Guests: Eric Crittenden, CIO of Standpoint Asset Management, and Jason Buck, CIO of Mutiny Funds.
Recorded: 5/1/2024 | Run-Time: 01:16:52 
Summary: In today’s episode, we talk about the sentiment around trend-following today. We discuss optimal diversifiers for trend-following, how the Herschel Walker trade relates to portfolio construction, and if investors are as diversified as they think they are.
Sponsor: Today’s episode is sponsored by YCharts. YCharts enables financial advisors to make smarter investment decisions and better communicate with clients. Visit YCharts to start your free trial and be sure to mention “Meb” for 20% off your subscription (new clients only). 
Comments or suggestions? Interested in sponsoring an episode? Email us Feedback@TheMebFaberShow.com
Links from the Episode:
- (1:01) – Welcome back to our guests, Eric and Jason; Episode #389: Eric Crittenden; Episode #440: Jason Buck
- (2:02) – Investor interest in trend following
- (6:00) – Herschel Walker Syndrome
- (15:55) – Building a portfolio away from the traditional 60/40
- (18:08) – Rob Lintner Revisited
- (29:02) – Interest overseas
- (41:30) – Paul Mulvaney’s back-to-back 40% months
- (51:19) – Show recommendations
- (56:22) – What Jason & Eric are hearing from investors today
- (1:03:22) – Love for ETFs
- (1:10:12) – Pairing trend following with factor investing
- Learn more about Eric and Jason: Standpoint; Mutiny Fund
Transcript:
Meb:
Welcome back to the show, everybody. We got, not one, but two podcast alums today. We’re joined by Eric Crittenden, the CIO of Standpoint Asset Management. We also got Jason Buck, also the CIO of Mutiny funds.
We’re going to spend a lot of time talking about asset outcasing, diversification, trend following, and much, much more. Welcome back to the show, Eric and Jason.
Eric:
Thanks for having us.
Jason:
Always happy to be here. I want everybody to know though, behind the scenes, Meb’s the OG podcaster, and it’s been an episode of Winnebago Man. I think we’ve been trying to get this started for a half hour, so I just want everybody to know, not all the time does it run smoothly.
Meb:
Part of this is because Jason is dialing in from his AOL CD dial-up from Napa Valley. You would think you would spend the money on Starlink. I mean, first lesson of Cockroach Portfolios, you need multiple layers of backup internet.
I wanted to start with a topic which feels like there’s been a disturbance in the force. We’ve all been doing this for a long time. And I’ve been talking about trend falling for a long time as a particular strategy, and have noticed over the years a difference in people’s reaction to it, their understanding and familiarity, part of that has just been talking. But it seems like there’s been a difference in the community of not just individual investors but also professionals. Are you guys noticing this reception? Jason, I’ll start with you. And then we’ll kick it over to Eric. Or is this just my imagination?
Jason:
It’s twofold, right? I think in one respect I deal with the classical trend followers that have SMAs with large minimums, and I think along that space we’re not seeing a lot of allocations come along that way. I think in the last few years people think they’ve missed some of the trend following trained at least among the classical trend follower SMA community. But then I think that obviously all the work you’ve been doing for decades is giving that groundswell, but then all the newer ETFs that are coming out with replicator strategies and different form of trend following, I think the rise of the ETF space, and then just so happens that most of the people in that trend following ETF space also have to be fellow podcasters and great blog writers. That’s giving a lot of hopefully groundswell to that community.
But I feel like throughout the decades there’s a lot of fits and starts, and I think Eric can speak to that more cogently about what he’s seen over the decades. And probably a lot of times it felt like the trend following was about to take off only to fall flat on its face as far as the allocation side.
Eric:
Yeah, I would say from my perspective, trend has done it again. It paid off and helped people in 2022 only to give back gains and have a down year in 2023. So it’s taken people on that familiar ride that they don’t like. So I haven’t seen tremendous inflows into dedicated trend funds. At least I haven’t seen them stick. You saw them in 2022, to some degree they’ve come out since then though.
Where I have seen growth is firms that are doing something similar to what we do, where we use enough trend in our own products and blend it with risk assets and other assets globally in order to get the benefit without so much of the bipolar, bull market, bear market effect that people don’t like from the space.
Meb:
I wonder how much of it is what you guys just alluded to, where it’s not as much trend falling as an isolated allocation, but more as a piece of the puzzle, whether you match it with something else, or include it as a part of allocation, maybe it makes it more palatable. What do you guys think there?
Jason:
All of us have discussed a million different ways. Every academic study, or anything we’ve ever looked at, has always said to allocate 20 to 60% of your portfolio to trend following. The problem is that all of us beat our heads against the wall because nobody ever does that. So I think all of us got tired of that and we just stuffed it into our portfolios and forced people to do that. And Meb, as you always put out these questions on your Twitter on X, how much of your portfolio do you have in trend following? And you, me and Eric are always the ones with the highest amount of trend following in our portfolios. I guess maybe because we were quants that beat our heads against the wall, or just think, if this is the number I should have, that’s what I’m going to put in there and not try to fight it.
But we’re behaviorally fighting people dealing with keeping up with the Joneses, but I think this probably a better question for Eric, because he’s really led the charge to me on really pairing this with S&P or other things, and that’s what’s really started to gain credence amongst the investment community.
Eric:
I think a couple of things have changed since 2009, Meb. One, availability. Getting decent trend products in a retail format was very difficult in 2009. It’s all over the place now. There’s plenty of trend programs to choose from both in a mutual fund and the ETF wrapper. That’s one thing that’s changed. Jason brought up the fact that the efficient frontier analysis, if done objectively, always says 20 to, he said 60%. I would agree with that. In trend over any 10-year rolling window really jams your Sharpe ratio higher, increases returns, lowers drawdown, lowers volatility. I don’t think anyone’s debating that, it’s just how do I get it into the portfolio in a way where the fees aren’t problematic, the access is available. So a lot of things have changed since 2009. I think you’re seeing more acceptance, but still nobody has really figured out a way to deal with the statement risk, or the line item risk, except for the firms that are starting to blend trend with risk assets, and you’re starting to see a lot more firms do that.
Meb:
Well, you guys both do a good job of this. And part of this, if you think about the branding of trend falling, the name, it used to be called Managed Futures. I mean, calling it trend falling already is slightly better, but it’s like the old leverage buyout LBOs now being called private equity. Is this kind of like the Herschel Walker article?
Jason:
It’s very similar. There was a great essay written by my partner Taylor Pearson about the great train robbery. What Meb’s alluding to is basically when Herschel Walker was drafted by the Dallas Cowboys, they eventually became a hall of fame running back, and I think it was over almost 8,000 rushing yards in almost 5,000 passing yards. And at that time, no running back was really a receiver, so he’s really a game-changing player. So the Minnesota Vikings decided they had to have him. And so they did everything they could to get him. I think they gave away eight draft picks and five additional players. So they went for the one sole superstar at the sacrifice of the team. And then Dallas used all of those draft picks and players to then build a portfolio of a team approach, and in the 90s they won three Super Bowls using a team approach versus an individual player approach or individual superstar.
And I think that’s what maybe we’re seeing right now, is like PE, is that individual superstar that we’re ball laundering that, and we’ll see how that turns out in the future. But I think hopefully that’s part of, like you’re saying, maybe the rise of trend following at least amongst the audiences we’re talking to. More importantly is maybe the rise of emergent portfolio effects, of how do you construct a portfolio. And hopefully that’s what really came more out of, like the GFC is the portfolio construction aspects.
As you’re saying, in the 2010s trend following as a whole, it’d be like a stock trend index, carried only slightly positively during the 2010. So everybody’s looking at that line item, they’re like, “Why would I have that in my portfolio?” But as soon as you pair that with something like an asset like buy and hold S&P, it totally changes that dynamic approach. But the hard part I think for a lot of people is, how do you build a portfolio? It’s not something we’re really taught in schools or anything. We’re not taught any of this finance or investing in schools anyway, but I think the people that are always looking at line items and they’re not looking at the emergent portfolio effects of combining things that are uncorrelated, or negatively correlated, and how that does to manage your wealth or your log wealth over time.
Eric:
I think it’s very well said. I love that example. I’m going to use that in the future, because the Herschel Walker trait that the Cowboys used to build a dynasty that won multiple Super Bowls is a great way to articulate both the value, and portfolio, Meb, because what you get in return individually, none of those players were of the caliber of Herschel Walker, but they summed up into a team that was just totally dominant for a long period of time. That makes a lot of sense.
Also, I’ll echo what you said about, if you offer trends to people on a standalone basis, they love it when it’s working, and the stock market’s going down. If that happens, they can’t stand it when it’s a drag on the portfolio. But if you mix it with other risk assets and show them the blend but don’t tell them what it is, they love the risk adjusted returns. It’s just an intuitive way to demonstrate that you can take two low Sharpe ratio assets that are durable but humble, blend them together, and the child that they have is much more beautiful than either one of the individual parents. Why that doesn’t translate into more people doing it? That’s a mystery to me though. But if you just show someone a spreadsheet and you anonymize these asset classes and show them the impact that trend has without telling them it’s trend, they love it every time.
