We’re thrilled to kick off another season of The Derivative Podcast. Our first episode finds us going into the lion’s den so to speak, finding out just what all our past and future hedge fund running guests have to fear from replication specialist Andrew Beer (@andrewdbeer1), of the successful DBMF managed futures ETF.
From the inception of a commodity firm to toiling away in the replication corner of the hedge fund space, Andrew shares his journey alongside some witty personal anecdotes, all the while explaining how he’s not necessarily trying to kill higher fee individual funds, just provide a lower cost beta complement to those funds. Think SPY versus buying Apple itself. After all, without the funds, he can’t replicate them – ponder that bit of irony.
We come at Andrew from a few different angles in this one, questioning the risks and limitations of replication, how exactly you can replicate 100+ market portfolios with just 11!, and even getting into the “whipsaw” effect many trend followers saw this past year with bonds fits and starts. This episode has a little bit for everyone, from finance enthusiasts to newcomers – filled with knowledge, humor, and a whole lot of excitement (well, as exciting as you can get talking quantitative replication). Don’t just listen; Turn up the volume. SEND IT!
- Listen on Apple Podcasts
- Listen on Spotify Podcasts
From the episode:
- Replicating Babies, Trend following, hedge funds, and Warren Buffet with Corey Hoffstein
- https://dbi.co/
- @andrewdbeer1
- https://dbi.co/news-research/
Check out the complete Transcript from this week’s podcast below:
Advanced Hedge Fund Replication with the Top Down – riding diverse ETF modeling flows with DBi’s Andrew Beer
Jeff Malec 00:06
Welcome to The Derivative by RCM Alternatives, where we dive into what makes alternative investments go analyze the strategies of unique hedge fund managers and chat with interesting guests from across the investment world. Hello there. Producer Jeff was telling me he should come up with something new this year. I don’t know. I’m sticking with the Obi Wan Kenobi line for now. Maybe we’ll change it up a little bit later. But welcome back everyone. Did you miss me? I missed you to be sure – there was Thanksgiving then the holiday party circuit. Then family here in Chicago over the holidays, New Year’s Eve some skiing? Yes, of course in skiing, Miami hedge fund week and boom before you know we’re here a few days before the Superbowl. Glad to be back. All that happened since we left with the seemingly straight up equity market. pretty poor managed futures performance in November, December, although bouncing back here in Jan and Feb. in the floor, just completely falling out of volatility. With reading showing some of the lowest prices to purchase protection on record. We’ll be sure to get into that on a future episode. What will the new year bring with stocks back at all time highs rates having stopped going up sort of crypto making noise Ukraine war still going on Middle East seemingly getting worse, not better. And all the rest? I have no idea. And to be honest, most of our guests who have no idea either are mostly quants modeling strategies that do what they do, no matter which way the wind is blowing, which is what to me makes them so interesting. How do you do that? How do you turn off that part of your brain that doesn’t really care what’s going on out there in the world. We’ll be bringing you a lot of good ones this season. So go smash that subscribe button as the kids say, which really means just subscribe to the pod please on your favorite platform so we can keep building that audience which helps us keep getting these great guests. Alright, enough about that. Let’s get back to the swing of things here. Put to several guests throughout last year, if you can remember what they thought of managed futures replication strategies, most run their own funds were understandably dubious of the approach. Throughout those questions, I was mostly implying if not outright saying a few times Andrew beer and his managed futures replication strategy. Will it work? Well, it seemed appropriate to go to the source and get his views after hearing all the pans and wonderings about how it could work from others. So we got Andrew on here and talking through just what he’s trying to do and also understand what he decidedly not trying to do, which is not trying to end the single manager fund business. So let’s get to it. Andrew beer send it. This episode is brought to you by RCM alternans Managed futures group. Our guest today offers a product he thinks provides a beta to the managed feature space for those who are seeking to outperform that beta. RCM’s team helps identify and gain access to single manager manage accounts and funds that are designed to be better than the average. They won’t all be of course, that’s how averages work. But the Managed futures were pleased with its filtering tools and ranking methodology you can greatly improve your chances. Learn more @rcmalts.com And now back to the show.
Jeff Malec 03:15
All right. We are here with Andrew Beer who has the big New York skyline behind them even though he is in the actual New York. What what what’s the real view just a brick wall or something? So you need to cover it with that or
Andrew Beer 03:20
I just moved two weeks ago, you have a largely empty room behind me. But if you hear an echo, it’s because unlike you I don’t have that nice furniture, making my office comfortable yet.
Jeff Malec 03:30
The where’d you move to?
Andrew Beer 03:33
To please call Darien Connecticut? So I spent I spent decades living in Connecticut and past several years I’ve been in New York and other places. So I’m back.
Jeff Malec 03:41
You’re back. I love it. And you’re still what’s the status, you’re going into Manhattan for work?
Andrew Beer 03:48
I do. Yeah, I go in probably about two days a week. But for the past 25 years, I’ve had my own businesses. So even when I’ve looked outside the city, I’ve always tried to balance getting into the city for meetings, stalking it around specific days. But then I spent most of my time doing stuff like this online these days. Love
Jeff Malec 04:07
And then take us a little bit through the personal background before we get into the firm. So all born and raised northeast, born and raised
Andrew Beer 04:16
in Manhattan. I’m a native I went to school through high school then I went up to Cambridge, Massachusetts for college, came back to New York. So at some point there I decided I was gonna get into business, but it wasn’t obvious and so started to work as an m&a banker went back to Harvard Business School, thought I was going down the private equity path and then a chance meeting. In my chance to interview with my second year I ended up going on the hedge fund path. So I’ve been doing that ever since. I’m relatively eclectic in how I’ve done it. I started working for very well known hedge fund managers as a portfolio manager. I later ended up starting Have a commodity for Pinnacle asset management that you’ve may run into in your business. That was in. So interesting story back in 2000, I started to get interested in commodity markets, it was something I didn’t know much about. But I could see a couple of things converging and tried to figure out how to make a business about out of it. And that ultimately came pinnacle. And
Jeff Malec 05:20
what who was the hedge fund? Again, I know you said it on other patents but shared here. Oh, the one I worked for even the first one that I went to work for. You’re the interviewer and the Oh, yeah. So
Andrew Beer 05:30
so so I went to work for this guy named Seth Klarman is a very well known value investor. You know, but my, my career is by hedge fund standard is pretty weird. I started as a value focused guy looking for eclectic investments anywhere you can find them. Eventually, I ended up starting both a hedge fund focused on the commodity markets, but really with the fundamental angle so different than what we do right now. That are called Pinnacle asset management. And also around the same time with a different group of guys started one of the earlier Greater China hedge funds. And then my current businesses is all about trying to bring certain hedge fund strategies to a broader pool of investors through easy to invest in vehicles. Do you ever felt around?
