Shownotes
Join us for a fascinating and in-depth conversation with Rob Carver, where we’ll discuss the current state of gold, the impact of rising borrowing costs on futures pricing, and how these elements intertwine with market trends. Along the way, we’ll tackle listener questions that challenge the status quo, digging into everything from fees in the hedge fund world to the implications of recent political shifts. It's a jam-packed session for anyone looking to get a clearer picture of the investment landscape today.
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Episode TimeStamps:
01:07 - What on earth is going on with gold?
04:58 - The hidden fees of the hedge fund world
11:25 - Industry performance update
15:00 - Q1, David: Since Rob's book was published, several multi-asset leveraged ETFs have become available. Do you think these products have a place in a long-term portfolio? If so, what kind of allocation would you consider reasonable?
21:17 - Q2, Carlos: Imagine a systematically traded trend following account starting with $100k across 10 markets. Over time, the account grows to $200k. Would it generally be “better” to split the capital into two separate and different trading strategies (each trading 10 instruments), or to add more instruments/markets to the existing strategy for greater market diversification?
24:49 - Q3, Chris: Does the use of ETFs to backtest Rob’s trend following strategies provide an accurate representation of performance?
29:41 - Q4, Steve: Any pointers on how to use predictive modelling techniques (linear regression, etc) and how would we combine it with your forecast scaling framework. Also can you comment on potential objective functions to use?
32:54 - Q5, Vik: Once you’ve included established risk premia rules like trend, carry, and fundamental valuations, do most research efforts by experienced teams in big and small firms amount to just fancy branding exercises? In a competitive environment where everyone is working with more or less the same data, is it possible to meaningfully move the needle?
38:19 - Q6, Andrew: Approximately about a year and a half ago or more you published on X that you were making a discretionary trade increasing your bond position. I am Just curious how that trade worked out and if you think, in retrospect, that discretionary call was correct? And are there any learnings for the rest of us about when to know if a discretionary call makes sense?
40:33 - Q7, Paul: What is the benefits/drawbacks of having an absolute strategy, that just looked at if the post returns were positive or negative (rather than relative to the performance of the asset class)?
43:12 - Q8, Samuel: What does the research say (if any) of trend following strategies that don't rely on lagging indicators? To your knowledge has anyone done any studies using the current state of monthly/quarterly/yearly candles for a trend following system?
48:41 - Q9, CryptoCaptain: How to handle missing data when contracts get delisted and then re-listed. Chatgpt suggested that I use Co-integration and Error Correction Models to fill the missing data because the larger contract data is available. What are other things I can try out?
52:01 - Key insights from Quantica on position sizing
55:14 - What should we be paying for risk?
59:10 - Should you still optimize for sharpe?
01:02:10 - Trends and Reversions in Financial Markets
01:09:43 - The economic consequences of Donald Trump
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1. eBooks that cover key topics that you need to know about
In my eBooks, I put together some key discoveries and things I have learnt during the more than 3 decades I have worked in the Trend Following industry, which I hope you will find useful. Click Here
2. Daily Trend Barometer and Market Score
One of the things I’m really proud of, is the fact that I have managed to published the Trend Barometer and Market Score each day for more than a decade...as these tools are really good at describing the environment for trend following managers as well as giving insights into the general positioning of a trend following strategy! Click Here
3. Other Resources that can help you
And if you are hungry for more useful resources from the trend following world...check out some precious resources that I have found over the years to be really valuable. Click Here
Transcripts
You're about to join Niels Kaastrup-Larsen on a raw and honest
Speaker:journey into the world of systematic investing and learn about
Speaker:the most dependable and consistent yet often overlooked investment
Speaker:strategy. Welcome to the Systematic Investor Series.
Speaker:Welcome and welcome back to this week's edition of the Systematic
Speaker:Investor series with Rob Carver and I, Niels Kaastrup-Larsen,
Speaker:where each week we take the pulse of the global market through
Speaker:the lens of a rules-based investor.
Rob,it is great to have
Speaker:you back this week. I think actually it's the first time in 2025.
Speaker:So how are things on your side? How are things in the UK?
Speaker:Things are fine. It's a bit cold and damp here and I've actually
Speaker:had, I've got a cold, which I've had for several weeks and isn't
Speaker:going away.
So,listeners should be aware that if there's any
Speaker:weird gaps in the conversation, it's because the editors
Speaker:had to take out about five minutes of me coughing. My voice
Speaker:sounds even sort of lower and gravelier than usual as well.
Speaker:Fair enough. I'm sure we'll work our way through that.
Weare,
Speaker:however, going to keep you pretty busy talking today because
Speaker:we’ve got a ton of questions in for you, which is great, so we
Speaker:much appreciate that. But before we even get to that, let me
Speaker:just ask you the usual question and that is, since we last
Speaker:spoke, lots of things have happened. Anything in particular
Speaker:that stuck on your radar the last few weeks?
Speaker:Yeah, I mean, something that's come up quite recently actually is
Speaker:what on earth is going on with gold? Right?
Imean,so, gold's gone
Speaker:up, which, you know, is one of these things that happens. And the
Speaker:causes of it, we could argue about - instability and uncertainty
Speaker:politically, which is interesting. But the thing that I
Speaker:find interesting about this specific thing is that there's some
Speaker:kind of weird technical stuff going on in the background.
So,according
Speaker:to market reports, what's happening is that gold is basically
Speaker:being moved from London to the US. And I'm not sure whether that's
Speaker:a physical movement or the gold bars are staying in the same
Speaker:place, but the kind of legal right to it is moving. I'm not completely
Speaker:familiar with what's going on there. And what's happening as a
Speaker:result is that…
So,when gold is a futures contract, like a lot
Speaker:of futures contracts, the futures price will depend on the
Speaker:spot price plus any kind of yield that you earn on it, less the
Speaker:interest rates for funding the position. But because gold doesn't
Speaker:earn a yield, you actually have to effectively put in essentially
Speaker:a borrowing cost and a storage cost.
So,the storage cost is, you
Speaker:know, if you've got a lot of gold in a warehouse, you've got to
Speaker:hire people with guns and thick walls and stuff to keep it
Speaker:safe, I guess, keep it underground somewhere.
Butactually,
Speaker:amortized over a large amount of gold, the storage cost isn't very
Speaker:much. So, what really drives the difference in the futures and
Speaker:the spot price is the borrowing cost. And borrowing costs
Speaker:have just exploded. I mean they're up something like they normally
Speaker:follow pretty closely the sort of “risk free rates”. You'd expect
Speaker:them to be about kind of 4.50%, 5%.
Likeroughly the kind
Speaker:of sort of Fed dollar rate, borrowing rates, because gold is
Speaker:priced in dollars of course. But actually, they've jumped up to
Speaker:like 10%, 11%, 12% which is just crazy because of this weird
Speaker:imbalance in inventories across warehouses.
Andif I look
Speaker:at the futures price at the moment, so, for example, gold for
Speaker:delivery in say December is 150 points or something like that,
Speaker:which it's up to about 10% annualized over the spot price, which
Speaker:is just weird. So, we have this interesting situation where,
Speaker:as a futures trader, gold is going up. I want to bet on gold going
Speaker:up.
Andactually, if I look at my own forecasts, I've got a long
Speaker:position on gold and on silver incidentally, and on Bitcoin (which,
Speaker:you know, it's digital gold, isn't it?). But the cost of carry
Speaker:on that position is negative because the future is well above
Speaker:the spot price.
So,it's one of those weird situations where you
Speaker:are kind of getting mixed signals from the price movement and
Speaker:the carry movement. And I love this sort of weird technical stuff
Speaker:that goes on underneath futures markets. And this is an interesting
Speaker:example of it. So, we'll see what happens over the next few weeks.
Speaker:Yeah, I had not picked up on that. Well, I will say I have been
Speaker:traveling for about a month, so, I guess that slipped my radar.
Speaker:So, I'm glad you brought it up.
Doesit say anything about, about
Speaker:who's moving their gold back to New York?
Speaker:I'm looking at the article. So, there's been a few articles.
Speaker:Some of them are in the less kind of accurate end of the financial
Speaker:press, shall we say.
ButI'm looking at the Financial Times, which
Speaker:is normally pretty accurate and, and it doesn't say so. So yeah,
Speaker:it's a mystery to me exactly what's going on. I'm sure that you
Speaker:can read all kinds of conspiracy theories on the Internet,
Speaker:but fair enough. But for the time being, yeah, it's definitely
Speaker:causing some issues.
Speaker:Yeah, very interesting. Thanks for bringing that up.
Forme, what
Speaker:hit my desk this week was an interesting, but maybe not sort of
Speaker:surprising in some ways, article that Bloomberg had about
Speaker:fees in the “hedge fund world”. And both you and I are old
Speaker:enough to remember when the traditional model 2 and 20 was the
Speaker:norm. Then, over the years, it was seen as being very rich and way
Speaker:too high for most investors. I think a lot of institutional investors
Speaker:certainly also helped push fees down in our industry.
Andinterestingly
Speaker:enough, of course now, actually the 2 and 20 model can be
Speaker:seen as pretty cheap and that probably needs to be explained somewhat.
Speaker:And it's this article on Bloomberg that basically compares
Speaker:the 2 and 20 model to the new multi strat/pod shop pass-through
Speaker:model.
ImeanI have to say it's pretty scary reading if you're
Speaker:an investor paying those fees. Although I do accept that the net
Speaker:return has been, for the most part, very good.
Butthere are some
Speaker:examples, and I'm not going to go through all of them. But there
Speaker:is, for example, one quote where they estimate clients are effectively
Speaker:paying something like 7 and 20 or even up to 15 and 20 - compare
Speaker:that to the 2 and 20 that hedge funds was known for.
Andit
Speaker:all starts out with a comparison of how much was left by
Speaker:investors or for investors, I should say, from the gain of around,
Speaker:was it 15.2% gain that the Balyyasny Asset Enhanced Offshore
Speaker:Fund delivered in 2023. Before fees it delivered 15.2%. After fees,
Speaker:what the client got was 2.8%.
Now,I have argued before that, of
Speaker:course, the net return is the most important thing to some extent.
Speaker:What surprises me, really, and I'm not sure it's covered by the
Speaker:article as such, is that we've seen (as many know) an enormous amount
Speaker:of interest and growth and money being allocated to this space.
Speaker:It's kind of the new thing in our world.
Andthat, you know, leads
Speaker:me to believe that this must be large institutions that can allocate
Speaker:this amount of capital. Otherwise, it just wouldn't be these
Speaker:numbers that we are talking about.