Meb:
It’s funny, because I’ve stolen this idea, this sort of Coke, Pepsi taste test that you love to do traditionally used trend falling. I do with all sorts of things. We do it with foreign stocks, and US stocks. We did a recent one that was popular where we showed the traditional 60 40 portfolio and I said, no one’s going to believe this, but if you just entirely swapped out bonds in the portfolio with gold, and it didn’t matter at the time frame, back to the 70s, or a hundred years, whatever it was, it made no difference. So gold had the same role in the portfolio really largely on the net effects as bonds did.
I feel like people are always like, “Huh, that’s interesting,” but I don’t know if it hits home the way that I would like it to on a lot of these, because the end behavior is all that matters. I feel like people are like, “Huh, that’s interesting.” Okay, I’m still in 60-40. I don’t know.
Jason:
I wonder though, like you’re saying, it’s not only just the nomenclature that changes over time and we don’t have good words, or references, like you said, managed future, CTAs, trend following all that stuff. I also think it comes from, I always think people coming up in the investing space, they either really get into the space by reading Warren Buffett, or they got into it by reading Market Wizards, right? Two very distinctly different philosophies. And most of the populace thinks about Warren Buffett, and value stocks, and buying low and selling high, and then when you’re doing the exact opposite and trend following, they can’t wrap their head around it, and then they start hearing words like derivatives, futures, leverage. Stuff that’s a little bit wonky for them, and so they tend to avoid it, even though I think people that read Market Wizards first and they get intuitively that you want these positively skewed assets.
They take a lot of little paper cut losses, but then you end up having explosive gains when you need them the most. It’s really hard I think for a lot of people to wrap their head around. So, to what Eric’s doing, and that I think obviously we believe in too, and you do as well, Meb, is to me it’s a spoonful of sugar that helps the medicine go down. To me, you have to give people those stocks and bonds, or whatever they want, that’s similar to keeping up with the Joneses, and then you pair that with trend following, or long volatility, or other things. And hopefully, those things just run behind the scenes, and they’re keeping up with that linear growth of the stock market over time. And then when they need it most, the trend following jumps out and saves their bacon. And then they’re finally appreciative of it. You almost have to hide that a spoonful of sugar helps the medicine go down. You have to hide it by providing them things that they’re accustomed to. At least that’s my take on it.
Eric:
Yeah, I mean, that’s essentially why Standpoint was created. It’s essentially an experiment. And that is that we’re going to do what works to deliver a reasonable compounded rate of growth at the minimum level of portfolio level risk. So we’re going to do it for them, and see if that makes it palatable, rather than trying to convince people to do it on their own. We made the decision, we capitulated, said, “You know what? I did this for 20 years trying to get people to buy diversification.” And it doesn’t matter how many times you prove it, you’re not really solving the problem for them that needs to be solved. It really is the statement risk, the line item risk, the peer pressure, the social pressure, whatever. It’s unsolvable in my opinion, as evidenced by some of the best firms in the world having really high alpha, beautiful kick-ass trend programs that have almost no AUM in them.
Meb:
This is actually a chart you had sent to me, Eric, where you can elaborate on it, but it is basically looking at some sort of risk-adjusted performance over the last five years, really been dominated by trend-following types of programs, as well as some others. Explain what you sent over.
Eric:
That reflects the analysis that I do pretty much at the end of every month. I run a query in Morningstar Direct, and I cover every mutual fund and every ETF in America mathematically solved for their level of alpha over a 60-40 portfolio. I calculate their max drawdown, or their worst decline. And I also look at their real return, their return adjusted for inflation. And then I like to calculate Calmar ratios myself. I like real returns divided by drawdown, that’s probably my favorite. And then the second one, if you’re interested in true diversification, if you want something that’s not completely redundant with what you’re already doing, you want to look at the alpha per unit of pain, so you take the alpha and you divide it by the max drawdown. And then I rank and sort.
And I’m looking for funds that are delivering some reasonable healthy amount of alpha that makes it worthwhile. And again, normalize it by the drawdown to get how much alpha you are getting per unit of pain, and sort it that way. And it’s a vanishingly small group of funds. If you’re considering doing something different than 60-40, that’s the first place to look. Look for firms that are actually, or at least products or programs, whatever that are delivering, alpha or real return that is unrelated to what you’re already doing and then calculate how much pain you have to suffer in order to collect that.
And you’re right, it’s a unique group of firms that cluster at the top. And that’s been consistent for as long as they’ve been doing this, and I’ve been doing this for over a decade. And I just find it very interesting.
Jason:
That’s part of the problem though, don’t you think? It’s like if you have to really look at a portfolio, look at a manager’s returns right now, always talking about things like Sortino ratio, ulcer ratios, MAR ratios, like you said, Calmar is more the three-year, I prefer the longer-term MAR as a sure you do as well- but now people are like, “Wait, I know Sharpe ratio.” But that trend following doesn’t look right on a Sharpe ratio, and because none of us really believe in that Sharpe ratio, because there’s all these faulty sides to the Sharpe ratio, especially downside volatility, but for people then would have to learn Sortino and these other things, and people, their eyes probably just glazed over as I’m saying those words.
When I give presentations, I would talk about the history of portfolio construction going all the way back to Talmud, but I also always throw your Trinity paper in there. And I was thinking, why did the three of us do this when you were asking the question earlier? And I think that it’s a weird thing in finance and investing that you investors over time are really subsidizing your mistakes. We have made so many mistakes over the last few decades that we’re hopefully getting better, at least we’re hopefully, but all three of us get to the point we’re like, “Look, I just want to build what I think is the best portfolio possible, and hopefully other people like my dance. There’s 8 billion people out there and so we’re just trying to find the other people that agree with us.”
We’ve talked about, Meb, was like, your Trinity paper is such a beautiful paper of that proper portfolio construction, and then you and I have talked privately about how much you just see people moving out in and out of the individual ETFs. Why do you think that people won’t stick to a Trinity allocation and they just want to market time the ETFs, and maybe they stray from Trinity? Or what do you think about it?
Meb:
I think the answer is simple, at least in this cycle, which is 15 years now. My god, 2009 was going on 15 years ago, I’m rounding up. But the S&P over that period has been exceptional. And we’ve had a few jiggles, these little 20% down markets. But when you have an S&P that’s compounding at 12, 13, 15% per year, I think the need for something else is less urgent, it feels like. And the more the behavior you get used to of having dips that rip right back up to all time highs, you feel less and less inclined to do something elsewhere. Despite the evidence that diversification and particularly styles, and strategies that really zig and zag, 2022 is a great example, you guys are both having great years this year, 2024, another good example. Until the S&P does something other than 15% a year, you won’t see large changes in behavior.
That’s my belief. I’d love to hear you guys’ thoughts. But also, try to interweave kind of how you guys do it too. So we’ve all arrived at slightly different conclusions and portfolios, but they’re all vastly different from what people traditionally do with 60-40.
Eric:
Well, for me it was actually simple. I left my previous firm back in, what was it, 2018, and I had a two-year non-compete. So I had plenty of time to sit around and think about what the next chapter was going to be like for me. And I built a whole bunch of stuff. I was a long short equity guy before I managed Futures. Did some market neutral, did some relative valve back then too. I had plenty of time on my hands. And in the end what I decided to do is exactly what I would do with my own money. My co-workers, the other partners here at Standpoint, essentially said, “Stop running in circles and just build it the way you want it. And what would you do with your own money, and why.” Because at least then we’re eating our own cooking, and you’re going to be willing to defend it.
So all weather, you call it absolute return, whatever, use enough trend, mix it with risk assets, put your idle capital and T-bills and hope there’s a yield. When we launched, there was no yield. Now I think I got 550 basis points on my last tranche at T-bills. Scalable, easy to run, simple, intuitive, durable, you can back test stuff like this going back into the 1960s. That’s what did it for me. So, we’ve all seen the efficient frontiers. We all know trends. Well, we don’t all know trends, the greatest diversifier, but some of us believe that.
Meb:
I have a hard belief on this, as I do not think you can call yourself an evidence-based investor and look at trend following and conclude that you should have zero trend following allocation. I think that’s almost like a CFA ethical violation, to look at the data and be like, “You know what? No, no, I don’t think that is going to work.” I don’t see how anyone in the world could logically conclude that it’s not the number one diversifier. I did a tweet where I was like, hey, I know the guy had sold his business, got 30 million bucks, and he is like, “I’m just going to put it in a boring old S&P 500 index.” And I was like, “All right listeners, if you could tell this poor soul to add one thing, what would you add?” Now, we got a bunch of trend-falling responses, but again, my audience is biased. So I think you can’t argue about it. If you do, you’re blowing smoke. All right, keep going. Sorry for the interruption.
Eric:
No problem. Didn’t Rob Littner make that case back in the 80s?
