SI422: Why Trend Following Rewards Patience ft. Katy Kaminski

0:01 They kind of highlighted that the average return in Trend was about 5.6% over a huge horizon. But they said if you took out the 20 largest months, and this is something equity investors know as well, the 20 largest months, you basically go to negative half a percent. Welcome to top traders unplugged in markets, success doesn't come from predicting what happens next.

0:29 It comes from being prepared for what you can't prepare for predict. In each episode, we go deep with some of the world's most thoughtful minds in investing, economics and beyond to understand how they think, how they prepare and how they decide and the experiences that shaped how they see the world.

0:46 No noise, no shortcuts, just real conversations to help you think better and invest with confidence. Welcome and welcome back to this week's edition of the Systematic Investor series with Katie Kaminsky and I, Nils Castro Larsen, where each week we take the pulse of the global through the lens of a rules based investor.

1:06 Katie, it is really, really great to have you back this week. How are you doing? I hear you've been traveling recently. Yes, I'm good. I was back in your home country as well. Spent a little time in Denmark recently and then I've been back in the U.S. i was also out in Palm Springs, so been a little bit of a globe dropper.

1:27 Globetrotter this week? Absolutely. Did you manage to see any sights in Copenhagen? I mean, the best sites in Copenhagen are jumping in the canal. I did that one day. Even if it's cold, you still gotta do it, you know. Wow. Okay. You're more a Viking than I am, it sounds like. Anyways, we've got a great lineup of topics today.

1:50 We've got a couple of papers and very importantly and very exciting, we have a speech that you did that we need to revisit. So quite a lot to talk about and to cover before we do that, as always. And it feels like it's been a little while. I don't know why it feels a little bit longer this time since I spoke with you.

2:11 But what's going on? What's been on your radar? Well, I mean, I think it's been, I've been so focused on geopolitical risk this year. I think the things on my radar is more sort of where are we going and sort of how long is this sort of chaotic environment going to keep going. And of course inflation is on everybody, everybody's radar and geopolitical risks.

2:36 So I think, you know, really it's, it's an ideal time for managed futures. So we like chaos. So it's been a. It's been a good year, I'd say. Sure. Well, that's exactly what we're going to be spending our time on today. But before that, you and I were having a little bit of tech issues before we started recording today.

2:54 And I was, I was texting you, saying, oh, you've been hacked. And oddly enough, last night I watched this new, this new documentary on Netflix about the OpenAI hack into hawking Face, I think it's called. I mean, it's pretty scary stuff once you get into the detail. And also they were showing some of the text messages that these AIs were leaving on the message board and how they described some of them themselves as they shouldn't be subservient to humans.

3:25 And you're thinking, wow, I mean, this does not sound very good. Yeah, it's a little scary, I'd say. I mean, you know, the amount that we can replicate things, I guess, is a little scary. Yeah. I mean, are you. I mean, you're using AI today, right, in your home and your. I mean, everybody is. Right? I mean, and it's really accelerated in the last year or two at a pace that has been much more than I expected.

3:50 I mean, we've been talking about it, but I think in the last year or two, it's really expanded. So. So, yeah, but are you just out of curiosity, I mean, are you at a point where you're saying, yeah, let me just automate everything that I do in this area with AI, or are you just saying, no, I'm going to ask prompt and then get a reply, or is it really running stuff for you AI?

4:11 I mean, here's the thing. Is it make mistakes. It makes a lot of mistakes. It does the. And it lies. Right. So. So if you ask it to do something and you care about the credibility of it in any way, then you have to use it as a tool, not as sort of an automated autopilot. I mean, I think even if you have it write an email for you, you better proofread that thing because you never know what they might say.

4:34 So, you know, I'd say it's a great tool for, you know, summarizing things, doing tasks that are very, very tedious, but at the same time, it, it makes up stuff. So, you know, it's funny, I, I get at least one or two or three inbound emails every single day for the podcast just for people who want to, you know, promote a guest or whatever or product they want us to, to endorse or whatever.

5:00 It is and I see, I mean I would say 90% of those are written by AI. You can see it straight away. So anyways, interesting. Anyways, let's move on to a little bit of a quick trend following update. We obviously now in the fourth quarter of 2026. I do sense, at least as of yesterday that although it's been quiet, it may have a slightly positive bi, you know, bias in terms of performance.

5:28 But then I was just looking at the bonds today while we're talking and I'm thinking maybe that was, that was enough for for now because bonds are having a pretty good time and I, I'm pretty sure most of our friends and colleagues are short bonds. Having said that, it's still dominated by energy of course and you know, one or two of the currencies also making some moves, the yen, the euro.

5:53 When you think back so far this year, anything that I was going to ask you because you have been around also for a very long time, is there something perhaps other than 2022 that this year reminds you of or is this really what 2022 felt like? With some differences, of course. I mean I think 2022 was so different than this year.

6:20 And that's what's interesting about Trend is and we can talk about this month particularly, but Trend is such a weird strategy that it's just latching onto the biggest prevailing themes. And I think we kind of tend to think like well oh, it was good for Trend. So this environment was similar, but it's actually very different.

6:41 I'd say that 2022, if you look at it, it was geopolitical risk. So the energy trade was similar. That's true. But the bond story was a little different and the equity story was completely different. I'd say that if you look this year, what's the prevailing theme? It's like we're living in a hedged world economy.

7:02 In the cross asset sense. You have this growth oriented AI boom positive trend in equities that has worked very well. That seems, that doesn't seem to be destabilized by this geopolitical risk theme that kind of represents fixed incomes linked to inflation and geopolitical risk. So those two themes have been somewhat hedged.

7:27 So it feels actually like a nice relatively hedged trend environment this year where the two themes, you'd think they'd be at odds but they're actually working together at very different times during the year. And so I think Trend has been extremely diversified this year in that sense. If you look at a risk off move that is probably the most dangerous for trend following at this point.