Jeff Malec 06:17
Yeah. Do you ever look back and be like, Oh, I should have stuck with Klarman always
Andrew Beer 06:23
billion in the bank, the moment I leave it firm, it’s about to take off. Oh, my God, I was, you know, I was at a private equity path. And the guys, you know, that I know who went down that path who just stayed on the path. You know, our, I was with a friend of mine in London, who’s, you know, one of the greats in the space. And, you know, he was sitting across across the kitchen table, he was saying, you know, remember when I was like raising a billion dollar fund was a big deal. And said, we just raised a $25 billion fund. In six months, we’ll raise another one. I mean, just the business has just taken off. And, you know, part of my theory on Managed futures, as a space is that it has that kind of potential, if we can, you know, if we could figure out if we can fix some things in how its positioned, that’s fully represented
Jeff Malec 07:10
before I let you off private equity anyways, that space is too big to inverted, right? It’s a print, it used to be a premium because it was illiquid. Now. It’s a discount, because it’s like when? Yeah, look,
Andrew Beer 07:21
I mean, I think I think all these spaces go through when they get institutionalized, and the whole hedge fund industry. I mean, when I look back at the stuff that we were doing at Bell post in the mid 1990s. Now, I mean, you look at that stuff compared to what you can do today, and you should have just done everything, you know, there was because there just weren’t that many hedge funds doing this kind of stuff. And so it was, it was kind of you a handful of guys against the world. And the opportunities were plentiful. Now, you know, every one of those guys has had 20 or 30. Guys who, you know, learned that their knee and have now gone off to start new businesses or gone to other firms it gets it gets immensely more competitive over time. Private equity is the same thing. You know, private equity used to be you know, it was Henry Kravis, taking some guy to a box at the opera who happened to run a big conglomerate, doing a handshake deal taking over one of these undervalued subsidiaries. It’s, you know, four times cash flow and MHC, you know, and having 99 to one leverage, but the business is evolved. And you know, what private equity is also done by pivoting into something like, like tech stocks, you know, is is these these are really smart guys who figure out how to evolve and adapt over time. So, but but, you know, clearly the great opportunities that put these things on the map, those are, are are long behind us. Right,
Jeff Malec 08:54
so what do you recommend your kid goes into private equity or net? I mean, that’s the tough.
Andrew Beer 09:01
I’ve got one of these two right now, I’ve got two daughters who are not interested in business in their 20s. And I’ve got a two year old so I’m gonna have to I’ll, let’s talk about the two year old about 15 years, right?
Jeff Malec 09:12
That’s a big spread. Will there even be jobs then they’ll just be like, yeah, exactly. Basic Income for him. A little bit of that background, and we’ll get into the firm in a minute but kind of funny to me that you’re kind of running a quant firm quant model, right? That has to replicate these strategies, but you’re not necessarily a quant? So not at all, like once not at all at point. I was being polite. But so how do you square that? How did that work out? Um,
Andrew Beer 09:45
so actually, so I met a quant in. I was pretty well known in the early 2000s as an entrepreneurial guy who could kind of because like, I wasn’t a typical hedge fund cedar I was basically finding it I read the market that I found really interesting and then scrapping together, you know, the people in the business plan and and the money and going out and talking to investors. It was kind of it was fun. I mean, it was, but it was in my 30s, that super active. And then in August 2006, I had a meeting with a guy who really was a quant. And he does PhD from MIT. And he was talking about some sophisticated trading strategy that I said and said, I just, I don’t know, I don’t I don’t know how to evaluate it. And then he brought up this idea of hedge fund replication. And I said, What do you mean by that? And he described it, and me too. I mean, look, I’m not a quant, but I almost did a doctorate at Harvard, I would have had to clean up some of my math, but I’m very comfortable numbers. Could have been a quantum right. But But he he described his own replication, which is, which is really simply just using risk models to figure out kind of the big hedge fund trades. And this was Andrew Lau. No, this was a guy named Jerome Abernathy. But it was actually happen to be the same month that Andrew Lowe published his paper. And for hedge fund guys, that was sort of obvious. I mean, if we had just come out of, you know, the.com crisis, where if you were long small cap value stocks, in short, large cap growth, you preserved capital to the great bull market. It didn’t matter. It wasn’t like, oh, I only bought the three value stocks and shorter the beds, I mean, it just you got the areas, right, hedge funds have always been betting the areas, right, even the 1990s. You know, I mean, when Val post was finding really esoteric ways to make money, they were doing things like buying Russian privatization vouchers? Well, again, it was so cheap things were 1/100 of what they were worth in the West, that it almost didn’t matter what you bought, you had to find the right areas. So the idea that you could apply a risk model and say, Hey, these are the big hedge funds have been traded with hedge funds, and we can copy it cheaply was was for a hedge fund guy, and not just me, like, I went around talking to a lot of guys, including Val post about this. And they’re like, Well, of course. The question is, are those the areas that we would be in because we do more esoteric things if you’re going to do it with futures contracts? So So what I thought it did, because because it was sort of obvious to me from a non quantitative perspective, then when I looked at the numbers, and you know, overtime, got more comfortable with how you interact with quants, and you work with quants. You know, I was, I was certain that for certain hedge fund strategies, this was the most simple and straightforward way to deliver kind of broad based returns. And the thing about hedge funds in the 2000s Was that the whole space was great. So everyone was just thinking about like, like fund to funds like Grosvenor had 45 underlying investments, like in your backyard, right? I mean, it was super diversified, just give money to everybody, because everybody’s gonna do well. And so it was a lot about access and fees and liquidity and other things. And this was just, it seemed to be pretty obvious. And so I, after about 45 minutes, I agreed to basically take a controlling interest of this company funded and that by that weekend, I was trying to write a patent on this thing.
Jeff Malec 13:16
Quick aside, what’s a Russian privatization voucher? Oh, that work?
Andrew Beer 13:20
So So when when the Soviet Union collapsed, some academics, including many of whom were at Harvard, got this idea that basically, the way to take it from a Marxist Leninist dictatorship to a capitalist economy was you take all the state owned enterprises, and you create vouchers and stock in them called vouchers, and you distribute them to the population and some sort of a scheme. And so because there
Jeff Malec 13:49
was no corruption involved in that was exactly. It was people
Andrew Beer 13:52
with bags of cash, you know, going around to Bublish goes and and, you know, giving them money for stuff that they had no idea what it’s worth, and so, so, like, it was a you know, I mean, the story has been written on that one. Yeah.