Meb:
Probably. Who’s Rob Littner?
Eric:
He wrote the Littner paper where he said that all financial advisors that choose not to include trends should have to write an explanation as to why and put it in the client’s folder.
Meb:
That’s great. Let’s dig that up and we’ll add it to the show note links. I don’t know that I’ve ever seen that. I mean, the two that we’ve talked about laughingly recently were Goldman and Mann. Now, Mann obviously runs Managed Futures, but they both were like, “Hey, Managed Futures should be half your allocation, but we have to make sure we can’t really add that much because no one will accept that. But that’s how much you probably should have.” Anyway, keep on, sorry.
Eric:
I’m pretty sure Littner was a Harvard finance professor back in the 80s, and he wrote that paper. And of course, everyone laughed and ignored it, and then there was another paper written called Littner Revisited. I think that was, I don’t know, 5, 6, 8 years ago, something like that. You should look into it because he basically argued the same thing that you just argued. Anyways, I’ll finish my story. The whole point is just do one thing and do it well, and it needs to be something that we’re willing to eat our own cooking we believe in. For us, that’s all weather investing. And what that means is, you give a big slug of durable managed futures trend in the portfolio, mix it with risk assets, charge a reasonable fee, try to keep the taxes to a minimum, and just see how it works. And that’s where we’re at.
Jason:
To simplify, would you argue it’s a 50-50 stocks trend?
Eric:
In risk terms, yeah, it’s about 50-50. Everyone gets confused though about, well, is it a 10-vol Managed Futures program, or a 16-vol, or an 8-vol, or whatever. But if you do the risk attribution, you essentially have two pistons and they’re both contributing about 50% of the total variance in the portfolio. That’s what simulates optimally if you’re trying to maximize your Sharpe ratio over the last 54 years. If you want to hire a Sortino ratio, you need to lean more on the Managed Futures. Go something like 60-40. So the optimal by my calculations was right around 52-48. So for simplicity purposes, we just went 50-50.
Meb:
How many advisors are you talking to that even define or explain what Calmar or Sortino is? Because I’m pretty sure it rounds to zero, Eric.
Eric:
Well, I mean, if they have a CAYA or a CFA, they’ve heard the term, they pass the test, so they had to have known it at some point. It doesn’t come up very much, guys. I mean, really what people do is they look at track records, they do screens, or they get a referral from someone else, and they try to get a feel for whether you’re crazy, you have common sense, you have skin in the game, or the people that designed it, running it. Are you wired the right way? Do you actually care? And then, if your performance doesn’t suck and you actually add some value to what they’re doing, meaning you’re not a hundred percent correlated with what they’re already doing, they’ll dip their toe in the water and build their allocation over time if their clients aren’t complaining.
Look, the mistake that we’ve made in the trend and Managed Futures world is not recognizing that we have to solve problems in order to do business. And we’re trying to solve the portfolio problem, but along the way creating social and political problems for people, by having all the stuff we’ve already talked about. So, if you can solve both though, well, then you can do some business. And that’s what an all-weather approach is trying to do. It’s trying to solve both.
Jason:
I refuse to use all-weather, just because I disagree with a lot of things Dalio did and everything, and I refuse to try to live under another man’s rubric.
Meb:
By the way, do you guys remember, speaking of Dalio, do you remember, and you guys can correct me on this, when the GFC happened, they’re a quantitative systematic firm. And it seemed to me from the outside that during the GFC they had these models, and then they overrode the models, and they’re like, “Wait a minute, we’re going through this depression process.” They called it the D process and they’re like, “Well, because of this we have to switch our models.” It’s like the cardinal sin of being a systematic quantity like, “Wait, hold on a second.”
There’s an amazing hindsight bias on this, because you either mucked around with your models and it worked and you’re like, “See? We should do this when we really know better.” And then when it didn’t work for them, you look back and you’re like, “Wait a minute, wasn’t this the whole point of this?”
Eric:
If I was running a risk parity portfolio, I’d have a depression filter on there too. And I don’t want to pick on Bridgewater. They’re very, very successful, and there’s plenty of high IQ people there and they’ve done very well. But I wouldn’t be able to sleep at night if I was leveraging up bonds and pairing it with essentially long GDP risk assets. And in my opinion, relying on negative correlation, or at least zero correlation between the two. Because I’ve done the math, you can look at the 70s and see that that just would not have been a pleasant experience 2022. Who’s to say it couldn’t have gotten worse or won’t get worse in the future? And if you don’t have a depression filter on something that’s got that kind of skew risk built up inside the portfolio with leverage, you’re going to hurt bad someday.
Meb:
That needs to be designed ahead of time. It’s not something that subjectively you flip on in real time. It feels more like an adjustment people are making when they’re… Anyway,
Eric:
I’ve built enough systems to know that the trap door risk that you’re taking with a highly leveraged risk parity approach, there’s really nothing you can do, other than try to anticipate when the environment’s ripe. That’s why I don’t want to live that way. I don’t even know what they’re doing today. They might be much more multi-asset and multi-strat than they were in the past.
Meb:
There’s two different portfolios, there’s the buy and hold and then there’s the pure alpha. And the media loves to confuse those too.
Jason:
I agree with Eric, and I have talked about this privately about rent tech and everything. If you have a leveraged short ball trade, or you’re counting on correlations, you have to have some sort of overlay to pull the plug, maybe on the machines a little bit, or the algorithms. But I think then what Meb’s saying though too is, allegedly, if you read about things that have happened at Bridgewater, Dalio’s called 30 of the last one depressions, or recession. So is it systematized or not? None of us really know because we’re not inside there.
But related to a lot of things that Eric said is we just built portfolios we wanted for our friends and family, and we wanted to access certain sort of niche kinds of institutional strategies that we couldn’t get access to at an individual level. But it goes back to all these great, I can’t help, it sounds like I’m giving Meb a reach around here, but all of his great research over the years has been what we built our portfolios around too, is all the studies on all the different asset classes throughout all the different decades throughout the centuries, all have their good times and bad. All the different portfolio constructions are good and bad. If you take IV versus permanent portfolio, versus risk parity, as Meb has shown, they all come out relatively similar if you’re using basic asset classes.
And so we use the model, Harry Brown was the one that came up with the four-quadrant model, which is my bone to pick with Dalio. He used the four-quadrant model and didn’t give Harry Brown the credit. And then just leverage up the bond side, and that’s the risk parity. But Harry Brown, if you hear about four quadrants these days, they’re on the axis of growth and inflation, whereas in growth or recession, inflation or deflation, it’s like a Venn diagram that overlaps, but that’s what Harry Brown talked about. But in the 1970s he just had stocks, bonds, and golden cash. And so to me, if he was alive today, he’d maybe use a little bit more nuanced strategies that we’re able to get access to.
And so we just try to diversify across that four-quadrant model, and we are able to use an aggregate by building a fund in this structure. We’re able to offer people their global stocks, their global bonds. We use an ensemble of long volatility and tail risk, and we use an ensemble of commodity trend advisors or trend followers. We also have a little bit in what we call our fiat hedge in gold and a tiny bit of cryptos. But the idea is there is, once again, broad diversification. Because what I found is being a huge fan of trend following back since I was a teenager is there’s times where trend following can go through a decade where it’s not doing well. And usually, during that decade, buy and hold equities are doing well. But it becomes anathema for a trend follower to pair it with equities.
And this is what Eric and I have talked about a million times and why I always applaud what he does, is because what I find, and I was just starting to flesh this out when I was on value after ours with Toby and Jake a few weeks ago or whatever, what I find is everybody has these faith-based investing ideas. Value is a faith-based investing, growth is a faith-based investing idea. Trend following is faith-based. They’re all kind of faith-based. And when you have to uphold that faith of that religion, you tend to excoriate anything else. You have to eat the pain of the trend following during the 2010s. Why would you dare pair that with S&P 500? It’s really weird that they have all these faith-based religions, and to me it’s like if you take a step back and you’re much more agnostic, you can get much more broader diversification.
And part of that issue I always had with trend following is, what happens when trend following is on the same side of the trend as your stocks and bonds, and then you have a liquidity cascade like we had in March 2020. That’s where you can have an air pocket that takes that whole thing down and correlations start getting very wonky. And so that’s why I believed in adding long volatility and tail risk in there to offset those liquidity pockets you can get, or those liquidity cascades that can happen across all asset classes when correlations go to one, and depending on the speed of your trend following, their look back and their speed of trading, they may be on the wrong side of that, they may get whipsawed, they might miss it entirely. But it just really depends on the speed of the trend following.
So to me, that was always a tiny bit of the whole trend following you needed to add those offensive long GDP long liquidity assets that go up linearly like stocks and bonds, but then you also had to worry about those liquidity cascades where you could get caught on the wrong side of the trend. So that’s kind of the way we think about it, and that was more than a mouthful.
Eric:
Jason, why do you do all this work? You guys have done tremendous work for a long time to offer products to high net worth accredited investors. Why do all this? What problem are you trying to solve for people and yourself?
