should adopt a Scottish accent. And, and my daughter, bless her, said, maybe you should start learning an English accent first.

Oh, the kids, they will tell us the truth, right?

Well, I mean, she's a first-class student, so I really don't complain.

No, no, absolutely.

Well, I mean, I have to say that all of the talk about Greenland has taken up a lot of the space on my personal radar in the last couple of weeks, especially the last week or so. And, you know, on one side you have the politics of the situation, which is, I think, in a sense, very regrettable to see how seemingly allied nations are just moving further apart.

Of course, this is somewhat emotional when it's Denmark on one side of the battle, but perhaps the bigger issue is that when you look at it, and we're seeing this in front of our own eyes, we're just seeing a breakdown of trust. We're seeing a breakdown of what truth is. And this is going to have a huge impact, I think, especially on the younger generations who may not have the same reference points as you and I have.

So, I mean, this really feels like the Fourth Turning that Neil Howe has been writing about and who has, of course, been a guest on the podcast in the past. And I'm happy to say that we're bringing Neil back in early March to see or to hear what he sees now.

But then, if I put on my purely investor hat, and specifically my trend following hat, I can't help to be a little bit optimistic in terms of the opportunities that this fraction of the world may lead to in terms of market moves. And I really think that we may see many, many unimaginable moves in the coming years where we, of course, have already seen a taste of this in recent years, maybe mostly in the commodity space, but who's to say that we can't see huge moves in financial markets if the world order really is breaking down?

So we're kind of back to what I said a number of years ago, and I said it many times, that we as investors, we need to imagine the unimaginable, and that focusing on building robust portfolios, that may not give you the highest returns but will give you or will get you through the next five, seven years safely, will be the key thing to focus on. And as I'm sure people listening to us today already know, I believe this can only be done by combining truly uncorrelated strategies and assets.

So that's really what, what I sit back with. And of course, we know the news flow is not over. We don't even know where whatever we got from Davos last night, where that's really going to land. These were just like headlines that sounded great and the markets reacted positively. But once they need to get down to the detail, who knows where this will end. But it doesn't change the fact that I think we unfortunately are just witnessing something really, really negative for how the world operates. So, we'll see how that plays out.

Yes, indeed.

Now, speaking of trend following, I think it is fair to say that this week has been a bit of a roller coaster thanks to the geopolitical noise that we've been receiving. But I think for longer term managers, that don't react on every single news item, it's probably been an okay week.

And then depending on how much you have exposed to markets like gold and silver in particular, but even also equities and perhaps the JGBs, that probably determines more or less how much you've been able to extract from these markets. But you know, there are a few market events, I think, that are worth highlighting.

Maybe not everyone follows all the commodities, but this last week, net gas futures up 71%. Now, this is purely driven by the fact that the US expects a massive cold weather front coming across the US starting in Texas and sweeping across to the East. So, nothing geopolitical about that. This is just how commodity markets tend to move when there are some big events and that changes the supply/demand balance, which this certainly will do.

These are really big moves and you know, not just in the JGBs but also in the yen, really big moves.

Actually, can I add thought to commodities, like, carbon emissions have also been a very, very volatile market in recent times. So, commodities for different reasons, as you said, for different reasons, different risk factors, you get some really big moves. And of course, there's also gold and precious metals as well.

Yeah, the usual suspects, the usual suspects at the moment but for very different reasons. I mean in the case of gold it's really the breakdown of trust in fiat currencies. I mean if you look at Ray Dalio, coming on an interview, and he says, you've got to have gold in your portfolio. It's really quite impressive.

Yes. But as I said, I think this could also lead, at some point, to big moves in the financial markets if we really see a breakdown of some of these historical alliances and ties. So, watch this space, I would say.

Anyways, my trend barometer is picking up a little bit of better conditions. It's finished yesterday at 50 which is a good, reasonably strong reading. And I think it ties in pretty well with what's going on various indices. I have got some numbers as of Tuesday, but I think yesterday was a pretty good day, from what I can tell on the early numbers.

It's not particularly risk managed, so, it's a little bit all over the place. But it's having a hell of a day.

It is, it's having a good time at the moment.

Anyways, MSCI World up 1.5% thereabouts, so far this year, and the US Aggregate Bond Index pretty flat so far this month. And then you have The S&P 500 Total Return is up about half a percent. So, an interesting start to the month.

Now, before we go on I just wanted to maybe ask you how market trends look from your different lens than mine so far this year.

