Episode #484: Rodrigo Gordillo & Corey Hoffstein – Instagram Frauds, Inflation Volatility, Tech Crisis, & Return Stacking

Episode #484: Rodrigo Gordillo & Corey Hoffstein – Instagram Frauds, Inflation Volatility, Tech Crisis, & Return Stacking

 

Guest: Rodrigo Gordillo is President of and a Portfolio Manager at ReSolve Asset Management Global.

Corey Hoffstein is co-founder and chief investment officer of Newfound Research, which offers a full suite of tactically risk-managed ETF portfolios.

Date Recorded: 5/10/2023     |     Run-Time: 1:12:22

Summary: In today’s episode, we start off by discussing some takeaways from prior periods of inflation volatility and lessons on managed futures from the Tech Crisis.

Then we dive into return stacking. We first spoke to them about this back in 2021, but we get an update on the topic, lessons learned over the past few years, and the launch of their first return stacking ETF!

Sponsor: Farmland LP is one of the largest investment funds in the US focused on converting chemical-based conventional farmland to organic, sustainably-managed farmland using a value-add commercial real estate strategy in the agriculture sector. Since 2009, they have built a 15,000-acre portfolio representing over $200M in AUM.

Comments or suggestions? Interested in sponsoring an episode? Email us Feedback@TheMebFaberShow.com

Links from the Episode:

 

Transcript:

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Meb:

Rod and Corey, welcome back.

Rodrigo:

Thanks for having us man.

Corey:

Great to be here.

Meb:

Both of you guys are multiple time guests. Corey, my producer Colby was saying, might be tied for all time most episode appearances on the show.

Corey:

I was going to say, you know like SNL, how they have the five time club with the jackets. I’m feeling like I need a jacket here. I’ve somehow wormed my way on this show a large number of times.

Rodrigo:

You’re like the Justin Timberlake of The Med Faber podcast.

Corey:

That’s right. That’s where I’m trying to get to.

Meb:

All right. Well listeners, we have Florida man and Caribbean man on the show today. Well-timed guys. Give us an update. Corey, you recently joined Dad Twitter. How’s it going?

Corey:

Yeah, I’m struggling. I went in overconfident for sure. I said, “How hard could it be? It’s just a small child.” And it turns out it’s exceptionally difficult. But finding our way through. I just hit two months yesterday so…

Meb:

Congrats. Did you guys have a night nurse at all?

Corey:

No. No night nurse. We did just get a nanny though to help out during the day. Work from home is really backfiring with a young child. This is where I really need an office.

Meb:

Rod, give me your updates. What do you got?

Rodrigo:

I’m still here. Still in the Cayman Islands. Traveling a lot more than I did back in the pandemic when I was hiding away from the world. But yeah, lots going on. More eFoiling. We have an eFoil club now. Meb [inaudible 00:02:48] when you’re ready to come.

Meb:

What does that mean?

Rodrigo:

We were, I think the first or second people to have that eFoil that you featured on your… Well, we talked about on your podcast a couple of years back, and now there’s like 15 of us. So we decided to… There’s just a lot of drones filming us do crazy stuff.

Meb:

Just a bunch of hoodlums running around, just terrorizing all the poor tourists sunbathing, burnt on the beach.

Rodrigo:

Pretty much. Yeah.

Corey:

I bet you could rent that thing for a pretty penny, Rod. Thinking about all the people who get jet skis on Cayman and then go rent them out to the tourists. I bet you could rent for an hour, get 150 bucks, 200 bucks.

Rodrigo:

You could. You have to do a lot of coaching though. Like I said, it requires… And in fact, there’s one guy who does it, and he has a remote control, water resistant headphone, headset, where he just walks them through from the beach what they’re needing to do, how they need to balance. So there’s somebody already doing something like that. It’s a lot of work. Probably be a bit more than 200 a session.

Meb:

Before my Instagram got corrupted with 30 to 50% IRR advertisements, there was a local guy advertising on Instagram for foil board lessons. So it must be profitable to be able to do it on Instagram. But I made the mistake of seeing one of these ads. So first, it was Tai Lopez with his 20% guaranteed dividends, and I liked that and I bookmarked it because I’m like, “This is absolutely [inaudible 00:04:17] preposterous.”

Corey:

You fed the algorithm.

Meb:

It seems like they’re going bankrupt right now, so who knows? But then I see one a week ago that was… And they just keep getting more and more ridiculous. So it was like, 30%. And they use nine different acronyms of the ARR, there was an AAR, IIR, average annual returns. One had four different ones in the same way, the same ad, and you’re like “Can’t tell the difference between what any of these metrics mean,” but either 30%, 50%, one had 700% returns. Although, to be fair, that one wasn’t annualized.

But I liked one. And then now, my entire Instagram, which used to be actually kind of useful, I got 90% of my clothes and gifts. It was very targeted. Google Ads has always been worthless to me. Facebook, dark hole. Instagram has actually been useful. Now, I need a new account because it’s…

Corey:

Well, hold on. I think there’s an opportunity in all this for you Meb. Because you probably saw the SEC just awarded their largest whistleblower fee ever. It was hundreds of millions of dollars.

Meb:

270 million.

Corey:

To a single individual. This is an opportunity for you. So I was trying to figure out what it was because if you go back, I assume the fee is something for a case they’ve already closed. You look at cases they closed in 2022, 2021, there was no four or five billion dollar case that would justify the several hundred million dollar payout. So the case hasn’t been announced yet, which I find kind of weird. That or I’ve just completely missed it.

Besides the point, what I’m thinking here is, you are sitting on a gold mine. You are getting fed things that are clearly in violation of SEC rule. You just got to start submitting those to the SEC and wait for your payday.

Meb:

We tweeted one about a year ago. It was called Platinum Partners. And it made these look tame. It was like, “12% returns,” whatever. “Guaranteed.” It was actually in Texas. A week later, it got shut down and it was a $250 million fraud, which is not nothing. But I was joking. I said, “I’ve actually submitted two whistleblower complaints.” Tell you guys in secret later who they are and the SEC declined to pursue them. And so I said, “You know what? It’s a headache, work… You had to go on the website, do all this stuff.” I was like, “You know what? Twitter, I’d just rather just throw them out here and let the pieces fall where they may.” Anyway…

Corey:

I was actually looked into it as to whether there’s some free optionality and just starting to… Why not? What’s the downside of spending some time just saying, “I think that might be a fraud. Let me submit it,” because the upside is so high you could even hire someone to do that full time. As it turns out, the SEC will actually ban you from submitting if you submit too many bad ones, so…

Meb:

It used to be, and I’m not sure anymore, that they required you to have a lawyer submit it and that’s just a lot of work. I don’t know if that’s true anymore, but the challenge I always have is I want to focus on the positive and all the great things going on, but then you see this bad behavior that gives our world a bad name when you guarantee 50% returns and 20% dividends. It irks me.

Anyway, let’s move on. So anyway, listeners, if you got any particularly wonderful frauds, send them along. We’ll share a bottle of tequila when you get a hundred million dollars.