Jason:
It’s pure solipsism, right? I’m trying to solve a personal problem for myself and my family. It’s like, how do you maintain wealth? So a lot of the clients we end up working with are entrepreneurs that had their first liquidity event. And so I always tell them, it’s like, you have to take enormous concentrated risk to make wealth. Now you’re going to have to do a complete one-eighty. You’re going to have to broadly diversify to keep it at wealth. A lot of times you see online, I can’t stand this stuff on YouTube, it’s like, your average millionaire has seven to eight income streams. I’m like, “Yeah, how many does your average billionaire have? One.” But more importantly, if you want to keep that wealth, you need more diversification than that. I can’t say a lot of clients we work with, they might be like an Amazon FBA seller, and then they go out and buy Amazon stocks. They think they understand Amazon. And I always ask them, “Who’s the CFO of Amazon?” They never have any clue, but now they’re doubled up on their exposure to Amazon.
So to me, it’s like if you look at a broadly diversified portfolio of ours with all that fractal diversification, you’re essentially getting 150 return streams. That’s the diversification you need to keep your wealth and maintain your wealth no matter what macro event happens. And so to your point, Eric, the brain damage is trying to solve a personal problem. And I think that’s what we’re all trying to do, is solve the personal problem, and then we put it out there to anybody else that wants to join in with us. And then I find it’s impossible to convince somebody otherwise. If they have no clue about what we do, don’t understand trend following, don’t understand long volatility terrorists, why you’d want portfolio insurance, I’m not going to convince anybody of anything. It goes back to those religious and faith-based things. It’s just like, “Hey, if you’re looking for this, this is what we do. Happy to have you aboard.”
Eric:
Do you think that’s why we get so much interest from overseas investors? I mean, I can’t do business with people overseas. I run a US-based mutual fund, but I get so much interest from people overseas. Is it because they’ve seen what happens to people that aren’t diversified? Whereas in America, we’ve been so pampered with markets performing well, and 60-40 being great for so long, that they just lost respect for what can happen if things don’t go correctly.
Jason:
Yeah, I think that’s a fair way of looking at it. We even talk about fiat hedges having actual physical gold, or physical Bitcoin, we can argue about what those things are or whatever, but I always say that’s for those truly cataclysmic events where liquid markets shut down, financial markets shut down. You have war, diaspora, everything. And like you said, when I talk to American audiences, it’s blank stares. But if I talk to South American or European audiences about inflation, diaspora and war, they tend to understand very viscerally what can happen to your wealth over time.
Eric:
So you feel like you’re doing the things necessary to protect that compounded wealth going forward, and that most people just don’t understand the uncompensated risks that they’re taking in these simple, convenient portfolios.
Jason:
Yeah, but I understand why they do it, because they’re like target date funds, essentially that’s what your 401k is set up for. There’s inertia there. And we can go over all the laws and every regulation that have changed that’s kind of forced everybody down that funnel. And then like you’re saying, it’s recency bias of what’s worked for the last 40 years. I find that’s actually the hardest thing to argue against. If you go, yeah, 60-40, you should be worried, then they just go to the scoreboard, and they throw it in your face. Like Meb’s saying, I just looked at it the other day, I think since January 2020 SA piece compounded 14.9%. I can’t remember if that was arithmetic or compounded when I was just looking at it the other day. But it’s really hard to talk about alternatives when, let’s put up 15% returns, as Meb was saying earlier.
Eric:
Meb, do you disagree with any of this? Why are you doing what you do?
Meb:
We had someone email in to me yesterday, and I get a similar comment every single time I post a tweet that references either our friends at GMO, or our friends at Hussmann. And people have a very hard time distinguishing between, “Hey, I want to read this research and be open-minded and independent,” and, “Hey, I’m going to look at the returns of whatever they may do.” And this will lead into another topic in a minute. But the funny thing is that, “Meb, I can’t believe you talk to these people. They’ve been wrong forever. They’ve been wrong for 10 years.” And there’s so much embedded in this because I’m saying, “Okay, well, how long are you willing to be wrong?” What most people think about all this stuff, the time horizon we all know that they’re looking at is zero to three years, when in reality things can go forever.
So I respond back, and now I don’t even bother, but when people say, “They’ve been wrong,” I go, “Okay, what’s the most universal held belief in all of investing?” You cannot find someone that does not hold this belief, which is that stocks beat bonds over time. I’ve never met a single person in my entire life who doesn’t believe that. And you say, “Okay, well, but in any given decade there’s been plenty of times where stocks don’t beat bonds.” There was a time in the pandemic where stocks had underperformed bonds, long bonds, for 40 years or something. And I said, in no scenario do you go up, “Yeah,” and as anyone replying to my tweet threads would say, “Yeah, you can’t invest in stocks because they’ve been wrong. They’ve been wrong for 10 years, 20 years, 30 years.” They say, “No. Stocks for the long run. You got to wait it out, you got to buy in the dip, you got to invest, you got to buy and hold.”
So it’s like this totally different mindset applied to certain things than other things. And a lot of it, I think it triggers a secondary reaction when it’s this topic of prediction. And one of you said this, I think, where you said, “Why is prediction so much more interesting than preparation? Why is preparation so much more effective than prediction?” Did one of you say this?
Eric:
Yeah, that would’ve been me.
Meb:
Okay.
Jason:
I was going to say, “It sounds smart. It must’ve been Eric.”
Meb:
Who can I attribute this to? What’d you mean by that, Eric, and why is it important?
Eric:
Well, the first part is self-explanatory. You know that predictions sell and that preparation is boring. What Jason and I do, and Meb as well, try to have portfolios that are prepared to deal with what we know can happen, because we’re being compensated for that through either lower downside risk, and/or higher returns over time. It’s a way to protect your geometric growth rate or your count compounded return.
Prediction is just the scoreboard. Just look at the predictors. Who are they? And what do their track records look like historically? Just not that great, in my opinion. But the people that I know, they don’t talk about it very much. But if you look under the hood at what preparers have been doing, people that are prepared, professional money management, true diversification, risk controls in place, they’re amongst the top echelons of people that have been compounding at reasonable returns for long periods of time.
So that’s the way I look at it is, who’s left standing after 20 years and has actually compounded wealth? Rather than somebody who’s working on their eighth fund, and you don’t really know what happened to the other seven funds, they’ve all been shut down or merged for probably a good reason.
So, the empirical evidence strongly suggests that being prepared is more important than trying to predict. I just don’t see a lot of success from prediction. And maybe you’ve talked about this, I think it came from you, where everyone predicts the S&P is going to be up eight to 10% next year, just always, every year. It’s very rare that the S&P is actually up between eight and 10%. It’s up 30, it’s down five, it’s up two, it’s up 27. These predictions are just wrong. So that’s what I meant by that. But everyone wants a prediction.
Meb:
Ken Fisher also has a great chart where he takes the yearly S&P returns. You can do this for just about anything, and put it in between that sort of zero to 10 that everyone expects. And then what percentage of time is it above 10, or negative, and it’s like most of the time, or is these, you said normal market returns, are extreme.
Jason:
Bring up your Ken French interview the other day, it was great. There was a lot of stuff you talked about: how many decades can you go underperforming for a strategy still to work, and what’s underperforming in that scenario. And then I think one of the other things Eric said that I think goes back to why you said people won’t allocate or hold trend following, is the explanatory factors. Like you’re saying, there’s a part of trend following that’s non-predictive, it’s just preparing. And then it takes advantage when markets break out or trend. And that’s really hard for people to understand, where if they say, “I have a DCF model and I’m buying low and selling high,” they think they can understand those things. They can’t, really, because none of them turn into Buffett anyway. But it’s interesting that there’s also an explanatory factor that’s missing in trend following for people that really wrap their heads around.
Although Eric and I talk about this often privately, even Myron Scholes, where they thought there was only alpha and beta coming out of the school, they admitted there’s omega, which is the risk transfer services. And so to Eric and I, that’s where trend following, or even volatility managers, that’s where you can eke out a living is in that omega factor, which is the risk transfer services to large institutional players that might have tertiary effects on their funding rates and everything, where it’s not really totally zero-sum, but historically trend followers have just said it’s based on human behavior. Which is kind of true too, but I’m not sure that sometimes we do the best job of explaining why these things work, or should work, or should have any sort of return to them.
Before you get that, I was just thinking, sorry, it popped into my head. One other thing about basically talking about global macro predictions. And there’s nothing that annoys me more. We’re all on these stages all the time. And 90% of the people on the stage get out their crystal ball and start talking about the future. And everybody in the audience knows the long. And I think it’s turtles all the way down. We’re so fearful about not knowing the future. And we’re so fearful admitting that nobody actually does know the future. To me, global macros are some form of audio-felatio for rich, white men that are bored. There’s nothing more seductive than having omniscience for anybody that thinks they’re relatively intelligent.