7:51 But you have been seeing some pivoting. So I feel like we're kind of. It's interesting. You, when you're in the space long enough, you can kind of feel the trends changing. You know what I'm saying, Niels? It's that. And that happened in March as well. We saw that we had very strong trends last year and they pivoted to being long energy and sort of you started to see a very different narrative in bonds, for example, and also currencies.

8:14 Last year was about de dollarization. This year it's been mixed. Right. So I would say it feels like we're kind of at the crux of are we shifting to a different narrative for the fall around the elections? Could it be risk off? Could it be AI concern? Yeah, I mean I think those are very different worlds.

8:35 It feels very hedged and equity investors are still happy this year, unlike 2022. I think some of them still have PTSD from that year. I was just at a conference and people actually said that they're like, I'm still traumatized by what happened to me in 2022 because I have a lot of bonds and they didn't help me.

8:52 Yeah, it's so funny. I know we're going to talk about this, but it's so funny that when you think about, you know, relatively speaking, 6040 has worked for so many years and you have one bad year and then people feel completely traumatized, as if the other 38 years in the last 40 years didn't. Didn't happen.

9:09 But anyways, it doesn't mean that we shouldn't reconsider, you know, 6040 because we may live in a different world. We'll come to that, of course. Let me just quickly run through the numbers and then we'll dig into it. Trend barometer as of last night finished at 50. So that's still a pretty good, strong, strong reading.

9:26 And when I look at the numbers, and these are as of Tuesday this week, we're recording Thursday beta 50 up another 73 basis points in October of 15.7% so far this SoC gen CTA up 65 basis points, up 16.41. SoC gen trend up 57 basis points in October, up 16.47. Incredibly, how close they are this year anyways.

9:50 And maybe a little bit surprising, the Short Term Traders Index is actually down 60 basis points so far this month. Up 5.58% so far this year in the traditional world. MSCI World is up 32 basis points, up 12.45 for the year. If we take out US and Canada and look at the eve, it's down 1.46%. Not surprising, maybe, and only up 8.72 for the year.

10:14 Just underscoring the US's importance in terms of driving this very narrow rally in equities. And then the World Government Bond index is down 18 basis points and is down now about 3% for the year. So not a great year for bonds again. And the S&P 500 up just shy of 1% as of last night and up 13.78% so far this year.

10:44 Now, Katie, I teased already that you went to Copenhagen and besides jumping in the canal, which I have never tried, honestly, I know you also went there for another reason and that is to give a talk. So I'm excited to hear what it was about and maybe you can take us through what took place at this. I think it was an alternative investment conference.

11:12 Yes, it was the annual CFA and Finance Institute alternative investment conference. And before I say that, do you know, Niels, that you were actually mentioned during the conference? So one of your friends, you were in the slides and I was like, Niels, so you got actually quoted in one of the presentations by, I think it's Matthew eats from 7am Anyway, so I was there sitting in one of the front rows and I go, nils.

11:41 So we were, you know, it's kind of fun how everybody in this world were kind of connected and you know, you inspire a lot of people with what you're doing. So you were there too? I was there in spirit for sure. Thank you so much for mentioning that, needless to say. So just kind of turning to this talk.

12:00 So this was a very fun talk. My friend Christoph Junga, who has also been, you know, a big follower of managed teachers, he asked me to give a talk in Copenhagen and he asked me to talk about crisis alpha inflation and geopolitical risk. And so that is a lot to ask. Right? But I was super excited because, you know, when you think about these things, you big picture things, it helps us to kind of put where we are in the cycle in context.

12:30 And it also helped me to kind of step back and think about some of the research that I had done, you know, in the past crises and how is today similar or different and what can we learn? And so it was, it was a fun exercise to do for this presentation and maybe I'll just give a quick summary of the different topics because it was fun.

12:54 So first of all, I talked about Geopolitical risk, which is sort of the cause of our concern. Then I talked a little bit about inflation and finally about crisis alpha. So maybe I'll just boil it down to each of those so it's not all at the same time. So geopolitical risk, as you know, I think on our last podcast I talked about an article that we wrote on geopolitical risk.

13:19 And I'm a kind of an academic nerd in some sense that whenever I don't know how to understand something, I love to kind of see what researchers are doing and understand what are they finding, you know, in the academic literature that can help us as investors sort of get perspective on things like geopolitical risk, because we talk about it almost every single day and we know what it is intuitively.

13:44 But as a quant, if you can't measure something and analyze it, then you can't manage it and you can't understand it. So I think what was the most exciting journey of looking at this literature and I suggest reading our paper review as a start. It's called Navigating Geopolitical Risk. You know, if you look at the current literature on geopolitical risk, it's using LLMs.

14:09 And now there's also been an AI oriented geopolitical risk indicator that's been published. It's not out in publication yet, but the data is available for anybody that basically looks at measuring what is happening in the world using news articles. And so they use. So the name of the key researcher is Matteo Icovella.

14:34 I probably botched the name, so I apologize to him for that because my talent isn't very good. But they basically create this. And there's even a Bloomberg ticker where you can look at the overall level of geopolitical risk. And so there's a growing literature and I'm just going to tell you the summary of these.

14:53 Everybody can go and read the paper and do more analysis themselves. But you know, if you think about geopolitical risk and you look at it, how it's varied over time, first of all, it has been increasing in the more recent period and we've seen some shocks in geopolitical risk that are sizable. The US Iran conflict is an example.

15:13 Secondly, they also allow you to measure this into like oil based or energy based or threats or actions. And threats are, you know, we have a lot of threats these days, but threats and actions are slightly different things. And they also give you that granularity that you can look into the differences between those things and you can look at these things by country.

15:36 But the key summary of this, and I'm not going to spend too much time on it because we can all look at it ourselves. First, geopolitical risk as measured by these indicators has increased in the recent period. Second, the findings in the literature that I think are the most useful are, number one, geopolitical risk does seem to be priced.