Jeff Malec 14:08
Did. I’m jumping all over the map here. Sorry. But do you think some of the were your comment of like, all the hedge funds were working? We moved to this period where that’s obviously not the case. And you have is it more of a case of we’ve just expanded we’ve grown we’ve evolved right up now this funds, were maybe doing these 50 things. Now they’re doing 50,000 things, right, and categorization and all the different flavors, we’ve just added way more flavors. So it’s hard to say that all are doing something just because there’s so many flavors.
Andrew Beer 14:41
I don’t think it’s so many flavors. I think it’s actually that just information and knowledge gets disseminated. Take managed futures, right. I mean, if you were if it’s 1990, like who becomes a Managed futures guy in 1990, you’re probably in Chicago, with him. Probably connected puppets you probably like to program. Right? So you’re the weirdo on the floor and that you like computers? And you’re, you know, and how do you and then you’ve got to figure out like futures roles and do all this stuff like it was hard to do it back then. Yeah. Now, you know, guy from The Wall Street Journal, Bob Henderson just wrote an article about the fact that you’ve got these kind of things, you can pull down these programs, you can pull down and build all of your own trading strategies overnight. So and you can trade right. I mean, like, you know, one of the things about even a strategy like merger ARB that seems so simple and obvious today, that was a that was esoteric, you know, you had to you had to go call a prime broker and borrow stock. Yeah, it just so a lot
Jeff Malec 15:45
of the Interactive Brokers borrow against your holdings bargain. I
Andrew Beer 15:49
mean, so the whole, you know, the industry goes to this. The technology improves, access improves, I mean, even like the whole Gamestop saga, right here, you had people on Reddit, in Reddit chat rooms, talking about the delta of options at various levels, like that was like, you know, if you were talking like that, in 1990, you were a senior guy at Goldman Sachs or some other place, you know, that looks somebody named Hello Kitty or something who’s doing
Jeff Malec 16:21
it city watch that movie. I didn’t know I haven’t seen it yet. either. I gotta be on the plane this week. Right. Another way to ask that would would John Henry have made his billions and on the Red Sox and everything if he had started today? Right? Like, you’re probably not probably not right. Just I actually did that back a year or so ago when chant GPT was becoming a thing of just a few keystrokes like, hey, write me a basic trend following model. And then I’m like, add this filter at this. But right, it wasn’t even a programming tool or anything. It was just spitting out actual good code, or a basic trend. Padma
Andrew Beer 16:56
my comment, my comment and Bob’s article in the Wall Street Journal is basically now millions of people with sensitive nominees who can do with it, what their, their hedge fund idols have always done, which is create things that look great and back test and lousy, and once they go through democratization, you can, you can be as dumb as your idols. And listeners
Jeff Malec 17:16
have heard me say this on the pod many times, but when I started my first business attained, they, I was showing my dad this spreadsheet, like we were gonna do this, and he’s like, nobody’s ever lost money on spreadsheets on. Yeah. Okay. So fast forward, you leave the hedge fund business, you have this meeting, learning application? Yeah,
Andrew Beer 17:39
so I think I think, you know, we’re gonna find a way to create almost index like problem products for the, for the hedge fund space. So first problem was everyone I spoke to, he did it. Yeah, he did it. And it was a it was, I’d never been really on the fund to fund side of the business, the consulting side of the business, or the wealth management side of the business. I didn’t really know those things. And and, you know, as I got to know, those sides of the business, I realized, like, oh, you love, like, all these myths. You guys talk about hedge funds? Well, hedge fund guys don’t believe that. But you believe that because that’s how you’ve sold your portfolios of hedge funds, derided investors. You know, I found that there were, it was deeply threatening what we were doing, right, because if it worked, the entire multi 100 billion dollar fund to funds industry was essentially worthless. I mean, in fact, in fact, one of the one of grossers competitors in Chicago, who shall remain nameless, but nearly as big, I found out years and years later that they ran internal replication models to see you know, could we actually do better than our portfolios of these flags, you know, our portfolio of greyhounds because this robot dog did better than our portfolio warehouse, and it did better. So they shut it down. Didn’t tell their clients about it. Because it because it’s an existential threat for them. Yeah, destroy
Jeff Malec 18:58
that computer. Yeah. So so what I found out, why couldn’t they run it? And still, right, yeah, they could have just run it and charge the same fees, you know, well,
Andrew Beer 19:05
or, you know, or you integrate it in some fashion. But yeah, the people who’ve gone into that business, you know, they like picking funds. You know, you’re if you’re running a fund of funds, or you’re a consultant at who’s covering hedge funds, you get really rich and powerful people who will come and kiss your ass, to get your attention to get approved, etc. And you have to fly to Florida and go to the conferences that everybody wants to talk to you. It’s a very, it’s a very heady experience. When you then say, Oh, and by the way, now I can be compared to this really cheap, simple way of doing it with six futures contracts. If that does better than you, then you’re stable of carefully selected thoroughbreds. Not a good look. And then you do it and you didn’t do the thoroughbreds, then you look bad as well. Anyway, so it took me years and years and years and years to find a market for what we did. band like a fool, I stayed with it and paid everybody to come to work with me for about 10 years, as we were trying to figure this out.
Jeff Malec 20:07
You have to have a vision gotta have the thing.