Andso, if that is the case,
Speaker:then I will say I am surprised that some of these pension funds,
Speaker:insurance companies, et cetera, et cetera, are accepting
Speaker:the level of fees being put on these investments, at least compared
Speaker:to what I have seen in my career in terms of pushback from
Speaker:large investors, even in the low, relatively low fee world that
Speaker:I've been operating in. So, that actually is something that caught
Speaker:my eye. I know I sent the link to you. I don't know if you had a
Speaker:chance to look at it or had any thoughts.
Speaker:I was sort of aware of this discussion, and actually I think
Speaker:it's interesting because I think it comes down to transparency.
Speaker:I think, for right or for wrong, the old model where we were
Speaker:like, “this is our management fee, this is our performance fee”,
Speaker:was very clear and transparent. Whereas now it's like,
Speaker:well, we have these management fee performance fees, but they're
Speaker:quite low. And then there are these other fees kind of falling
Speaker:out of the back door of the fund that you can't necessarily see
Speaker:because everything's been charged effectively to the client's
Speaker:account.
So,I think the issue might be that institutions just look
Speaker:at, as you say, look at the net performance, look at the kind
Speaker:of headline fees, and think, well, this seems fine without realizing
Speaker:that there's all this money kind of disappearing out the back
Speaker:door almost invisibly. So, yeah, I mean, it's not a new problem
Speaker:in the sense that if you think about a kind of fund of funds model.
Speaker:So,you know, before Mr. Madoff came along, the fund of funds
Speaker:business was the way that people tended to get exposure to
Speaker:lots of different hedge fund strategies at the same time. The
Speaker:sort of multi strategy pod shop was less common.
Butin that
Speaker:model, you had the issue where, for example, if you had managers
Speaker:that were doing really well, but the overall portfolio was doing
Speaker:badly, you'd have to pay performance fees to the managers
Speaker:that were doing well. So that's another issue with the pods.
Speaker:Imean,if you're sitting in your pod and the whole strat fund,
Speaker:as a whole, is down, you're still going to want to get paid.
Speaker:And the pod guys want to keep these guys sitting there in their
Speaker:seats, so they're still going to pay them their bonuses even if
Speaker:the fund overall is losing money. And that's another thing that
Speaker:kind of ratchets up the overall expenses.
So,that specific
Speaker:issue is not new, but I think the issue of the transparency of
Speaker:costs, I mean, I feel like we're going backwards. Because in
Speaker:the retail world, transparency costs actually improved a lot. If
Speaker:you look at things like UCITS, the transparency costs is much better
Speaker:for the retail investors. But it seems like these multi strategy
Speaker:pods are taking a step backwards in terms of transparency,
Speaker:which I don't think is a good thing, frankly.
Speaker:No, neither do I actually.
AlthoughI will say someone mentioned
Speaker:to me that even the UCITS space, you can now find examples
Speaker:of people, if you read the perspectives close enough, where
Speaker:you have the official fee. So, everybody says, oh yeah, that's great,
Speaker:and they may even state a certain expense ratio. But then when
Speaker:you drill down, there are some other costs, like research costs,
Speaker:et cetera, et cetera, that crop up. And so that's a little bit
Speaker:worrisome if we start seeing that in the UCITS space because it
Speaker:really should be crystal clear, from the expense ratio, what
Speaker:people are paying and what people are not paying for.
Okay,so
Speaker:let's leave that aside because I do want to just very briefly mention
Speaker:one other thing because it was on my radar when I saw it. It was
Speaker:just this picture of Elon Musk with one of his many children on
Speaker:his shoulders in the Oval Office. I don't want to make this
Speaker:political, but I thought it was very telling of the times we
Speaker:live in. And then people have to make up their own mind as to what
Speaker:they think of it. I know we're going to come back to some of this
Speaker:a little bit later, but from an economic point, of course.
Anyways,it's
Speaker:too bad people can't see your face right now, Rob, because you
Speaker:really want to say something. But I will now gently move on to
Speaker:the trend following update that has also been very interesting.
Speaker:I'm really curious to hear your thoughts on the first six, seven
Speaker:weeks of the year.
Now,as far as I can tell from looking at the
Speaker:indices, it's been a mixed start across the industry. Different
Speaker:managers doing, you know, well, not so well in terms of performance.
Speaker:The CT indices are not moving a lot, frankly, away from zero. Some
Speaker:above, some, some below.
Obviouslywhen you think about the
Speaker:market moves we've had so far, you would think things like equities
Speaker:have done well for trend followers, coffee, even some of the
Speaker:metals. You mentioned gold, for sure. And frankly, also, at least
Speaker:if you have a longer term horizon, I would have thought that
Speaker:fixed income had also done okay, despite the recent rally we
Speaker:saw in bonds. But now it's selling off again with the latest
Speaker:inflation figures.
Theonly thing I can kind of see, from my
Speaker:vantage point, that has been a little bit tricky this year has been
Speaker:the currency sector, and that's mostly been in February actually.
Speaker:So, does this resonate with what you're seeing in your different
Speaker:models?
Speaker:To be honest, I've not looked at my performance. So, I'm actually
Speaker:just going to do that now. From memory, my gut feeling is that
Speaker:I think I'm sort of up a little bit this year. But, if you
Speaker:give me a moment, I'll be able to tell you for sure.
Speaker:Yeah, no, I'm just curious to see because obviously all managers
Speaker:are different so these could also just be general observations
Speaker:even though I'm sure you don't follow…
Speaker:I'm up like 1% for the year, so, basically noise, to be honest.
Speaker:And that consists of being down about 1 1/2% in January and
Speaker:then, so far, in February being up like 2 1/2%.
So,not very
Speaker:meaningful to be honest.
Speaker:No.
Myown trend barometer finished yesterday at 30 which is
Speaker:actually a weak reading. But, again, it’s a different time frame
Speaker:for what I use for calculating that to what we see in the indices
Speaker:will also play a role. I think yesterday, which was Wednesday, probably
Speaker:was an up day for most people.
Anyways,in terms of numbers, BTOP50
Speaker:is up 46 basis points as of Tuesday, up 1.68% so far this year.
Speaker:So that's actually doing the best of all of the indices. SocGen
Speaker:CTA index up 15 basis points in February, up 77 basis points for
Speaker:the year. The Trend Index up 42 basis points so far in Feb, and
Speaker:only up 57 basis points this year. And the Short Term Traders
Speaker:Index down 18 basis points in Feb, and down 12 basis points in
Speaker:this year so far, and continues to struggle, frankly. I
Speaker:talked a little bit with Tom about that a few weeks ago. And so,
Speaker:I'll probably bring that up with him next time he's on the podcast.
Speaker:MSCIWorld up 30 basis points in Feb, and up 3.79 so far this year.
Speaker:And the 20+ Year S&P Treasury Bond index is down 32 basis points
Speaker:(it obviously was hit a bit by these new inflation numbers), but
Speaker:still up 15 basis points so far this year. And the S&P 500 Total
Speaker:Return is pretty flat, up about a quarter percent this month,
Speaker:and up 3% so far this year.
Allright, as I mentioned, we have
Speaker:a ton of questions in which is great. Now, first of all, some of
Speaker:them are long to read and I'm going to stumble across them, but
Speaker:I'm going to do my best. Some of it is also a little bit technical,
Speaker:although I have tried to weed out at least one that I thought was
Speaker:just maybe too narrow because we want something that is something
Speaker:that many people can benefit from. So, we'll do our best.
Weobviously
Speaker:take the questions as they come, but just bear with us and then
Speaker:we'll move on to your topics which are truly very, very interesting,
Speaker:Rob. So, let's do it.
So.the first question is from David, all
Speaker:the way from Spain. “Thank you both for creating such a high quality
Speaker:content for retail investors. I've been studying Rob's book and
Speaker:working on putting the concepts into practice both for a
Speaker:long only portfolio and a managed futures portfolio. Question
Speaker:for Rob, I've been studying smart portfolios and am in the process
Speaker:of designing my own portfolio.
Sincethe book was published, several
Speaker:multi asset leverage ETFs have become available such as the WisdomTree
Speaker:Efficient Core, series such as the WisdomTree EF, and a one and
Speaker:a half times leveraged 60/40 US Equity Bond ETF. And there are
Speaker:some return stack portfolios, as he mentions. Anyways, the question
Speaker:is, do you think these products have a place in a long term
Speaker:portfolio? If so, what kind of allocation would you consider reasonable?”
Speaker:Now,I want to preface this, David, and to all the other questions.
Speaker:Of course, we do not provide investment advice on the podcast,
Speaker:and of course each of us will just voice our own opinion. So, it'll
Speaker:be as much as we can say. But don't take it as investment advice.
Speaker:Definitely not. Because I'm actually not regulated to give investment
Speaker:advice anywhere. So, I used to be, but not anymore.
Soyeah, this
Speaker:is an interesting one because actually if you do read smart portfolios
Speaker:and this is a kind of good general piece of advice, leveraged
Speaker:ETFs are generally a little bit dangerous, especially for holding
Speaker:for long periods of time. What happens is, if they go down a lot
Speaker:and then go up by the same amount, if they go down 10% and they
Speaker:go up 10%, you actually end up down. So, you're not back where you
Speaker:started and then that's leverage. So, instead of going down
Speaker:10%, you go down 20% and then up 20% and again you're even further
Speaker:back from where you started.
So,what will happen over a long
Speaker:period of time, with very volatile assets, is the value of
Speaker:these will tend to drift down. So, if you're underlying is something
Speaker:that's already quite volatile, like say the S&P 500, or let's get
Speaker:really silly and look at, say, MicroStrategy, it's called strategy
Speaker:now isn't it? The strategy company, which is basically just
Speaker:a bag of Bitcoin which you can buy at twice the value of the Bitcoin
Speaker:plus a small software business. I would definitely not,
Speaker:in a million years, buy a leveraged ETF on that because the
Speaker:underlying is very volatile and the value of that's going to
Speaker:end up getting sucked down to zero over time with these large volatile
Speaker:movements.
Nowto get technical for a second, the appropriate
Speaker:level of leverage and risk depends on something called the Kelly
Speaker:criteria, which depends on the expected performance of the thing
Speaker:you're investing in. And that's true for ETF, it's true for
Speaker:someone targeting a futures trend following strategy or anything
Speaker:like that. And so, as a rule of thumb, if you kind of say, well,
Speaker:if the risk you're getting on something is more than about 20%,
Speaker:25%, 30%, it's potentially quite likely that that's going to
Speaker:be more than the amount of risk you should actually be taking
Speaker:because it's unlikely that your performance will end up being
Speaker:high enough to justify that.