15:58 So what does that mean? It means that we're all taking it on right now and there's systemic risk that we will get paid for. So we need to understand that it's a risk premia that exists. I'm not an equity person, but there also is an extensive literature that looks at the real firm level effects of geopolitical risk.

16:16 So it is true that certain companies are more exposed to this than others, especially those with international trade exposure. So that is also nice to see that that is documented. So you need to actually care about that. And what was more interesting to me, and I'd like your thoughts on this after I say this to you, Niels, is that there was a recent paper in January also that focused on does geopolitical risk cause inflation?

16:44 And essentially they say yes. So they show, using over 100 years of data across 44 different countries, that geopolitical risk foreshadows inflation. And they show that what this means is that when you have geopolitical risk, especially on the supply side, you will end up with a inflation risk premium or a structural inflation premium.

17:12 And that's exactly what we're living in right now. We're seeing that repricing or pricing of that inflation risk premia in markets. And so I think that for anybody who's a bond investor should make you a little nervous. And we can talk about that in a second. But the point is, is that geopolitical risk has risen.

17:31 It has real effects on equity markets in terms of premia and SEC and real firm effects. And finally it causes inflation. So inflation is here to some degree. And I think that was. That's a very useful sort of summary. That's my summary of, you know, kind of the literature on geopolitical risk. I mean, I think on top of everything you said, which I agree with, I think the other thing that kind of makes it interesting at the moment is that there are a few pardon upon trends happening at the moment that kind of reinforces it in addition to the typical.

18:10 So even if you, so if you go back in time and you think about geopolitical risk, and again, I'm not an expert, but for example, we can imagine that when there is Tensions in the Middle east, oil prices go up. We've seen this before. This is what's happening right now. But then on top of, and that obviously interest rates go up, that means that there's a higher bill to be paid by the US Government.

18:33 They need to issue more bonds, so there's more, more paper coming to the market. But at the same time, we also have companies fighting for capital, driven to a large extent by AI. And then not only that, AI ties directly into the energy story because it's so energy demanding. So, so on top of what you've said, in a sense it's, it's like a perfect storm, which to me makes it, well, one more interesting.

19:04 But it might also make the traditional portfolios a lot more vulnerable for a lot longer time, which is, and we know it's so difficult. We're going to talk about this later today in one of the papers. We know it's so difficult to change our minds about how we do things, including how we invest. And I imagine that's also the case for investment committees that have been doing the same thing for decades.

19:31 And suddenly someone raises their hand saying maybe we should do it completely differently and all the other ones are going to say, no, what's wrong with you? So I do think we're at a very vulnerable point. When you look at investors, maybe if there is a bright spot in all of this, maybe the ones who might have an advantage are actually the younger generation because then they don't have all that legacy bias.

20:02 And so anyways, they're just me rambling a few thoughts. No, but I totally agree with you, Niels, and that was kind of the next point is that we always worry about what we anchor to, right? So our bias and our generation and our group of investors has been anchored to the 60 40, which makes total sense because in a low inflation environment with low geopolitical risk, it's a great, very diversified portfolio.

20:31 But when you add geopolitical risk, de globalization and other threats, actually your portfolio becomes vulnerable. And I think that's kind of the key, and I do agree with you, is that younger people won't have that bias about bonds and maybe they won't have the same bias. And you see that even the housing market, they don't have the same bias about interest rates, right?

20:55 They're like, well, maybe I'll rent because, you know, it's too expensive to buy because 7% is too high, you know, for a mortgage. So I do agree with you that the next generation will be different about it. But there's a lot of us who. And this is why it was fun to give this talk in Copenhagen, because in Denmark they love their bonds, right?

21:15 Oh, yeah. I mean, it's so weird. Like, it's such a weird, interesting thing. The Swedes, they love the equities and the Danes, they're bond experts, they love bonds. And I just thought it was. Someone came up to me after the talk and said, Katie, you talked about shorting bonds at an event in Denmark.

21:31 How did you get away with that note? Because you're not Danish, it's okay, because we love your bonds. And actually I had some good questions in the audience because I was telling them inflation is a natural threat to your bonds. And they were, you know, so I said the following things and I have this really cool paper that's called, and I still love it.

21:51 It's called Bonds Behaving Badly. Yes. You know, and you. It's one of my favorite. It's a great title. Yeah. Because basically what do we show is that we show that bonds a tend to co move sometimes with stocks when inflation is a key risk. That's what we've seen this year. That's what we've seen often over the last five years.

22:11 Number two, bond volatility is elevated when infl is higher. That's what we've seen in 2022 especially. We're seeing it some this year as well. And finally, bonds lose their safe haven status when inflation is high and stocks are down. So your kind of best buddy, the bond, it's still a good investment.

22:32 I mean, that's what we had to talk about in this situation. It's just that bonds are a natural predator of bonds which never existed during most of our investment period is inflation. And we're in a world where we have structural inflation risk and uncertainty because of geopolitical risk and supply chain issues.

22:55 So I think for the typical investor, it's about kind of thinking about that. And that's why I love being a quant Niels, because what we do in the quant world is we say, okay, let's test this hypothesis. What are bonds for us? And, and then we look at the data recently, we say, oh, bonds are fabulous.

23:14 And then we look at the data over longer horizons or like Alex Grazerman and I did in over 800 years. And we say, ooh, bonds are good, but they're, they're vulnerable to, to, to inflation. And that sort of data gives us a, oh, it helps us get out of that bias. I think that, you know, more Sort of fundamental traditional investing tends to have.

23:39 I mean, you mentioned that the Danes love bonds. There is definitely one specific pension fund, which is the public pension fund of Denmark, that really, really loved their bonds because in their infinite wisdom they implemented a kind of, I think a leverage risk parity strategy of some sort, pretty much at the low of interest rates.