Andrew Beer 20:10
Not a great vision. But
Jeff Malec 20:12
and talking about that is the vision that this can the replication model, and we’ll get into the details in a second, but is division, the replication model can be better perform better? And the average then the top greyhounds, as you call it, then what is it trying to be better or cheaper? Or in that it’s cheaper? It’s also better? Well,
Andrew Beer 20:32
it’s so and that was sort of something. So in the beginning of replication 15 years ago, it was hedge funds are amazing. We don’t care about fees, because they’re magicians. And so if we could just get what they’re doing after fees, but with liquidity and low fees would be wonderful. Yeah. There are no people don’t think that magicians anymore. Right? And so one of the one of the actual the funny things about replication, right is when you look at the broad industry, it’s the broad industry really isn’t that interesting? It’s a you look at these guys over time, the equity markets go up by 10. They go up by three, equity markets go down by 10. They go down by three. Yeah, think about it. So So what it did in a sense is replication actually shined a light on the fact that across the overall industry, hedge funds as an asset class is really not that interesting. And
Jeff Malec 21:30
broad brush up hedge funds, mostly we’re talking what I would call
Andrew Beer 21:34
equity Long, short or event driven relative high net look. Now there are some within it that are superstars, right. I mean, Ken Griffin, happen to be in my college, I don’t know the guy, but happened to be in my college class. You know, that’s a guy who he’s the Michael Phelps of investing. Like, I mean, just fired. Somebody called him the Elon Musk of money. Like it just, the guy’s just incredible. And he will do things at a level. That is why he’s the greatest of all time. But the other 99 Out of the other people, other 100 people you put on in the pot, probably they’re going to do well, but you’re not so much if you invest with them. So, so the thing about replication, right after the crisis, we started thinking, just taking a step back and thinking about GFC. I mean, we start thinking about like, you know, what do we do with this tool? Right? I mean, hedge funds are not covering themselves in glory. And we sort of realized that actually, no, I think we can actually do better, right? If hedge funds make 10, you get six. Now, replication is not perfect, by any means it’s an approximation. But we’re pretty good at getting eight or nine out of the 10. And if we can do that efficiently, maybe we’ll give you seven, maybe we’ll give you eight, sometimes we’ll even give you nine. So it became this very, very interesting thing where you can by being efficient, you can outperform that which is expensive. Now, if you’re a sovereign wealth fund, who can go to hedge funds and command fees, because everybody wants, you know, ADIA to invest with them or something, we don’t bring as much value. But if you’re a, you know, high net worth investor, if you’re a wealth advisor, etc, who by the time our product gets to you, it’s either watered down or has high fees or something, then we can offer you something of real value. So the big pivot in our business turn was really around the mid 2000s, late 2000s. Do that since mid 2010. Through late 2010, we realized we need to be talking to people who build model portfolios in the wealth management space. Those are the guys we can help
Jeff Malec 23:42
instead of endowment and whatever dolmens penalty
Andrew Beer 23:45
lands, etc, because it looks we’re basically a a, you know, how, how can we how can we ruin your career allocation?
Jeff Malec 23:54
Yeah. That’s when Cliff Asness was at the Managed futures CME award night. They used to have here in Chicago, that big shindig, the I’m blanking on the name, but they gave him the like, Lifetime Achievement Award. And like all these sea days were in the crowd snickering like, he’s the one who like launched models with low fees, like, are we sure we should be given this guy and touching on Citadel or millennium, like there’s certain places and certain ones you can’t replicate, right? Whether because of their scale or their access, like where do you where does that line get drawn? Or do you? By
Andrew Beer 24:37
the way, I would say like every six months for a number of years, people would come to us and say, Can you replicate this not to be named fun, and it’s millennia millennia. It’s like the only thing you can rapidly when you do a factor analysis that fun. You don’t find any visible factors accepting money
Jeff Malec 24:58
or money tree in the end Okay,
Andrew Beer 25:00
so no, because so you can’t do that you can’t do illiquid strategies, there really only two things you can work, you can replicate really reliably, which is equity, long, short, and managed futures. And, you know, equity long short, because it’s these big shifts, you know, they dial up or down their equity exposure, they get out of, you know, value into growth, they pivot from the US to international, it’s those kinds of big shifts, that happened pretty slowly. And, and that, you know, but again, that would be the equivalent of within that group, there’s always some guy who’s killing it this year, and doesn’t think he’s doing terribly. So it’s really designed to kind of give you really index like exposure, which, which, for an hedge fund allocator it’s not very exciting. But for if you build a model portfolio, and you’re saying, I’ve got these, you know, 15 different asset classes, and one sleeve of it is equity long, short, it’s a way of getting almost diversified low cost exposure to a strategy, where you think because of the fee differential, you’re likely to kind of consistently outperform over time, that’s compelling. So it works in really equity long short, and it works advantage futures and and people have tried it in other areas, and it doesn’t work.
Jeff Malec 26:19
And what what are your thoughts, I can’t remember, if I was Corey Hofstede, I would have the author and the date of the paper. But right, there was the paper that uh, once a factor becomes known, the basically the factor ceases to exist, right. It’s hard to make money off that factor anymore. So what are your thoughts? That was I think the paper had long short equity was one of the examples of right off like, if you put all these fat, classic, long, short equity factors, they’re well known now. And the premiums come way down, if not, negative or flat?
Andrew Beer 26:49
Yeah, I guess my so I know Cory really well. He’s a super friend of mine. And I And and he actually has jumped into he, he used to invest with us now he’s jumped into the replication business. So he has ETFs that compete with us. And I’m
Jeff Malec 27:02
happy to partner with him last year called replicating babies and something else. Yeah. He’s having a baby had a baby. So replicating humans.
Andrew Beer 27:13
So look, and we are all in favor of it, anybody in this space will tell you that I’m all in favor of more smart people coming in and trying to figure out ways to deliver it. I guess I would differ with him on two points. One is that by by the time the papers are written, it’s probably already all over not not that it’s known by them. But that the world changes. You know, so by the time farmer wrote his great value paper in 1992, there were no farm of value stocks left. I know, because when I went to work for Seth Mar, trying to get them for them. And and I also knew on the LBO side, if you had these big fat pitch companies sitting there with a lot of assets on it, and you could borrow nine to one leverage from from from, you know, from forgot the guy’s name, who was the big guy at Bank of America. He was doing all of this kind of the senior cheers, leverage. Yeah, as leveraged buyouts, then you had junk bonds filling the rest? Well, they bought them all. They’re all gone. Right? So value didn’t exist. By the time farmer wrote the paper momentum didn’t exist. By the time Carver wrote his papers the way the way they talked about now, you could argue or you can, if you want to be a little bit more cynical, you’d say nobody writes papers, that where the end result is sorry, guys, we looked at it’s all noise. Right? Everybody has to correct with
Jeff Malec 28:37
with one guy. Right.
Andrew Beer 28:39
But, but I think also, but I think as it relates to hedge fund, it’s this. It’s, it’s in part that. But it’s also this, just, it’s also a zillion hedge fund, guys now, you know, there were dozens of firms, not 1000s of firms in the early 1990s. I think what’s interesting about managed futures, though, because I think people like I think managed futures has been in a 20 year process a 30 year process of commoditization. It’s easier to get the information, it’s easier to build the models. More and more people have as great as many gel is you’ve got many job. Yeah, you know, descendents sprinkled everywhere. You’ve got Winton descendants sprinkled everywhere.
Jeff Malec 29:26
That’s a funny man cubs versus tiger cubs.