Sothat's why, for example, I wouldn't
Speaker:invest in say a two-times leveraged S&P 500 ETF because that's
Speaker:going to have volatility of 30%, 40% a year, which I think is
Speaker:too high. I’m certainly not investing in a strategy times two
Speaker:ETF because that's going to have a volatility of hundreds of
Speaker:percent, probably.
Nowthese particular products though, so, if
Speaker:you look at say 60/40 leveraged by times 1.5, that's probably
Speaker:going to have (I've not looked at the product documentation), just
Speaker:off the top of my head, I would imagine that's going to have
Speaker:a volatility of somewhere around the 12%, 13%, 14% level, something
Speaker:like that, 15% maybe. So, on that basis, I'd say that that's probably
Speaker:okay, that's probably a reasonably safe thing to invest in,
Speaker:just purely from whether the leverage is appropriate or not.
Notwith
Speaker:any respect as to whether 60/40 is a good investment, or whether
Speaker:that particular product is a good investment, or whether the fees
Speaker:on that particular product are a reasonable level because I haven't
Speaker:looked at any of that stuff. The return stack stuff, again, so,
Speaker:it's two times leveraged S&P plus managed futures. That's a little
Speaker:bit, sounding a little bit scarier.
Idoknow and have a great
Speaker:deal of respect for the people that actually launched this product.
Speaker:So, you know, they're very sensible people who think very carefully
Speaker:about what they're doing. So, for that I'm not going to just say,
Speaker:oh, it's probably fine. I'm saying, okay, I'd want to have a
Speaker:close look at the documentation, look at the volatility
Speaker:of that product and look at how that's come out.
AndI would
Speaker:be a little bit skeptical and a little bit concerned because it's
Speaker:probably relying on the fact that, if you look at the risk of
Speaker:that thing, if the correlation of managed futures and S&P stays
Speaker:relatively low, then it's going to have a lowish risk, and
Speaker:applying some leverage to it is going to be fairly safe. The risk
Speaker:is potentially, of course, if the correlation of those two things
Speaker:increases and stays increased for a long period of time, then the
Speaker:volatility is going to be higher and it may potentially then
Speaker:be beyond the level which I'd consider a safe level of leverage.
Speaker:So,I'm reasonably comfortable with 1 1/2 times 60/40. I'd need
Speaker:to think quite carefully about 2 times S&P plus anything, never
Speaker:mind managed futures. And as to what allocation, you'd have those
Speaker:in your portfolio. Well, I mean, you know, that's an impossible
Speaker:question to answer in a short period of time because it's very
Speaker:much going to depend on what's in the rest of your portfolio, to
Speaker:be honest.
Speaker:Next question is from Carlos and with some of the questions that
Speaker:I can sort of quickly overstate oversee here, I'm going
Speaker:to rephrase them and make it shorter just so we have more time
Speaker:actually.
ButCarlos brings up an interesting question I thought
Speaker:actually, and that is, if you start out with a trading account
Speaker:where you are able to trade 10 markets but you're just using one
Speaker:model for that, you know, could be, you know, one approach,
Speaker:call it that. If you then suddenly have more money, would you
Speaker:then rather split the money and trade, you know, equal amounts
Speaker:of money but using more systems (so, say, a system 2 and
Speaker:trading the same markets), or would you add more markets to your
Speaker:model that you're already running?
Iknowthis is of course
Speaker:completely impossible to answer without lots of research,
Speaker:but philosophically I guess the question is, do you gain more
Speaker:from diversifying on models than you do on markets?
Speaker:I love the way you give me all these impossible questions, Niels.
Speaker:I really appreciate that.
Speaker:Well, Carlos actually gave it to us.
Speaker:Oh Carlos. Anyway, thanks Carlos.
Okay,so the answer is it
Speaker:depends, right?
So,if for example, your trend following system
Speaker:was relatively undiversified and just consisted of a single trading
Speaker:speed and then you were thinking about adding something to
Speaker:that, well, it's quite likely you'll get more diversification from
Speaker:adding more markets than by adding further trend following systems
Speaker:which are fairly similar. Because it comes purely under correlation.
Speaker:So,the extra markets going in are probably going to have a correlation
Speaker:of 0.4, 0.5 with the ones that are in there, something like that.
Speaker:Another trend following system might have a correlation of 0.8 0.9
Speaker:because there are only so many ways you can do trend following,
Speaker:even if you're doing it at different speeds, it's going to be
Speaker:fairly similar. So, I probably instinctively go towards more markets
Speaker:with my first answer.
Whenwould be a case when you wouldn't
Speaker:do that? Well, if you've already got quite a lot of markets,
Speaker:for example, then the additional markets going in are going
Speaker:to have a very small marginal benefit to the existing portfolio.
Speaker:Andif you're then adding not just under the trend flowing system,
Speaker:but something that's a bit different, like say carry, which
Speaker:we talked about briefly when we talk about gold earlier, then
Speaker:that potentially has got a correlation of maybe only about 0.7
Speaker:with the existing system. So, at that point the pendulum swings
Speaker:from more markets being better to a different system being better.
Speaker:Andthe other advantage of adding systems is at least if you
Speaker:do it the way that I do it, you don't actually need more capital
Speaker:to do that. So, adding systems is virtually free as far as capital
Speaker:goes, whereas adding markets isn't.
So,my answer is yes, markets,
Speaker:definitely. But given that adding systems is sort of “free”
Speaker:if you're fully automated, it's just a matter of writing some
Speaker:code. You know, obviously you lose a bit in terms of intuitively
Speaker:and complexity of your system. I wouldn't, you know, rule out completely.
Speaker:I wouldn't just add a thousand different signals to my model just
Speaker:because they all might produce a tiny marginal increase. I think
Speaker:there's a point at which that's not really adding any real
Speaker:value.
Butyeah, markets first is my normal instinctive answer to
Speaker:that question.
Speaker:Yeah, that makes perfect sense.
Allright, we're going to
Speaker:jump to a quick question from Chris again. I'm going to try and
Speaker:summarize it.
EssentiallyChris is asking you,
Speaker:Rob, whether using ETFs to backtest trend following strategies,
Speaker:you know, will give an accurate representation of performance.
Speaker:Of course, Chris is aware of the challenges with rolling inside
Speaker:an ETF if it's based on futures, but also compared to obviously
Speaker:having to roll yourself if you're using futures contracts in
Speaker:your backtest. Any thoughts on this particular issue?
Speaker:Well, the first question I have is what are you actually going
Speaker:to trade, Chris? I mean if you're going to trade futures, then
Speaker:you really probably should be using futures to actually do your
Speaker:backtesting with. If, on the other hand, you are trading ETFs
Speaker:then it would probably be better, if you can, to use ETFs to
Speaker:do your backtesting with.
So,with that in mind, what are the
Speaker:differences between, say, holding an ETF which has underlying
Speaker:it some contracts like, say, the Bitcoin ETFs that have futures
Speaker:underneath them and holding the actual future itself? So, what
Speaker:are the differences between doing it one way or the other?
Well,one
Speaker:difference is fees. So, there'll be fees applied to the ETF
Speaker:product and costs. And as we've discussed already, some of
Speaker:those costs may be obvious, some not be obvious, but what costs
Speaker:are those people going to have to pay? I mean, obviously they're
Speaker:going to have to pay some administrative costs, they want some
Speaker:profits.
Andthere'll also be trading costs from rolling from one
Speaker:contract to the next. And of all of those costs, the only one
Speaker:that you'd have to pay in the futures space is the actual rolling
Speaker:costs. So, you know, you should be able to get a rough idea
Speaker:of how much it's going to cost you to roll and then compare that
Speaker:with the total annual expense ratio of the ETF and then check that
Speaker:does include everything that you think it includes and there's
Speaker:no hidden stuff coming out of the back, and that'll give you a
Speaker:fair comparison.
Andultimately, you're probably going
Speaker:to end up paying a bit more for the ETF, I would imagine, because
Speaker:although, in principle, a big asset manager has got economies of
Speaker:scale and can actually probably end up getting lower costs
Speaker:than you can potentially, because they're big they're going
Speaker:to have more slippage, so they'll end up with higher costs.
Speaker:And secondly, because they've got to make a profit and support
Speaker:all of these, you know, various functions, they're going
Speaker:to have higher costs coming in there. So, all the things being equal,
Speaker:I would expect the ETF to cost more money.
Speaker:Yeah, and one final thing I just want to add to that, Chris,
Speaker:and that is just be aware also of liquidity. A lot of ETFs have
Speaker:been issued, but they don't all have very good liquidity, frankly.
Speaker:So, you know, just be aware of that.
Speaker:Yeah, and the other difference, of course, between them
Speaker:is that if you're looking at the futures price, then you're basically,
Speaker:you have to sort of effectively add on the risk-free
Speaker:rate to that because the margin that you're holding against
Speaker:that futures contract, you will actually earn interest on it.
Speaker:If you just look at your backtest, you won't actually see
Speaker:that money coming in.
Whereasthe ETF will actually include
Speaker:that interest within the price of the ETF, because the ETF is actually
Speaker:earning that interest on the capital, it's got the exchange and
Speaker:it can return that to the investor as well. And that might
Speaker:be in the form of, you know, an outright dividend yield or it
Speaker:might be imputed into the price.
Ifit's a dividend yield,
Speaker:then, again, you've got to kind of add it back in. So, essentially
Speaker:you want to be computing what I'd call a true total return series.
Speaker:So, for the ETFs, that's going to include any dividend yields and
Speaker:it's going to be less any costs that you're going to have to
Speaker:pay, either implicit costs that are hidden or explicit costs
Speaker:in terms of a management fee. And then you can compare that to
Speaker:the futures price, back adjusted price, and that's effectively,
Speaker:again, a total return series. But you need to add in the risk-free
Speaker:rate or deduct it from the ETF to get a fair comparison. So, this
Speaker:is why it's much simpler if you can, if you're trading ETFs to
Speaker:use ETFs in your backtest, if you're trading futures to use futures
Speaker:in your backtest.
Andthen a second question is, what is better?
Speaker:Well, as you say, I think costs and liquidity are the two main
Speaker:points definitely to consider. But the reason why you would want
Speaker:to go down the ETF route would potentially be market access and
Speaker:contract size.
So,if the contracts are really big in the world
Speaker:of futures and you need a lot of capital to diversify, well, you
Speaker:may be better off going down the ETF route where the share prices
Speaker:are smaller and potentially even you can buy fractional shares.
Speaker:So, as far as the decision between ETFs and futures go, it's
Speaker:not straightforward.