Where do you guys want to begin? It seems like the conversation this year… You guys talked to a lot of investors, advisors. It seems like there’s really been kind of two topics that have been front of mind. One is, it used to be inflation but now it’s just like, “Hey, I can get 5% on T-bills,” but we had a print today, inflation seems to be coming down.

Any general thoughts? Rod, you’ve got some PTSD from prior conversations about inflation and historical kind of thoughts that I think have been really insightful. Where do we begin? What do you guys think?

Rodrigo:

Yeah, I guess I could tackle that. I mean I think as always, right, as we’ve spoken many times before, I got the hybrid blood of a Peruvian and a Canadian, so inflation weary and gold loving kind of personality. Gold coming from the Canadian side surprisingly. And it’s because if you really understand what drives markets, there are two things that I think generally the world agrees that drives the asset prices and its growth dynamics and inflation dynamics.

And yet I think the vast majority of the people in our industry are purely focused on growth dynamics. Are we in a growth cycle or are we in a low growth cycle? And for the first time in 40 years we’re finally focusing on the inflation cycle. But like you said, that was almost like the discussion of last year. And as we’ve discussed in your podcast, I think seven years ago, when inflation does come in, the places to be are going to be in the commodity spaces, in inflation protected bonds.

The inflation protected bonds is basically like buying the 20 to 30 year treasury plus an extra 25% on commodity stacked on top. So that’s some protection there. And then we find ourselves this year with a 4.5, 5% yield and people think, “Well that’s great, that’s enough. We priced that in now we’re now we’re set.” But we to realize what real yields are and that inflation continues to be high. And then in spite of people believing that it’s almost over, we certainly peak momentarily, we don’t know. That’s the honest truth. We do not know whether it’s over. We’re seeing conflicting results on all the global macro inflation numbers. There’s really no direction. We’re seeing the Fed continue to stick to a plan of tightening because of this and they don’t know.

So again, from the perspective of what’s going to happen next, the truth is that you need to first focus on preparation rather than prediction. And part of that preparation is making sure that your portfolios are robust to inflation and that needs to include things like gold, like commodities, like trend following that have proven historically to be great hedges against that very important high inflation, low inflation dynamic.

Meb:

So I think a lot about this. I think a lot about psychology and behavior. I mean in the US for, like you mentioned, 30, 40 years, it’s been kind of one broad regime. I mean, we’ve had obviously bear markets and things like that, but it is particularly with interest rates and how much of that colors people’s behavior and psychology and expectations today. I imagine it’s a lot, but certainly with a world of some new behaviors like the bank runs we’ve seen as long as time has been around with banks but instantaneous bank runs now, where they happen overnight I think is somewhat new. Corey, you got any general thoughts on what’s going on? Is gold creeping on a new all-time high right around here?

Corey:

I love that point you just brought up now, which is, the bank runs can happen faster than they ever happened before. There was this great term that got coined during the meme stock mania which was this called social gamma where gamma is this idea tied to options. You can sort of think of it as velocity is speed, gamma is acceleration. How fast can things accelerate?

And the idea of social gamma was that things can move so much faster today than they ever could. The news can spread faster and people can act faster because you don’t have to call the phone up and get your broker on the phone to buy a stock. You can go on your app and do it instantaneously and buy it with leverage via options. To your point, for me to get my money out of a bank, I don’t need to show up anymore. I just go on the bank website on my phone wherever I am and I wire money out to my brokerage.

And so the digital bank run can happen with so many magnitudes faster than you can in prior decades. I think it’s something to consider on the inflation side too. If we go back to the 1970s, I tweeted something out, I think it was a couple of months ago, where I said, “I think it’s funny that we look at the 1970s and talk about a high inflation regime. It was really three crests of inflation and no one can actually tell me what caused that inflation.” And then I had hundreds of replies of people telling me exactly what caused the inflation, none of which agreed with each other, right?

But I think when we think about the way the economy has to react, the way businesses have to react to changing economic environments, changing prices of inputs, dynamic consumer behavior and then all of that’s accelerated because of the rate at which the consumer can react via the phone, I think you can get things like inflation coming back very quickly in a way that would be unprecedented in the historical data.

Rodrigo:

Yeah, look, I think just adding to that Corey, the key word here is you’re going to have inflation volatility too and it’s going to be incredibly fast both on the upside and the downside. Note that in any public discussion we’ve had on inflation, it’s never been like “Inflation’s here, everybody should run and buy some golden commodities and overweight that.” It has been, “There’s going to be some thrusts of inflation that are going to make your head spin and then there’s going to be some inflation fighting that is going to make your head spin right back and you’re going to need to be able to prepare for all those scenarios.”

And in the beginning of this discussion, I talked about the two dynamics, high growth, low growth and high inflation and low inflation. When we go through a decade of inflation like the seventies, it’s not, as you said originally, a full decade. It’s those three peaks and so that’s, I think, going to be the same case here but faster as you mentioned.

And so how do you deal with that? I think there’s a couple of ways. Number one, be balanced between your growth assets, your deflation assets and your inflation assets. And that of course is in the realm of risk balance, risk parity, a portion in equities for bull markets, a portion in treasuries for bear markets and a portion in commodities for inflation regimes.

And then a lot of work done by AHL and our own work show that managed futures is a great way to manage on both the upside and the downside of inflation and how that affects commodities and bonds and so on. So yeah, you’re going to need to recognize the volatility of inflation in the period that we’re in right now.

Meb:

As you chat with advisors, and this could be institutions too or even individuals, but they tend to all kind of rhyme in my mind, what are the missing parts that they tend to exclude, it could be all of them, of these that we’re talking about? Last year, traditional 60/40 got walloped. Is it commodities, is it trend, is it tips? What is missing or is it just all of it?

Corey:

Well, I think… I’m going to take a little tangent here. You guys might have listened to the Masters in Business interview with Cliff Asness that came out, I don’t know a month ago, and Cliff coined a phrase that I will probably steal for the rest of my career where he was talking about statistical time versus behavioral time. And you look at the 2010s and you look at the type of economic regime it was, it was a predominantly deflationary regime.

You had periods of economic growth, you had periods of economic contraction compared to trend, but it was primarily deflationary, which is an environment that is incredibly beneficial for both stocks and bonds. So your 60/40 portfolio printed, at least US based, one of the best realized Sharpe ratios ever for that decade. Statistically that is a blip, right? You go back a prior decade, it was an environment that you had both inflation up and inflation down and going back to the 1960s, these sort of four quadrants Rod’s talking about occur about 25% of the time each, right? Growth up, inflation up, growth down, inflation down and then the varying versions.

So statistically you look at the 2010s and you say, “Great, that exposure of a 60/40 that does super well in a deflationary environment was phenomenal,” but in the grand scheme of statistical time, not a big deal. We needed to construct a diversified portfolio.

In behavioral time though, a decade is forever and getting a client to do anything other than a 60/40 after a decade of US dominated 60/40 performance just beating everything else in the world, I think it’s been hard to get people off of zero candidly. So you say what are they missing? Are they missing tips? Are they missing commodities? Are they missing managed futures? They’re missing international diversification.