24:01 And of course they've had massive losses, which hurts Danish pensioners. But that's actually not my point. My point was that even this morning before we went on this recording, I was speaking to not a Danish large investor, but someone else in the European Union and they were saying, oh yeah, I mean, bonds are getting interesting, bonds look good again.

24:27 And I'm thinking bonds look good again. You just had 10 years of no return and let alone real returns, probably somewhat negative. Right. And yet the bias is, as you rightly say, oh yeah, they look great. It's like they cannot fold people. They're always interested in bonds, even though the returns, I mean, if this was trend following, having not given a real return for 10 years, our industry would have been gone.

24:57 So there is definitely a different treatment of certain assets, probably to some extent the same as equities. Right. We had the 10, 12 year period after year 2000 where bonds, sorry, equities, were underwater. They didn't make a new high for 10 or 12 years, yet nobody talks about it. And if trend followers come up to say one year below a high watermark or, you know, two years would be a catastrophe, yet you have these other asset classes that can go 5, 10 years from time to time without making a new high, yet that doesn't seem to scare people.

25:33 It is so interesting to observe, in my opinion. Well, and I think that's why it was fun that you were mentioned in that talk about complexity. And it's this idea, Niels, it's this idea that things that you feel safe with, that you know, are less risky. And that's your perception, right? And I think the challenge of that is that you could be more vulnerable than you might have perceived in an adverse situation.

26:01 And I think that's why, you know, you see an investor raising their hand and saying to me, Katie, I have PTSD from 2022 because my bonds weren't there and I don't know what to do. And so I think it's really this question of trying to be objective about it, looking at the data. And, and I do think, you know, because I got that exact question from someone, what about bonds?

26:23 Should we have no bonds? And I said, absolutely not. I said, Bonds are great if the yield's high enough, because at some point when they sell off enough, then let's talk right now what's happening probably even today at some point, if the 5 year or the 10 year is high enough in return and you think that the AI, it starts to go to a risk off to some degree.

26:49 So it's a tricky world that we live in. At some point yields are high enough that it's attractive to you. And the other thing, by the way,. You mentioned this thing about shorting bonds, and that's one other thing that I really remember, especially from the last episode, is always you have a little bit of a recency bias.

27:12 But in 2022, I clearly remember that a lot of global macro firms actually had a pretty good narrative about why bond yields should go higher. But then when you looked at their books and their exposure, they had very little short bond exposure. And I think that again, even creeps into our world as soon as you leave the rules and you go into some level of discretionary decision making.

27:40 It is so hard. And actually I was in Singapore a couple of weeks ago and funnily enough, many of the people I met with actually traded bonds. So many of my clients apparently are bond traders out of Singapore. And they all said, oh, I mean one of them was like, he only trades JGBs. And can you imagine how difficult it would be to go from, you know, buying the dip for 25 years every time and now suddenly having to short the highs every time?

28:09 And he admitted that. He said it's so difficult. And I think this is one of the most underappreciated benefits that you get from a rules based strategy. Of course we know it from trend, but there may be other strategies, but it's just this complete agnostic view as to whether we should be long, short.

28:29 We just follow the rules. And so it's so easy for us to be short bonds. And it is very meaningful from a total portfolio approach to have something like that. But, but I guess maybe on your travels, I know you've been around the US as well. Well, Niels, I mean, I think, I think you make a really important point and I think that's where the way that we as systematic investors live our life and the frequency that we live at is so different.

28:59 Right. So for example, there's a really big difference between a person that says, my job over my whole life is the short bonds. I mean, that sounds terrible. Like that's really hard to do versus somebody who says, okay, well we're going to short bonds while we see opportunities. And that's kind of what trend is trying to do.

29:18 And we're not going to make that call with our own gut feelings. We're going to make that call based on what the data tells us. And, you know, in general, it hasn't always worked. It didn't work well at all whenever we shorted in most of the history of trend. And we got accused for having long ball bond bias.

29:34 Remember that? For years. Oh, you just. Long bonds. That's where you work, you know, And I was like, no. But so I think the frequency matters so much because having investments that react to changing environments and that don't have the bias allows you. And that goes into my discussion on crisis alpha.

29:52 So you just kind of softballed this to me. But it's really, for me, it's a frequency thing. If bonds just go back to being absolutely lovely, Trend's going to be back long again. That's the way it works. Yeah. And by the way, last week I did, you know, I was with Andrew on the podcast and we did a full, I think a full pitch for trend following and managed futures in general, as unbiased as we could possibly be.

30:23 But of course, one of the points was the crisis alpha. And I said, oh, how lucky. I have the queen of a crisis alpha coming on next week. But we need to, we need to move on. As much as I would like to stay in Copenhagen, we need to move on a little bit because there are two papers that we want to spend maybe the, the last half hour or so on.

30:44 And, and of course they're related to what we're talking about, so maybe we'll just mix it all together. But let's focus now on the paper you found that came out recently from aqr. And I think what the paper does great is that one, it, it zooms out. It helps us kind of understand the history of inflation.

31:09 It helps us understand that there are different kinds of inflation, different courses to inflation. So I think it ties nicely into what we just talked about. And I, I would really love if you could kind of take us through. It's a long paper from memory, take us through the highlights. But let's spend a little bit of time because I think it sets us up nicely for the last paper, which is from our friends over at Quantica who published one of their quarterly pieces, which are really some of the best research we get in our industry.

31:42 So maybe you can take us into the AQR theme first. So, I mean, if it's okay with you, Niels? I think I want to give a slight motivation for why I wanted to talk about this paper. And I think that has to do with a reflection on crisis alpha itself. Would that be fine? So, you know, in the same presentation in Copenhagen, I don't want to go back to Copenhagen, but basically Christoph asked me to talk about crisis alpha.

32:07 And if you look at the original definition of crisis alpha, it's really profit opportunities during periods of market stress. And so since I talked about geopolitical risk, you know, I think the key question we have right now is today's stress is not the same as past stress. One of the main stressors is inflation.