But this is why everybody keeps falling for this stuff over and over and over again. It’s like these people do not have predictive power. And more importantly, they can’t, they shouldn’t run a fund or an ETF, because then it’s like the old Silicon Valley show, never showing revenue. As long as you can predict, you can make all these predictions and point to only your winners, and hopefully everybody forgets about your losers. If you actually had to have the P&L associated with it, people would be pretty disastrous. Sorry, that was my rant about global macros.
Meb:
I’m just now wondering if this show is going to get flagged for talks of fellatio and reach around. It’s like, by the way, the previous of all pervs is Buffett. There was a great tweet the other day that listed his top 10 quotes, and it’s like, “I need Buffett as my sex therapist and his letters over the years.” It’s like how has Buffett not got in trouble at some point for all these comments over the years? But anyway.
Jason:
This is the part of the show I guess where we talk about polygamy too, because nobody wants to talk about that with Buffett either, right?
Meb:
This is why my pirates of finance hat is a collectible, as opposed to a current issue hat, which I’m really sad, listeners, Jason used to have one of my favorite shows. And I’m holding out hope that he’ll bring it back one day. It’s just on sabbatical while he was writing this book.
Jason:
It’s because of all these edits that you’re having to do because of the things I can’t help myself to say because, yeah, I don’t have a great speaking voice, or yeah, I’ve not set up for network television. But going back to your question, actually, what do we do that’s different, I guess is like, one, we combine global stocks and global bonds, which I know you agree with, Meb, but it’s surprising how many shit I get for having global stocks and global bonds, because everybody wants to point to the line item that’s not doing well. And then we pair it with that commodity trend following. But I find with commodity trend following there’s a couple of different factors I look for, and we use more of an institutional allocation model, where we’re still allocating via SMAs to these classic trend followers, but we try to tranche them out into look back periods of short, medium, and long-term.
Because there’s a huge dispersion in CTAs as you see over the years. And to me, it starts to break down at that short, medium, long-term on their look backs, or their forward-looking trades. And then within the short, medium, long-term, we still try to find managers are doing different, whether they’re doing breakouts, moving average crossovers, whether they’re ball targeting or not, just trying to have all those different flavors. Because I’m looking at my Benoist Mandelbrot, I want fractal diversification there too, trying to be as broadly diversified as possible. And then we’re still trying to find CTAs that trade at least 40% commodities. And that’s getting rarer and rarer defined, as they, especially European or British CTAs tried to raise more and more AUM, they got away from the commodities and moved much more towards the financials. For us, we were able to capture a lot of that Coco recently through some of our managers, which is, you want those obscure markets, but you need the lower AUM to capture those more obscure markets. At least, that’s what I believe. That’s why we added it there.
Then the more obscure thing we do is the long volatility and tail risk. And to me, CTAs is one of those last bastions of active management. It’s really difficult to manage a portfolio of options, especially put options, people think it’s very easy to put those trades on. But then how do you monetize? How do you take them off? How do you roll them? It starts to get a little trickier as you get into that allocation set. And then we use long volatility managers. They’re much more like opportunistic long volatility, trying to pick their spots on the left and right tails, and we use a little bit of vol, relative value managers that are using, whether it’s intramarket spreads between VIX and S&P, and trying to use those more as a pairs trade.
The ideas there you can hopefully generate a little bit of income to help pay for the insurance that you have to pay for that bleed on the put options. But we allocate to 14 vol managers across maybe four distinct buckets, and so we’re just trying to capture a beta from that space. And then on the CTA trend follower side, I’m trying to capture a beta from that space too by having that broad diversification. So if I have global stocks, global bonds, that’s beta, crypto is beta, I’m just trying to create a portfolio of beta for long volatility risk and a portfolio of beta for CTA trend following.
Meb:
By the way, so listeners, Jason referenced Coco. And Peter Bernstein, the late great Peter Bernstein, the writer, had a really great quote on asset allocation. And he goes, “I viewed diversification not only as a survival strategy, but as an aggressive strategy, because the next windfall might come from a surprising place.” And this is interesting not just from the standpoint of, hey, looking at US stocks versus foreign. So hey, Chile might have great returns next year, or Japan, which is everyone’s talking about now, but also you mentioned Coco. And Coco, for listeners who don’t know, has gone totally nuts to the upside. It’s probably coming back down now, and eventually I’m sure it will crash. But I don’t know if I’ve ever seen, and you guys may weigh in here because Eric spends more time digging through the databases, I don’t know if I’ve ever seen a manager, an institutional level manager who’s been around for 30, 40 years, then I’m talking about Mulvaney here, who then proceeds to post back to back up 40% months. 40% back to back.
I don’t know that I’ve ever seen that in the history of financial markets. And I think Dunn was pretty close too. Have you guys ever, I mean, I’m talking about stocks, maybe in VC, but that’s smoothed out. I’m talking about public markets. There’s some that come out and do it in their first year or two. Have you guys seen anything like that?
Eric:
I think David Drews had something similar at one point, especially I think he had a high vol program back then too. It’s rare to see it with a long vol strategy. Sometimes you’ve seen it with option sellers coming off of a blow up, they’re down 80 or whatever, and then they’re getting liquidated, but then they make two huge months in a row. But Mulvaney is just on a different level. I do not know what those guys are doing.
Meb:
There’s some docs, we’ll post on the show note links, where it talks about it where it’s almost like, I have a soft spot in my heart for, we spend a lot of our time, those of us here, we’re trying to reduce vol and risk. We’re trying to make things palatable. And then you have a couple of these old school cowboys and they’re like, “You know what? I just don’t give a fuck. And I’m just going to let this sucker, I’m amping it up.” And I think it’s actually like a pyramiding position sizing up, where you’re allocating more as it’s breaking out. But it’s funny, because there’s all these old threads on Twitter, like, “Trend volume doesn’t work. Show me a trend power that’s ever made money,” or da da, da. I’m like, “Well, look at these. These are going on for four decades now, some of these guys who have been at it for as long as I’ve been alive.”
Jason:
Part of the issue with Mulvaney, that’s smart. It’s almost like we take a stand of what we all want to do with our lives, as Mulvaney is doing it too, having capacity constraints. So I think they’re about to shut down again. So to operate in those smaller markets, to get those kinds of crazy returns, you have to be fairly capacity constrained., So you’re taking a very different stance than a lot of firms would take. You’re saying they’re doing the old school part. Part of the reason we call ourselves Mutiny, is where were those swashbuckling CTAs of the 60s and 70s running like 40 to 80 vol. And they were like, you’re a pusillanimous to run a 20 vol. Now everybody’s running sub 10 vol. And it’s like if you compare those in a capital efficient manner, you actually want that higher vol if you know how to allocate to a position size accordingly.
And the other thing with Mulvaney, like you said, is they’re adding or pyramiding into it. And that’s what I always hate when people try to aggregate the CTA style, or trend following style, down to a long straddle or long gamma straddle. It’s not really only if you do it in that 60 or 70 style if you are pyramiding into those positions, and very few of them do that anymore. Most of them do actually do the opposite with vol targeting.
Eric:
When Mulvaney’s numbers came out recently, of course everyone was sending me emails and asking me questions about it.
Meb:
Say, “Why aren’t you doing 40% back to back? Come on.”
Eric:
Well, I went and looked at some of the models that we built internally at Standpoint, and basically leveraged them up to the same vol level as Mulvaney. And I looked at it and I’m like, “Okay, wow. It’s pretty similar.” Of course, we’re not doing that in real life with real money, but Mulvaney, he’s a little better than the models I’m looking at, but not much. If you match the drawdown in the vol, yeah, I mean, a high octane pure trend approach that’s just trading all the smaller markets and the bigger markets looks pretty similar, if you’re willing to take that kind of risk.
Jason:
I also want to touch on the MAR ratio again, that we have been talking about. Once again, that’s your compounded return divided by your max drawdown over the entire lifecycle. And your biggest drawdown is always ahead of you. That’s why you have this sharp stick on your back. But more importantly, why we keep bringing out MAR ratio, it’s not gameable. So you’re saying Mulvaney’s doing back to back 40% months, you have to look at their max drawdown too. And then, how much leverage are you taking? And that’s why it’s interesting that it’s not gameable. And I actually find the opposite, Meb, is the more broadly diversified you get, especially with uncorrelated negative pluralized strategies, you should up your leverage. That’s what actually Sharpe Ratio was intended for, is actually portfolio construction, not single asset class styles.
And so it’s the opposite. Even I talk to institutional allocators all the time, and they all still want sub 10 vol. And I keep telling them, you realize the fees you’re paying are double, because you want sub 10 vol. And they’re just like, “I don’t care.” It’s just CYA. They’re worried about their seats. They’re not worried about the actual returns for the end client for the university or the endowment.
Meb:
Or you just say, “Yeah, I’ll run this at five vol. Deal.”
Jason:
Yeah.