Allof the things being equal, I'd say generally
Speaker:speaking, if you've got enough capital, futures are better. But
Speaker:not everyone's in that position, of course.
Speaker:So, we can summarize it to test what you trade and trade what
Speaker:you test.
Speaker:That is a good thing to have. Definitely, always.
Speaker:All right, next question that came in is from Steve, and Steve
Speaker:writes, “In AFTs, (which, of course, I had to ask you, what exactly
Speaker:is AFTs? Of course it's a good way to plug one of your many books,
Speaker:Advanced Futures Trading Strategies), all forecasting techniques
Speaker:are rules based. Any pointers on how to use predictive modeling
Speaker:techniques like linear regression etc. and how could we
Speaker:combine it with your forecast scaling framework? Also, can you
Speaker:comment on potential objective functions?”
Ithinkagain, let's
Speaker:keep it broad so that most people can get some use for it and
Speaker:just allow for the rest of the questions too.
Speaker:Yeah, so this is kind of a general thing which is how do we
Speaker:get from what, in machine learning, they called a feature to
Speaker:a forecast of a price. But, in general terms, you've done some analysis,
Speaker:you've come up with something you think predicts futures prices.
Speaker:How do you get from say that wiggly line on the graph to a thing
Speaker:saying, right, this means we should buy X many futures contracts
Speaker:in say gold, which we've already talked about in the episode.
Speaker:Andthe sort of simplest way of doing that, which is what I do,
Speaker:is literally to say, well I'm going to treat that wiggly line as
Speaker:something that has some kind of distribution. I'm going to construct
Speaker:in such a way that if it's positive then I'm bullish, if it's
Speaker:negative I'm bearish. And then I'm going to kind of calculate some
Speaker:scaling around it. So, I've got some way of saying is it high,
Speaker:is it low?
Andthat comes down to quite simply just dividing it
Speaker:by a number and producing something like, if you're familiar
Speaker:with the terminology, something a bit like a Z score. Now,
Speaker:that process could equally be done by, say, a linear regression.
Speaker:And with a linear regression what you'd say is well, I'm trying
Speaker:to predict prices.
So,on the left-hand side of my regression equation
Speaker:I've got the price, or probably you want a normalized return,
Speaker:actually, a volatility normalized return on the left-hand
Speaker:side. And on the right-hand side of regression is the thing that
Speaker:you're trying to predict it with. Well, that will be the wiggly
Speaker:line on the graph. And then the alpha and the beta of that regression
Speaker:will effectively be, the beta’s going to be (we won't go to
Speaker:the details of calculations), it’s going to be very much the same
Speaker:thing in the sense that the coefficient on the regression is
Speaker:going to be something that tells you how big the wiggly line
Speaker:is. You know, is this a big forecast or a small forecast? And
Speaker:then the alpha, the insert on the regression, well that's just
Speaker:a way of essentially removing any systematic bias from forecasts
Speaker:that are systematic long or systematically short, which you may
Speaker:not want to do, by the way. And that's a whole big debate we
Speaker:can have on another podcast.
So,actually, there's not really
Speaker:any fundamental difference between using say linear regression
Speaker:and doing what I do, with the possible exception of the fact that
Speaker:I don't, generally speaking, remove systematic biases because
Speaker:(and we can have a big discussion about that) I just prefer
Speaker:not to. But in principle I could.
So,in answer to the question
Speaker:about the objective function, which just means in plain English,
Speaker:what is it we're trying to forecast? Well, I would always be
Speaker:trying to forecast risk adjusted returns. I think that's
Speaker:the most appropriate thing because we then want to size our
Speaker:positions according to risk.
Speaker:Yeah, cool. Good question. Next question that came in is from
Speaker:Vic.
Vicwrites, “I'm curious about limits of research in finding
Speaker:new or improving systematic trading rules in the liquid mid low
Speaker:frequency space. Once you've included established risk premier
Speaker:rules like trend, carry, and fundamental valuations, do most research
Speaker:efforts by experienced teams in big and small firms amount to
Speaker:just fancy branding exercises? In a competitive environment where
Speaker:everyone is working with more or less the same data, is it possible
Speaker:to meaningfully move the needle? Would love to hear your views
Speaker:and thanks and all the best.”
Whatare your thoughts?
Thisis obviously
Speaker:super difficult because we don't know what goes on inside the
Speaker:research teams, but we know they have some very clever people
Speaker:working there. What are your thoughts, actually? I have my thoughts,
Speaker:but what are your thoughts?
Speaker:Yeah, I mean, this is an interesting one and it's quite a
Speaker:cynical view, isn't it, to say that, well, everyone's just doing
Speaker:the same thing. It's just fancy branding and all this sort
Speaker:of stuff. So, you know, there are Indeed some CTAs that have not
Speaker:changed their model for years and not done any research and are
Speaker:just plugging along quite happily and that may be a very valid
Speaker:way of working as well, to be honest.
So,what are they doing inside
Speaker:these big shops with hundreds of PhDs? Well, they could be doing
Speaker:things like, for example, implementing new markets, some of
Speaker:which have issues with pricing. So, certainly when I worked
Speaker:at AHL, that was something that we were pushing to do in a big
Speaker:way, and don't mind me plugging it, their very successful
Speaker:Evolution Fund was a result of that. And of course, there are other
Speaker:funds out there like Florin Court that have also pushed big into
Speaker:alt markets. And this is something we've talked about in the
Speaker:podcast before. So, that's a big job.
Andgoing back to the earlier
Speaker:question in terms of whether you should be adding markets or systems?
Speaker:Well, actually, adding markets can often give you the biggest bang
Speaker:for your buck. So maybe that's what you should be doing.
Youcan
Speaker:be looking at things like improving execution as well. The
Speaker:bigger that you are, the more important execution is. So, for me,
Speaker:I can do a pretty decent job of execution with an algorithm that's
Speaker:a few lines of code long. But if you're a big fund trading hundreds
Speaker:of millions or even billions of dollars of notional a day, then
Speaker:execution is something that you should definitely be thinking
Speaker:about.
Thenthe other alt, of course, out there is alt data. So,
Speaker:there are people looking at alternative sources of data. And
Speaker:that's also quite a big growth area.
Ithinkwhere there's probably
Speaker:less research effort than you might expect is in using, let's say,
Speaker:alt methodologies. So, we had all the alts in this question. Alt
Speaker:methodologies, so that's your neural networks, your machine learning,
Speaker:your artificial intelligence. So, basically working with existing
Speaker:data, but doing it in kind of fancier ways. That's an area where
Speaker:I think you're less likely to get much value, although undoubtedly
Speaker:people are doing it. But I'd be very wary of any sort of team
Speaker:of researchers that were purely focusing exclusively on that
Speaker:area of improvement, because I think the lower hanging fruit is
Speaker:quite high up in the tree there. And I think there aren't many
Speaker:places, with the obvious exception of Renaissance Technologies,
Speaker:that are really good at that kind of stuff.
Speaker:Yes. At least for their proprietary fund, I might add. But
Speaker:there we are. I completely agree with what you just mentioned.
Speaker:It'snot just the kind of data that I think firms are looking at.
Speaker:It's actually also what to do with the data before they stick it
Speaker:into their algorithms that I think is an area of interest for
Speaker:these firms.
ButI tend to agree. I don't think necessarily
Speaker:that, as an industry, we're coming up with many new ways of doing
Speaker:trend following. Although I don't necessarily think it's a bad
Speaker:thing that you use more than one approach to trend following.
Speaker:Instead of saying, “Oh, I'm wedded to moving average crossover,”
Speaker:well, okay, maybe you can combine that with something else
Speaker:and actually get a better result. So that's kind of one small
Speaker:thing.
Butthe other thing I was going to say is that I think
Speaker:where I would suspect we see the most evolution still, and where
Speaker:there's still room to improve, is probably risk management. I think
Speaker:that, at least what I see, is that better ways of dealing with
Speaker:risk, forecasting risk and all of that stuff I think is pretty interesting.
Speaker:And I think, as an industry, I think we've always been risk managers,
Speaker:first and foremost, and I think we've done a pretty good job.
Speaker:It's rare that you hear about a trend follower blowing up unless
Speaker:it's specifically because they were running like a 5x leverage version
Speaker:of their strategy. That's obviously something I have seen in
Speaker:the past, which is crazy.
Inone of the conversations we had
Speaker:when we did the SocGen CTA Index series with all the managers,
Speaker:I think some of the ones, maybe was AHL where they talked about
Speaker:that probably of their research budget, 35%, 40% of that
Speaker:goes to course execution - improving execution to not lose out
Speaker:when they get more inflows and manage bigger amounts of money.
So,I
Speaker:do think that is true and that's obviously where managers have
Speaker:to be careful that they could still improve enough to increase
Speaker:the capacity of the strategy. But thanks for the question.
Thenext
Speaker:question is from Andrew, and Andrew writes, “Thank you very much,
Speaker:Rob, for your books and your transparency in your trading. Question,
Speaker:approximately about a year and a half ago or more you published
Speaker:on X that you were making a discretionary trade increasing your
Speaker:bond position. I'm just curious how that trade worked out
Speaker:and if you think, in retrospect, that discretionary call
Speaker:was correct. And are there any other learnings for the rest of us
Speaker:about when to know if a discretionary call makes sense?”
Speaker:Yeah, I have to say I really didn't like this question because…
Speaker:Well, when you asked for it on X…
Speaker:I know, I know. Well, I'm a very good systematic trader. So,
Speaker:if you ask me how a particular trade works out, I can tell you with
Speaker:precision because it's all in a big database.
But,the small number
Speaker:of discretionary trades I make, and the last one I made was
Speaker:during Covid, I'm not very good at kind of keeping records of
Speaker:them and sort of saying how they did in terms of P&L.
So,I did
Speaker:do that for my Covid trading because there was a lot of it in
Speaker:quite a short period, and I did work out that I had actually
Speaker:made some money. So, you know, that was nice.
Butthis particular
Speaker:one I actually just had to quickly check while you were talking,
Speaker:and have a look, and I did quite well in catching the bottom
Speaker:of the bond market, the top of the market in terms of yield terms.
Speaker:But I didn't do a very good job of sort of closing the position.
Speaker:So, I think I actually closed the position basically flat.
So,I
Speaker:made a good entry decision but a poor exit decision. I should have
Speaker:had a, I mean this is ridiculous because I literally have
Speaker:written books about this, but I didn't have a predefined sort of
Speaker:stop loss or exit criteria for my trade which is just crazy. And
Speaker:this is why I'm not a discretionary trader because I'm
Speaker:rubbish at it. Absolutely rubbish.
So,the learnings from this
Speaker:is don't do it, I think at least as far as I’m concerned.