Andrew Beer 29:31
Also his babies. And, but yet, it had its best year ever, and 2022 Right. And so, because like by that same logic, right, equities are commoditized you know, bonds are commoditized. So the fact that that you can easily access something or create strategy, right, like how hard is it to create a long only equity strategy today? You and I could do it by the time it’s podcasts. is over. But it doesn’t stop the asset class from being interesting. And so what I think people miss about managed futures, is people like to look at an isolation and you know, disguise building a model that’s going to beat that guy over time, or That guy’s models better or he’s made some tweaks to it. But to me, it’s, it’s it’s managed futures against everybody else. Because there aren’t many flexible and nimble strategies out there that are good at pivoting and changing their positions, when we go through these big regime shifts. Because every one of those pension plans, endowments, advisory firms, model portfolios, etc. They’ve sold their clients on, it’s good to be slow. Our job is to be slow, slow is fast, with a steady handed the wheel, we don’t panic, right? Sometimes you should panic. Right? In early 2022, if you have a 6040 portfolio, you should have been panicking. But their job is not to panic. Now, the beauty of meta futures is beyond a certain point, like, you know, I mean, because they’re always looking in the rearview mirror. They don’t have memories, they don’t care, they didn’t tell people that they had some great macro call and rate staying low. So so it’s, it’s, I fell in love with it as a strategy as a non quant. Because I realized that every instinct that I have, as an investor, something goes down, I want to buy it. Right, it’s got to be tethered to some intrinsic value. So that goes way up too much. It’s got it’s got to come down at some point. And if I were to build a portfolio, it’s gonna be built around those kinds of principles. But the nature of diversification is you don’t find a lot of guys who think like you, you know, you find people and strategies that do things differently. And so managed futures to me is just so interesting in that it’s the single most valuable thing that I found to bolt onto that 6040 portfolio, it really add some value to it, as opposed to most like private equity doesn’t add value, the 6040 portfolio. Yeah, it’s equities,
Jeff Malec 32:14
where you could argue you can switch swap the 60 with it, but yeah. And I’ve always thought, let me know your thoughts on this right does. So maybe the factor would break, maybe it does break from time to time in managed futures, because it’s so well known. But because of the drawdowns because of what happens in the normal managed futures profile. People flood back out, which then reinstates the factor back to right, you know, I’m trying to say like, is the natural cycle of it keep it from breaking long term? Like, if everyone stood with it through the tough times would it would, quote unquote, break?
Andrew Beer 32:53
I don’t think so. I mean, I mean, let me think, I mean, think of the big trades and 2022. You short, the, you know, you buy oil in the first quarter, you, you know, you’re short treasuries throughout the year, maybe you’re shorting equities, at some point, I don’t think those were capacity constrained traits. Now, now, the guy who’s trading sauce, he’s gonna start hitting a capacity wall, much quicker, much, much faster. But but the space is a whole. I just don’t see it. I mean, this face really hasn’t grown in 10 years, and everything else has grown a lot. The risk of it is the same proliferation risk that you see in every other strategy in that, you know, by the time we get to or it’s it’s the fact that, you know, sometimes managed futures are like mosquitoes toward a flame, except they’re going toward a propeller, basically. Yeah. And, you know, and so, by the time you know,
Jeff Malec 33:52
the flame doesn’t sound so good, either.
Andrew Beer 33:56
equally bad, a flaming propeller. Yeah. The, you know, in early 2022, there was talk about inflation coming back, but in terms of putting money behind it, it was still a very contrarian trade. You know, it’s why certain macro hedge funds had their best year ever. It’s why certain, because most people who had told everybody by the end of 2021, that rates were never going up. It’s very, very hard to unwind. It’s very hard to call your clients and say, three months later, sorry, guys, because again, it wasn’t it wasn’t obvious at that point. Right. And so, but again, manner shooters have this beautiful ability to just lean into it. Once they see the tea leaves. They’re not worried about getting whipsawed, right. They’re not worried about being embarrassed and are worried about the trade running on too long. So the absence of those characteristics is very, very powerful. But by the time you get to the fall of 2022, or end of October, last year, that instinct also sets them up because they’ve got their chin out. All right, well, well, human beings are saying, you know, I don’t know. You know, the, you’re still short treasuries across the board. Yeah, sure about that. A lot. Yeah. Have you? Have you looked at the leading indicators recently? Nope. Because I’m a computer. That minutes. Exactly. So. But again, even in the last two months of last year, which was a terrible time for administrators, because it was really like the mother of all whipsaws on the right side was still, that’s okay, because everything else in your portfolio went up. Right? You know, if everything in your portfolio of stocks and bonds had a correlation above point eight last year, corporate bonds had a good correlation to the s&p 5.9. I yield that a correlation of point nine REITs at a correlation of point nine, right? This is not good. execution risk. Yep. Bitcoin has a correlation of 70 If it’s possible, mathematically conceivable. So, you know, I think so I guess it’s, it’s, to me, I’m always thinking about it as this is a tool in our broader portfolio set. And when you talk about, you know, people sticking with the investment, it’s got to have a role like that, you know, it can’t be a trade, it can’t be I’m gonna get in and a hole as soon as there’s like sunlight coming up, I’m gonna, you know, dump it and go back into equities,
Jeff Malec 36:27
which is now a huge trend right up, like, I’m gonna put it with the equities in a single investment to hide that line item risk. Because people are too behaviorally stupid for lack of a better term to stick with it.
Andrew Beer 36:40
Have you read it? Have you heard Eric Eric written on? Yeah, yeah. Multiple times? Yeah. Okay. Second podcast episode, the guy’s a genius. Yeah. I mean, he is no, he’s absolutely right. And Abby, capital has a has a fun that does it as well. It’s, like, you know, people invest in things that they like, we, as investment managers, you know, we’d love we want to try to convince people with the logic of it, you know, here, here’s an ETF for the negative correlation to the s&p 500 800 basis points per annum of alpha, right? If the investment is scary, and they’re gonna have trouble explaining it to a client, if they make a 5% allocation to something like that, it’s not meaningfully going to change their clients lives. It’s, it’s going to meaningfully make their lives better if their clients like it and feel like it’s valuable in their portfolio, and it’s going to help them to grow their assets and to sleep at night. But zero of those clients and 20 years are going to go back and say can we do a comparative analysis of what the Congressman had in 2023 as to whether this raised my Sharpe ratio over the subsequent 20 years? It doesn’t happen, right? As you said, you can’t, you know, you can’t. Spreadsheets versus reality.