Oh I mean, this year has really started well. I think Japan is obviously a big story but there are trends in small countries like Taiwan; Taiwanese dollars, interest rates. There are trends in the US market actually, you know, but there's also trends in Turkish lira.

There are a lot of trends everywhere. So,FX, EMFX has been very good and credit has been choppy a little bit. Of course, it rose a little bit at the beginning of the month, and then there's been a small reversal, and then it's coming back again. This is all based on Trump news on this one.

But the bond market is actually where there's a lot of interesting issues. So, you have the issue of debt. And as you say, in Japan there's concerns about the spending plans for the government, about the budget. So, you see almost like a route in the Japanese bonds.

And then you see rerouting because Japan holds a lot of US debt. So, once the gap between Japanese yields and US yield is closing it becomes actually better. That carry trade is kind of disappearing and you see flows from US bonds back into Japan. And that, of course, puts pressure on the US market. So, you see the US 10-year crossing 4.2%. You see a little bit of a downtrend there as well. So, it's very interesting, at the moment, in terms of debt management.

And then, of course, the second question is inflation, exactly what you said. As you have a breakdown in trust between different parties you see each country becoming more interested in securing its own supply chain. And you see, you know, talking the UK, we need to spend more on military, on everything. Yeah, on everything.

And I think, actually, that's something that Bill White spoke about in terms of we have structural secular trends at the moment, which are away from globalization; structural trends which will support inflation. You have a huge transition from a carbon-based economy into metal a based economy; energy markets.

So, talking about electricity, and storage, and metal, and Bill was saying, well, it takes 20 years to build a mine. And that that sort of impact basically means that price needs to do a lot of trend, to do a lot of the work. So, you will start seeing a lot of trends in commodity prices, all over the place. And that's one of the reasons for inflation.

So, if you look at what Mark Blyth was talking about, we tend to think about inflation as being driven by demand, by just too much money chasing too few goods. But actually, a lot of it is at the moment, it's been the supply in terms of gas from the Russia stopping, in terms of supply chains being compromised, and we'll see a lot of the countries are sacrificing the efficiency of really super tight supply chains to try to get a little more security because, as you say, trust is gone.

Yeah, absolutely I should know this, Yoav, but do you trade, in your product, both fixed income and currencies or is it just the fixed income?

So, I trade carry. So, I traded quite a lot of things but I was responsible for both fixed income and I'm trading in the portfolio fixed income, which is like interest rate swaps, bonds, inflation linked bonds, but also FX (I view it as almost a carry trade), and also credit.

Okay, cool. Yeah, that's kind of what I gather from what your comments were. Okay, cool.

And there are essentially two ways for people to get the Guide, and it's a free of course, either if you're subscribed to my Sunday emails, you'll get it automatically or you can basically just go to the website, toptradersunplugged.com/ultimate and then there is a way for you to opt in and get it free of charge, of course.

Anyways, speaking of great content, free of charge, you should go to your LinkedIn profile because there's another good article from him in cooperation I think with someone called Adam Peddle this time. I hope I pronounced that correctly.

No, you pronounced perfectly. So, you know, Adam is a commodity side. So, Gresham has got a fixed income focused fund, which is run by me, and then there's a commodity fund, and Adam is a senior researcher there.

Sure. Fantastic.

Let me tell you what we did because I'm very excited.

Yes. I was just going to say I can't wait to hear what it's all about.

So, it's called the Eras Tour (and you can tell that I'm a Swiftie). What we're thinking about is inflation. It is precisely what Bill White is concerned about, what Mark Blythe is concerned about. And I think a lot of investors are concerned because that will really affect their bond portfolio.

And they've taken an economist's view of what the problem is. But we kind of want to think about the solution and we're trying to think about sort of how does an allocator approach the problem of constructing a portfolio which will be robust in all weathers? And what we mean by all weathers, we think about regimes, we talk high inflation regimes, rising inflation regimes.

I don't think people are particularly concerned about falling or low inflation eras, I think. That's not a problem at all.

I do know someone, who lives in a house that is painted white, that is very concerned about low inflation.

That's very true. That's very true. But as an investor, I mean, there are a few reasons why you're concerned about bonds at the moment in terms of debt, of the US debt, but also in terms of inflation. And what we try to do is to say, okay, let's look at how do you construct an all-weather portfolio?

And what I mean by all-weather is a portfolio that will be consistent over different inflationary periods. Okay, so, and the problem that you have is normally you would think, okay, my best building blocks, you start with equities and you start with bonds.