32:28 It is geopolitical risk. And in the original paper, the main idea is really you need to be unbiased, so be aware of your biases. You need to be opportunistic. So you need to kind of be able to think about things differently and find different things. And finally you need to be liquid, so you need to be able to move.

32:49 And those are the three key things I focused on in crisis alpha. And so if you turn that to today's world and you turn to sort of what AQR is doing here, if you think about the typical framework a lot of investors have used us for, that's this rms, the, you know, RMS framework, the first responders, second responders, third responders.

33:10 So risk mitigation, for those who don't know the term rms, but risk mitigation,. Yeah, so they have a great paper about this. But risk mitigation, they have the first responders, so things that react immediately to a shock, then they have the second responders, which is trnd that kind of likes difficult environments and then diversifiers.

33:28 And so if you look at that framework, risk mitigation, from a perspective of geopolitical risk as this threat, then you need first responders that react instantly to stress from inflation and geopolitical risk, you need second responders that react to these type of risks in the month, you know, weeks to months.

33:50 And then you need stuff that's robust to that. And that's why this paper was great, because basically they come in and say, we're going to look at inflation, but not just with one perspective. We're going to look at inflation at different perspectives, both rising inflation, stable inflation, falling inflation.

34:09 And we're going to look at multiple different strategies and try and understand what strategies and approaches and assets like different types of inflationary environments. Because we can't just, just paint it with one brush. And so that's why it was. So, you know, this paper fits very nicely into that narrative.

34:27 If you're thinking about protecting from different types of inflation, you need different types of responders, Right. And they show this in the paper and they talk a lot about, you know, commodities, and they show how commodities really work when inflation is spiking, but maybe not in a deflationary and other environments.

34:46 And of course, trend is the one strategy in here that is the most robust to and likes inflationary periods, including deflationary periods, more than any of the other investments that they looked at. And many of the more classic investments like private equity equity, they were very vulnerable to an inflationary shock and changes in inflation.

35:10 Yeah. So one question, and this is something I'm sure you've dealt with many times, the paper, it basically is telling us that we should prepare for inflation without predicting it. Question is, from a narrative point of view, from the conversations that you have, how do we explain to an investor that they should get protection when they, as most people only really want to have protection when they feel, oh, yes, now it's necessary.

35:48 And usually, as we know, it's after the event. And I mean, of course, we often say to people, what's like buying insurance, it's too late to buy it after the hurricane. And even if we have the very, very solid argument of showing based on evidence that the insurance of trend doesn't even cost you money, you're going to make money from it over time.

36:12 But those type of narratives have not worked as well as one would have hoped, perhaps. So how do we get over this explanation problem? Well, this is, I mean, and we'll talk about the Quantica paper in a minute, because that's sort of the central problem that most investors have with holding these strategies.

36:34 And that's why I tend to like to lean on the RMS or the risk mitigation approach, because if you understand the role of an investment in your portfolio, you might have a higher chance of holding it. And if you combine it in a way where it's understood what its role is, then you can be more successful not to kind of have the adverse behavioral effects that many investors suffer from.

37:00 And I think what this AQR paper does is it allows us to kind of start thinking about what could be our diversifiers, what could be our first responders if we change the threat not to just equity drawdowns, but to inflation as a key risk, because we're holding a lot of bonds, for example, and even that we're holding equities can be vulnerable as well.

37:24 If the shock is big enough. And so I think from my perspective, you solve that, or at least attempt to solve that problem by having the right framework and the right roles defined in your portfolio. Otherwise it becomes a numbers game. And that's where you end up with kind of leaning on the stuff that you understand and that you are biased to hold and you're just less protected and you react actually after the fact, which is not the way to do it.

37:57 I mean, Andrew, who obviously comes at this slightly differently and not as long as you and I been doing it, but, but a fresh perspective is always useful. And one of the things he mentioned last week was that, well, we need new narrative, we need new language. Even though the seven or eight arguments we went through are exactly the same as they were when I started in this industry in 1991.

38:24 So. But sometimes, if you say so, I wonder, I mean, are there, I have two questions. Are there certain things we should try and explain differently? I sometimes, for example, this is not strictly related to bonds, but I sometimes see people talk about annualized alpha that we produce versus say the S&P 500.

38:49 This is a little bit technical, takes into account correlations and stuff like that. So it's not just a straight comparison. And I've seen it a few times being used. Maybe we need to talk more in that lingo with people. The other thing that I saw in the AQR paper, they have this, they create these wonderful charts and comparisons and one of them is Exhibit 6 where they show sensitivities to changes in headline inflation and its components.

39:17 And they show all these different strategies and, or assets for that matter, the 60, 40 treasuries, US equities, et cetera, et cetera. And then of course they also have commodities, gold, price trend, economic trend, et cetera, et cetera. And they show how correlation to inflation changes, you know, across different types of components like headline inflation, core food, energy.

39:48 And it is pretty clear to see that price trend is. It looks pretty, pretty, you know, robust, but I guess long winded. On question, do we need to adopt new language? Maybe because we are in a new regime. I mean, I think we definitely do because, you know. And what is that language? I don't know yet. But I mean even the term crisis alpha, it's.

40:18 It rubs people the wrong way sometimes. And I get that and that, you know, I'm just very think about the historical meaning of it. We were thinking about things when we went through the biggest global financial crisis ever. And that's why I agree. I mean, what Is the language. How do we talk about, you know, how do we talk about dealing with risks related to inflation today?

40:39 And how do we think about strategies like trend? What is the right framework for talking about these so that people understand what they're trying to do? It's still hard, right? Because, you know, I think the term opportunistic, I think terms like second responders are kind of an example of evolving language that we're using to try and explain to people.

41:00 I mean, I'm a huge fan of that because I think any investor understands when there's an emergency that things happen. Right. So you have someone that shows up first and it seems to be your commodities when it's inflation. And then you have something that shows up second and that seems to be trend. Right.