Eric:
Yeah, you look at what we do, our vols, I think about 11. So on Twitter, there’s people screaming at us every day. They want a 2X or a 3X version of what we do. And there’s just lots and lots of clamoring for that. But if we rolled that fund out, there’d be 10 million bucks in it. If I rolled out a half vol version though, and I had a 10-year track record and a couple billion dollars under management and a better pedigree and more staff, well, then we’d get stuffed with $12 billion in the half vol program. Because the half vol program would have a nice Sharpe ratio, very stable returns. That’s exactly what they’re looking for.
So it’s like a business decision. Do I create a make money fund trying to target 18% returns a year? No, it’s a terrible idea, because there’s just a small pool of capital looking for stuff. Now, they’re very loud, and they’re all over Twitter, and it seems like there’s a lot of them, but like Jason said, if you map back fees collected to pools of AUM and mutual funds, SMAs, hedge funds and whatnot, you’ll see that 80% of the money, the revenue, comes from things that are sub 10 vol.
Meb:
I have an idea for you. Here’s what you do. You either do what Jason does, but you say we’re only marking this once a year. Or you say, I’m going to do an interval fund. And instead of the stocks, which get marked daily, we’re going to do private equity investments, so those only get marked whenever you feel like it, and so you have a natural smoothing so you can take the managed futures up to a higher vol. All of a sudden, you’ve magically through alchemy created two Sharpe products. I say that jokingly, but that actually, I’m sure the regulators would have no problem with that whatsoever.
Jason:
You’re not joking at all. You’re unfortunately giving away my roadmap. No, I’ve been looking into interval mutual funds for the last year because it’s not with private equity, but I actually, Cockroach 2.0 to me is the things we do are covering all the liquid assets of the world, but we have all these illiquid privates. And the big problem with the illiquid privates is granularity and ability to deploy capital in incremental amounts into them. So I actually think you could build the interval mutual fund by using what we all do on a liquid side, and then pairing that with more illiquid, deterministic cash flow assets like real estate, private equity, lending credit, all those sorts of things.
Meb:
Here we go. Now we’re talking.
Jason:
I’m throwing farmland in there just to get you as an investor. I need a piece of farmland to get Meb excited. But then you want diversification in the farmland, as you know, from organic berries to Timberlands, to staple crops like soy and corn.
Meb:
I like this idea.
Eric:
Distribution though. What’s the distribution solution?
Jason:
Eric’s going to talk me out of it, always.
Eric:
Yeah, it’s like I’ve tried, because I know that the best fit in the world for what we do is Silicon Valley. But there’s the least amount of interest coming from them. All of my contacts in Silicon Valley, they just want more risk. That’s a hundred percent correlated with what they’re already doing. I’m like, “You guys already have 60% downside risk and your appetite is even higher.” No interest whatsoever in diversifying. And it’s because of what we talked about 20 minutes ago. Just haven’t felt the pain. They’re not cognizant of what can go wrong. If you grew up like Rodrigo from Resolve down in Peru, you’re cognizant of what can go wrong. Here, we’re not. We’ve been coddled. So most of our money comes from the Midwest. We have so much money in the fund from Ohio farmers, dairy farmers, all kinds of people in the Midwest by our fund, but Silicon Valley, San Francisco, San Jose, Cupertino, where I have family and friends, have no interest whatsoever.
Meb:
This sort of reminds me of the recent Tony Robbins book called the Holy Grail. I feel bad picking on Dalio this entire episode, because I think, again, Bridgewater puts out some of the best research in the world, but Robbins summons Dalio and calls this the Holy Grail of investing. And no offense, if you call your book The Holy Grail of Investing, you’re inviting scrutiny. We all know in the investing world you cannot say something like the Holy Grail, because any strategy is going to get taken to the woodshed. Anyway, The whole point of Dalio is he’s like, you need 10 return streams that are uncorrelated, which is literally everything Jason talks about all the time. But in this book, he then presents seven return streams that are all exactly correlated. They’re all just long equity. They just happen to be private equity, public equity, sport team equity, on and on. Anyway,
Jason:
GP interests. All of it. The same thing.
Meb:
Yeah. I have to add this one last piece, because everything old is new, vice versa. I wrote an article in 2015 where we were talking about digging through old investing books. And I mentioned the three old ones that most listeners have never heard of that are fun to read: Once in Golconda, The Zurich Axioms, and Supermoney, the old Adam Smith books. If you haven’t read Supermoney, it’s super fun. But there was another one I came across called Diversify. Have you guys ever heard of this book, the Investor’s Guide to Asset Allocation published by Gerald Parrott and Alan Levine?
Eric:
What year was it published?
Meb:
1985.
Well, it turns out in this book they have something called the all-weather portfolio. The all-weather portfolio is 30% stocks, 15% foreign stocks, 15% US bonds, 20% international bonds. Good luck with that. 5% gold, 15% T-bills. This looks like a risk parity S portfolio. And of course, if you back test this fund, it looks exactly like the all season’s all-weather portfolio. I’m not saying Ray took the name from this book, but it is an odd, odd coincidence. Anyway, it’s a good book, listeners. What have you been reading that’s good lately? Shogun, what else? Three body problems? I hear the news series is terrible.
Jason:
I didn’t want to watch it on Netflix to disrespect the people who are saying it’s terrible, but yeah, I’m not that big into sci-fi, which I know is going to disappoint the resolve guy. It’s tremendous.
Meb:
Really? That’s shocking. I would’ve pegged you as a super sci-fi person. Or fantasy, maybe.
Jason:
No, I’m more going to argue with your wife about ancient philosophy more than anything else, probably. But I think that’s part of it, right? That is, you can learn from philosophy, you can learn a lot from fiction, you can learn a lot from television shows and series that are about broadly diversifying, because bad shit can happen. Because I’m not worried about AI or any of these other things because essentially we have a non-stationarity problem with our data. So it doesn’t matter how much data you plug in, you still need to be creative and inventive about the bad things that can go wrong. And like Eric was saying, have somebody pull the plug just in case. Unfortunately, that’s an ongoing problem that we all have to deal with.
Meb:
You can also learn a lot by volunteering at your son’s science class this morning, where I learned something very relevant to you. Did you know that a cockroach can live a week without its head? It was on the wall, in the science room. It means it has to be true.
Jason:
I’m using that one too.
Meb:
Yeah, it’d be like, “Meb said it. It’s got to be true.”
Jason:
It’s got to be true. I’m citing you as a source just in case the NFA or SEC asks.
Eric:
Jason, you just said something that was very interesting to me. Tell me if I got this right. Non-stationarity of data means what to you going forward. I agree with you a hundred percent by the way, but what’s the implications going forward if that’s your belief?
Jason:
It boils down to the belief that, I firmly believe in the past performance is non-indicative of future returns, because as markets change, as people change, as everything changes legislatively, you can’t use the data set you priorly use. If we use the data set as from stock bonds for the last 40 years on their correlation. Correlations changed throughout time. I had one the other day where people were asking me about why gold diverged from real rates. I’m like, “Why did you believe that in the first place?” The data and life changes. And unfortunately, a lot of the ways we think about markets are through this lens of ludic fallacies, or game fallacies, where we know the probabilities. It goes back to ergodicity, and markets are non-ergodic systems. And our life path has sequencing risk, and weird shit happens, that has never happened before.
And it actually, a good example I think is everybody likes to show me a hundred-year back test, or 150 year back test. And I like to be the turd in the punch bowl and point out that that’s likely to be one data set. You had the rise of the industrial revolution. We went from 1 billion people on the planet to 8 billion people. Are we likely to see exponential growth like that, or linear growth like that? We’re going forward. It’s kind of baked in already. If you give me a 150 year back test and 150 year back test on America, to me that can be one data set because moving forward it can be dramatically different.
Eric:
Let me ask you a question then. So, a listener right now might be asking the question, “Well, why do you guys do what you do then? Why do you put any weight on these back tests? Why do you care that these strategies worked well in the past if that’s your belief going forward?” How would you respond to them?
Jason:
I’m trying to flesh this idea about religious beliefs and being agnostic to any market environment. This goes back to even Meb and Ken French. If I can hold all the world’s liquid asset classes, and I can have uncorrelated strategies and everything, I am hoping that’s my best way to muddle forward in any sort of for macro quadrant, because like you’re saying, the stationary is also a [inaudible 00:53:16] Guardian problem. We have to live through the windshield, but we understand life through the rearview mirror. And so if I can’t be certain of that moving forward, that broad diversification helps me sleep a little bit at night, but it doesn’t guarantee it’s going to work. And so I’m just trying to be less wrong in trying to be lucky and right. I mean, I’ll take luck every day, but I think most people are built around luck, and they’re not thinking about how to reduce the luck quadrant or function of my portfolio.
Eric:
Yeah, so I’m driving at a point here. Because I agree with you that the data is non-stationary, at least to enough of a degree to be problematic. And that has been the case. If I go back and look at the 50s, they didn’t look like the 60s, the 60s did not look like the 70s. The 80s in some ways looked kind of like the 70s. The 90s were basically the reciprocal opposite of what you saw in prior decades. So, someone might be listening to what we’re saying and say, “Well, you guys are contradicting yourselves,” but we’re really not. Essentially, I think what we’re saying, and I’m going to speak only for myself, trend following, the systematic rules-based trend following, is a set of rules that you design to solve a couple of problems for you. One of them is just don’t make the same pitfall mistakes that you’ve observed historically.