You talk about that one all the time Meb. They’re not even willing to go beyond just pure dollar exposure, they’re missing currency diversification, they’re missing commodities, they’re missing really anything that could hedge non-pure US stock bond exposure and I think it’s because that behavioral time has compressed their behavior into the portfolio that did so well and for advisors to continue to compete with each other, they sort of fall into the bad behavior of buying the portfolio that’s done the best, which has been the US 60/40.

Meb:

There’s a lot of times, and recently I was tweeting about this, where we were talking about how most investors don’t establish how they’re going to deal with an asset or a fund and particularly in our world of active stuff that looks pretty different and weird, it’s probably even more pronounced, but I said because most people don’t establish sort of the criteria ahead of time and they just wing it, invariably it ends up in the performance chasing.

And there’s many times I think to myself, it’s not all the time, but sometimes I say, “I kind of wish these weren’t public funds,” because I would like to have a one-page intake form. Almost like you go to the doctor’s office and advisors like, “Meb, we’re going to buy your strategy.” And I say, “Oh, hold on a second. You need to fill this out, because in six months when you complain about this strategy killing you or it’s been a debacle, I’m going to hand this back to you and say, ‘Look, let’s go through your criteria,’ because when you bought this, you said you were going to hold it for a minimum of five years, more likely 10. You said you would only sell it if there was a manager change on and on all these things and none of these criteria so why are we even having this conversation?” And kind of just do a little shaming but also try to keep them behaving. Obviously with public funds you can’t do that.

Corey:

You ran that big global asset allocation horse race, right? I mean, your book… And you say for all these varying global asset allocations, they’re not really that different at the end of the day, but that was over… That was the time horizon there? 60, 70 years?

Meb:

It was early seventies, so ’72, ’73 through 2014.

Corey:

All right, so you’re talking a pretty long time horizon, but a horizon most people couldn’t tolerate from a behavioral perspective, right? I mean it’d be really interesting to go back to each of those portfolios that you examined and say how’d they actually do in 2022? Because I bet the annual dispersion between them is pretty wild and people would’ve just jettisoned out of the worst case situation.

Meb:

Here’s the statistic that explains everything. So these portfolios over 50 years essentially cluster within about a percent annual performance of each other. The dispersion per year between best and worst on average is 30%. Way more than you would expect. It’s a massive, massive number.

Corey:

And I bet over rolling five years, it’s pretty wide too. And that’s what Rod and I have been working together to try to figure out because you end up in this scenario where the US 60/40 dominates for a decade, everyone converges on it. And the question is, if you want to build a robust portfolio, how do you incorporate things that can hedge against inflation without running into this relative comparison problem or what I would call the funding problem, which is, “Okay, I’m going to ask you to sell your stocks and bonds to buy commodities that went down 50% in the 2010s or buy managed futures which went nowhere in the 2010s.” That’s a really hard proposition, particularly when those funds tend to be worse from a fee perspective, tend to be worse from a tax perspective and tend to be more opaque for clients.

The reality is a lot of advisors end up allocating to stuff that is easier for their clients to understand because it becomes easier for them to stick with. And so we’ve been running into this wall for the last decade as firms that run alternative strategies and have now started to come to market with what we think is an innovative solution that allows people to sort of, I don’t want to say have their cake and eat it too, but to a certain extent keep the asset allocation that they’re comfortable with, that they’ve converged upon, but start to introduce some of these diversifying alternatives as an overlay rather than having to sell out of what they’re comfortable with and buy something that they don’t understand.

Meb:

I think that’s smart from a mental bucketing standpoint. We talk a lot about product… People talk about product market fit. The iPhone, amazing product market fit, and people talk about product investor fit, but in between, and particularly for advisors, there’s product advisor fit and there’s a lot of things for better and for worse end up having great product advisor fit that may not actually be great for the end investor or they might be somewhat irrelevant.

I mean, direct indexing to me has amazing product advisor fit and it’s probably totally fine for the end investor depending on how it’s implemented. But the interesting thing what you’re talking about is, either way they may think about doing it, they probably end up in a similar situation, but it is mentally bucketed totally different.

If I have to get rid of my bonds in my head to add something like trend or it doesn’t even matter what it is, Chinese stocks, alternative energy, whatever it is, you set up a wrestling match whether you know it or not. Now if overlay is different because you’re just saying, “Okay, well I’m keeping what I have and I’m just layering this in,” it’s almost like stirring the cake batter. That seems to me a much more palatable, thoughtful way of doing it than, it’s like a neuron pathway that’s going to end up somewhere else.

Rodrigo:

You get to have your cake and the overlay is, you get to add a little bit of whipped cream on top depending on how much whipped cream you want, right? And so it doesn’t change that you’re getting your chocolate cake, anything that goes into that layered cake that you want, you’re just getting an extra sweetener on top that behaviorally allows your clients to look at their neighbor and say, “Hey, they got their 60/40 or their 50/50, or whatever their allocation is, did we get the same thing?” “Well, yes we did. Plus a little bit more that has nothing to do with that 60/40.”

Meb:

Let’s teleport back for a minute because as some of the most often joined guests for us on the show, most people are familiar with you guys in your work. But for those who are coming in from somewhere else, give us a brief overview of the core idea of this kind of stacking and return concept you guys are kind of touching on the periphery here.

Rodrigo:

Sure. So the idea here is that ReSolve Asset Management has been managing futures contracts for many, many years and one of the benefits of being able to use futures contracts is that you don’t need to fund the exposure with a hundred percent nominal cash. If you want exposure to the S&P 500, you buy a futures contract, you need to put a little bit on margin and the rest remains in cash, right?

And so when we say… Historically return stacking has used other language like portable alpha or overlay strategies. These are really complicated things that the average retail investor doesn’t really quite get. But in essence, if we changed the language to, “We’re going to stack these exposures on top of other stuff, return stacking,” it all of a sudden went viral. So in our paper that we wrote, I think was called, Return Stacking Strategies for Overcoming a Low Return Environment, this was written in July, 2021 when Corey and I had been banging our head against the wall trying to make room in a 60/40 for alternatives.

We finally came to the conclusion that there were enough public exchange traded funds and mutual funds including our own, that have more than $1 exposure for every dollar that you give them, right? So there was an ETF and [inaudible 00:25:34] there is an ETF out there that is 90% equities and 60% bonds. Okay, what’s special about that?

In essence it’s a balanced portfolio levered at 1.5 times. Now that in one world could be seen as, “Hey, I get more returns and more risk.” In another world it could be seen as, “What if I only buy 66% of that in my portfolio? So I buy $66 worth of that 1.5 levered bond portfolio and now I have $33 in cash to do whatever I want with. I could stack medium duration bond, I could stack a gold position,” and if you x-ray that portfolio, you’ll see that you’re getting 60/40 and 33% in gold.