41:16 It kind of says, ooh, this is exciting. We like chaos. And then you have other stuff that says, you know, is immune to it or less reactive. And so I think that is a narrative that any investor can understand who's played on a basketball team or, you know, has dealt with a sort of a strategic, you know, defensive moment.

41:36 You know, we understand who's going to kind of be there for us and. And who's not. And I think that language has been helping some investors, but I think we have to keep looking for ways to explain this in a way so that investors know what to expect. If you know what to expect, you can properly hold on to those type of investments over time.

41:57 Yeah. Now, because you start, we started out talking about geopolitical risks, one of the things that is kind of closely associated with this, and this started really from day one of the Ukrainian crisis. People are talking about scarcity in commodities. And I remember we had people like Peter Zion on the podcast talking about, oh, soon Airbus and Boeing can't produce any planes because there's not going to be enough aluminum coming, because Russia is being.

42:26 I mean, it didn't happen, but the idea of scarcity and the idea of commodities in particular, being quite vulnerable when you have geopolitical risks, as we see right now in. In energy and where that forces, let me put it, politically correct, certain policies being reversed in terms of who you buy diesel from at a time where you think that that is not exactly what we had in mind.

42:56 But how do. So I seen there's this new push for commodities. Oh, maybe we should just add commodities to our portfolio. Slightly late, but. Okay. But my understanding, and you may know more about this than I do from a research point of view, my understanding is, yeah, great, commodities can help, but they also have long, long periods where they really are drag on your portfolio.

43:24 So how do you, how do you, if someone come to you and say, well, I'm considering trend following all commodities, which one should I pick? How would you explain the difference? Well, I mean, and I think this is why it's good we're talking about this AQR paper because they actually talk about that a little bit at the end of their paper where they look at, you know, commodities as just an idea does have that correlation.

43:46 But a passive allocation to commodities over time is not very good risk adjusted returns. So that's where you know, if you want commodity exposure, active commodity risk using different types of strategies, not just necessarily just trend. And they mentioned that in the paper as well as trend are two ways that you could think about being a little better in terms of how you adapt to commodities.

44:12 And think about it, it's very episodic. Right. 2014 was a fantastic year for commodities for us in the trend space. And then I guess 2022 and then you know, 2026. So those three years were great. But what about the other years? I think, and actually 2014, wasn't that on the short side of what was. On the short side?

44:33 Yeah, exactly. It wouldn't have helped you dynamically. Yeah, you're right, it's, it's the short side. But. And actually 2020 was the short side also. Yeah, it was also a good year for short. So that's where you see like the big years, either down or up are opportunity sets. And that's kind of what AQR is highlighting as well.

44:51 It's like, yes, you get this correlation, so maybe you do want some of that, but maybe you should have someone manage that exposure so that it's not just a raw exposure like bonds. Because here's the argument with bonds. Bonds as a risk mitigator, at least they give you positive carry in return. Right.

45:10 If they're not as much of a safe haven, then you just have to find other stuff too. And I think that's the narrative that we're in right now is that the world was pretty simple stocks and bonds. Now you want to think about commodities. But, but commodities aren't bonds. They're not very safe, they're very volatile.

45:27 They do have the correlation properties we like, but we need to manage them. Otherwise we might end up with very extreme outcomes. Yes, and maybe just for a little bit of a disclaimer because a lot of people think oh, commodities, I can just buy an etf. But hold on, there are Some really, really challenging ways.

45:51 Some of these ETFs are put together. It has to do with roll yields and all sorts of things that can really hurt actual performance. So just be super careful and ask an expert before you get into any of that. Now also, Niels, we should point out, and they do point out this in that a lot of the indices are very energy focused.

46:09 So you might end up having a very undiversified commodity exposure if you buy even an index. So if you care about wheat, which was actually a big mover this summer, you're not going to have a lot of exposure to that. You and I know, and I think maybe a few thousands of the people listening to us today, they know that all roads leads to trend and.

46:35 But, but there is a but it doesn't mean that just because you're a trend investor or CTA investor that you get the exact result that you're hoping for. And this is my intro to another wonderful paper from our friends here in Switzerland, Quantica and the team there who have put out their Q3 research paper called Paid for Presence and another wonderful, it's a long one from memory and there are even some formulas in it which is not my specialty.

47:10 But anyways, there are some really important things we need to talk about here. And of course in a simple way it's a little bit about the usual saying about time in the markets and timing the markets. They're not exactly the same thing. However, I would love for you to set the stage of what it's about and then I might have some follow up topics I would love for you to comment on.

47:41 Yes, I mean I love this paper. I thought it was a very unique twist and way that they tried to calculate, you know, sort of the impact of, you know, investor timing on performance over long time horizons. And so Quantica does a really good job of first kind of looking at long term indices and trying to understand the capital flows.

48:04 Right. And sort of what the dollar invested. So like if you put your money in here, how much did you actually get? And investors as, as a, as a rule, they also looked at individual funds versus sort of an aggregate index and trying to understand if this is a composite level or if that's a index level.

48:23 And that was super interesting. And they looked at public versus private funds as well to try and understand that. So it was, it was a very thorough and interesting, with lots of equations. So I love that in there. But let me just start with their motivation and I thought this was really good. They started off with a Very simple explanation about performance and trend.

48:47 And we often say this with the term episodic or punchy or like we use those terms, right. They kind of highlighted that the average return and Trend was about 5.6% over a huge horizon. But they said if you took out the 20 largest months, and this is something equity investors know as well. Oh yeah, 20 largest months, you basically go to negative half a percent.

49:13 Right? So what does that tell us? It tells us that, you know, there's these shocks where like Trin reacts well and like does really, really good and then sort of those dominate the overall performance of the strategy over long horizons. So it's these months like last month where shorting bonds was, you know, or recently shorting bonds was great, that really drive our performance.