See what goes wrong in the money management world, and figure out, “are there rules or processes that you can put in place to at least not fall victim to those? And two, I think that long vol trend following is a great way to participate in a non-stationary process going forward. Because it’s going to reorient you into whatever the new reality is. And how many times do we have to have something that’s never happened before? Valuations never did this, gold didn’t diverge like… These things have never happened before. And then trend followers to be on the right side of the trade and be profitable, but not have a good story for it. How many times in a row do you need to see that for you to develop some level of respect for this very disciplined, structured, unemotional, non-predictive mechanism for participating in a potentially rapidly changing world that’s not predictable going forward?
Meb:
How do you guys precondition to the extent you do it all? Investors, when you talk to them about when they say, “Hey, look, man, I’m putting 10, a hundred million in your funds.” Do you say to them, “Okay. Well, hold on. Let’s talk about how you’re going to get rid of this, or how to tell if I’m an idiot, or if you should sell this.” Do you have those conversations, or you just go ostrich style and be like, “All right, thanks for the money. I hope you forget about this and let inertia take its course”? And what would you say if you did say something?
Eric:
I know Jason’s going to have a good answer, so I’m going to let him go first.
Jason:
He does that because we talk privately a lot, and especially his team shout out to Matt Kaplan. I try to fire as many clients, pre-fire them as possible. Like you said, Meb, we all go out here and dance and we’re trying to get people in the top of the funnel, but I’m just trying to find the people that agree with what we do, or that are looking like us like water and a dither.
Meb:
Good, send them to the public equity markets. We’ll take those. At least, we’ll get some volume out of it back and forth.
Jason:
Exactly. We try to find people that have tried to do what we do, try to do it themselves and figure out how difficult it was, and then they find us and they’re like, “Oh, my god, this is exactly what I’ve been looking for.” So I’m trying to weed out the 99% of people that aren’t those people. I can’t convince those 99% that they need to do what we do. And if I can find those clients, and that’s why it’s not about any money, it’s about finding the right clients, that’s then sticky capital for us moving forward. And that’s good for the clients, what’s good for us, good for our business, is trying to find that symbiosis between manager and client relationship. And this is why I wish we could be frictionless and have ETFs and all that stuff, but I don’t mind the friction of a private placement because I know who my clients are.
When I talk to you and our other buddies in the ETF space and they have money coming in and out like in mid-month and they have no idea who the people are that are putting that money in and out, to me, I would rather know who my client is, and that way we can take what we do is so difficult as far as taking them up the education curve, is we can spend that time to take them up to the education curve so that way they can be stickier. And as you know, compounding takes time for it to manifest itself. And so you need them really, even though we offer monthly liquidity, like you said, you almost want to tie them up for 10 years, because it’s the right thing to do.
So the way to do that I believe is to fire 99% of clients, because they’re not good for you, and desperately just try to find the ones that are really symbiotic with you and that match up over time, will be better for both of you involved.
Eric:
And at Standpoint, we have a pretty structured process for targeting a certain persona of advisor. We use software to gather intel, and then we look for people that have a fit into certain boxes, because they find that it’s a lot less painful and it’s easier to do business with them. And it’s worked really well for us at our conversion rate, which is significantly higher than it otherwise would be.
Meb:
Are you just targeting people that own ARK on the 13F, or what are you doing?
Eric:
Matt Kaplan at Standpoint would be able to articulate it better. But he and Will and Courtney put a lot of time and effort into using Broadridge and Salesforce and some other tools to write queries and find advisors that are between a certain size. They have a certain number of decision makers, they’ve used Alts, at least it’s on their website, or in their ADV, or whatnot. And the main thing is to get away from places that have large investment committees, places where it’s going to take them a year to make a decision, and there’s a lot of politics involved. It’s basically going after small to medium-sized financial advisors from the Midwest, upper Midwest. And we don’t target New York or LA because tons of competition. It’s a sense of entitlement in some of those places that we’ve run into in the past, that is not overcomeable when you’re a new firm, we’re only five years old. Maybe when we get bigger, we have more AUM and a better looking pedigree, Boston and San Francisco, we’ll have money from them, but that just wasn’t a good growth plan for us right out of the gate.
So we did what we knew how to do and what worked in the past. And the other thing is that we try to do, and then Jason does this too, is don’t give him a reason to sell. Have a good geometric rate of return with good risk controls in place, and don’t put them through hell. And then what I’ve tried to do at Standpoint by, I call it all weather, some people call it absolute return by mixing risk assets with trend, is to give them enough beta that they don’t feel the compulsion to liquidate because you’re underperforming the market for such a long period of time. I’m just lucky that that happened to integrate in with what I already wanted to do.
So it’s just one of those things where it’s solved by mixing trends with risk assets solved two problems. And one of them was the statement risk problem of, “Hey, in 2023 the S&P was up 26 and the trend was down eight.” Can’t keep clients that way.
Meb:
The screen you run on LinkedIn is, are there hobbies, sadism and masochism where they are okay with pain? I can’t even remember which one is which. The word cloud for this episode is going to be weird. Jason talking about friction. What were you going to say, Jason?
Jason:
I want to hold on to your points you made briefly, like you’re saying they do this due diligence, I actually call it the theater of due diligence, especially on the institutional level. As Eric’s saying, they take a year or two to make that decision, but they’re doing things like site visits, they’re doing all these check-the-boxes theater of due diligence. And then a lot of times I ask the managers, they’re like, “Hey, do they even understand your strategy?” They’re like, “No, but they check the boxes of due diligence, but they don’t even actually understand what we do.” So that’s one part of it. But then like you said, once they make the allocation, how long are they going to hold it?
Part of it is we’ve actually seated a lot of managers, because to me it’s like, philosophically, if I agree with what you’re trying to do and we do a due diligence to understand strategy, we get an SMA to see how you trade in real time, if I understand philosophically, I should be in. But a lot of times people go, “Well, you’re just launching, we’ll see how you do.” They want to wait two years, and that’s essentially the trend following their P&L. And is that adequate data set to trend follow their P&L? No, but that’s the way a lot of people allocate.
And then more importantly like you’re asking, how do you know when to cut a strategy or cut a manager? Well, one with what all we do, we’re just automatically rebalancing between these different asset classes that are uncorrelated. So that makes it easier at the asset class level to rebalance. But I have a unique problem that you guys don’t necessarily have, is when do you cut a manager. And if you look at the pod shops, they have real tight cuts. If you’re down two or 5%, you’re cut, you’re done, you’re gone. And that’s how pod shops have those very tight risk metrics. But then there could be argued if you have uncorrelated strategies, if you believe in what the manager is doing in their strategy, you should have some loose pants and allow them to revert and rebalance them with your other managers over time.
So the answer is actually complicated and convoluted in the sense like, cutting short your losses is the right thing to do, and/or allowing mean reversion a little more loose pants is also the right thing to do. So you almost have to choose your own adventure. What I find is not necessarily that you try to dislocate your thoughts from the P&L, but just more about what the manager does philosophically. And at the institutional level, we have a unique thing where managers do very neat strategies.
So to me, if you have a very neat strategy doing one particular strategy, and I know the macro environment was good for that particular strategy for these few years, and you have not produced an adequate P&L to that benchmark of that strategy, then you’d be willing to cut. It’s not necessarily about the drawdown or the returns, and quite frankly, a lot of times I’m one of the few people I find that are asking the managers like, “Hey, your returns have been excellent. That seems outside the bounds, are two standard deviations higher than they should be. Tell me what’s going on, what’s wrong here.” And usually everybody’s like, “No, just celebrating.”
Meb:
Elastic waistband solves. Let’s find something to disagree with. What do you guys think would be something that we could spar about? Is there a topic on y’all’s brains currently that you’re thinking about that you want to discuss? Something that you’re particularly excited, anxious about that you’re working on, research, you’re writing, thinking about.
Eric:
Well, how are we different? You’re an ETF guy, Jason’s a LP private placement guy, and I’m a mutual fund guy. Why are we on these different paths? Meb, why do you love ETF so much?
Meb:
I’ve been very honest over the years that an ETF is just a structure. We’ve run individual accounts, private funds, insurance dedicated funds. I would love to do an interval fund. But I think for a number of reasons, we settle for different asset classes on the ETF structure, it’s not the best for everything. So for example, for catastrophe bonds, if you wanted to do catastrophe bonds, which I would love to do, you can’t do that as an ETF because it’s not scalable. So they’re good, and I think they’re much better than your traditional active equity world, particularly the mutual funds, but not all the time and not all the places. So I think they’re great, and I think they’re eating a lot of the traditional equity asset management world, but I think there’s plenty of areas where they’re not like bonds. Although West seems to have found a particularly interesting use case for the bond world with Box. But we think they’re great, but not all the time, not all the places.