In the paper we highlighted the blind spots of the 60 and the 40, of equities and bonds. This is again back in 2021 before we saw inflation or anything. This is just basic portfolio construction, understanding the fundamental variables of global markets and saying the 60/40 has a big blind spot.

Number one, it has the blind spot of rising rates due to inflation and the second one is bear market from equities because the 60 of the 60/40 dominate the risk of the portfolio. So you have a 60/40 that does well mostly in disinflationary growth environments. What happens if we are going through a period of inflation or we go through a bear market? What can fill in those gaps that’s an easy stack to put on top? And it turns out that managed futures tend to be a really good option there because it’s futures, as I described earlier, it’s easy. You don’t need to put up all the capital in order to get exposure to those things. So managed futures are an obvious solution, but they also happen to historically show a strong offset during periods of inflation and a strong offset during periods of bear markets.

During inflation managed futures funds tend to get exposure to 20 to a hundred different global markets, including most of them being commodities, agriculture, metals, grain, energy and so on. But also bonds and equities and currencies and they also can short, so if it’s a bear market, they can short the things that are losing money and go along with things that are making money over time and it just so happens that if you look at the Soc Gen trend index or the B top 50 or whatever trend based managed futures you want, you’ll find that the correlation over time is zeroed equities and around zeroed bonds, which is kind of what we’re all looking for, right?

But when you’re making room for those things and you’re 60/40 and we go through a decade of 60/40 being the ex post best performing portfolio construction on the planet, you’re not going to get a lot of buy-in. But if you then say, “You get your 60, you get your 40, and on top of that in the paper we added another 60% of alpha, of managed futures stuff,” now you’re talking, right? Now you get an extra layer of return that’s non-correlated to equities and bonds so you’re stacking returns, but you’re not necessarily stacking risk, you’re reducing drawdowns.

And it’s a way for investors and advisors to think, “Okay, I see the blind spots, but I don’t know if we’re going to see inflation, so I’ll just have that as an insurance policy on top and if it has a terrible decade, like it did in the previous decade, I don’t lose out. And if it a good decade, then I win.” That’s kind of how this all went about. And so that’s return stacking in a nutshell. I don’t know if you want to clear anything up Corey or Meb, but roughly speaking that that was the original idea and then obviously, it’s not prescriptive. The concept has been used to fill in some gaps, but you can stack whatever you want at the end of the day.

Meb:

Corey’s too busy checking on prices of his shitcoins. My favorite part is we always look up people’s most popular tweets before episodes and Rod’s is very on brand. It’s a story of inflation and deep macro. And Corey’s is a meme of Mark Cuban falling off a bicycle as he was talking about regulating crapcoins.

Corey:

Yeah. What do they say? You got two wolves inside of you. I got one side of me that’s very traditional, buttoned up finance and the other one that is slinging shitcoins.

Meb:

Yeah. Corey, you and I actually, quick diversion, talked about this years ago where I said, “I’m surprised Corey isn’t a hundred millionaire billionaire at this point from setting up some very serious ARB type investments.” And I was like, “I need someone to go into all these alt offerings,” which now by the way, you even see the amount of late stage privates I’m seeing offered down 80%.

So series CDEFGHI, less so the kind of series A world, but the later stage, but also the whole collectible universe. When you have bear market, everyone’s puking out, whether it’s wine or sneakers or whatever. I want to be the low ball bid on all of them. I want to be… Somehow there’s a phone you call and be like, “Hey look, Meb’s willing to buy any of this inventory down 90%.” But I was like, “Corey had to be the one to ARB zed run and all the various crypto…” Anyway…

Corey:

Yeah, I like the not so subtle, just complete insult of like, “Corey, why are you not worth a hundred million dollars yet?”

Meb:

Yeah.

Corey:

“You’re a complete failure.” Thank you, I appreciate that.

Rodrigo:

Your nickname’s safety boy, you did all the work and all the things at 1% of your portfolio, that’s not going to make a difference.

Corey:

So let me get back on point to the return stacking stuff because I think Rod laid it out beautifully. If I could just summarize it in a single sentence, it’s the goal of return stacking is to give you more than a dollar of exposure for every dollar you invest. And what we have found [inaudible 00:31:16] working with advisors is that the goal for us is to give them the strategic asset allocation they have been comfortable with their clients, the stock bond mix they want and then use this return stacking concept to try to overlay the least invasive but most effective diversifier we can find. And that has historically predominantly been managed futures.

Managed futures have positive expected returns. They tend to exhibit fairly absolute returns. Their drawdowns tend to be pretty low compared to other asset classes. They exhibit low near zero correlation of stocks and bonds as Rod mentioned, but also conditionally tend to do very well during prolonged equity bear markets and very well during inflationary markets.

And I think the added benefit there is, we use inflation as this term of just a broad umbrella term. There’s so many potential drivers of what inflation could mean. Is it demand based inflation? Is it supply based inflation? Is it monetary inflation? The reaction among different asset classes is going to be very different depending on what is causing inflation. Managed futures as a strategy is, and I know Meb you love managed futures, is so dynamic that it can go long and short so many different asset classes. It has the flexibility to respond in a variety of ways.

So 2022 we think, “Oh, high inflation, you should be long commodities, let’s be long gold.” Commodities and gold didn’t really work in 2022. What you really wanted to do was be long the dollar and short bonds, right? Managed futures got that trade right. I know a lot of people in 2020 who bought gold and it ended up being the wrong inflation hedge for the type of inflation we saw.

Now gold is potentially breaking out this year and you’re starting to see it be added more heavily in managed futures portfolio. So for us, managed futures ticks a lot of the boxes we wanted from the non-invasive overlay perspective and has ended up serving as the basis for the first product we’ve launched in this new suite of ETFs that we’ve built together called Return Stacked ETFs.

Rodrigo:

Yeah, that’s just… Honestly from first principles of what you want in a portfolio, is you want things that have positive expectancy but move differently from each other. It’s as simple as that.

Meb:

The funny thing about this, circling back to the booked we published on Global Asset Allocation, when we update it, we need to include some probably trend and active strategies because the best performing allocation in the book was an endowment style allocation, which makes sense. Seventies, eighties, nineties, growth heavy equity portfolio did the best.

That portfolio, simple modeling of it has underperformed the S&P, I think till last year, 12 years in a row. Not 12 years total, 12 years in a row, which is the longest period in history. So we’ve actually modeled and simulated some of these back now to the 1920s and there’s been various periods of underperformance, but this was 400 percentage points of underperformance or something for all these allocation models.

And so I talk a lot about this, the bad behavior the last couple years culminating in this one very specific mindset and I consistently get ratioed on Twitter for this, which is, all in on US stocks at any price no matter what and anything else just GTFU.

