Welcome back to Top Traders Unplugged. In this episode we continue our conversation with Dr. Mathias Bucher the Co-Founder of AllMountainCapital.

In this episode we go deep in the philosophy, habits and personal traits required to excel in the hedge fund industry.

It’s a pleasure to have you here and we hope you enjoy the episode.

In This Episode, You’ll Learn:

• About Stop Loss, Risk Management and overall Exit Strategies
• How the current drawdown is effecting current testing and research at AllMountainCapital
• How Mathias takes the stress of drawdowns and turns it into creative power
• The research cycles in the program and the company as a whole at AllMountain
• An example of a research idea developed and how it was implemented
• Current research interests in business development and market positioning as a CTA
• Why Dr. Mathias Bucher and Dr. Tilman Keese base their business in Wollerau rather than a major financial hub
• The threats and challenges involved in growing a young CTA firm
• Dr. Mathias Bucher’s perception on why the CTA industry excellence seems to be shifting to Europe
• Learn about the concept of the Industrialization of the Global Financial System
• The human traits needed to strive in the CTA industry

Resources & Links Mentioned in this Episode:

• Larry Hite and ISAM
• Watch another interview with Dr. Mathias Bucher on Opalesque TV

Follow Niels on Twitter, LinkedIn, YouTube or via the TTU website.

IT’s TRUE 👀 – most CIO’s read 50+ books each year – get your FREE copy of the Ultimate Guide to the Best Investment Books ever written here.

And you can get a free copy of my latest book “The Many Flavors of Trend Following” here.

Learn more about the Trend Barometer here.

Send your questions to info@toptradersunplugged.com

And please share this episode with a like-minded friend and leave an honest rating & review on iTunes so more people can discover the podcast.

Niels

Now you mentioned another subject which I would like to talk about next - risk management. You've mentioned it and talked about it so that my understanding, at least, is that this is very important in the way you approach things, the way you design things, so maybe you could tell me how you define risk and what targets of risk you're looking at, and how you've gone about using this approach?

Mathias

So, we're typically looking at risk as the volatility with the VAR budget, pretty much in line with the industry here. Our risk management consists of three layers. We have a risk management layer on the portfolio level, then with the VAR budget that we want to allocate, then, on an asset allocation level we will make sure that the portfolio is optimally diversified each time. Then we have volatility stops on a single market or single position level. We don't use profit targets or this kind of thing. You can think of it like a probability band around the trend. So, when the trend is up...for example, (like it is with) equities right now, should equities revert, the probability that this trend is still up gets lower and lower until it comes to a point where it tends towards zero, and that would be the moment where our stops would step in and take the position out.

Niels

So when you say volatility, it's not purely volatility, it is also based on a reverse movement in the parts?

Mathias

Absolutely. It's essentially expanding volatility against a trend.

Niels

Sure. And correlations...it sounds like that clearly plays a role in your approach as well, when it comes to diversification. We also know that correlations are not stable, they change from time to time, and certainly at times of crisis, correlations seem to be often very different from how it is normally. How do you look at that and how do you take account of that?

Mathias

You are fully right here. Correlations are certainly very important, but it's also a very tricky subject. We did a lot of studies and we really looked deep into that. Essentially we considered correlations, but we considered them in a very long run, and we considered tail events.

Niels

OK. Now part of risk management, of course, is also the drawdown side of any trading program. I guess, for those of us who chose to be involved in the CTA space, drawdown is something that we almost have to live with every day, because most of the time any trend following CTA strategy is in a drawdown, and for a short period of time, it's making a new equity high, which feels great, until you then get back to your next drawdown. Tell me a little bit about what your experience has been, and I don't mean just in terms of the worst drawdown, whether that is within expectation of your design, but also the evolution of drawdown. Clearly what we've seen in the industry as a whole is that, even some of the managers who have been around for 2, 3, 4, decades, have seen some level of difference in their drawdown profile in the last few years, compared to the very long history they have. So, maybe you could put that into perspective as well.

Mathias

So, I think you're spot on here. What has been different this time in the current drawdown that the industry is in, is not so much the absolute level or depth, but it's more the time - the length of this drawdown. I think that this...when I talk to peers out there, this is something that many of them mention, especially the ones that have been around for a long time, that this is quite unusual. I think it's majorly due to the central bank behavior I mentioned earlier on in this conversation.

Niels

And for your own part, would you say that the drawdown that you've been through (and I don't necessarily mean the current drawdown, but I just mean the worst drawdown) is that within expectations of all your testing and research, or has that also been impacted by what you just mentioned?