And what you find is equities are a great all-weather growth portfolio. The idea behind it is that it will essentially return to you CPI plus something. And that something varies depending on the conditions, the growth of the economy. It will give you 0%, essentially 0%, in high inflation environments. So CPI plus 0. And it will give you CPI plus 10, or 12, or even 15, in low CPI environments. So that's great.

And in between rising or falling inflation, it will give you just a little bit. But the problem that a lot of allocators have is with bonds because bonds are great in the periods that we've seen where interest rates have been falling, and interest rates are very low at zero, and suddenly bonds are really doing great, and also, of course, they've got negative correlation to equity. So, it's a really great idea to put them in your portfolio.

And the problem is once you start looking at rising inflation, bonds start to underperform. They no longer give you CPI plus, they start giving you CPI minus. And as you reach proper inflation (and I mean, by proper inflation, I mean just 4.5%), you have a situation where bonds are not only negative, quite strongly negative, CPI minus big numbers, but also they become much more correlated to equities. So, putting that in the portfolio actually makes it very difficult.

Now obviously you don't really want to throw away bonds from your portfolio, but how do you create a component which is stable over different inflationary periods? And what is very interesting is that commodities act as almost negative; the mirror image of what bonds are in a sense that this is an asset class which does very well in inflationary time. But commodities, of course, do very, very poorly in environments of low inflation.

But commodity trend, actually, is a great strategy for both inflationary times, for the obvious reasons like what we see at the moment, but also during low inflation times it has a little bit less drag, a little bit less of a negative carry. So, what you do is if you put a portfolio like simply a 50% commodities, 50% bonds, you get something which is truly all-weather. What it does, it gives you CPI plus 4% in all environments regardless of whether it's high inflation, low inflation. So, in some sense, you don't have to worry about what is going to play out.

It's very difficult to guess what the exact environment will be. As you said, events, random events can happen, lots of things can happen. You don't really know what you want. So, you want a sort of defensive portfolio starting, as a building block which is, I don't know if inflation is going to spike, I don't know if inflation is going to go down CPI plus 4%, all I need is like a 50% bonds and a 50% of commodity trend. And that is really, really quite interesting as a tool for an investor.

So normally we try to sell, you know, we try to market to our investors CTAs as a true diversifier, or maybe a little bit of convexity and a little bit of crisis alpha. But that's sort of an equity story. I'm here trying to think about how can we create a defensive portfolio. And it turns out that CTAs, and in particular commodity CTAs, really play, together with bonds, to create a really nice building block for your allocation. So that's what the paper is about.

.So, I have a couple of initial observations, and you can dive deeper. The first thing I noticed in your post was you have this chart that shows the different eras of inflation, the low and the rising, the high and the falling.

And I don't know what people think is the norm but actually, when I look at your data, it almost seems like they're equal in time, meaning that you have, in the last 70 years or so, you've had as much of rising inflation as you have had falling inflation.

Even though we may not really remember much of that except for a short period of time after Covid, most people will remember kind of falling or low inflation. But it is interesting and I guess it goes to your point about how to build portfolios for all environments because they should… Well, we don't know about the future, but certainly, historically, in the last 70 years or so, they tend to have as much of one as they have of the other. So that's kind of one thing I wanted to touch on.

The other thing I wanted to just touch on before I forget, and that is you mentioned, I heard you say, well, this is kind of why we see commodities go up right now. But most people will say, well, hang on, we don't have inflation right now of any significance. So, I just wanted to touch on that a little bit.

Absolutely. So, the first point is that we kind of cook the books a little bit. So, we chose the boundaries for low inflation and high inflation so that the data spends 25% of the time, roughly 25% of the below 2%, and roughly 25% of the time below 4.5%. We needed like round numbers. So, that's that.

And actually, what you find is interesting is that it spends more time coming down, even though, it's a symmetric, you know, it should be once you've declared both upper and lower bounds, inflation spikes much more quickly and then takes a little bit longer to come down. So, it actually spends a little bit more time coming down. It's stickier. And that kind of translates into different economic policy as well.

So, what we've seen since the ‘70s, we've seen the Fed essentially overshooting, having a much more, much higher real borrowing rates. So, borrowing fed funds, less inflation on the way down because it's trying to control inflation.