And so last year, you know had kind of the reversal of that and you’re having this reversal of the reversal this year. Managed futures in trend to me, I was inoculated early, but it seems so obvious and you hit on the key point, is you never know when you’re trading 50 to a hundred markets, what’s going to be the one to hit. You can cheer for stuff and you can always guess, but I love watching all the macro bullshitters on Twitter, particularly all the VCs that are whining about the Fed and everything. They never pat themselves on the back for how much the Fed helped them maybe prior, but now that it’s hurting…

But I always look back and say, “This is so obvious. Were you guys short bonds?” No, of course not. No one shorted bonds but managed futures did. So you didn’t know where the return stream was going to come from in the crisis and in 2008 it was different. You were short equities, all sorts of other stuff. This one, it was short bonds and that saved your hide. I mean most of these trend strategies did what, plus 20 last year or something?

Rodrigo:

Short bonds, long commodities, right? So they were getting the inflations trade and they were getting the bear market and bonds all kind of tied together but-

Meb:

Check out their website, returnstackedetfs.com. It’s beautifully designed like a lot of stuff these guys do. Some good research. The first ETF is a bond and managed futures, RSBT. You guys want to talk a little bit about the sausage? So when you say trend, tell us about the bond, I imagine that’s the easy part and then kind of dig in deep.

Corey:

Let me set up the ETF and then I’ll let Rod talk about the trend side. So the basic concept of the ETF is for every dollar you give us, our goal is to give you a dollar of exposure to core US fixed income and then a dollar of exposure to a managed future strategy. How could you use this, right? Let’s talk about the potential use first. Let’s say you’re a 60/40 investor, you have 60% in stocks, 40% in bonds. Well, you could sell 20% of your bonds and buy this ETF. And what you would then effectively have is 60% in stocks, 40% in bonds, and a 20% overlay of managed futures. So the idea is by giving you the two in one in this ETF, you can replace your beta, the ETF will maintain that bond beta for you and give you the managed futures as an overlay.

The way we do that under the hood on the bond side is pretty easy. Every dollar you invest in the fund, we take about 50 cents, put it in a broad bond ETF. We then have to have cash collateral, which we use for the managed future strategy. So we have about 50% of the portfolio sits in cash. To make sure we fill out the rest of the bond exposure, we buy a ladder of treasury futures. So the bonds are basically made up of a core AG type exposure plus a ladder of treasury futures and then all the cash that’s sitting there serves also as collateral to the managed future strategy, which is the more interesting side of the portfolio. The core goal of the bond strategy is just to try to give you something that looks like core US fixed income.

Rodrigo:

And then on the trend side, I mean what we wanted to make this, is a very accessible product, right? And when you think about managed futures, when you start exploring that world, and one of the biggest objections I’ve seen over my career is, the problem with managed futures is that you’re all over the place. Yes, broadly speaking there’s a correlation, but in any given quarter, month, year, your dispersion between manager one and manager two is 20%, right? Because you’re looking at certain managed futures managers that are running at short-term trend indicators, medium term trend, long-term trends, some include carry, some have seasonal patterns and so on.

So there’s a big objection to being like, “What is managed futures? Is there an index that I could just get all of them?” And turns out there is, so there’s a handful of them out there and the one that we are currently tracking is the Soc Gen trend index which is, I think it’s the most liquid 10 CTAs out there after fees, transaction costs, slippage, and you can look at the index, it goes back to 2000, right?

So the idea here is to say, “Okay, if we’re going to put together an approachable return stacked, where you get a dollar of bonds and then an extra dollar of managed futures, we want that to be as diverse and as close as possible to a benchmark that people can sink their teeth into.” And so instead of running, because we run our own alpha trend following at ReSolve, that’s our alpha and it’s different than anybody else and so on, which is what we don’t want to do here, what we did is we used our expertise in trend following in order to create, I think, a fairly unique approach to replication.

And there’s two major replication approaches. One is bottom up and the other one’s top down. The top down seems to be the one that we’ve seen the most out in the market, which is in essence a regression analysis on whatever index you want to replicate. You do some sort of regression where you’re trying to peer through the corners and extract the weightings of asset classes that that particular index has. So you’re really just trying to match as close as possible, using regression analysis, what we think they are holding at any given time. So that’s the kind of top down approach. It’s a pretty good approach and it has a R-squared of 0.7 to 0.75 depending on how you do it. You’re really looking at on average the last five days of movement in order to extract those, right? So it’s the equivalent of going into the room and peering to see what the allocations are, okay?

The bottom up is a lot tougher to do if you are not already a managed futures manager because it requires you to understand the machinery behind the trend managers. So, how many trend parameters exist out there, breakout systems, moving averages, time series momentum and so on.

If you have those in your back pocket, if you know what they look like, then the top-down approach is an interesting one because what you can do is you can do some more robust regression analysis using machine learning in order to identify what are the machines or the parameters that the vast majority of these managers have used historically in order to gain their returns.

So now when we’re peering around the corner, we’re not peering to see what they’re holding but rather what machines they’ve used historically. And what you find is that they mostly use medium to long term trend systems and we now have the parameters in place and the weightings that they use so that when we are “replicating”, what we’re doing now is we have a portion of it that is trying to assess what they hold and then another portion that is actually executing the triggers as they happen immediately, right?

Because one of the downsides of top down is that you could be late to the game. Something quickly changes, it’s going to be a while before you pick up on those changes. Whereas if you have the machinery in place and they’re triggering, then you actually have a full trend system that is highly correlated to the trend systems of these 10 managers. So we’ve used a combination of both, basically a third goes to top down and two thirds goes to bottom up.

Meb:

And so what does that end up looking like today? I mean the fun thing about general, most of the trend stuff is you can often sit back and say, “I have a pretty good idea what’s in there. Probably long gold, probably long some equities.” What else?

Corey:

I think the fun thing about these ETFs now is all the positions are disclosed daily. So when you’re interested in actually seeing what’s in there, you can go to the website and look at the actual positions. I don’t think it’ll come as a surprise to anyone who’s been following markets. The absolutely violent reversal in bonds in, what was that, March? It was the week after my kid was born. It was a really bad time for markets to turn violent on me, right?

You saw a big contraction. Most CTAs were very short bonds. You saw a big contraction in those positions predominantly first driven by vol expansion. Those positions became so volatile, managers tend to collapse their allocation to target vol, and then the trends started to turn positive. So we saw in that bottom up system react much more quickly, almost instantaneously after the selloff to cut those positions, whereas the top down approach was much more slow to react.

So again, sort of contrasting those, but today what you see is in the trend following system, much less exposure to bonds. You can look and see that indeed, yes, long gold. Yes, long international stocks. I think again, the nice thing about trend following is it’s fairly intuitive. What I always say to people is, “You should be able to pull up a chart of that index and guess.” If the chart over the last nine months is going up, we should probably be long. If it’s going up a lot, we should be longer. If it’s kind of flat, we should be flat. If it’s going down, we should be short. And I think there’s a nice amount of transparency to that. You shouldn’t be surprised by the positions.

Rodrigo:

And of course, like always right, Corey and I excel and we really like launching new product a few weeks before the worst historical price action have you seen in anything. So of course I think the ETF launched early February and we had the SVB fiasco, which look, it was an interesting use case because, as a diversifier, your equities did okay, bonds did exceedingly well during that period. Most trend managers were short bonds and so they took the other side of that bet, right?