Jeff Malec 38:00
So I’ve always loved the efficient frontier and like the Sharpe goes up, point oh, two or something, right. And you’re like, does anyone really care? Right, their volatility was 50 pips higher, and their return was 10 pips higher like,
Andrew Beer 38:14
it doesn’t because literally no, no 5% allocation, your portfolio, unless it’s a lottery ticket, yeah, is going to meaningfully change the risk return of that portfolio, you’re gonna have a 98% correlation to that which you had yesterday. And if you kill it during the next crisis, and this asset outperforms by, you know, 20%, you’re gonna have changed your life by 1%. Yeah, yeah, it’s so. So I think I mean, a lot of asset allocation is, I just went back to your point, I was on a, a, it was asked by a university to help them look at proposals. And they had a eight consulting firms that made proposals to their existing portfolio, and every one of them completely changed the portfolio. Like, this is terrible, we should change this change that change this change that add these 12 different asset classes that it did. And it was like the same Sharpe ratio. Yeah. And so but, but that business exists, because there’s an audience for it. Right, the person at the foundation has to report to trustees, and they want to be able to show them an analysis that shows I mean, it’s very much of its very theatrical asset allocation is very theatrical in a lot of ways. And I think what Eric did, and what Corey is trying to do now is to take and we’re doing it trying to do it in a different way, is to is to listen to the audience. You know, and one of the great problems of miniatures, I think, is that they have been cared about the audience, that they that they’re used to talking to the family offices, you know, the European family offices had managed futures since the 1980s. And we’ll always have managed futures. Yeah. And whether you stuck to the institution where they’ve got a consultant, you know, a guy who covers only macro funds and loves to go around and talk to all the 20 constituents at this auction, CTA index and write reports on who’s doing what and who’s not. And that’s works in that audience. It doesn’t work for somebody who’s not neck deep in the space. And I think I think an inquiry is addressing something around, you know, where are you to take money to put it into manners futures? Right, you got to take money from something and that raises the risk that you’re wrong. You know, what, so you take it from equities that equities outperform, you look bad, you take in bonds and bonds outperform you look bad. So maybe you don’t have to take it anywhere. And then Eric’s addressing a separate issue, which is, you and I both agree, this is a great investment. And you and I both agree, it can be awful in certain years.
Jeff Malec 40:58
Yeah. And we won’t stick with it during this.
Andrew Beer 41:03
Because because, you know, because the business of people is not winning an argument, the business of like, advisors is not winning an argument to prove to their clients that they would give them a better, sharper, it’s to keep their clients happy. Yeah, it’s to keep their clients engaged and cetera. So
Jeff Malec 41:19
cynical view is even to like reduce the number of phone calls.
Andrew Beer 41:24
Which is, honestly, it helps the clients not to get anxious about the underlying investment. Yeah, and make that the asset management is very weird in that the entire like, for you look at US stock picking, we have reams of data, that all of these firms out there that do long only stock picking, have added zero negative value to clients over the past 50 years. But people still do it. Yeah. Because if you do it,
Jeff Malec 41:57
right, I have a little play account just right. It’s fun, you get that rent,
Andrew Beer 42:00
but like like you, like I was, you know, if you asked me like, What would I do? I think it’s a good use of my time to start pulling up 10 ks and looking at companies and try to figure out where I put incremental dollars? Absolutely not. Yeah, I have much better, much more important, but not more important. I’d like much, much more valuable things that I can be doing. Like that’s the so the asset management industry as a whole offer something of value that is not economic in nature. And, and I think, you know, the ETF business, in a sense, and, and a lot of the evolutions that asset management has been hearing, like, like, for instance, private equity. Right, there was this, this this, you know, journalist started writing a few years ago about, like, you know, you know, watch, the markets have gone down and 2022 and private equity firms aren’t going to mark down, you know, their, their assets the way they should. And, yeah, and it’s, you know, they’re pulling the wool over their clients eyes. Okay, so I called some guys who run private equity firms that I grew up in, in the business with, I’m like, talk to me about this. And they’re like, seriously, we don’t care. Like we really don’t care. What are what are your end mark is on XYZ company, you don’t cares, our clients. And and if we’re co invested with those guys over there, and they mark their investment, save invested more, more than we do. They’re more aggressive on the way up and more aggressive and not marking the way down? It actually makes our investor look bad to his investment committee. Right. So it’s, I think there’s this this, I think, you know, what I’ve learned over time, going back to, you know, my foolhardy decision to get into this business and not really understand what the end audience really cared about, which I think was very naive, you know, my 15 year education has been listened really hard to what people are saying. And, and and think about, are they saying is what they say is what they’re saying they want? What they really want? Does it really make their lives better? Because you get people throwing out things like, oh, I want something that has no correlation to equities. Okay, yeah. But why? You know, what is it? What is it that how does it actually make if that’s a 3% allocation in a portfolio? How does that actually make your life better? And I think it does in many circumstances, but it’s not not always obvious.
Jeff Malec 44:26
circle back to something you said before on the capacity and different positions, curious of your thoughts, because you’re kind of modeling flows essentially right? into and out of different markets. So when you see these articles of, oh, the CTAs are all going to get short here, they’re all going to go long or they’re all going to exit and that’s what caused the sell off. And I’m seeing books of actual positions and like that’s not happening whatsoever.
Andrew Beer 44:54
So look, that’s like the media version of CTA is like it’s when you read the headline, it’s like, um, You know, Trump lied, Biden stumbled, like it’s like, yeah, come on, guys. The
Jeff Malec 45:07
CTA, big sellers down here, sellers,
Andrew Beer 45:09
you know, this is the point at which they’re all gonna go short. It’s gonna it’s gonna be $30 billion of selling. Yeah, which has absolutely no impact
Jeff Malec 45:18
on anything. Tomorrow could be 130 billion of by for some other mechanism. Yeah. So.
Andrew Beer 45:24
So we Yeah, I think I think it’s I know a lot of journalists, I’m very, very good friends, a lot of journalists and competition, that space is around finding exciting things to write about. And in the same way that, you know, you go to publish an academic paper, you have a huge incentive to make it interesting, you know, journalists have a huge incentive to make it interesting. If you read about hedge fund positioning, you know, it’s often like, you know, record reduction in in net long exposure of equity, long, short, hedge funds from 38 to 37. In one week, you know, and you’re, like, here’s the weekly moves, and we’ve never had a 100 basis point move. And it’s, it’s, like, it’s natural for people to do but I think, as investors, and I think, where I think within the miniature space, it’s more slow moving, and more obvious that I think most people think, at least when I look at our portfolios, now what we’re doing is very different, right? So the way the way I think about the Managed futures space, is that you’ve got a lot of really smart guys who build what we call wave detectors, you know, the markets are going up and down everywhere, and they’re looking for waves in the markets, if something’s going down, they want to be betting on a continuing this, in general, if it’s going up, they want to bet on it going up. And so the bias is, is, you know, well, would it be better to analyze 100 waves than 10 waves? Because what if wave 97? Is the great waves this year? Yeah. And there are two reasons people do it. One is there is some evidence, that diversification, you know, beyond a small number of instruments does help your risk adjusted returns. But I think it also sounds good. Right? Yeah.