The second point is, yes, in fact one of the reasons why we haven't seen, necessarily, commodity trends, strong commodity trends, is because we have been between Covid and the Ukraine, we've seen falling inflation. And falling inflation is actually kind of bad for commodity trend. And you know that's going historically, and we can see that in the data as well.

But we are beginning to see trends, and these are to do with the way that inflation is coming online. And it is really about, supply constraints and supply shocks which induce trends. So, if you talked about natural gas, if you have less storage, and if you have a constrained supply of natural gas, suddenly when there is a cold spell in the US, suddenly you're going to start seeing big, big trends in natural gas, for example.

So, if I understand you correctly, what you're saying is, or maybe you're not saying it, but what I'm hearing is that inflation, actually, unlike what some people want, is actually not going to come down. And what we see in the commodity markets is kind of the prewarning that inflation numbers, I should say, should be picking up. Is that what you're saying, that the markets are ahead of time here?

So, I'm saying that there are multiple reasons why you should be concerned about inflation. We're not economists and even if we were economists, I think trying to make a prediction is always difficult. As you said, the events eventually overtake what you think is going to happen.

But there are certainly issues in terms of quite a relaxed monetary policy actually in the sense that real rates are at 1% or so. So, CPI is nowhere near what the Fed target is at 2%. And yet we've seen a drop in the Fed rates over the last year. So, the Fed has started as like has ended the cycle sort of thing. It took rates from 0 to 4.5% and now it's been taking it down consistently even though inflation is really not a target.

So, certainly, the Fed is very accommodating. Certainly, US debt is sitting at US$30 trillion. Financing that debt is now costing the US about US$1 trillion a year, which is enormous. I mean 10 years ago it would have been like US$250 billion. It's one of the biggest ticket items at the moment for the US. It's insane.

So, there are many good reasons why we are likely to see inflation coming on. But, on the supply side, all the things that we discussed, in terms of secular trends in each country like deglobalization tariffs, all of those are things that drive sort of supply shocks on the commodity side. And yes, these are drivers of inflation. So, these are things to be concerned about.

I'm not saying they're going to happen. But what I am saying is, if you were to look at a mixed portfolio of bonds and commodity trend, what you get is something which is resilient to either environment. So that if what happens, everything is hunky dory, and maybe inflation is coming down, and I'm completely wrong, then great bonds will do well for you.

Conversely, if inflation is going to be picking up and you're going to get high inflation, great, commodity trend will do well for you. Together you have a portfolio which is actually quite resilient to all environment. And that's what I call an all-weather defensive portfolio.

When you talk about commodity trend. Because I know this first came up in a paper a few years ago and the author's name escaped me, a well-known volatility manager who later closed down his fund. But he wrote some really great papers on building this 100 year portfolio. If you couldn't change your portfolio for 100 years, how would you build it? And he introduced this commodity trend.

But I've never quite fully understood whether, when people talk about that, do they mean trend following only on commodities? Because you are not going to find many, maybe with the exception of your firm, that does only commodities as trend following.

I mean we all try to combine it with some trends in financial markets. That seems to work better certainly as a standalone portfolio. So, when you say commodity trend in your paper, are you meaning trend following on just commodities?

Yes, absolutely. And, actually, very standard BCOM type of commodities. I mean it's absolutely true. If you are managing a standalone fund then it may be easier for you to put together both financial assets and commodities because, from your perspective, you might think that you get a better diversification. In fact, that's not necessarily the case. I mean, I think we all know that commodities are a great diversify, and you can create a very diversified commodity standalone trend. But the way we think about it is in terms of what is the utility that we give to the allocators?

So, it might be that, from your perspective, you think, oh, it will be better to shove it all together. And some investors want that. They want, just give me the best version of trend. So you can combine both the financial and the physical trend.

But some investors really appreciate a lot of the people that allocate just to the commodities. They think about inflation, and about real assets, and about how that kind of combines in the sort of asset class universe. So, they really appreciate there are different risk factors. And also, we kind of trade it slightly differently. So, each asset class, we kind of think about exactly how it does.

So, you know, the way I trade fixed income is slightly different to the way we do things in commodity because you have to think about the physical attributes of the asset class in terms of what? Supply shocks in commodity is not really relevant in fixed income.

What springs to mind when I hear you talk about that, and obviously this is your analysis and you came up with this idea of saying, well, actually if you combine commodity trend with fixed income, then this is really a great combination. And I'm immediately thinking about a country that I've been trying to get interested in trend following for a long time and where they have a lot of fixed income, and that's Germany. But at the same time, most institutions will not invest in anything that has commodities in it. So, it's very interesting that you might have a country, here in Europe, where they really should be thinking about combining what they have with commodities. Yet, for many different reasons which we don't have to get into right now, most of them say, no, can't do that, won't do that.