So put them all together, you get a pretty benign equity line, but if you take them apart, it feels like, “Well, you just got caught off side.” Turns out trend got caught on side in February and March of last year. Got really, really lucky with the… I don’t want to say it’s lucky, but positioning wise during the Ukraine war and inflation, obviously that’s unlucky for many people, but the point is that it had outsized returns that maybe can be seen as pure luck. And in March it was unlucky. The point being, it’s non-correlated still and it’s expected to have a positive return over long periods of time.

Corey:

I was just going to say this is a category that I think is a lot more prone to dispersion than many other categories. It might be of all the investment categories, the one that has the most dispersion. Because when you look at the way… Ostensibly, it’s like, okay, they’re all just following trends. How different can that be? Well, right, there’s so many different parameters that go into building these systems. What futures contracts are you trading? What type of trends are you following? Are they short, intermediate, long term trends? How much vol are you exposing yourself to? How are you building the portfolio, right? Are you equal weighting commodities, currencies, rates and equities? Is there some other approach? Is there an optimization based approach?

And when you start to look at the impact of all those decisions you end up with… I mean, this might surprise people, but there were managed futures funds that posted negative returns in 2022, despite the fact it was a gangbuster year for the broad industry. Again, that dispersion is incredibly wide. So to your point Meb, I mean, for years before this fund launched and I wanted personal allocations to managed futures, the stuff that I didn’t have in private funds, I allocated across a swath of public mutual funds because I just said, “I want the average exposure and I’m just going to rebalance across them. I don’t want to try to pick which one’s best because I just think there’s too many much noise in the short term for that to matter.”

Meb:

Yeah, makes sense. Altogether reasonable approach. What else on this fund and ideas we’re talking about?

Rodrigo:

What’s interesting about the seventies, as you mentioned, AQR has a trend following index going back to 1926. I just looked at the seventies just to tie it into the conversation we’re having before, this idea of inflation volatility. What you’re seeing in this chart is US equities in dark blue from 1970 to 1980. We also have risk parity here, which is a third risk to equities, third risk to bonds, third risk to commodities, but importantly the yellow line is commodities and that’s kind of telling the story that Corey told earlier, right?

You have one peak, then one peak of inflation up to 73, then it kind of flatlines and gives some of it back, then another peak, then a 37% draw down and another recovery that was highly volatile. From point to point commodities did make 650%, but you did have to deal with a 37% bear market in commodities as you waited.

So I think again, when you think about, what does trend following tend to do, it actually is a pretty good asset class to own for inflation periods and bear markets, right? And the blue line is AQR, is a trend following model. And you can see that it does a fairly good job of keeping up with commodities and inflation, flatlines to slightly up during the commodity bear market and continues to make those excess returns.

So I think again, it continues to be a strong appeal for trend following. Now this is a month to month chart, so it seems a lot nicer than what being in a market like this is. If you actually get to the nitty gritty of trend following and you look at it from a microscopic lens and go through what it may feel to be invested, making room in your portfolio for trend following, emotionally, is difficult. This came from a conversation I had with a veteran in the industry where he’d made a lot of money running his own CTA.

We were talking about how great it is right now for having that type of strategy. And I said, “We’ve suffered for 10 years in this space, it’s going to feel great now that…” I said to him, “I think it’s going to be like the tech crisis. That three year period, Soc Gen trend was up 58%. It’s going to be fantastic.” And he looked at me and he said, “Rodrigo, are you out of your mind? I got to tell you, that is the worst emotional rollercoaster I’ve ever had in my entire career because at the end of the day we won. But in spite of that, it wasn’t a bear market.” He said, “2008 was a walk in the park. It was a single shot. Trends were clear, happened quickly, made all this money walked away. 2000 and 2003 was not the tech crisis. It was the tech crisis, it was 9/11, it was Enron, it was WorldCom, it was Iraq, it was the balance sheet recession. There were a series of things that broke one after another for connected reasons. And yes, I agree that we’re likely going to be in that period, but I disagree that it’s going to be fun for you.”

And so hung up, looked at the data and looked at the data and he was right, right? Upon first blush… This piece is called, Define the Bear’s Grasp the Emotional Journey of Achieving Managed Futures Prosperity. And just quickly, I’ll just show the bar charts right? 2000, 2001, 2002 against global equities and 2003. Three of the four years, the Soc Gen trend index is double digit positive. One year’s flat when global equities lost 13, 18, 21 and nine, right? Looks great. Who wouldn’t invest in the blue bars? You look at the equity line, looks fantastic, right? Soc Gen trend index from peak to trough of the equity markets is up 58%. Global markets are down 49%. Who wouldn’t buy that blue line?

But from the perspective of the investors we know, what I did is I shaded the areas where you’d be in drawdown or you’d be kind of in just sideways mode. And what I found was that 85% of the time you’re having to explain yourself as to why it is that you’re losing money. “I thought you were supposed to make money when equity markets are down.” And I think this is a testament to that, in these types of markets where you have eight V recoveries in the equity markets, you’re also getting a lot of trends and counter trends and trend following that’s going to be very difficult to hold if you’re trying to make room for it in your portfolio. And I think this is a different story if we stack it on top.

Corey:

Rod, you know what this reminds me of? This reminds me so much of those studies that talk about when you’re buying equities, what happens when you missed the best 10 days, right? And the conversation I’m having a lot with advisors is, “Well, can you time your exposure to managed futures?” Right? They tried to buy managed futures in 2013, they got burnt in the 2010s. Now they’re trying to figure out can they add it back in? Is it a good time? Is it not a good time?

I think this graph so clearly shows those periods of outperformance where you make new highs are a very limited subset of the time in which you’re allocating. This is something you need to have as an allocation. And so then the question becomes, what’s the easiest way to have it as an allocation, setting myself up for the slam dunk here, we believe it’s the overlay, it’s the stack, not the funding, not trying to sell stocks and bonds to make room. And I think you’ve beautifully illustrated it here.

Rodrigo:

And if we fast-forward to today, and that’s what it looks like, right? 2022 to now, massive run up, very strong signal, trends are awesome. And then there’s been the give up. Now from point to point, we’ve seen assets go into managed futures in June of 2022. Maximum inflow there. And we are starting to see the outflows from a AUM perspective because of what happened over the last six months plus SVB. But point to point, Soc Gen trend was up in this piece when we published this. Up around 14% when equities were down around 14%. So point to point, great. Emotional experience, bad. You stack it, easier.

Meb:

I think this goes back to our conversation about sort of the checklist and listeners, I’m going to point you guys to this tweet, and it was kind of offhand comment, but I said, “Most people when they think about buying a fund, just wing it. So these managed futures potential investors are saying, ‘Hey, I’m interested, but maybe I can time it. Should I buy it now? Should I wait till the end of the year? I’m going to wait for a pullback.’ That’s a classic one.” I said, “Look, this is a four item checklist, listeners.”