Jeff Malec 47:09
I mean, I’m in Oh, you know, 130 markets,
Andrew Beer 47:12
have you seen the moves and wheat last month, you know, and, and, but thing is also when you go to 100, instruments or more, you also don’t bet the farm on any any underlying instrument. So our view, when we looked at the space was that actually, that information is really valuable. But again, as somebody who, you know, also started a commodity business, commodities moving clusters, you know, if if, if, if oil goes up over the next five years, natural gas isn’t going down. It may go up to x, it may go up, you know, the same amount or something, but, or if, you know, there are underlying things like interest rates are going up, you know, that’s going to reverberate through a lot of different markets. So so the idea behind replication is not to try not to worry about, you know, whether we’re picking up on trade 72 or 73, etc, but rather to say what portfolio of the deepest most liquid instruments, you know, two year tenure 30 year Treasury futures, s&p 500, ephah em, Euro Yen, you know, crude oil, gold, like these really, really big, deepest, most liquid instruments are representative of those clusters. Because, you know, the nice thing about those instruments is you have nearly unlimited capacity. And you also they’re incredibly efficient at trade. And when you have a portfolio, it’s not that hard to understand, you know, you can look at it and actually get a feel as to, as to when you look at the markets, whether we should be up or down today. And so, so, I think if you think about it from that framework, and then you think about this idea of, you know, if CTA slipped from long to short, which by the way will happen much more gradually than people expect, then you see that it’s this is this is not a strategy that I see having a huge impact, like driving like a the tail wagging the dog.
Jeff Malec 49:17
talk for a second, I get them confused. So you’re a top down, we’re top down. Yeah, top down. I’ve always thought until some a couple years ago that most replicators we’re going to bottom up I’m going to build a strategy that mimics the index. So there you can do it both ways. You found top down better.
Andrew Beer 49:37
We found so yeah, so we we looked at bottom up and we actually run our own models are but we use our own models and sanity checks. But we’ve run several models, right like, you know, 50 in 10 days and 150 and 20. I’m like all sorts of things to look at it because it gives us a sanity check it all We’re seeing, we are totally top down, right? So we’re taking daily performance data of hedge funds and their ilk, and basically looking at a big diversified pool and inferring what their positions are today. And then we wait a week and then rebalance again. So Cory, for instance, uses that as part of what he does. Now, the bottom up says, well, that’s kind of incomplete. You know, what if, in early November, or mid November, it looks like wow, this is this is the big one on race. This is the big pivot. Well, we’ve also got shorter term models in here, we got other things in here that are kind of be picking up on that which you wouldn’t pick up on in, in a, you know, sort of simple replication. The reason we didn’t do those is because we think the greatest landmine for a lot of investors investing in the space is single manager risk, you have a space with massive dispersion between the winners and losers every year compared to most other asset classes. And with no persistence of returns, no persistence of alpha. So the guy who doubt did well, last year, is statistically no more likely to do well this year. And as often, you know, often he was wildly leveraged into some trade that worked really well last year, more so than the next guy, and then gets gets gets tanked this year. So even if you build if you build a bottom up model, index, like Mount Lucas has a very good one, they have an ETF called KLM, you have to make a lot of decisions as to how you want to do it. And in general, when you’re doing bottom up replication, you can’t keep changing your mind every six months, because then you’re not a replication, you’re just a single manager firm. So you have to so they’re very rigid in the approach. And so and we don’t think the space is rigid, we think the space is more naturally evolved. So the reason we’d like
Jeff Malec 51:55
so you’re bottom up my work for six months, and then it’s outdated.
Andrew Beer 51:59
Yeah, I mean, Camelot has been a rat. Lucas has been on a tear for two years. I mean, they write numbers the past two years. And but if they started three years or five years before that, you’d have a much more big picture, right? And same thing happens with our models. And I think it’ll, it’ll happen to Cory, it’ll happen to everybody else does it. So they’re great, in that they tend to be cheaper and efficient and transparent and easy to understand. But they have limitations. Now,
Jeff Malec 52:25
my classic examples of Wisdom Tree futures, that pick trader Vic’s model that didn’t go short energies. And like literally, after they launched it, there was the huge 2014 sell off in oil. And they were underperforming like well,
Andrew Beer 52:39
and they look in 2022, right? They had a Bitcoin. They added Bitcoin, I think at the end of 2021. You know, Bitcoin cost him a lot last year and made them the top performer last year in 2022, and made them the top performer last year. So So the whole point is, is that, you know, when you’re investing in space, and that can be great fun for allocators? Because you’re always trying to figure out how do I mix and match these guys, to put them together into some sort of a diversified package? Our view was there already is the Diversified package. It’s those, you know, it’s the sock Jen CDA index with the 20 largest hedge funds, it’s the, you know, it’s the Barclay index, it’s so so you already have measures of diversified portfolios. And, again, this is a little bit of a difference in what we’re trying to do a typical guy in this space is like, you know, how am I going to generate the most returns and and capture the best trends, it’s very focused on on them. Our appeal is that we’re trying to be the index the benchmark, we’re trying to become the default allocation. If you want to invest in managed futures, we want to be the most simple and straightforward way to get broad based exposure. What does that mean? It means not betting on Fred, or Harry or Jana, or whomever else, it means having Broadway’s exposure to the mentors in space, because three years from now, when you’re sitting in front of your IC, or your clients, and they’re evaluating how well this strategy did, yes, they’ll care whether it went up or down over that period of time. But if the benchmark is up five a year, and you’re flat, that’s a much bigger problem than if the benchmark is up five year and you’re up seven. Right? And if the seven comes from just being cheaper and more efficient, then then for a model allocator, we think that’s what they were trying to do, because that’s what we were trying to do and one of our own portfolios.
Jeff Malec 54:37
The and where do you where do you think or where do you aim to land? But two questions one, I’ll go back to dispersion don’t I’ve always had a little bit of issue with this of the dispersion. If you look just inside the trend index, right, the dispersion is not it’s great.
Andrew Beer 54:52
No, no trend. This
Jeff Malec 54:53
trend is much tighter. Yeah, so it’s a little like, yes, CTA but that’s because we have 72 different things inside those CTA index some short term, some discretionary some. So putting that aside for a second, and there’s many things you can do to lower the dispersion of like, okay, if I vol wait them and I have guys that only have five year track records or right there’s a few things you can do to really tighten in that desperate.