Mathias

Actually our deepest drawdown was not the recent one. This is the longest one, but not the deepest, and even the deepest has been falling within the boundaries of what we expect in our testing, bootstrapping (the theories) many times, so no stress from this side. However, I need also to be totally honest, nobody likes to be in a drawdown, and when it goes on for a long time, there are several factors that pile up. You get punished by markets, of course the client interaction is not easier, but this is also something normal. This is something, in the end to be expected. We need to face this, and if we want to be in this business, we need to be able to stomach it. On a positive note, a drawdown also triggers a huge amount of creativity, and research in many aspects, so I always think there is always a good side to a stress level or to a rather difficult situation with being in a drawdown.

Niels

Absolutely, I agree. It leads me to a couple of other questions on the same subject. One, would be whether you design your systems to have a certain drawdown profile that is within your personal taste, or what you feel you can stomach, or whether you designed your program to show a certain profile of what you think your ideal client can stomach?

Mathias

It's rather the second one. In the end we are here to serve our clients, and we need to take their wishes, their needs into account. It doesn't make sense, in my view, to design a program that makes your life as easy as possible, not creating any emotional stress, and at the same time is not living up to its potential - what it can do for a client.

Niels

To me it's quite an interesting discussion actually, because I think many people would argue that, certainly within trend following, that the bigger the drawdown you can stomach, the more profit you will actually make over the long term. So it is, certainly, an interesting balance to take, even though of course, most people will give the answer that you just gave, that clearly you can't have a product that your clients are not comfortable with, and that makes perfect sense.

Mathias

Let me jump in here. I think it's interesting what you are saying. I have a slightly different opinion. I think, in the end the program profit over time is pretty 'past dependent'. So if you go into too deep of a drawdown, your probability of getting ruined because of redemptions will be very high - 10 to 1, so I strongly feel that there is a natural boundary to a reasonable leverage that you should take, as a manager, if you don't want to gamble your business.

Niels

Sure, sure, and I think that is the balance. It is the business versus what's the optimal trading approach, and those two are not always in sync. Clearly, if people want to be around, then the business-side, usually takes over. But our industry has also seen examples of some very, very famous and great managers who have stuck to their guns, and they may have lost clients along the way, but they certainly made a lot of good returns as well. Before we leave the point of drawdowns, I wanted to ask you a little bit about the emotional side of this, and how you balance this thing about being in a drawdown, and in particular now, where we talk about drawdowns being somewhat long and maybe longer than we used to see, how does that effect you as a portfolio manager to go through this, and what do you do to counteract it?

Mathias

I think you need to take this kind of stress as a stimulus to get creative: creative as a researcher, creative as a business manager by diversifying your offerings - get creative. This is essentially my take on things. Get energy out of it, and as long as you have ideas you can improve, you can do something. In the end it's something good in the long run.

Niels

Sure. Have you ever doubted your system? This environment, as we mentioned now a number of times already, is clearly different and it's certainly not the environment that most systems in this particular strategy are designed for. Has that ever caused you to sit down and look at the screen and say, hmmm, I wonder if we are still doing the right thing?

Mathias

I think it's very important that, if you ever get to such a situation, you actually take a step back and think about what you are actually promising your client. I think, with a CTA, what you promise is to have outstanding returns in times of crisis, and generate a positive return, a positive benefit for the client on average, over time, for the other periods. So this is essentially my take on what I think should be the profile of a good CTA.

Niels

And that is actually a perfect segue to my next topic, because I wanted to talk about research and clearly that is where your creativity is really important. So tell me a little bit about how you and Tilman approach research. What kind of research cycles do you have? What are you looking for, in general, when we talk about research?

Mathias

Let me first talk about research in our program, and then I'll expand a little bit and talk about research in our company as a whole. For this program, Tilman and I are essentially in a constant exchange. We are both interested in what is going on in the market. We really live and breathe this futures markets, so there is always a lot of discussion around various topics. From time to time, these (free flowing), looser discussions condense into topics that we really decide this is something that we need to look into. So from a more loose, brainstorming type of conversation, we will define clear research projects and we will work these projects down in a very disciplined way. Both of us really like to do the research work, and we really like to push in this effort, so we try to always follow a very concise research agenda with clear outputs and also measurable decisions.