I say, “Here’s a simple checklist we put on index card. We should start sending out to everyone. Say, ‘One, why did you buy this fund? Two, how long do you plan on holding it? Three, do you plan on rebalancing? And if so, when and how? And lastly, four, what criteria will you use to evaluate when you sell it? When to sell it.'”

So one, the way that people typically do it, “Why’d you buy this fund?” “Heard about in the media. Maybe I screened for some best performing funds. More likely it was just outperforming the last couple years. Maybe a friend suggested.” “How long do you plan on holding it?” “No idea,” is usually the answer. “I’ll see how it goes.” “Do you plan on rebalancing? If so, when and how?” Usually that’s a blank stare. And lastly, “What criteria will you use to evaluate to sell it?” And most people, I think if they were honest, they would say, “If it underperforms after a while, I’ll probably sell it. If it goes up, I’ll just let it ride or I might buy more.”

And I think there’s obviously more reasonable answers to this, and I’m just going to read this, sorry guys, but, “Why do you buy this fund?” Hey, I researched the investment methodology, I read the prospectus.” No one does that but, “Considered the historical ballpark risk return correlation numbers, how they impact my current allocation.” “How long do you plan on holding it?” “Hey, for me this was ideally 10 years, but minimum of X years. This is going to be my planned holding period.” “Do you plan on rebalancing? If so, when and how?”

Good example would be like, “Hey, I’m going to rebalance yearly back to target based on tolerance bands, tax implications…” And these are all very specific to individuals. I’m just giving examples that are reasonable answers versus the unreasonable answers. And lastly, “What criteria will use to evaluate when to sell it?” And again, and I’d love to hear you guys’ input, but for me, this is what I wrote. I said, “A manager change.” So if Rod and Corey get fired and they hire someone else, Bill Gross, to run it. That’s an example. The strategy changed. So if they wake up tomorrow and they’re like, “You know what?” And I love our friends at Wisdom Tree, but they once did this. They’re like, “Our trend fund’s not going to be able to short oil.” Because at the time, oil had only gone up and then what happened next? Oil went down.

So doing something like that where you’re just mucking around without a good excuse. You can muck around, not a good excuse. A structural change in markets, which is exceptionally rare.

Rodrigo:

That is a tough one. That last one.

Meb:

Yeah, it’s very rare, but sometimes it happens. If they were like, “All right, onion futures are illegal.” They’re like, “You can’t trade futures anymore.” It would change something. But worth re-looking. Another fund perhaps better expresses the strategy launches that’s more pure. And I said, “Be very clear to resist the temptation of it being ‘better performing’ as the reason.” And then remind yourself that under or outperforming a benchmark is almost never a reason to sell. It’s worth looking into see if something’s amiss. What would you guys add? So if somebody says, “Okay, I love you guys, handsome gentlemen, they sound smart. I’m going to implement this.” How should they think about it? The holding period, what to do with it?

Corey:

I love your point about the purity, right? And it’s hard not to quote Cliff Asness all the time because he says really smart, quippy, brilliant things. But he talked about how value stocks really underperformed over the 2010s. It was a tough period, particularly the second half of 2010s to be a value investor. And he made this brilliant point, which was, if you look at the performance of value investors, it was actually the ones who were implementing the most pure exposure to the value factor that did the worst. That if you were comparing managers and said, “Oh, that manager beats you by tens of percentage points,” it’s probably because they had a worse implementation of value. It was actually all the people… You’re right. If they had a worse implementation of value, they didn’t get dragged down by value as much and they looked better relative to the people who were really good at value, right?

So even they are certainly looking at returns is not always the obvious answer when you’re looking for this pure exposure. I think the harder thing here, Meb, I’m just going to take a big step back, is we’re talking about evaluating these funds in isolation, right? And to me that’s always a fundamental problem, right? So consider that most asset classes, most strategies that are available in an ETF or mutual fund give you a Sharpe ratio, a reward to risk ratio of 0.3, which means you are going to most likely experience a lost decade. That is probabilistically, if you’re investing over a 40 or 50 year horizon, there’s going to be a lost five years, a lost seven years. A lost 10 years is not unreasonable. We saw it in US stocks and global stocks in the 2000s, but somehow it’s not allowed for something like managed futures in the 2010s.

But if you were to find three asset classes or strategies that were uncorrelated and all offered a Sharpe of 0.3 and you were to put them into your portfolio equal weight, you end up with a Sharpe of something like 0.5. So the portfolio so long as you’re rebalancing, decreases the likelihood of a lost decade. But if you look at those line items, if you scrutinize those line items, they’re still going to be lost decades within the line items. And so I think to me, the fundamental problem is, we, as an industry, still continue to look at every single line item in our portfolio without thinking about how it contributes to the overall composition. And we are willing to sell stuff because we don’t like its recent return without considering that going forward it had a very important role from a diversification perspective.

Rodrigo:

Yeah, I’ll add this. I’ll add this. So all of that I think we all need to internalize. It needs to be seen from the perspective of the portfolio. In this piece, what I wrote when it comes to thinking about trend following is, number one, can you identify a reason why trend is likely to continue to provide a positive expected return? And there’s a ton of work done by Danny Kahneman, Amos Tversky about momentum anchoring and adjusting cascade effects.

I think these are emotional and behavioral reasons why we’re likely to continue to see people behave in hurting manner. And that tends to provide a positive rate of return over time. Does this type of strategy offer low correlation of stocks and bonds? Do they provide offsetting returns during full bear markets? And then do they achieve strong real returns during inflation regimes? If these are the things that it claims and if you buy into that, if you buy into trend doing those things, then it’s an emotional buy-in to the methodology, not an emotional buy-in to what you did for me lately. It just can’t be.

You need to allocate, you need to go back and write down why you allocated to those things. And if those things are wrong and all the things that Meb delineated in his tweet are on still, then you don’t change your allocation. If you all of a sudden believe that all that work on human behavioral finance and trend falling and hurting behaviors are off and that it’s not going to be non-correlated during bear markets, it won’t be able to short… These again, intuitive, right?

Can we count on a prolonged bear market for trend following managers to find negative trends that they can benefit from? Probably. Over a full cycle, probably. Not in every single quarter, but over a full cycle, yes. Similarly in inflation. So if those things check, then you accept your investment policy statement. You accept your allocation and you rebalance and you’re rebalancing. Capture that rebalancing premium or as Corey likes to call it, the diversification premium.

Meb:

Here’s another way to think about it, listeners. Because I always love to flip things back to US stocks because they’re very sacred and I think a lot of people would think about the managed futures allocation, if it’s doing poorly, they’ll kick it out. So totally eliminate it. How many people when you’ve gone through an S&P US stock period totally sell all their stocks never to reinvest again? They don’t, right? It’s just not even a consideration. So the framing of… I always love doing the blind taste test where you just blind out what the asset class is, try to mix them together and see which one you’ll pick. And the same thing with the charts. You always end up with a ton of managed futures.