Speaker:All right, all right, good question. I'm glad we got that straightened
Speaker:out.
Thenext question is from Paul. Paul writes, “I have a question
Speaker:about incorporating value/long term mean reversion strategies. In
Speaker:Advanced Futures Trading Strategies, Rob introduces a mean
Speaker:reversion strategy based on past five-year performance relative
Speaker:to each instrument asset class. The strategy has a negative
Speaker:Sharpe ratio but improves the performance of his baseline trend
Speaker:plus carry strategy. I was wondering what the benefits/drawbacks
Speaker:of having an absolute strategy that just looked at if the post returns
Speaker:were positive or negative rather than relative to the performance
Speaker:of the asset class. In the academic paper Time Series Momentum,
Speaker:Moskowitz, al, in 2012, the authors show that returns years 2
Speaker:through 5 are negatively related to subsequent returns. Given
Speaker:this result, it seems like applying a value approach on an absolute
Speaker:basis could increase the Sharpe on the standalone value measure
Speaker:while still maintaining the strategies negative correlation to
Speaker:trend.”
Speaker:I'm trying to, I'm really trying to dig through my mind and
Speaker:I can't remember if I've ever tested an absolute momentum, an absolute
Speaker:long term mean reversion, rather, which is just negative momentum.
Speaker:So,this should definitely work, and actually one of the things
Speaker:I want to talk about later is a paper that talks about momentum
Speaker:and mean reversion behavior across different time periods. So,
Speaker:this is a nice kind of preview of that. So, it should work in principle.
Speaker:Idon'tthink I've tested it in like the last 10 years because
Speaker:I'm quite good at blogging about things that I've researched
Speaker:and I'm pretty sure I haven't blogged about it. So yeah, I'll have
Speaker:a look at it. I mean it's in terms of Occam's razor, you should
Speaker:always go for the simplest possible version of something.
Andobviously
Speaker:this is simpler than the relative mean reversion. And even
Speaker:if it's sort of similar in performance, it's probably diversifying.
Speaker:It's probably going to give you something a bit different.
Soyeah.
Speaker:Now, as the questioner says, there's a lot of research in it,
Speaker:particularly in equities. I mean there's papers by people like
Speaker:Richard Thaler and stuff on mean reversion and you know, it's
Speaker:sort of related to value effect and equities. So yeah, I'm
Speaker:a fan of the idea of it.
Ofcourse, as a long term signal
Speaker:it's going to be quite hard to get statistical significance. So,
Speaker:you know, and it's never going to be that good in terms of Sharpe
Speaker:ratio because of that. And it may even be negative in the backtest.
Speaker:But yeah, I'll make a note of that and have a look at it.
Speaker:Okay. All right. The next question is from Samuel. It's a long
Speaker:one which I'll probably butcher a few places, but I'll try
Speaker:and do my best.
Hestarts out by saying, “I'm a big fan of TTU
Speaker:for a number of years now, but a few concepts have made their way
Speaker:into my head that would apply to the trend following universe and
Speaker:yet haven't been covered on the show. (Well, there we are. Good
Speaker:that you bring them up.) Namely, what does the research say,
Speaker:if any, of trend following strategies that don't rely on lagging
Speaker:indicators?
IfI recall correctly, EMA - exponential moving
Speaker:average (that's what I was just about to say) crossovers versus
Speaker:Donchian breakout strategies, if applied systematically, don't
Speaker:change backtests all that much on a diversified basket. As Rob Smith
Speaker:highlighted (I'm not sure who Rob Smith is but), as Rob Smith highlighted
Speaker:in his May 2022 presentation, price doesn't have mass. So, using
Speaker:the term momentum with stocks is more like describing a sports
Speaker:team that has momentum. It's not literally applicable to the thing
Speaker:being described.
Onesimply needs to look at any duration candlestick
Speaker:chart to recognize that price often turns on a dime. Bright green
Speaker:on one candle, bright red on the next one, changing without any
Speaker:hint of a transition. To your knowledge, has anyone done any studies
Speaker:using the current state of monthly, quarterly, yearly candles
Speaker:for a trend following system, say reducing volatility at the beginning
Speaker:of those time periods rather than on a rolling basis. Same thing
Speaker:with adding to positions in addition to or in lieu of the various
Speaker:channel breakouts of EMA crossovers. Why not look at the current
Speaker:state of high time frame candles to increase exposure progressively?
Speaker:Same thing on reducing exposure, should something that was
Speaker:doing great one quarter turn around immediately be the next?”
Speaker:So first a few caveats. Things I do not understand in this question
Speaker:or don't know about Donchian breakouts. I'm not familiar with
Speaker:the work of Rob Smith and I don't tend to look at candles.
Withall
Speaker:that in mind. ultimately, all indicators are lagging because they
Speaker:look at the past, right? How can we reduce lag?
Well,we can reduce
Speaker:it by using less of the past and more recent periods. So, for
Speaker:example, we can speed up a moving average by using shorter numbers
Speaker:in the moving average. Exponential moving averages weight
Speaker:more recent periods more than periods longer ago. Okay, so that's
Speaker:another way of doing it.
Sobasically, to get technical for
Speaker:a second, both the moving average and exponential moving average,
Speaker:and indeed any indicator that takes a series of past returns, is
Speaker:a weighting function over those past returns. So, a simple
Speaker:moving average is literally just the last, say 20 returns equally
Speaker:weighted so that the response function for that would be flat.
Speaker:The exponential weighting response function, obviously, is
Speaker:exponential. So, it's high for recent periods and then goes down.
Speaker:So,I think, if I understand the question correctly, it seems
Speaker:that he's talking about doing something weird with the most, perhaps
Speaker:most recent observations, and weighting those. Either weighting
Speaker:them more highly or changing your response in a more nonlinear
Speaker:way to that.
So,for example, to paraphrase it might be something
Speaker:like, well, the moving average says we should be long, but because
Speaker:the last week or so is negative, we should actually be short
Speaker:or change our position. Something like that. I'm not generally
Speaker:a fan of sort of nonlinear stuff because it's not very intuitive.
Speaker:And also, it's highly, potentially can be highly overfit
Speaker:because you need additional parameters to do it.
So,you know,
Speaker:to implement the kind of thing I've discussed, you'd need to have
Speaker:a parameter saying, well, how far back do we look, what do we actually
Speaker:do when this thing reverses? I mean, there's quite a few extra parameters
Speaker:potentially there. It's making the system more complicated and potentially
Speaker:more overfitted.
Itmight be better. A simpler way of doing that
Speaker:is to say something like, well, I'm not saying this probably
Speaker:isn't true, and I'll discuss why in a bit when I get to my part
Speaker:of the podcast. But if you think, for example, that prices trend
Speaker:over six months but then tend to mean revert, if they have been
Speaker:trending for six months and they start to mean revert suddenly,
Speaker:then you should go short.
Well,a better way of doing that
Speaker:is to have a separate mean reversion one week signal, or to
Speaker:fit some kind of response function, as we were talking about
Speaker:earlier with the question about regression, between how prices
Speaker:move depending on how strong your forecast is. And again, I've
Speaker:done that and there are some effects there, but I've judged that
Speaker:the complexity they add is not worth the tiny, tiny, insignificant
Speaker:performance that they add.
Soyeah, I think this is one of those
Speaker:things that kind of sounds like a good idea. Let's get rid of
Speaker:lagging indicators and use indicators that don't lag. Well,
Speaker:actually it's impossible to do that.
Speaker:Actually, it would be better to have future indicators, right?
Speaker:So, we would always know.
Speaker:I mean, I would prefer to have future indicators. Unfortunately,
Speaker:I've not been able to find any because, you know, time travel is
Speaker:not possible.
Speaker:Not yet.
Anyways,last question and then we get to your
Speaker:topics. I have to preface here. First of all, it came from
Speaker:Crypto Captain. Now Crypto Captain is, I think, a longtime listener,
Speaker:so I really appreciate that. And Crypto Captain has also asked
Speaker:questions before, as far as I recall. I do think, however, I did
Speaker:mention last time, Crypto Captain, that you really should use
Speaker:your own name or at least tell us who you really are because we
Speaker:don't really appreciate people being anonymous on this. I will never
Speaker:mention your last name, but let's make it more direct instead
Speaker:of using these different names.
Anyways,you asked two questions,
Speaker:Crypto Captain. We will answer question two because the first question
Speaker:was simply, in our opinion, too narrow for our audience. And
Speaker:so, I'm sure you will understand that. However, your second
Speaker:question is something that we both felt was relevant. So here goes.
Speaker:Youasked, “How to handle missing data when contracts get delisted
Speaker:and then relisted. In my case, many contracts in some commodities
Speaker:got delisted in June 2020 and then got relisted in February 2023.
Speaker:ChatGPT suggested I use co-integration and error correction
Speaker:models to fill the missing data because the larger contract
Speaker:data is available. What are other things I can try out?”
So,Rob,
Speaker:over to you.
Speaker:Well, the easiest thing to do is to ignore any data before February
Speaker:2023. So, basically ignore the period it was trading earlier and
Speaker:obviously ignore the gap.
Thenext thing to do that's still
Speaker:kind of okay, but more complicated is to create your trading
Speaker:system so it can actually deal with missing data. So, then what
Speaker:would happen is that in your backtest you'd be trading this thing
Speaker:for June 2020, and then you'd go to a position of zero until the
Speaker:prices started coming in again. And then once there was enough
Speaker:prices to form an opinion about what the forecast should be
Speaker:and what the volatility should be, et cetera, et cetera, then you'd
Speaker:go back to having a position.
Iwouldreally, really not interpolate
Speaker:data, price data, and then, then use that in a backtest and say,
Speaker:oh yes, look at, this is great. I think it's a fundamentally
Speaker:stupid thing to do, to be honest, and I'm not surprised that
Speaker:ChatGPT has suggested it because, you know, I'm not a big
Speaker:fan of AI, as you know. I really, really wouldn't do that,
Speaker:to be honest.
Now,there are some limited cases in which it might
Speaker:make sense to do this. So, for example, if you are, say, estimating
Speaker:a volatility and you've got hourly data, but obviously you've
Speaker:got a period where when markets are closed, then it's probably
Speaker:a reasonable thing to do to get a better estimate of volatility
Speaker:to actually interpolate those overnight hours. I've seen people
Speaker:do that. It's a reasonable thing to do.
Interms of techniques,
Speaker:I wouldn't use co-integration or an ECM. I'd use a Brownian bridge.