Let me elaborate. This research is a very two sided sword. You can do too little, and lose your innovation, or you can do too much and fiddle around too much with your model tweaking parameters, trying to optimize - mostly in sample, what your model is doing and end up with losing the robustness of the model. This is also based on our background in quantitative finance. This is a danger we were very aware of from the start. So we have designed a research process that essentially mostly removes this bias to over optimize in sample. Essentially we have a set of criteria that we need to see fulfilled before we implement a change in our model. We fully, fully need to understand what we change and why. You mentioned the black box, I beg to differ here, we are calling our model a white box. We fully want to understand what our model does and why, because, "I think only then you will have the confidence to trade through a drawdown". So we need to understand what we change and why, then the change needs to bring a significant increase in performance. We have a performance matrix that we have defined, and we want to see, essentially, the overall score of this performance matrix increase above a threshold. If this is the case, we implement the change, otherwise we don't. So far this has actually worked pretty well.

Niels

Can you give me an example of something that you've discovered over the last few years, and maybe describe and say, well this is what we were looking for, this is how we solve the problem?

Mathias

An obvious example is how we create our portfolio. So we had a different portfolio generation mechanism, not a totally different one, but we had a different one in the beginning, and we observed certain effects that we were not pleased with in all situations, and that led us to some ideas. These ideas led to a better approach, a better measure. What we saw in back testing was that this would really increase performance and so that's what we implemented, and I can confirm so far, that (it is proving itself) in live trading.

Niels

Now, of course, many investors will tell you that they want you to innovate, they want you to research, but not all investors want change. How do you balance innovation and research and change, which may lead to some, certainly potential investors to say, "hmmm, you're making a change now, I want to see the next two three years before I decide whether to (go with it)?"

Mathias

Absolutely. This is a very real danger and it goes back to what I said. We value model robustness very highly and we are certainly very aware of the danger of style drift, so that's something we don't do. As I mentioned in the example before, we would not start trading some intra-day patterns now just because we might have had, in the last three months, better results because of it. We are a medium term trend follower and we stay a medium term trend follower with this program.

Niels

What kind of research are you looking at, at the moment? What catches your attention and interest?

Mathias

Now, this leads me to the broader perspective I wanted to bring in as well. So far we've talked about the intra-program research. Being a business manager, I need to make sure that the product offering of the firm stays competitive. As we've seen there are periods that are difficult for CTAs, so it's, for us as a business, certainly good to have products that don't show the same kind of payout profile. A recent big research project that we just concluded is a new equity program that we are going to launch shortly with a high profile Swiss Bank.

Niels

Tell me a little bit more about that. What have you created?

Mathias

Essentially it's a very interesting offering for many clients. This product will give the investor the possibility to be exposed to the long up trend in equities, but removes a lot of the drawdowns and the suffering during bear markets.

Niels

So kind of an asymmetric profile: you keep most of the up side and hopefully no downside.

Mathias

Yes, and here we are strongly building on our expertise in risk management. Because this is a different kind of product offering with clearly different characteristics, at this time we also broadened our view on the information that you can use. Now in a managed futures context, like our big program that we're running at the CTA, you typically depend on price information only. Here we are going much broader, so we're looking at macro economic data, we're looking at market risk data, and we bring them into a consistent quantitative framework that allows us to discriminate regimes: the bull market from the bear market, to say it very simply. This allows us, with a big conviction, to go long or stay long in the bull markets, or get out in the bear markets.

Niels

And is this also a fully automated strategy that essentially has the same implementation as you have in your CTA program?

Mathias

This will also show intra-day stops, and has a long term exposure to equities with rather infrequent trading however. The regimes are changing very infrequently. It's not like a big portfolio shift. So this is, on the one hand, a slower moving approach; and on the other hand is still maintaining this edge of inter-day risk management. If you are running into an '87 crash with this product you are going to have a safety net.

Niels

Sounds very interesting. Now staying on the theme of the business-side. You just mentioned that product innovation can also be a tool to expand the business overall, and I think diversification of product offering makes a lot of sense. There's a couple of things I just want to also talk a little bit about that you have been expose to: one is, for example, location. You've decided to set up your company a little bit away from the busy financial centers. What was the reasoning for this, and do you think it helps you be more creative to be removed a little bit from the pulse of financial centers, or is there anything else that is behind this decision?

Mathias

Yeah, as you know we are located in Wollerau, which is actually just a 1/2 hour drive from downtown Zürich. So it's not really that we're very far away. However, on the other hand, it's extremely tax efficient - one of the most tax efficient places in Switzerland, so this is clearly a good aspect for our company. Being in the countryside, for me personally, is a very good thing because I get a lot of creativity from being in nature, and doing sports. So, yeah, I think I would feel less comfortable sitting in London, for example.

Niels

Sure. Now, again just looking at it from the business side, what's been the biggest challenge do you think, from starting your business? What do you think is the biggest challenge and how do you overcome these challenges when you face them?