Corey:

Well, I like to be sympathetic though and recognize there’s a very strong argument as to why buying stocks and buying bonds, you should earn a premium. These are cash flow generating assets. There’s a very, I think, intuitive economic reason why you should earn a risk premium. I don’t think that’s necessarily true for strategies like managed futures and not in the sense that you won’t earn a potential risk premium, but that it’s intuitive for people.

And so the blind taste test, which I agree with, you almost always end up with people buying managed futures because of its sort of sharp profile. The drawdowns are much lower, the returns are much more consistent. The problem becomes, I think it’s easier for people to stick with stocks because they have a much easier fundamental understanding of stocks than it is to stick with a strategy whose returns are definitively coming from a trading P&L.

And everyone would say, “Well, this trading P&L could get Arbed away.” If you have a lost decade, is it because there was a growth issue in the economy and stocks went down? Or is it because this strategy no longer works? And I think people are much more likely to say, “Stocks will eventually come back,” than “Managed futures will eventually come back.”

So I like to have at least a degree of sympathy for that line of thinking. And again, I think to me, it only further promotes the argument of, that’s why I think an overlay is so important, thinking through the asset allocation, not through the lens of either or, but how can we make this an and conversation? “How can I have my stocks, bonds and a diversifying overlay,” I think is a much more powerful way to think through asset allocation going forward.

Meb:                                                                               

Well gents, we’ve covered a lot. What else is on you guys’ mind? It could be about the strategy, just could be about what’s going on in the world. It could be about something totally different. [inaudible 01:03:34], anything else. What are you guys thinking about? And feel free to chat with each other, ask each other stuff too.

Rodrigo:

What keeps on getting me really excited about the world today of investing and retail investing, I was just chatting with a financial planner where he was telling me what his goals are for his clients. And it was a goals-based approach where you have a certain liability and the magic word here is it has to be a real return to pocket for their standard of living. And the standard has been LDI type of investing, right? Matching your cash flows. That dollar amount. We’re going to give you $10,000 a year and we’re going to match those cash flows with bonds and him realizing that doesn’t actually meet his goals, right? That there has to be some sort of inflation protection, the actual nominal amount doesn’t matter. It’s what you can purchase with that nominal amount. And then getting into how do you create a more stable equity line and diversifiers and that inflation dynamic and growth dynamic and getting back to why that hasn’t been part of the conversation.

And it hasn’t been part of the conversation because we were told 20 years ago when we first started in the industry that you want to have a bunch of non-correlated return strategies. You want to reduce the volatility, increase returns, so return to risk ratio, and then if you need to get more return, you increase it by using leverage. And if you want less, you decrease it by using cash. And so we all learned this, the efficient frontier, the capital market line, and then we get into doing it in real life for investors and the tools were not there.

We had a huge evolution in technology by going from being able to pick some stocks to being able to get exposure through exchange trader funds. That was a huge leap forward for investors. What I’m excited about now honestly, not just with return stack ETFs, it’s just across the board, we are finding more capital efficient exposures, mixes of alphas and betas where we can finally implement that William Sharpe Nobel Prize winning concept where we can provide the diversity, provide the stability of the equity line, and provide the leverage necessary to meet the objectives from an absolute return perspective that includes hedging against inflation.

I mean there’s just so much more you can do that you couldn’t do three years ago. Literally three years ago you did not have the tools to do this in as a retail investor. So this is a brand new concept, but brand new technology. That’s the evolution here that I’m excited about.

Meb:

This is hard to drop at the end and then Corey can comment. One of the things that people that really understand some of these concepts you used to complain about over a number of years was because a lot of these trend style funds, like you mentioned the collateral, a lot of the collateral was earning zero, which is now earning five. And they were like, “Well, this is a major reason trend is going to suck or not do as well.” Do you now hear the opposite or is that something that’s even a feature that people think about?

Corey:

For me, the conversation doesn’t come up a lot. The reality is everyone thinks about, “What’s the excess return to the risk free rate?” So yes, it’s nice to earn five, but you’re earning five because inflation is north of five, right? It’s a-

Meb:

Right. But that was the same thing before, but it was just an excuse not to buy managed futures.

Corey:

Yeah, I think that was more the excuse. Yeah. I’ll chime in on your question before, and it echoes somewhat of what Rod is saying around the innovation and the technology. ETFs were an unbelievable innovation as a tool, especially for tax deferral for investors. I don’t think that can be underestimated how valuable that is. It was able to lower cost compared to mutual funds, improve tax outcomes. I think there’s so many wonderful things about ETFs.

One of the things we have seen is further innovation as to what can be packaged in ETFs. Started with stocks and bonds, has moved to include OTC derivatives and exchange trader derivatives. And I think those are going to continue to open up really innovative exposures. So not just things like tail hedging ETFs that I know you have Meb, but there’s a firm out there that launched an inflation swaps ETF.

These are really potentially powerful tools in an asset allocators toolkit that just weren’t available before. Part of what’s now making this possible and what I’m excited about is the regulatory environment we’re in. Normally we complain about the regulatory environment, but I actually am really happy with this 18F-4 derivative rule that came out. Prior to this rule, it was very unclear to folks like us who are trying to build product, how much leverage you were allowed to put in a mutual funder ETF. It was very unclear. And now it is very clear with this derivatives rule, the sort of risk parameters.

Meb:

The answer is just infinity? It’s unlimited?

Corey:

Well, the answer has to do with sort of a risk profile. So it’s not about leverage, it’s about risk. And so before, if you were running a long short equity fund, you might not be comfortable going more than 200% levered. But now given this 18F-4 derivatives rule, for folks who are running a managed future strategy, it’s now very clear they can have six or seven turns of leverage so long as they are within their risk parameters. And if they violate those, they have to cut risk. And I think that sort of regulatory clarity will continue to improve the innovation of the products that come out. And I think particularly on the side of alternatives, and I’m really excited about that over the next five years,

Rodrigo:

And to be clear, what’s riskier? A small cap long only mutual fund or a two-year treasury lever three times, right? That’s 300% leverage versus no leverage. Explicit leverage anyway. People look at that because again, it’s been 40 years of not having the conversation. We need to start having the conversation of risk-based asset allocation where levering up the two year to 300%, that shouldn’t be a red flag. That should be a, “Tell me more. Help me understand the risks behind doing that versus what I own currently.”

And so I think now with this technology, there’s more written up on it. We’re going back to first principles and the William Sharpe approach portfolio construction. And we’re going to get advisors and FA’s and small, mid-size pension plans to understand the incredible value behind understanding leverage, the benefits, the risks, and how it can improve portfolio outcomes over time versus simply going out the risk curve to equities in private equity and private real estate and so on. So I think this next decade is going to be, for those who want to differentiate their practices as financial advisors and consultants, there’s massive opportunity to differentiate in that valley.

Meb:

Gentlemen, it’s been a whirlwind tour. Listeners go to returnstackedetfs.com as well as all the usual spots. We’ll put it in the show notes. There’s a bunch of articles from Rod and Corey we’ll add so you guys can check them out at length later. Thanks so much for joining us today you guys.

Corey:

Thanks for having us.

Rodrigo:

Thanks man. Always a pleasure man.

 

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