Speaker:If you don't know what one of those is, you shouldn't be doing
Speaker:this, frankly, because, you know, it's quite complicated stuff
Speaker:and you need to be very careful with it. But I would use
Speaker:it in that specific instance and if I think hard, I can probably
Speaker:think of a few more. But 99.9% of the time, interpolating missing
Speaker:prices is a fundamentally stupid thing to do, that only an
Speaker:AI would suggest.
Speaker:All right, let's move on to your topics. Now we're going to talk
Speaker:about your most recent blog post, which is on a very interesting
Speaker:topic, which has been discussed in different shapes and
Speaker:forms over the years now. However, actually, there is a very
Speaker:nice sort of bridge into you into this topic from the most recent,
Speaker:which is Q4 2024, paper from Quantica, our friends here in Switzerland,
Speaker:who write some excellent stuff. People should go and check
Speaker:it out.
Now,I think, and I can't remember if I did the discussion
Speaker:on this paper or maybe Alan did with Katy. I'm not entirely sure.
Speaker:Anyways, maybe you could just quickly summarize what they concluded
Speaker:about dynamic position sizing and so on, and so forth, and then
Speaker:gently take us into your blog post and guide us through that.
Speaker:Yeah, so, the Quantica paper is a really nice paper and I definitely
Speaker:encourage people to read it. I'm not going to summarize it in
Speaker:great detail here because that's not the main point of the
Speaker:conversation, but it's about evaluating three different kinds
Speaker:of position sizing framework.
One,where you enter a trade and
Speaker:you take a certain number of contracts and you hold that fixed
Speaker:number of contracts.
Thesecond method is fixed notional,
Speaker:where you would say, all right, I want to get say $100,000
Speaker:of exposure to this particular future. On day one, that might be
Speaker:five contracts. On day two, maybe the price has gone up a bit,
Speaker:therefore you might lower it to four contracts. Obviously with
Speaker:a very small amount of capital it would be quite hard to get an
Speaker:exact notional, but with large enough capital you can obviously
Speaker:get pretty close to the notional you want to target.
Andthen
Speaker:the third methodology is the methodology I use, which is to say
Speaker:I want to get a certain amount of risk on my contract. So, you'd
Speaker:say I want to have $25,000 of annualized risk on that contract.
Speaker:What does that correspond to? And then that will change if the
Speaker:price changes, but it will also change if the volatility changes.
Speaker:So, most notably, if the volatility goes up a lot, then you'll
Speaker:reduce the number of contracts that you hold. And they look at this
Speaker:specific example of cocoa, because obviously cocoa was the poster
Speaker:child trade of 2024.
Andthey then sort of evaluate these different
Speaker:techniques. And I've done a similar work myself, and they come
Speaker:to the conclusion that the volatility adjustment has the highest
Speaker:Sharpe ratio. Okay.
Whatthey don't do, however, and I have done
Speaker:in my own work, is look at skew. So, you know, trend followers
Speaker:reduce positive skew. And it turns out that the closer to your
Speaker:sort of fixed position sizing the system you're running, or even
Speaker:the notional position sizing, the greater the skew you'll get.
Speaker:Andthe reason for that intuitively is, well, what's happening
Speaker:is that if you have something like cocoa that explodes in price
Speaker:and goes up a lot, and you're just holding a fixed number of contracts,
Speaker:then that's going to produce an outsize effect on your P&L and
Speaker:an outsize effect, positive outlier on the upside of your P&L.
Speaker:And the same thing doesn't happen on the downside because obviously,
Speaker:when things move against us, we close our positions.
Sothat's
Speaker:the kind of intuitive logic behind that. So that's the Quantica
Speaker:paper. Go away and read it. It's very interesting.
Butthis comes
Speaker:down to essentially a question we should ask whenever evaluating
Speaker:any kind of strategy or asset in finance, which is what should
Speaker:we be paying for risk? And we use Sharpe ratios because as futures
Speaker:traders we can use leverage. And that means essentially if by
Speaker:risk, if you mean volatility, well we can get any level of volatility
Speaker:we like. We just need to change our leverage. And that's not
Speaker:going to change our Sharpe ratio,
So,effectively, the price
Speaker:of risk is basically zero for a leveraged trader. We can get any
Speaker:amount of risk that we want to get. That's not true of skew though,
Speaker:necessarily.
Sooften when we're evaluating different options
Speaker:or, say, different hedge fund strategies, we might have a choice
Speaker:between something that has a really good Sharpe ratio but negative
Speaker:skew. And an example of that would be something like… An extreme
Speaker:example of it would be something like an option selling
Speaker:strategy. A less extreme example of that would be something
Speaker:like an equity market neutral strategy. They tend to have negative
Speaker:skew as well.
Andthen you might be comparing that with something
Speaker:that has positive skew, like, say, a trend following strategy.
Speaker:And you could also be comparing different kinds of trend
Speaker:following strategies, so ones that are closer to mine, where you've
Speaker:got good Sharpe ratios but the skew maybe isn't so good and then
Speaker:you've got other funds that have lower Sharpe ratios but very,
Speaker:very high positive skew.
So,what I wanted to do was, in a
Speaker:sort of intuitive way, kind of say, well, if I'm comparing two different
Speaker:assets, whether they be funds or strategies or underlying instruments,
Speaker:and they've got different Sharpe ratios and different skews,
Speaker:what should the kind of trade off between those two things be,
Speaker:at least in theory?
AndI say in theory because in practice people
Speaker:have preferences for this sort of thing. So, some people really
Speaker:like positive skew and they'll, you know, happily give up
Speaker:more of them, their Sharpe ratio to get it. Other people won't.
Speaker:So, this sort of is like a risk neutral approach, if you like,
Speaker:as far as skew goes.
Anyway,my conclusions were quite
Speaker:interesting because I was surprised to find that trade off
Speaker:wasn't actually that substantial. So, in other words,
Speaker:the amount of Sharpe ratio you should be giving up to “buy” positive
Speaker:skew was actually be very small.
Toput it another way, if
Speaker:you have two strategies, one with a very good Sharpe ratio and
Speaker:one with a slightly worse Sharpe ratio, but with very good
Speaker:positive skew, generally speaking, you want to go for the
Speaker:higher Sharpe ratio strategy because the geometric return of the
Speaker:product is going to be better. And the geometric return, sometimes
Speaker:called the CAGR, the Compound Annual Growth Rate, maximizing that
Speaker:basically maximizes the amount of money that you have at the end
Speaker:of your investment horizon. That's, I believe, the kind of main
Speaker:fundamental metric that everyone should be using when they're
Speaker:evaluating anything.
Sharperatio only works if everything
Speaker:has the same skew. And here we're looking at a specific example
Speaker:where things have different skews.
Soyeah, it was interesting,
Speaker:and I guess for me it was another nail in the coffin, if you
Speaker:like, of the idea of using something like a constant contract
Speaker:or a constant notional, as is in the Quantica paper, because they
Speaker:do have a lower Sharpe ratio. I found that. Quantica showed that
Speaker:as well.
Butany improvement in skew… There's no conceivable amount
Speaker:of improvement in skew that would justify that lower Sharpe ratio
Speaker:and sort of pay for that lower Sharpe ratio if you like.
Speaker:So first of all, people should go and read this full blog post on
Speaker:your website and we'll put a link to that in the show notes, of
Speaker:course. And again, because we're starting to run out of time
Speaker:a little bit, I just have one general question that I think some
Speaker:people might think and sit with, hearing your thoughts on this.
Speaker:Andthat is, well, on many of these episodes we've had in the past
Speaker:decade or so, I'm sure many people, including myself, would have
Speaker:said, well, hang on, Sharpe is not really great to optimize for
Speaker:when it comes to trend following falling because it penalizes
Speaker:upside volatility. How should people think about that when you
Speaker:say, well actually we should still optimize for Sharpe?
Speaker:It penalizes upside volatility, sure.
Butthe point is
Speaker:that if an investment has a high Sharpe ratio, you can sort of
Speaker:leverage it up so that the benefits of getting the upside and
Speaker:the downside…Yeah, this is quite a hard question to answer actually.
Speaker:That's fine. It was on the fly, so don't feel like…
Speaker:So, I'm trying to think of an intuitive way of explaining it, but
Speaker:basically what I did was sort of simulate the effect of holding
Speaker:different investments with different levels of Sharpe ratio
Speaker:and skew. And I said, well, the only metric I care about is how
Speaker:much money I have at the end of time.
Speaker:Right.
Speaker:So that simulation accounts the fact that the high skew, positive
Speaker:skew, lower Sharpe ratio investments, their pattern of returns
Speaker:is going to be getting all of this extra upside volatility.
Thepoint
Speaker:is that, in this framework, you don't really think about volatility.
Speaker:Volatility only matters in as much as it will reduce how much money
Speaker:you have at the end of time if it moves against you.
So,the point
Speaker:was basically that the additional benefits of having a higher
Speaker:Sharpe ratio massively more than compensate for the fact that
Speaker:we're not getting those big upside volatility moments. So, I
Speaker:think it's quite a good framework thinking about things,
Speaker:because you don't need to say, well, okay, yes, upside volatility
Speaker:should be valued more than downside volatility, which Sharpe
Speaker:ratio doesn't account for, but skew does.
Butactually, combining
Speaker:those two things together, combining a measure of symmetry,
Speaker:essentially, in your performance judgment, which is what
Speaker:skew does, it still tells you that you should generally be hunting
Speaker:for higher Sharpe ratio investments. Because, you know, the
Speaker:benefits of positive skew are, when you actually look at how much
Speaker:money you're going to end up with, you know, they're limited.
Speaker:Yeah. And of course, always a warning that some very high Sharpe
Speaker:strategies, I can think of one like Bernie Madoff, may not always
Speaker:turn out to be that great of an investment at the end of the day.
Speaker:Absolutely. Yeah.
Speaker:All right.
Speaker:Especially if they've got a lot of, you know… Ignoring like outright
Speaker:frauds like Bernie Madoff, I mean, we should always be careful
Speaker:of high Sharpe ratio strategies that require a lot of
Speaker:leverage because even if they haven't got negative skew risk in,
Speaker:in the backtest during the historic returns, it's something
Speaker:you should always be concerned about.
Speaker:Yeah, and are opaque at the same time in some cases.
Okay,all
Speaker:right, the next one, we'll keep the best for last, of course.
Speaker:So, we will get through this one first because you mentioned that
Speaker:this is actually an interesting paper and I simply hadn't
Speaker:got the time, when I came back last night from my travels, to dive
Speaker:into it in any great details. But you already mentioned that it's
Speaker:somewhat relevant to our previous discussion today.
So,I'd
Speaker:love for you to take us through this paper that is very recent.