Mathias

That's a very good question. I mean, in the beginning the challenge was certainly to get fully up and running in a professional way. So we did that the first time and it certainly took a lot of effort to get to the professional level that we are today with our full automation, and highly competitive IT infrastructure. That was certainly a big challenge, but also a very interesting one, I must say I liked it a lot. Now, looking forward, the big challenge will certainly be to convince investors that the trends are not just dead forever. That they need to be patient, (we need to be able) to explain well, to them, what is going on and what they can expect in the long run, so I think client retention will be a big challenge, (as it will be) for everybody in the CTA industry right now. The next big challenge is certainly to launch this additional product. We also have others in the pipeline. I don't want to go too deep into that right now, but to (say our goal is to) successfully launch these new products - that's the next big challenge. In the medium term I think that (all the) regulations in Switzerland can get almost overwhelming, and poses a serious threat to the competitiveness of smaller managers.

Niels

Sure.

Mathias

So here we clearly need to find answers, and we are actively working around these issues as well.

Niels

Sure. I also wanted to ask a completely different question. I don't know whether you have an opinion about this, but the CTA industry started off as being very US centric, and a lot of the names from back in the '80s and even '70s - some of them are still around, at that time of course, the US managers were dominating this industry. But in the last 10 years or so it seems like the industry has moved east to Europe. European managers have become the powerhouses of this industry. Why do you think that is? You've clearly studied some of the US managers and the history of the CTA industry before launching your own, is there anything that you think has attributed to this change? Is there something that European managers do or the way that they look, maybe more scientific, than your classic trend follower, or why do you think that change has taken place?

Mathias

I think it's a very interesting observation. I tend to agree with you. In the '80s, and until well into the '90s, the Americans were dominating. Then you saw the likes of AHL, Winton, Aspect, BlueTrend, growing. Clearly European firms are very academically rooted. They got very big.

Now, let me share with you my perspective on how I think the industry will evolve from the facts that we have stated so far. What I think right now is that we are in a major industrialization of the finance industry, and the CTA industry is no exception. So we got very big. Right now I think we will see a massive margin squeeze. I think a lot of offerings, for example AQR, Pimco Comp. have very competitive rates, which brings up the question of what the performance of these more passive products will look like. But never the less, they are here. And I think we will see something that we have seen, for example, in the automotive industry a long time ago, (and that is) that you essentially will see a kind of a barbell situation, where you have the very big shops (that need to be super efficient, very cost sensitive and will have rather low fees), and then you will see the boutique shops (who have specialization in certain markets - a clear edge), similar to the difference between Volkswagen and maybe Lamborghini - the one is the mass market, and the other is the boutique - higher priced with special clientele and a clear profile. The other's very efficient and very industrialized. I think this is where we are going and maybe the pendulum swings a little bit back now in favor of the Americans. I would not even call it the Americans now, more the specialists who have deep market insights, a very good idea what they trade and good intuition. Think about the big market that is opening right now in China. So many interesting future markets are there, very different price dynamics than here, and I think that this is, for example, one market where specialists know-how can make a difference. So I think there will be space for both: very focused, very smart, small shops - boutiques; and then there will be the big industry conglomerates ( to say it in a very extreme way), who have more streamlined cost based production centers, and rather competitive cost structure.

Niels

Interesting. I think I don't disagree with what you say, but I think it requires certainly one thing and that is a mental shift from the investors, because clearly, at the moment, it would seem that big is beautiful, and that people certainly take comfort in size relative to any other thing except if you are so exceptional, from a performance point of view, that they can't ignore you. So, I think what you are saying makes sense, but it's going to require some change in a bigger shape within the investor community as well.

Mathias

Yes, I tend to agree. It will also require a more benevolent environment for the CTAs in general. In times of stress and times of subpar performance, many investors would rather take confidence in bigger structures because at least they know they cannot err too much with so much other capital betting on the same horse. We might see that change when the industry gets back to new highs and the market environment gets more interesting for real pure CTA strategies and less of this asset allocation behavior that we see from many big CTAs right now.

Niels

Sure, sure. What does it take, in your opinion, to become a great trader or a great CTA? What are the traits that you need to have as a human being to strive in this industry?