Yeah. I think the UCITS regulation and actually the aversion to commodities, in general, is rooted in the past.

No, I'm not even talking about UCITS. In UCITS, you can use commodities. That's not the problem. It's actually investing in anything that has commodities inside it.

Oh my God. Yeah.

Yeah.

Well, what can I say? I completely agree. I think commodities are a beautiful diversifying asset class.

Yeah.

And I think that the dynamics are very, very different to the dynamics in the financial universe. And you're talking about diversification, it's a really true diversification. And it's really nice to see a portfolio which you can get diversification both in terms of what type of commodity, you know, in things are not fungible. So, oil this year is not the same as oil next year. You know, the crop this year or the crop next year are affected by different things.

So, you can, you can get temporal dislocations, you can get different geographical differences, you can get a 61% iron ore trading differently to the 65% iron ore. So, there's a lot of fun in commodities, really a very great diversifier and it would be a shame not to allocate to it.

It will be a shame. And a lot of these, how should I say, pushbacks come from philosophical beliefs (is the best word I can come up with) in terms of what we, as managers, may or may not do to commodity prices and therefore they can't support it. But it's a little bit like the discussion that you see, from time to time, about people investing in the green transition, where a lot of pension funds did well initially when green was, you know, very popular. The last two or three years, that has not been the case. And so those portfolios have certainly been underperforming more traditional portfolios.

And I heard the discussion once, with the CEO of the largest public pension plan in Denmark actually, where he was asked, but what really is the mandate? Is the mandate for you to be investing for the green transition or is the mandate for you to get pensioners in Denmark the highest possible return? And I think from memory he said, well, when you put it like that, it is our job to give people the best possible long-term return for their pensions.

And so, you could kind of argue the same, maybe, when it comes to German investors who say, no, we won't do that. If you can show evidence that, actually, you should do this because it will give you a better outcome at the end of the day.

I think it's not necessarily just that. I mean, if you think about, okay, we're trend followers, so we're quite agnostic the way the price goes. What we do is we do provide liquidity in markets which are just emerging and are part of that green transition.

So, if we think about the lithium contract, right, so there used to be some lithium contracts in the US, In Europe. There was no liquidity there. And the reason why there was no liquidity is because the type of lithium that it was trading was nothing to do with the type of lithium that was used for batteries. So, the physical players didn't really use those contracts in the US.

And then suddenly, you see the Chinese market, there was a lithium contract and an explosion in volumes because hedges really needed somehow to pre-sell, essentially, the lithium production. And we, as trend followers, I mean, we don't really determine the price, but what we do is we provide liquidity in the market. So, we did, actually, get involved in that market very early on and that's sort of a positive thing, in a way.

So, I think that trend followers, as market participants and providers in liquidity in markets which other funds might be more reluctant to get involved in, were we try to give those risk factors because these are very diversifying. Sort of green-ification is a different risk factor to the rest of the economy. I think it is actually contributing.

Exactly. So, yeah, but even without this argument, I think it's important to appreciate that the CTA industry is actually not that big. It's not big enough to really do that. So, we are trading… The CTA industry is like, what, US$300 billion give or take, at the last count, a little bit higher now because the trend has been doing very well for the last six months.

But also, Yoav, we have to remember that a lot of things that do use trend like, for example, the QIS desks that Nick Baltas runs, they don't report their AUM. I think it is bigger than what we think it is.

That is very true. So, there is a… Well, first of all, don't blame us for the QIS, right? Clients want that. No, but you're absolutely right. There are maybe US$300, another US$300 or so in the QIS universe or thereabout. But you know, if you think about The S&P market it's like US$50 odd trillion, US$56 trillion, I think. So, you know, adding a little bit of perspective in this.

We are significant players in some commodity markets. And I think that is an issue. And I think the careful CTA manager will try to take that into account and actually try to be less present in the market because we actually don't like to trade against ourselves. One of the big indicators for poor performance of trend is actually, oh, you're trading against yourself.

That's always bad, and that's always a disaster happening. So generally, we try very hard to avoid markets where we are like the only players in the market.