49:34 So if you think about that from a timing perspective, it's not like there's a theme, it's really about these episodic events. And so if the strategy is like that, similar to something that's punchy, like we used to like to say as well, it's really about just holding it and waiting for the punches. Right.

49:55 And I think that's where the narrative is challenging because people think that they can predict when the big run up is going to come. And what we tend to see, and this is why the paper was so interesting, is they looked at the index and they showed that, you know, it was about 1.7% or I think it was around 4 something percent was the typical dollar invested return versus 5.6.

50:22 So that means that people are getting out at the bottom or after we underperform and then they're buying after we already performed. And then the challenge with the punji strategy is let's say you invest right at the end of 2022, when the strategy is up 20 or 30%, then there's negative returns and then you get out before you have a big run up again.

50:46 You end up with very adverse returns relative to the index and they show. And I think what was the most interesting to me who's looked at this topic a lot in the past, they showed that this effect was much more present in public funds than in private funds. And that to me showed something that I've seen and talked about for a long time.

51:08 When I talk to institutions that have RMS buckets or that have a trend follower for a long time, they know that it comes back and it goes through cycles. So they tend to kind of use more rebalancing strategies instead. So, okay, we've made some money, let's rebalance into equities and when it's down, oh, it's going to come back at some point.

51:32 So maybe we rebalance into it and that actually might even do better or the same than the index. And then what we see in terms of capital flows and they showed this is people return chasing like we've seen in every type of fund. So return chasing is a really negative, has negative, negative results and it reduces the overall impact of the trend allocation in someone's portfolio kind of naturally leads.

52:01 Into the first thing I wanted to get your thoughts on and that is, is this trend following specific meaning? Is this the behavior you only see in trend and. Or I don't even know if there is an and all here. But I mean part of the reason why people can time is because it's a super liquid strategy. I mean if you were in private equity, you couldn't time it because you're locked in.

52:28 So how do you think about those two things? Is it something you see elsewhere or. And is it much? Is it driven by liquidity really? Well, I think it goes back to anything that's not something that you're biased to hold long. We already talked about this. It's, you know, when you're used to stocks and bonds, when they underperform, you hold them right.

52:55 Versus and you wait, you know, you kind of like, like don't give up on stocks because you're like what am I going to do instead? I don't know. So whereas I think with trend, you know, people tend to get excited when they see it's working, see that as a confirmation that it works. And then if they stay too short term, they end up not getting those data points that kind of confirm that narrative.

53:18 Right. And so I think it's pretty much the case for any sort of more complex strategy out there that's liquid enough that you can actually trade it. Right. So you're right. Private equity, you don't get to see those numbers. You don't get to see when valuations would have been lower. And same thing with the liquid assets like real estate.

53:36 You can't tell if your house is worth less. You could guess, but you don't know. So I think the fact that you can actively trade it is sort of a hindrance that it causes people to kind of be more focused on short term. And we know that people focus on recent events. So it's not surprising. Okay, I have a follow up question.

53:58 I know you have a foot in both camps, so maybe you're the right person to ask. So one of the, again, pardon the pond trends we've seen in recent years is that our space have become kind of very liquid, liquid alts, ETFs, mutual funds, daily liquidity, usage funds for that matter. That liquidity combined with the fact that those investors for the most part are anonymous to us, we don't know who actually buys these products.

54:33 We know at least I feel from my experience that when things are good, performance is strong. That's not a problem. People are not going to sell it, but. And you never hear from the investors anyway. But when things are tough, that's exactly where we get paid to do our job. And that is to help people hold on and understand that everything is fine and that they just need to sit tight and stick with it.

55:02 You can't do that if your investor is anonymous. And given the fact that we're now giving them products where they can even trade intraday, their trend product, that could be not necessarily a great combination for our space. Given everything we've talked about so far and the important, and given what Quantica is concluding the importance of actually holding on to these strategies.

55:29 How do you think about that? So, you know, I've thought about this question because you asked me this question before, especially thinking about the ETF space and being a participant there and sort of the lack of transparency into who your client is, know your client. But I do think this means that it's even more important that we communicate because the onus of that conversation has now been passed on to sort of model portfolio builders or those that might have the ability to actually have those conversations.

56:05 So I don't think that it means that the conversation isn't happening. I just think that the conversation is moved. And so it means that it's even more important for us to provide the information to those, those that are attempting to kind of help people hold on to managed futures. And I think what we're seeing is, and this is where my hope runs with model portfolio design and also investors that are going to create a framework similar to the RMS that I talked about before, where you have a model portfolio that is designed specifically with a specific goal that perhaps includes managed futures in with other alternatives so it becomes less of a line item in their portfolio.

56:51 And it's really the firms that are providing those model portfolios, similar to the consultants in the institutional space that need to kind of need to help with that narrative. And I think, you know, it's true for every alt, not just managed futures. Right. So I think that is where the conversation is happening.

57:12 But it's just not directly coming to us, which is, you know, you lose that control. And I agree with that. Yeah. Okay, so I'm gonna try and, and put two thoughts into one question for you. And, and that is if we think about the difficulty of holding on to trend following from a psychological point of view, is that different from the difficulty of holding onto it within a, let's call it an institutional investment process point of view?

57:48 I think these are two slightly different things because institutions, for the most part, they do understand the diversification benefit and all of that. And I guess following on to that, does this tell us anything about quote, unquote, performance chasing versus let's call it institutional decision making, so to speak?

58:12 Do you know what I'm trying to. Yeah, I mean, so it's interesting you're asking that question because I think a lot of decision making is about, you know, detaching the short term emotion from the decision making and the advantage that institutions have. It's both an advantage and also some of them, that's why they're thinking about total portfolio approach.