Mathias

You know, to become a great manager. I think you need to have two sets of characteristics. One is to be a good trader, and the other is to be a good business man. That's how I define success. It is to be successful in business by being a good trader. Now (what I am about to share) this is not necessarily the same kind of characteristics that would make a good trader and a good business man, but I can share my opinion on what it takes to become a good trader, just speaking about myself. I think a good trader needs to have really solid in depth market knowhow. He needs to understand markets, he needs to have a big passion for markets, he needs to be totally interested in markets. I think this is a very, very key and obvious characteristic. Now, these are more the cognitive aspects of being a good trader. You cannot neglect the emotional side. I think you need to be emotionally stable enough to not get panicky if things are not working well. But on the other side not get exuberant when you are making a big buck. These characteristics are very important. (Knowing) the markets, (having) the basic know how, (utilizing) quantitative technology, but also the emotional stability (are all needed). Then on the business side, I think it's important to have a good strategic vision - where you want to go. Then a good discipline to implement the measures to reach these targets. Finally, the bigger you grow, you need to have a certain way of dealing with people that you can be a good leader in an organization, and inspire the next generation of people and create a great atmosphere within the company. I think these are the important things.

Niels

And talking about aspiration, but in a different way, when you were starting out, and even today, are there any of the big firms, the brands that we all know, that you aspire to?

Mathias

No, not necessarily. I think in the end it's important that everybody finds his or her own way, and I think I certainly admire or recognize all these achievements, but in the end I don't want to just aspire to become someone else. I want to really fulfill our potential at All Mountain Capital.

Niels

Now, Mathias, did you always want to become an entrepreneur, or was that something that just came to you because of the opportunity of taking the program out of Horizon 21 suddenly materialized, or has this always been your dream?

Mathias

Actually, I always had it in the back of my head, so I kind of wanted to get the education and the working experience that would enable me to become an entrepreneur one day. This is probably a little bit of a family legacy. I have some pretty successful uncles as business men and I always liked the way they worked. I liked them a lot as people, so for me this was certainly an inspiration to become an entrepreneur myself. I must say I love this lifestyle, and in the end, the responsibility it brings, and I happily accept the additional work that comes with it.

Niels

Sure, sure. Fantastic. Now based on everything that you've learned, in your career, if you were starting out today, what would you do differently do you think if anything?

Mathias

That's a difficult question actually. (laugh)

Niels

(laugh) I didn't say it was going to be easy.

Mathias

Niels

What would that have made you do differently if you had that understanding? Would that have forced you to do your additional product offering at that time, is that what you're saying, that it's better to have more legs on the stool, so to speak, than just focusing on one product, or is there something else you mean when you say that?

Mathias

Of course it's a very hypothetical question. Also I want to be realistic. There are only that many resources that you can dedicate to projects, but retrospectively, it would certainly have been good to start diversifying our product offering earlier. That's for sure, yeah. We would certainly, if we now already had a suite of products up and running, weather the storm easier.

Niels

Sure. Now we've been speaking for almost an hour and a half, so this is a great conversation, and very much appreciated. I only have a few more things that I wanted to ask you which are not really related to your program or trading as such. But, if you could ask a question of the next guest on Top Traders Unplugged, probably some of your peers, what would you ask them?

Mathias

Well, I would ask them, where do you see the CTA industry in 10 years from now - Not in 2, but in 10?

Niels

I will make a note of that. Now, final question, is there any fun fact - because this is also about getting to know you as a person and not just about the program and the risk management and all these quantitative things, but the real people behind the systems, the models - is there a fun fact that you can tell me about yourself that most people wouldn't know?

Mathias

(laugh) That's a very good question. Look, I think it's pretty well known that I'm quite a family person, that I love action sports, be it kite surfing, be it mountain biking, or skiing, what is probably less known about me, I don't know if it qualifies for a fun fact, (laugh) certainly a bit less known about me is that I totally love music and I played an instrument myself until I was about 20, and then I stopped it also because of my education and everything, but today I absolutely love music. I listen to a lot of different music, be it world music, or contemporary, country, Americana, be it classical music, or fusion jazz, or even like a heavy dose of heavy metal.

Niels

Fantastic, and may I ask what instrument you played?

Mathias

I played trombone.

Niels

Wow, that's unusual if I may say. Mathias, before we finish our conversation, could you tell our listeners where they can best reach out to you and learn more about All Mountain Capital?

Mathias

Yes, sure, best go to www.allmountaincapital.com. You will see a web page with some basic information and then you can click on what you are interested in most. You just need to register to unlock everything and you have full access. There you will also find our phone number. I'm very happy if you give us a call. I'm happy to continue the discussion with you personally or answer whatever question you might have.

Niels

Fantastic. Mathias, thank you ever so much. This has been a great conversation and I really appreciate your openness and your willingness to share your insights and views on your own strategy, of course, your firm and also our industry as a whole, and of course our listeners can find all the details of today's discussion in the show notes for this episode on TOPTRADERSUNPLUGGED.COM. So I hope that we can connect at a later stage to get an update and see how all the great work that you do pans out, and of course the launch of your new product. So, thank you so much again, and take care.

Mathias

Thank you very much Niels.

Ending

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