Speaking of Nick Baltas, I spoke with him recently and I think we may have put a little bit of remark out there that you might have said, well, this concerns me because I think we said something like the last couple of years must have been really difficult to be a trend follower in fixed income simply because when you look at , the way, at least the exposure that I see in our portfolios, how they've gyrated from being very long to very short to being very long again. Anyways, by no means meant against you.

No, no, no.

You may have felt it.

No. So, I actually really enjoyed that one. So, you have to articulate, by the way, to your clients also why do you have just a fixed income focus?

Right.

And, of course, I think we'll come to Rob Carver. So, I'm kind of a big believer in fixed income markets and, of course, you can blame me because up until three years ago fixed income really was the best asset class in terms of performance and the last three years has been a disaster. So, the last three years in trend, in general, was not particularly strong and fixed income, in particular, within that was even worse. And it's not a huge bet for me to take that I think you are probably down last year in fixed income. In fact, I suspect most managers are.

But I think it shows the testament that what specialization and attention to detail and trading different asset class slightly differently in taking into account what's actually doing there actually can do. So, you know, SAFI has been trading for three years, three positive years. I mean we haven't done spectacularly well over three years. We're like up 12% after fees, but very few managers who have like a more generalistic view, and trade trend the same way across asset classes, would have had these numbers. And I think it's kind of nice to launch a fixed income fund right when the tide goes out and you see people who are swimming without the swimming trunks on.

So, I really don't mind. And you know, if that's the worst performance that we have seen on fixed income, then I'm fine with that and I'm looking forward for better times just in fixed income. But to come to your question, it is about providing the allocators a better way to allocate.

Again, you can just put the commodities together, you can put the bonds together, you can get something which is more diversified, but different investors are more interested in, let's say, global macro opportunity. And that's kind of what SAFI is doing. That's what they value. So, giving them different risk factors and the ability to allocate separately, I think that's very valuable.

We may come to this point about whether you should trade all markets the same or not later in our outline. Is there anything else you want to say about your own blog post? Is there anything that we can take away from it? You know, inflation is persistent. Is that why the edge is following it and not trying to forecast it? Or is it the acceleration that really is the key, not necessarily the inflation level?

So, let me talk about allocation in general. So, one of the problems that you have in allocation is that a lot of allocators try to time their allocation to strategies. So, they say, oh, this is happening now. So, we're allocating this. We are starting to… You know, it's very difficult.

Maybe if we have time we can talk about a paper by Gappy Paleologo, he put out a way to maybe actually time your own strategies. It's just very difficult and it's very difficult for allocators to do it.

I think stability and offering something which is, you know, CPI plus 4%, which should be sort of a building block for covering pretty much all historical situations, like, in the last 70 years, with very little correlation to equity in all inflation environment. I think that's a very valuable thing for allocators. And you don't have to worry anymore about whether you're going to predict inflation next year or not.

Yeah, I completely agree.

Now, you mentioned one of our other good co-hosts, namely Rob Carver. I was not going to say ex friend of yours, but ex colleague of yours and a good friend. He also put out a blog post that you wanted to touch on. So, I will hand it over to you.

Yes, so, Rob put out a blog post because we've had quite a few heated discussions about fixed income. What a surprise. He used to be a fixed income trader, I think it was in city, before he went dark and went to the systematic universe. And, and in fact, I followed in his footsteps. In fact, our wives share birthdays. So, it's really kind of spooky a little bit.

And I say, well, I think actually I can do better in fixed income than if I concentrate on that, then I can do better than just doing the full CTA. And Rob, of course, doesn't do that. Rob trades sort of 200 futures, and so forth, and doing very well as well.

So, full kudos to Rob and he's always trying to challenge me. So, he put out this paper, which is really, really nice. And an amazing thing about Rob is the speed at which he does research. And that was even in AHL. He can prototype something very, very quickly and get to the heart of the problem.

So, he does two things in this blog. The first bit is he looks at carry. And he says, does carry add value? You know, how much carry does add value in into the asset class? Because, of course, I like to trade fixed income, I like to trade FX, especially now when there's a gradient of interest rates across different economies. And he says like how valuable is carry historically? And he plots lots multiple asset classes and multiple markets.

And what you find is that if you were to look at the Sharpe of spot versus the Sharpe of what we trend followers are doing, the Sharpe of the spot doesn't really explain what we get. It's a sort of a flat feat. And then it does the same thing for the carry returns. And again, it doesn't explain particularly well what we do.