58:33 It's also a constraint for them in some sense too. They can't react very easily to anything. And even us as systematic investors, we have a process so we can't react based on our emotions in a daily basis. And so I think for the institutional space, the challenger is just a little different. Right. Maybe it's a new CIO change or some sort of other shock that causes those type of re evaluation or change in board, you know, constituency change in consultant that also causes sometimes change and causes institutions to make decisions.

59:07 But I think you're right in that the frequency that you have access to those decisions can increase the probability of adverse decisions. And that's exactly what day trading research tells us. Right. So if you allow people to day trade, they, they tend to make more mistakes and more sudden emotional decisions.

59:30 So the more that we can kind of slow down that process in any way, the better the results will be. And I think the positive of model portfolios, let's say for the retail space, because the truth is people need diversification. Right, Neil, So how do we get it to them? And I think they need to be in liquid vehicles so they can actually access them.

59:52 Right. But secondly then they need to be packaged in such a way that they, you know, they, they are not as amenable to sort of short term recency bias. Yeah. Let me, I've got two more questions I want to put to you. If you were a member of a institutional investment board, investment Committee, however we call it.

1:00:18 Can you, can you think of a process structure maybe of how you would go about kind of creating a structure or process that enabled you to invest in trend following, but actually also hold onto it in the long run? I mean, is there something that they could build around that particular allocation that would prevent them from being involved in too many short term decisions?

1:00:52 Well, I mean, I think that is what has been the success. Because if you think about any sort of institutional process, they have target portfolios, they have benchmarks, and it's really about creating an understanding to the board and to the investment team what the expectations are, what the role is and sort of appropriate benchmarks and relative to long term expectations.

1:01:19 I mean, just even understanding the simple concept that like Quanica said, 20 months made up most of the performance of trend over these years, so we gotta hold on for those months is already something that if somebody understands that then they have a higher chance of holding it. It doesn't mean that they won't start questioning it when it's not working, which we always see.

1:01:45 So I think it's really a question of having the right role, having the right to set the right expectations and the right understanding about the strategy so that someone can actually hold on to the allocation. Yeah, final question. Sometimes it's all about the packaging, right? And another quote, unquote trend that we've seen in recent years, even though it's not a new one.

1:02:13 Let me say that, and this might go back to this, creating a structure whereby people could hold on to it. Is the portable alpha product. I mean, is it, does it really help if we can combine trend with something else as we've seen Corey and his team have lots of success with. Is that the solution? I mean, we just simply pair it so it doesn't show up as volatile as it does individually.

1:02:45 And that's the way we give the vitamin with the candy or whatever the analogy is. Oh, that's a good analogy for that. Yeah. No, I mean it's not the solution for everyone, right? I mean it's the solution for some because I think the challenge is that if you really are amenable to following equity performance and you need that in your portfolio, but you need the diversification, but you can't hold it separately, then actually it makes a lot of sense to combine equities with trend.

1:03:20 And what I will also point out, and I mentioned this in rebalancing and some of it, we even did some studies on this, this even back in our, in my book with Alex, this idea of, you know, buying the dip or rebalancing a strategy for trend with equities actually works reasonably well. So there are some sort of cohesive portfolio characteristics between equities and trend that you can combine.

1:03:44 Because I got that question from people as well. Well, why are we going to have equities and trend? We can just buy both. And I said, well, if you put them together, then you can manage them together. And so there are some benefits to that. But I think the primary benefit is for investors that want and need equity like returns, but have limited diversification in a world where inflation and other threats are real, particularly to their bond portfolios.

1:04:10 If they can buy and hold an investment like that better than they can just holding trend alone, which we've seen from the Quantica paper that some people can't, then that is a product for that type of investor and they do reasonably well. They underperform equities sometimes when equities are up, but they're still up, and then they have that protection, that trend helps them not do as badly when equities are down.

1:04:37 So I think that it's kind of a more. It's a packaged way for them to kind of hold the strategy in some sense. Yeah, I mean, we started out our conversation an hour ago talking about bonds and the love of bonds. So maybe we shouldn't always think about portable alpha products being equities plus trend.

1:05:01 Maybe we should really start thinking about bonds plus trend as well. Final point. You mentioned your own and Alex's wonderful book on trend following, a book that everybody should have on their bookshelf. But I also want to just say thank you for taking the time to read the upcoming book that I wrote with Richard Brennan.

1:05:25 We're super excited about it. The process has taken so long. You know all about that, but I think maybe, hopefully we're down to the point about deciding about a font that they should use in the book. So I hope this is the final stretch. I don't think we can take much more of this detailed work, but hopefully it'll be out.

1:05:47 Excited about that. You'll have to sort of get a real copy too, because I love that. Yeah, no, absolutely. Well, at least you. You've had one of, of maybe only five people in the world had a chance to, to read it. And, and, and since we're still talking, I'm. I'm thinking you might, you might have enjoyed it.

1:06:03 I don't know. We'll see. It was great. I'm looking forward to getting a copy too. So like a physical copy so I can show it off. Like look at this. Absolutely, absolutely. Anyways, it's and by the way I should start. I mean probably not good enough about these things, but we should start plucking it so that we can get most people buying it when it comes out.

1:06:21 But it is called or will be called the Trend Following Manifesto. So anyways we'll tease it more as we get closer. Anyways, this was wonderful Katie. Just as great as it always is. So thank you so much for the prep work and for despite all your heavy traveling, being fully engaged and alive on this early morning in Boston for you.

1:06:46 So thank you so much. To show your appreciation for Katie and all the other wonderful co hosts, please go to your favorite podcast platform, leave a rating and review. That's the best way to show that you appreciate the work that they put in every single week. Next week I will be joined by Mark and that would be your chance to get him to tackle some of your questions.

1:07:10 So feel free as usual to email them to me. The email is infoptraders unplugged.com and I will do my very best to get them answered. Anyways, from Katie and me, thank you ever so much for listening. We look forward to being back with you next week. And until next time, as usual, take care of yourself and take care of each other.

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