Eric:
Yeah, I need to get an equity stake in what West is doing, because all my clients are asking me about his Box thing.
Meb:
Great. I mean, it just goes to show the nerdy ish [inaudible 01:03:47], can’t even pronounce it, type of idea, but when you find this little profit market fit, I was dying laughing, because I saw someone yesterday, I think it was federated. There’s somebody on Twitter that tweets all the new filings. It’s like, “Federated, it’s finally entering the ETF space with their large cap growth, large cap value, mid-cap growth.” And I’m like, “That’s what you guys are coming to the plate with on the 10000th version of this fund?” But it goes to show if someone launches something truly unique and innovative, they can get a lot of assets.
Eric:
Yeah. Well, that Box thing, I didn’t think anything of it until people started asking me about it. And then he sent me over the material and I read through it. I’m like, “Well, that’s very, very clever.”
Meb:
Very clever.
Eric:
Very clever.
Meb:
Now they’re so clever and raising so much money, they’re kind of like, “Hold on, we’re getting too much attention.”
Jason:
Well, they were really clever the way they were able to put it in the ETF for the tax advantages. But as you know, options traders have been doing it in the box trades to manage their cash for decades.
Meb:
I had never heard of it. It was new to me. You guys I’m sure.
Jason:
Yeah, it’s very prevalent in the options trading community. And then if it wasn’t so hard to buy T-bills, Box wouldn’t be such a great ETF, maybe either. I love what they’ve done, but like you said, now they’ve got an 800 pound gorilla problem, and if rates ever do come back down, it’s a very specific time. Like you said, the timing luck of when we launch products is very prevalent. And Meb, I know your latest question is kind of like, “What do you say that people don’t agree with?” And I was really trying to think about this one, because I think everything I say normal investing spheres people don’t agree with, but I was trying to think what would surprise the three of you, which I think is really hard to do, because we’re all, like you said, so much alike.
But one, I mean I think you guys probably generally agree, is I don’t believe alpha exists, I just believe in combining betas and rebalancing them over time and we could argue about what alpha is. The other one is, Meb, I agree with you, I’m probably the only person who agrees with you. On the Fed, is the fed’s doing a pretty decent job because what I can’t stand is everybody rails against the Fed and I go, “Okay, do you want that job? And what would you do?” And they have nothing to say. And then more than not, the people that are rallying against the Fed are hedge fund managers, I just know now they have negative PNL. They’re in drawdown, that’s why they’re blaming the Fed. And I’m like, “Your job is to understand if you think the Fed’s doing the wrong job, but you understand what they’re doing, then you can trade accordingly, and you should be making money.” So I don’t understand what everybody’s talking about the Fed, it’s a weird thing that everybody’s aggregated around in general.
Meb:
You can’t falsify the claims, it goes back to predictions. Who are the most popular people and commentators? It’s always the people that are very smart, that are very opinionated, often anti-consensus, but they have opinions that make no difference whatsoever usually to what they do, or what’s going on in the world. But people, it’s like moths to a flame. And some of them are exceptionally good at it. Look, if you predict 50% GDP per year, and your stock’s going to do 50% per year, you probably aren’t going to be right. But guess what? You’re going to be in all the headlines, and you’re going to be probably facing some SEC scrutiny at some point, I imagine, in FINRA. But you get published, and you get invited on TV for those things. But the Fed is perfect, because you can complain no matter what, what they’re doing is stupid, and it’s causing distortions. And so no matter what happens in the future, it distorts the upside, downside. No matter what, you win. So it’s very unsatisfying to be like, “Yeah, they’re doing a fine job.”
Jason:
I got two more I can maybe get you guys with, I’m not certain on this, but when we’re going back to the non-stationary data one, is, to me, the middle class is a transitory phenomenon. So going back to stationary data, we always get that the boomer generation has had the best economic times in world history, and everybody wants to go back to this golden era, the 50s, the 80s, where you could buy a house on a single income, and two cars and all that stuff. But that’s coming out of World War II, where every industrialized country in the world was destroyed. The US was producing the majority of the oil across the planet. That’s a unique phenomenon. That’s not likely to repeat itself.
Eric:
Yeah, no disagreement.
Jason:
And then the other one, unfortunately, I think you guys, I know, well, Eric and I have discussed this a lot, maybe differently, is I believe that we’re in the entertainment business. And I think Meb was one of the first ones to this game to realize this is an entertainment business. Now, everybody goes, “No, what we do is very serious,” and it is. Under the hood it’s very serious what all of us do. But at the end of the day, what we’re always talking about, for instance, we started this conversation, is that we all have very idiosyncratic views on how to build a portfolio. And then we go out publicly and talk about our idiosyncratic views, and we’re trying to find other people that align with them. And to me, I’m trying to draw the eyeballs away from YouTube, Netflix, and they like my particular way of talking or entertainment, and then therefore that’s sticky capital for us to grow together over time. And it’s just interesting to me that people think this is not the entertainment business. But to me, modern life, it’s unfortunately personal branding and entertainment.
Meb:
I will agree. I’m trying to take it from Instagram. If you see, I made mistakes bookmarking a few sketchy, 50% IRR, ARR, whatever, return ads. It’s all like private real estate for some reason, or private equity. But that’s where it seems a lot of the frauds are hiding out. It sounds like I was negative earlier on Dalio talking about, hey, maybe he didn’t invent all weather type of ideas, but look at our big ideas, shareholder yield, trend volume, I mean, these ideas have been around for forever. It’s not something that we’ve invented.
So I think a lot of the investing world is very much narrative driven, meaning, I think as you can educate and get people to understand a way to go about it that you think is better. I think there’s obviously some value to that, but the weird part is most people don’t do it the way that we do it, the three of us. Most of the world, we’re in the 0.1%, 0.001% of people that do something similar, I would argue. I feel like we’re slowly winding down here. Do you have any future thoughts? Do we skip anything today that you guys really wanted to talk about that we missed?
Jason:
I got one. Eric and I were texting privately recently and we said we’d save it for this, if I asked him, has he ever thought about pairing trend following with certain styles of factor investing? Does it pair better with value investing, or growth investing, instead of maybe just buy and hold S&P? And I thought, yeah, this is the perfect group to think that through. And I told Eric to hold his comments even until we got on here.
Meb:
Give us the reveal. What’s the answer? What is the perfect anti-trend following the equity curve, is kind of what you’re saying, like the perfect diversifier?
Jason:
Exactly. Exactly.
Eric:
Yeah. So that was a project that I did back in a year before we launched the fund. My coworker, Matt Kaplan, said, “You built the trend following system. Now go find the ultimate diversifier to the trend following system, and just use all the data from every asset class, every strategy.” So I pulled it all out of all the different databases I had, and Morningstar Direct, and ran them all. And it’s true that trend following blends better with growth investments than it does value investments. There’s some higher level of redundancy between value and trend.
Meb:
Do you think that’s just the vol on the beta showing up where when these things go through a nasty bear market, they’re getting destroyed? Trend falling theoretically should be hedging and short, and when it’s going up, it’s more of like a leverage version of the S&P almost?
Eric:
I’m not sure. I never really figured that out. But pure growth investing blended better with trend than value. Value had somewhat more redundancy, especially during the recovery period, than growth investing. And corporate bonds actually blended the best with trends. But, between you and me, the prospect of trying to trade corporate bonds inside of a mutual fund structure was not something I was-
Meb:
I just wonder how much of that is due to the fact that you’re getting a de facto stock and bond correlated mix, because the corporate bonds feel like they’re sort of a smashed together of stocks and bond-like characteristics. So I wonder if you’re getting a little bit of extra “free diversification” in the corporate bonds. I wonder, I don’t know.
Eric:
Yeah. Corporate bonds are basically 60-40 in a sense- but in third place was just pure market cap weighted. And the separation was very small, very small. It was like 10 basis points a year, one way or the other. So not really worth agonizing over.
So this was all before transaction costs and before tax consequences, and before capacity and scalability issues. When you adjust for those, then market cap weighted standard indexes were by far the most superior. But just theoretically in a spreadsheet, growth investing was superior to value investing for a spouse to pair up with trend, and with corporate bonds actually being in first place. So that was interesting. And that was his hypothesis too, that growth investing would be a better mate for trends if you’re trying to pair them up. And he asked me if my research had confirmed that, and I said yes.
Meb:
And there’s so much variability in the future too on looking at those versus what they do in the future. They’re all pretty good for various reasons.
Eric:
I’m going to go download Jason’s paper and read it this afternoon. Actually, I’ll probably read it on the plane to Puerto Rico. So, I’m glad you guys reminded me about that. I hadn’t looked at it yet.
Meb:
Send us some pictures from the ocean and the Pork Highway, and they’re about you guys. It was a blast. Thanks for joining us today.
Eric:
Thanks for having me.
Jason:
Thanks, Meb.