And then you look at the Sharpe of the underlying asset total return series. So, both carry and spot moves, and trend, obviously you get this smile effect that if the Sharpe of the underlying market is plus one, you will get maybe 0.8 Sharpe into your P&L of your trend following system. And the same, if the Sharpe is minus one, you will get again 0.8 or thereabout.

In the second part of the paper he also observes that different asset classes do actually perform differently. So, if you have a Sharpe of 1 in your underlying assets, bonds and FX and metals seems to be actually doing very well and actually able to get 0.8, whereas equities are unable, essentially, to harvest the underlying trend in the asset. And both observation, by the way, I completely agree with. And I think he's just like…

The first interpretation that I would like to put is in terms of the spot versus the carry. It's precisely what I say. What I say is that if we have an asset class which, essentially, has got very little carry or it doesn't have carry at all, then the spot doesn't really explain our own Sharpe and it's not particularly good… You don't actually perform particularly well.

And I'm not saying that carry is like the ‘be all and end all’, and if you have carry in your system, you'll get a Sharpe 7. That's not the case. What we are trying to do is we're trying to take a market.

If you think about what a CTA does, this Sharpe of a single market that we have may be somewhere between 0.2 and 0.3. And then we diversify across our portfolio and that gives us a reduction of volatility of say 3, 3.5 X, and that gives an increase in the Sharpe of the overall portfolio. So, my 0.2 Sharpe asset, if that's my average Sharpe, and I multiply it by 3.5, I get a 0.7 Sharpe CTA.

And that's really the mathematics of what is going on here. And what I'm saying is carry just gives you this little extra, instead of the average being 0.2, the average is 0.3. And that, when you multiply it by 3.5, now gets me to 1.05 Sharpe. And I kind of like that. So, the question is, do you want to tilt your portfolio to assets which are high carry? And does carry explain this in the same way that I might ask, do I want to tilt my location to markets which, right now, are in supply shock, or supply demand, or the structural reason why they are more likely to trend? Maybe there are more physical players in the market.

There are various reasons why we might think about it and the aim is not to get to say, oh, I'm taking my Sharpe from point 2 to 0.7. The aim is to say can I tilt? Do we have historical reasons or fundamental underlying reasons why we understand why there is a trend?

And I think what is nice about his blog is that the answer is yes, if you look at just a spot market, you get a relatively mediocre Sharpe. But if you put the carry into the price time series, then you get a slightly higher one. So, that's the first part of his paper and it's a really nice one.

The second one is even more interesting because he just makes this observation and he says, well I don't really understand why equity seems to have trended worse. Long only equity has been on a tear. So, if I look historically over the last 50, I don't know, I can't remember, 30 years that he's looked at a really nice Sharpe. But trend hasn't performed that well. And I think here is where a lot of people miss out in terms of the mathematics.

So first of all let's do the mathematics and then we can talk about the fundamental reasons why different asset classes have it. So, I put out another paper with Adam Peddle about the mathematics of trend following. And, you know, most people say, oh, if there is a trend in the market you should be able to make money. But actually, the trend quality, the autocorrelation of the underlying price is really important. Trend is about positive autocorrelation.

And you will have markets where this autocorrelation is very muted. In equities it's actually negative… Well, at different times, at different times and in different horizons. But that negative autocorrelation translates into a lower performance. So, you're not able to harvest, as a trend follower, unnecessarily, using a generic trend following machinery you will be able to get less trend. Because the autocorrelation basically means price goes up, you put in a position, and then you suffer a day later when price comes back down. That's what negative autocorrelation means. On a short term basis it’s up/down, up/down, up/down. That's not particularly good for trend.

And what is observed, which is true, is that in fixed income we see, actually, a much higher autocorrelation and that means that we're able to harvest it.

So, the paper we put, with Adam and myself, we actually did the mathematics for that and we kind of can calculate what is the worth; what is 1% of positive autocorrelation worth to you as a trend follower? And then there's the second question, which is a much more deeper question, is like why are different markets different autocorrelations?

And I think here is really a structural question which requires you to understand what's going on in terms of, for example, rebalancing in equities, in terms of value traders in equities, in terms of day traders or zero day to expiry the option markets. So, you have different players, and they will have different dynamics that will feed into the price.

And once you understand that, you can think about, oh, how do I modify my trend to be able to address the structural nature of the market? And, by the way, the structure can change over time. So, it's a moving target.