Speaker:It came out, I think only a few days ago. I think it's called
Speaker:Trends and Reversion in Financial Markets on Timescales from
Speaker:Minutes to Decades.
AndI should of course have mentioned the
Speaker:authors. I don't have it in front of me here. You may have it,
Speaker:just to be full credit.
Speaker:Yes, Sara Safari and Christof (and I'm probably going to mangle
Speaker:this) Schmidhuber, both of whom are not far from you, Niels.
Speaker:Exactly. That's exactly why we want to definitely give a plug for
Speaker:Zurich University, which I think this is where they relate from.
Speaker:Anyway,I'm going to turn it over to you, Rob. You read it much
Speaker:more carefully than I did.
Speaker:Yeah, I mean this is a really interesting paper.
So,we've mentioned
Speaker:my previous book already, but in my previous book I say, well one
Speaker:thing that's interesting is that at different timescales mean
Speaker:reversion and momentum tend to do better or worse. So, as we discussed
Speaker:with one of the earlier questions, if your time period is
Speaker:multiple years, then generally speaking you're probably looking
Speaker:at mean reversion. Momentum seems to work well, empirically,
Speaker:certainly in futures, across multiple asset classes for time periods
Speaker:of say a month up to a year.
Andwe also know that if we go right,
Speaker:right down to kind of really small time increments, mean reversion
Speaker:tends to work well because that's where the high frequency traders
Speaker:are operating and their strategy is very simple. It's buying
Speaker:on the bid, selling on the ask and they're relying on the prices
Speaker:kind of bouncing between those two points.
Andin my book I say,
Speaker:well, there's a sort of a gap between this high frequency trading
Speaker:and this one week, one month time horizon where momentum or mean
Speaker:reversion may be working. And I kind of, unfortunately I didn't
Speaker:have the data to do an analysis and say what actually happened
Speaker:in those time periods.
Ikindof waved my hands around and
Speaker:came up with some suppositions that actually this paper says are
Speaker:false. So that's kind of, I don't mind having my vague guesses
Speaker:refuted. I'm much happier to see hard evidence because, apart
Speaker:from anything else, it's a really good guide to if you're thinking
Speaker:about sort of going into faster trading, whether that faster
Speaker:trading should be mean reversion or momentum. I think it's
Speaker:really useful to have that as a starting point.
Butanyway, what
Speaker:they do is they, they look at probably the widest range of time
Speaker:frequencies I've seen in any paper ever, which is fantastic. I
Speaker:won't go into the technical details of what they're doing, but
Speaker:basically what they do is for different time horizons, time frequencies,
Speaker:they basically say, is this a time frequency where we see momentum
Speaker:or is this time frequency where we see mean reversion? That's
Speaker:kind of what the paper boils down to.
Andif you do nothing else,
Speaker:go to page 28, figure 10 and that's the figure I'm now going to
Speaker:describe to you. And that basically summarizes the paper beautifully.
Speaker:Nowwhat complicates things slightly is that the way that they
Speaker:analyze trends is a bit weird. They fit a cubic polynomial, which
Speaker:is a slightly unusual way of doing it. And to get technical for
Speaker:a second, it allows you to model both the sort of relationship
Speaker:between trend strength and mean reversion and also the general
Speaker:trend. But we'll not talk about trend strength because there
Speaker:is some interesting stuff in there but I think it takes away from
Speaker:the key idea in the paper I want to bring out, which is the relationship
Speaker:between, as I said, at a given horizon, do we see trends or do we
Speaker:see mean reversion?
So,they go right down to sort of minute level
Speaker:data, and they basically find that, let's say for time periods
Speaker:of less than an hour, mean reversion occurs. Okay. And I think
Speaker:the most mean reversion occurs at roughly a five minute time window.
Speaker:So,that's kind of the area where, if you're going to be a mean
Speaker:reversion trader, you want to be playing in.
Anda huge caveat
Speaker:here, you know, trading at those kinds of frequencies is a massive
Speaker:engineering and backtesting exercise and it's not something that
Speaker:you should be casually doing. You don't just now sit at your computer
Speaker:and look at charts and every five minutes do mean reversion trades.
Speaker:Do not do that, whatever you do. But empirically that seems to
Speaker:be what's going on.
Now,if you look at trend horizons of more
Speaker:than an hour, they find momentum occurring. And this is where
Speaker:this sort of fills in the gaps in my previous knowledge because
Speaker:I wasn't sure what would be happening at these time horizons.
Speaker:But basically, if you're trading for holding positions for
Speaker:an hour, or two hours, or four hours, or a day, you should probably
Speaker:be trading momentum. And again, big caveats about trading
Speaker:that quickly.
Speaker:Sure.
Speaker:Trading costs, in particular, are going to be very hard to overcome
Speaker:if you were trend following in short time frequencies, so be very
Speaker:careful there.
Andthen they go on to sort of two days, three
Speaker:days, four days, five days, ten days. It's still momentum. You
Speaker:know, three weeks, six weeks, three months, six months, one year,
Speaker:it's still momentum. So that, you know, it's momentum all the way.
Speaker:Thisis a great paper for our industry because it's basically saying
Speaker:that as long as you're not really a really fast trader, you
Speaker:should probably be a momentum trader, which of course is what most
Speaker:CTOs do. And then is when the switch happens.
Thenis when the
Speaker:switch happens. So, anything longer than a year is when mean reversion
Speaker:kicks in.
Andas I said, they do look at ridiculous amounts of
Speaker:data because they go up to 16 years. They look at data out 16 years
Speaker:and they're still finding mean reversion out there. And to do that
Speaker:they're looking at data from 1692. So, they're looking at, you
Speaker:know, 330 years of data to do this analysis.
So,it's an incredibly
Speaker:thorough job and very, very, very impressive. But yes, the bottom
Speaker:line is, so we talked earlier about looking at absolute mean reversion
Speaker:over multiple years. This paper supports the idea that if you're
Speaker:trading, is it really trading if it's multiple years or is it just
Speaker:investing? I don't know.
Yeah,but if your forecast horizon
Speaker:is, you know, two, three, four years, definitely a mean reversion
Speaker:strategy is more likely to make sense. If your time horizon
Speaker:is anywhere between one hour and one year, you should be a momentum
Speaker:trader.
Andif you're able to trade at sub one-hour frequencies,
Speaker:then yeah, you could look at mean reversion. So, it's a beautiful
Speaker:empirical survey of everything from right down to the tiny, tiny
Speaker:subatomic structure of high frequency trading, zooming out to
Speaker:the giant galactic views of multiple year holding periods.
Speaker:I'm surprised, actually, that it cuts off at one year, a little
Speaker:bit, because I do think that many trend followers use lookback
Speaker:periods that are somewhat longer than one year.
Speaker:Yeah, well actually, the cutoff point is two years. One year
Speaker:has the strongest, has a very strong trend flowing performance.
Speaker:Two years is pretty much flat. So, you might get away with 18 months.
Speaker:Yeah, that's actually what I would have thought.
Speaker:Yeah.
Speaker:Without doing all the research, of course. There we are.
Speaker:Okay,we've come to the last topic brought to you or brought by
Speaker:you, I should say. And it's about one of your favorite persons
Speaker:to talk about, Trump, but not in a political way. It is from a
Speaker:economic way.
Speaker:Yeah.
Speaker:What does it mean?
Speaker:What does it mean? What does it all mean? Yes, what is the point?
Speaker:What are the economic consequences of Donald Trump?
Speaker:Correct, absolutely. In your view.
Speaker:There’s a paper written, by John Maynard Keynes about Winston
Speaker:Churchill, almost exactly 100 years ago. Yeah, so, I've been told
Speaker:I'm not allowed to be political on the podcast. It’s not
Speaker:a politics podcast and I might offend some of the people listening
Speaker:who are fans of the man. So, this is not political at all.
Thisis
Speaker:a pure hardheaded macroeconomic analysis of the likely
Speaker:consequences of Donald Trump and, of course, the implications
Speaker:for any investments that you might care to make over the next
Speaker:four years. So, we'll start with the big one, tariffs, of course.
Speaker:Bythe way, I should preface this by saying that I'm going to
Speaker:assume that he is successful in his endeavors so that he's going
Speaker:to actually do the things that, A, he said he's going to do
Speaker:and, B, he appears to be trying to do. So, you know, there
Speaker:are some instances already of pushback from the courts, potentially
Speaker:some Republican politicians. And it's going to be quite interesting
Speaker:to see how the sort of conflicts between the different branches
Speaker:of the US Government resolve themselves. Because there are going
Speaker:to be conflicts and there are going to be arguments and discussions,
Speaker:that's for sure.
Ithinka lot will depend on how much he gets done
Speaker:in the next two years because I can't really see the midterms going
Speaker:that well. And midterms generally don't go well. Like, for
Speaker:presidents it’s sort of a stop light.
It'spretty usual that if
Speaker:you start a presidential term with a majority in the House and
Speaker:the Senate and the presidency, it's pretty likely you'll end up
Speaker:losing one of those majorities in the midterms. That happens nearly
Speaker:all the time, mainly because people just don't like sitting, you
Speaker:know, they don't like sitting governments. So, the midterms are
Speaker:almost a bit of a protest vote. And we see a similar thing
Speaker:in the UK with sort of local council elections, but those are
Speaker:far less important than the midterms, clearly.
So,yeah, it's
Speaker:going to come down a lot to what he manages to get done in the
Speaker:next two years before he loses, I think he'll probably lose
Speaker:the Legislature.
Anyway,having said all that, let's
Speaker:start with the big one which is tariffs. The tariffs are interesting
Speaker:because it's probably the one of his policies that there's the
Speaker:most pushback by people who, actually, he's going to listen to
Speaker:to. Because most Republicans think that increasing tariffs is
Speaker:a terrible idea. Trump uniquely seems to think they're a
Speaker:good idea. But it's generally accepted that tariffs will increase
Speaker:inflation and just generally be a bad thing.
AndI don't think
Speaker:I need to talk about that in a lot of detail because a lot of ink's
Speaker:been spilt on why tariffs are a terrible thing, and almost no mainstream
Speaker:economist thinks that they're a good thing. So, they're going to
Speaker:increase inflation, but of course they won't just increase inflation
Speaker:in the US, they will increase inflation globally, I think, for
Speaker:sure, due to retaliation and just generally. So, let's put that
Speaker:one aside and look at other things that he's up to.
So,he's
Speaker:planning to deport a lot of people, and send them back to where
Speaker:they came from. What effect will that have? Okay, well, simple
Speaker:supply and demand. If you reduce the amount of labor in the
Speaker:market, then that will probably increase wage costs, I would
Speaker:imagine, which is more inflation. Now, there'll be an effect
Speaker:on the demand side as well, but I think it'll be less substantial.