But I think it's really important, from our perspective, when you look at different asset classes, you know, you can close your eyes and say, yes, I'm going to have an inventory system on the side. But if you're saying I'm committed to trend, I really want to trade trend, then it's really important to you for you to understand, okay, what are the things that are structural in this market, and how do they play, and how can I combine them into trend in a way that I'm still got this positive convexity, this trend dynamics, this beautiful risk management system and at the same time takes into account the physical nature of what the actual thing is and who the other players in the market are?

So, I think it's a really great paper by Rob. I really enjoyed that. And I think I'm looking forward to another coffee with him later on where we can discuss this world.

So, I have a question for you. It may sound very naive when I asked this, but I know I can ask it of you. So, you say bonds have a higher autocorrelation. So, I'm thinking well, over what period? Because haven't we just had 40 years of falling interest rates? And isn't that really the explanation as to why “the auto correlation seems to be higher”?

Absolutely. So, it varies over time. As you say, it varies over time. And I think here is what the “alternative” comes into play is. SAFI trades about, let's say, north of 100, 150 market, but at any one time we will actually allocate meaningfully to only about 50 of those. And the idea behind it is that there are certain characteristics of the market, like curry, which contribute.

So, for example, if you look at DM FX, okay, for many, many years it was doing really badly both as trend and as a carry asset because interest rates were zero. There was nothing. There was no, what I would call like a temperature gradient that really caused prices to drift.

You know, if interest rate in the US is zero, and in Europe is zero, then really it's just sort of noise. But you know, certainly in EM market, if I look at Turkey, I think interest rates is like 38% or something. Okay, but we don't have to go to that extreme.

Once you have, even in the DM space, once you have different economies with different central banks who are trying to sort of all different for different things, then you start getting these temperature gradients, and suddenly it's becoming interesting, and suddenly autocorrelation picks up, and suddenly there's also drift. And you can see why this is happening because, you know, Japanese investors would like to take their money and park it in the US. And by the way, this is going away.

So, it's over time, and different players, and it's not that bonds are always going to be better. Bonds are about fixed income. Bonds are about the coupon, about carry, about positive carry. So, I suspect there will be carry for many, many years to come. But they're not the only asset class that has carry.

I think it's important for us, as investors, as trend followers, to recognize the different things which are very salient for each asset that we trend and to understand how that affects the dynamics. And maybe, you don't have to do a different model for every market, but broadly to understand what are the important characteristic of each one of your asset classes.

Yeah, I like that you brought up the Japanese example, again, as we wrap up our conversation, because actually I think Japan, and what's happening there, and the changes there are actually much more important than people may realize. This is a topic that we started talking to our good friend Dave Dredge about, two or three years ago, Cem and I, and it's actually even becoming even more important as time goes on. And those conversations really people should go back to listen to.

We had one out, not that long ago, where Dave and Cem talked about these things, and it’s super important ,and hopefully we'll get him back again in the not too distant future to talk more about it.

So, anyways, I think, Yoav, this is a perfect place to wrap up for today. We just hit, you know, almost the hour mark, and super exciting to dive into some of these topics that you found. I really appreciate all the hard work that goes into the preparation of these conversations. So, thank you so much. And actually, I want to say to all the listeners that if you want to show your appreciation to Yoav and to all of the other co-hosts, please go to your favorite podcast platform and leave a rating and review. And also, of course, share the episodes with your friends and colleagues because it really does mean that more people discover the podcast and benefit from these really super experts and experienced people who come on every week and talk about these things.

And actually, just to reiterate what you started out by saying, Yoav, you really should go back and listen to Bill White and Mark Blyth speaking to Alan because they were really outstanding.

Much more eloquent than myself. It's always a pleasure.

Yeah, absolutely. Thank you so much.

Next week I'll be joined by another expert, another fan favorite. Katy Kaminski will be back, and I'm sure that will be an interesting conversation. It'll be timely, it'll be fun, insightful, maybe she has another paper she's been writing since we last spoke to her. You never know.

But you have a chance to ask her questions. And you could do that by emailing me at info@toptradersunplugged.com and I'll do my very best to bring them up to Katy.

So, from Yoav, me, thank you ever so much for listening. We look forward to being back with you next week. And in the meantime, more important than ever, I think, in this time we live in, take care of yourself and take care of each other.

Absolutely.

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 from Top Traders Unplugged.

If you have questions about systematic investing, send us an email with the word question in the subject line to info@toptradersunplugged.com and we'll try to get it on the show.

And remember, 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 see you on the next episode of the Systematic Investor.