Speaker:But the other thing that really worries me is the likely effect
Speaker:that this will have on supply chains.
Ithinkwhat Covid really
Speaker:showed us is that the sort of network of supply chains in the world
Speaker:is a very delicate thing, and anything that causes damage to it
Speaker:can have consequences which are very problematic. And you end
Speaker:up with stuff in the wrong place, and stuff not being manufactured,
Speaker:and issues with that.
AndI think there are also potentially
Speaker:supply chain consequences from the tariffs as well, because, for
Speaker:example, I know that US cars, bits of cars, go backwards and forwards
Speaker:between Canada and the US across the border. Think about where
Speaker:Detroit is actually physically located for a start. So that's again,
Speaker:potentially going to lead to inflation. Again, I think a lot of
Speaker:these things are inflationary, I really do.
Thenwe get into something
Speaker:a bit more esoteric, which is regulation. So, I think it's fair
Speaker:to say that Trump doesn't like regulation. And there's a sort of
Speaker:naive view that all regulation is a negative cost for businesses.
Speaker:So, therefore, less regulation should be positive for share prices
Speaker:because businesses will make more profits. Obviously, there is
Speaker:some truth in that to an extent. But actually, what businesses
Speaker:want and like is things like certainty, and the rule of law, and
Speaker:a set of rules and regulations that they can kind of rely on. And
Speaker:if you start messing around with things like that, then what
Speaker:that's probably going to do is actually increase what economists
Speaker:call, the risk premium.
So,people will demand to be paid
Speaker:more to hold risky assets, because everything's getting riskier,
Speaker:everything's changing, everything's all over the place.
Speaker:So, I think potentially, actually things like regulation and
Speaker:things like tariff policies that change every five minutes even
Speaker:if they don't end up going in the wrong direction, that's going
Speaker:to increase the risk premium, which would be bad for equities.
Speaker:Ithinkthat zooming out a bit more, and looking at the fact that
Speaker:he seems to be, how can I put this politely, making some fairly
Speaker:radical changes to the way that the sort of US Government operates,
Speaker:and potentially even doing things like literally, metaphorically
Speaker:putting his finger (or perhaps it should be Elon Musk's finger)
Speaker:on various spigots of money that are flowing and keeping the
Speaker:US Economy moving and going. Just putting a finger on and saying,
Speaker:what happens if I just stop this payment?
Again,what's that
Speaker:going to do? Well, potentially it's going to make people unemployed,
Speaker:it's going to cause supply shocks, it's going to cause demand
Speaker:shocks, it's going to cause uncertainty.
Andso, I think the
Speaker:fact that he's sort of breaking the contracts that the American
Speaker:government has with its people, and also that the American
Speaker:government has with other governments, it's going to increase
Speaker:uncertainty, it's going to increase risk premium, it's going
Speaker:to be bad for equities. I think there's going to be inflation,
Speaker:which is going to be bad for bonds. And of course, the conclusion
Speaker:of this is we should just all buy CTAs, lock ourselves in our bunkers
Speaker:with our shotguns and our baked beans and hope for the best.
Speaker:Well, I mean, there's also a little bit of a nuanced view on this.
Speaker:I don't, I don't disagree with some of the stuff you've said.
Andactually,
Speaker:you tricked me a little bit, Rob, because you sent me a link to
Speaker:an article by the FT and that that was a slightly different version
Speaker:of what will happen under Trump. So, you know, kudos for me
Speaker:to agree to this topic.
Speaker:You can still cut it out at the edit, now.
Speaker:No, absolutely not. That's not how we do things here.
ButI think
Speaker:there are a couple of interesting observations in the paper
Speaker:or in the article in the FT, because I agree with you that there
Speaker:are certainly a lot of risks in doing what's likely to happen.
Speaker:But there's also this conundrum that we see the risks showing
Speaker:up in only parts of the financial markets at the moment.
Speaker:Right?
Sofixed income is probably showing a little bit more
Speaker:concern about what's going on while equities…
Speaker:So is gold of course.
Speaker:And gold, as we talked about, yes. Whilst equities are not really
Speaker:showing a lot of angst at the moment, if we just measure angst
Speaker:by the price level on many of these indices. So, it is an interesting
Speaker:time.
I'veobviously alluded to it in my previous conversations
Speaker:and I will dig a little bit deeper with a very special guest
Speaker:in a couple of months time, because I think what you're saying
Speaker:and what I'm saying, in a slightly different way, is I think
Speaker:that not just what happens right now in the White House, but
Speaker:actually what's happened in the last couple of decades, is an
Speaker:erosion of trust, erosion of trust in institutions. I think that's
Speaker:probably also why I mentioned the picture from the Oval Office
Speaker:earlier in our conversation. I do think we are losing respect and
Speaker:trust in a lot of these institutions.
Andthat to me is a
Speaker:serious issue. And in a world where there is definitely a disconnect
Speaker:also happening between what is value and what's the price. I do
Speaker:agree with you that, actually, a price-based strategy that doesn't
Speaker:care about ‘is it the right value or not’, but just follows the
Speaker:price. Of course, I would at all times say that that's a pretty
Speaker:good strategy to have in your portfolio. And trend following is
Speaker:certainly one of very few that I can think of.
Speaker:So actually, if I think back to 2007, 2008, the equity markets
Speaker:for a long time thought everything was fine and it was in
Speaker:the bond markets, in the CDS markets and so on, the corporate
Speaker:bond markets and the mortgage backed security markets that the
Speaker:initial pain was and the initial foresight was.
AndI do think
Speaker:that I'm reluctant to say that market X always leads market Y, but
Speaker:I do think there is an argument for the fact that most of
Speaker:the people trading equities are naturally, how should we say
Speaker:this, optimistic people who might be slow to kind of make a judgment
Speaker:about market news. And that's probably particularly true now that
Speaker:I think equity trading now has got a much bigger percentage of retail
Speaker:traders than it ever used to have.
Thebond market however, is
Speaker:still, I think, dominated by more professional traders. And I
Speaker:think bond investors also are naturally grumpier and more conservative
Speaker:than equity investors. They must be to accept that kind of 4%
Speaker:or 5% yield.
So,I do think that potentially this could be a
Speaker:situation where the bond market could be a bit ahead of the
Speaker:curve and maybe even the gold market in saying, well, look at,
Speaker:there's some scary stuff going on here.
Andobviously there are
Speaker:different drivers because the bond market's probably more concerned
Speaker:about inflation rather than, say, the risks of a recession, whereas
Speaker:the equity market. Is inflation good or bad for equities?
Speaker:There is not an obvious answer to that question.
Soit may be that
Speaker:it's just a more direct thing, that Trump's policies are clearly
Speaker:inflationary, therefore bonds will probably react, equities, not
Speaker:so sure. But I do think that as some of these other effects start,
Speaker:I mean, he's not been in office that long, Right?
Youthink
Speaker:about the amount of stuff he's done already, but, you know, a lot
Speaker:of the things that he's doing, there'll be quite a lag before they
Speaker:have an effect on the real economy and start showing up in things
Speaker:like jobs numbers and even bigger lag before they show up in
Speaker:equities. So, I'd say watch this space.
Speaker:Yes. And I'll finish with one thing which actually I do think might
Speaker:be also a little bit of the signs that we're seeing now. Many,
Speaker:many years ago, I came across someone who talked about this idea
Speaker:of cycles between public and private, Where sometimes the public
Speaker:trust is high, sometimes it's very low, and it's the private…
AndI
Speaker:will say I have been thinking about this concept a little more
Speaker:recently, and I would not be surprised if what people think is
Speaker:safe, i.e. government bonds, will turn out to be not so safe.
Speaker:And actually, what we think of, maybe more risky normally, such
Speaker:as equities, might actually turn out to be more of a safe harbor.
Speaker:Thisis not a market forecast, but I just think we need to revisit
Speaker:or even take out of the archives some of these concepts,
Speaker:some of these cycles that come across so rare that we don't think
Speaker:about them day to day. And always, at least in my mind, I always
Speaker:think about the conversation we had with Neil Howe and the books
Speaker:that he or the book he wrote back in the early 90s, The Fourth
Speaker:Turning.
Ithinkthat is a concept that we should not ignore
Speaker:at this point in time. And I fully, firmly believe that this is
Speaker:what we're seeing right now. And it will turn more ugly and more
Speaker:surprising before it's over. So, it will be interesting times
Speaker:and there'll be lots of things for us to talk about every week on
Speaker:the podcast.
Rob,thank you ever so much for doing such a thorough
Speaker:job without coughing, despite having to bite your tongue at times
Speaker:when we discuss certain elements on the podcast today. Great
Speaker:stuff and I hope people appreciate all the preparation that
Speaker:Rob put into this. If you did, by all means go and leave a rating
Speaker:and review on your favorite podcast platform to show your appreciation.
Speaker:Nextweek I have another interesting, super insightful guest
Speaker:that used to work actually with Rob, namely Graham Robertson
Speaker:from AHL. So, that’s going to be another fun and very insightful
Speaker:conversation.
Ifyou have some questions for Graham, something that
Speaker:you might want to challenge him about, then by all means send
Speaker:your questions to info@toptradersunplugged.com and
Speaker:I'll do my best to get them in front of him.
Andof course, as you
Speaker:can tell from my dyslexic way of pronouncing some of these words,
Speaker:by all means make them short and easy for me to put forward to
Speaker:him. Anyways, this is it from Rob and me. Thanks ever so much for
Speaker:listening. We do look forward to being back with you next week.
Speaker:And in the meantime, as usual, take care of yourself and take care
Speaker:of each other.
Speaker:Thanks for listening to the Systematic Investor podcast series.
Speaker:If you enjoy this series, go on over to iTunes and leave an honest
Speaker:rating and review. And be sure to listen to all the other episodes
Speaker:from Top Traders Unplugged. If you have questions about systematic
Speaker:investing, send us an email with the word question in the subject
Speaker:line to info@toptradersunplugged.com and
Speaker:we'll try to get it on the show.
Andremember, all the discussion
Speaker:that we have about investment performance is about the past, and
Speaker:past performance does not guarantee or even infer anything
Speaker:about future performance. Also, understand that there is a
Speaker:significant risk of financial loss with all investment strategies,
Speaker:and you need to request and understand the specific risks from
Speaker:the investment manager about their products before you make investment
Speaker:decisions. Thanks for spending some of your valuable time with us
Speaker:and we'll see you on the next episode of the Systematic Investor.