Andrew Beer 55:18
Of course, we’re not we’re not a sea change from what people do. Yeah, so an institutional investor is gonna pick six guys in this action, CTA index, obviously, not all six long term trend, guys. Right, and they’re gonna mix their bets around. And that package, though, right, is going to look a lot like this action, CTA index over time, because that’s, that’s where they’re trying to get diversification. If you only love trend, right, and you think that actually the real driver and I personally think long term trend is the most valuable thing within the energy sector space, most durable thing. You can pick Alpha simplex, you know, you can pick if you’re brave, you’ll pick done capital, if you, you can pick a lot of people in the space, a low cost market trend fund, there are a lot of things out there that will give you that now, they’re all going to have because the big driver of returns of something of the benchmark is options, you can X is trended long term trend, that’s a bigger driver returns anything else? You’ll have an 80% correlation 83% Correlation over time, we’re going to
Jeff Malec 56:19
be my question, why not just take the index and pick the guy with the highest correlation? We
Andrew Beer 56:23
will do the highest go to court, we certainly were 90, right. So we’re a bit better. But But again, it’s not a it’s not night and day. And you know, we’ve also tried to make it cheaper and an ETF, which nobody else has really done.
Jeff Malec 56:37
So So okay, I’m in there. I’ve got the high correlation. In any one period, do you have a goal of like, I want to be above average, I want to be average, I want to be in the top five, I want to be right, like how are you explaining to investors? Like, by definition, you’re probably never going to be the best, and probably never going to be the worst. But you’re somewhere in between there.
Andrew Beer 56:57
Yeah, usually, I would say we’re consistently in the second quartile. Okay, right. So, I mean, you have to pick like how much of a rolling, you know, time period you want, you want to pick but again, my goal would be whatever the index is up over three years, we’re hoping to be ahead of it, you know, 123 400 basis points depending upon it. Last year, we had a terrible year by our standards we underperformed. Right? It was the first year that we’ve gone through that, you know what I so what else I tell people is replication is a simplification. It’s not perfect. There are two things that can go wrong with replication, well, three things one is you can do a bad job of modeling it, which fortunately, we haven’t done, we’ve been doing this forever. But you can get very cute on the modeling side. And that’s what’s tend to blow people up. The second thing is we’re gonna miss traits. So if you think about those clusters, sometimes you’re gonna have a you know, just think about it. simplistically, if we’re picking up trades, big trades, the largest 10 trades. But across the space, you’ve got another 90 trades out there. Most of the time, some of them will be having going gangbusters in their favor. And some of them will getting whipsawed and punished on them. And so they kind of average out over time. So our argument is that most of the time 90% or more of the time, just by efficiency will tend to outperform. In January, February of last year, a whole bunch of things that we weren’t exposed to one up at the same time, Mexican peso, Canadian front end of the Canadian interest rate curve. With Nikkei went up like it all this was all wheat sauce, we’re going up all these things that we weren’t touching, were going up at the same time. So we underperformed. But the key is, the question then is, is that something structural? Right is for the next 10 years are these guys gonna be making money only in these, you know, markets sort of slightly more far afield markets or less or less, less central markets. Our view having looked at this for a long time is that’s probably not going to happen that actually the big clusters, the big drivers, so we didn’t change anything. And then we came back in the second or third quarters, and we outperformed. Or we can be too slow. Second risk is we’re too slow. Because everybody in the manager space is looking at a rearview mirror. But we’re looking at a rearview mirror of their rearview mirrors. And so, you know, we will we can be now, half the time being a little bit slower. works in our favor.
Jeff Malec 59:26
You don’t get whipped in and I
Andrew Beer 59:27
don’t get that whipsawed. Right, because you get because people talk about fall controls and short term models like lately take a an American beacon man HL and PIMCO. were great in November and December on a relative basis, because they have a lot more shorter term models. They evolve controls have all sorts of bells and whistles that basically you know, somebody’s pulling, pulling, pulling the chute board right. But it means that by the time they get to Jan one, you know, it looks like they’re now long bonds. Right? So they’ve they’ve they pivoted faster but then now they’re betting Beats are going to keep going down, and then it reverses. So the same thing happened in March of last year, they pivoted out of things quickly, and it took them forever to reestablish their positions and rates started going back up. So, um, so our investment and research conclusion is that is that the both those two risks are manageable over time, and are outweighed by the amount that we tend to up before. So just and we started doing this in 2016, we outperformed in 2016. We outperformed 2017, we have four in 2018. We have 14,000. It we matched in 2020 outperformed in 2021. According to 2022 by varying amounts, right, sometimes it was like more than we would expect, sometimes a little bit less than we’d expect.
Jeff Malec 1:00:45
Past performance is not necessarily indicative of future. Well, and
Andrew Beer 1:00:49
look, last year we underperformed by more than we would have expected because it was like you know, it felt like but it’s very frustrating. I’ve got I do these videos, by the way we talk about it on on a if you go to dB mf.com. I talked about this stuff, because it’s you know, we’re very open with our investors.
Jeff Malec 1:01:04
But when I think was and I was I had 23 flags to talk about so we’re gonna jump in there. What made 23 so difficult. I’m seeing some reports. I’m gonna get around to writing a blog post about it like the worst year for trend following of all time, perhaps. Is that what you’re saying? And your models and your? Well, I
Andrew Beer 1:01:25
mean, having lived through it, or it felt like the year or the whipsaw? Like it’s it’s I mean, it just felt like Like, every time you felt like, you really had that kind of momentum that you felt in 2022. Because I mean, I mean, 2022 was was a historically good year. But it was scary. Right? I mean, you’re you’re you’re still holding your yen short down at 150.
Jeff Malec 1:01:44
Yeah. When they don’t when the Bank of Japan like saying all that stuff. Yeah, like, Yeah,
Andrew Beer 1:01:49
I mean, I mean, it’s, I mean, manners creatures is like that, though, right? I mean, you’re, you’re often particularly if you’re a trend follower, you’re going to be in a trade, after the money’s been made, when when, when the commentary is starting to pile on that we’re due for a big reversal. Now, in 2022, because you had this underlying regime shift in rates that went on for, you know, 18 months, basically, you know, it was the right thing to do. Last year, you know, we start with, you know, there’s a the markets utterly convinced in January that we’re going to be tapering by the second half of the year, then then, and then February comes around, and it’s gonna be higher for longer. And now, just as you’re kind of like, like, you know, it’s starting to work that SVB habits that was and you have like a three and you have somebody says, like a 13 Sigma move in treasuries, which I think is, you know, I have a higher likelihood of getting hit by a comment before this call. But, um, so and then, and then you’re making money back, right. And by late summer, it’s, it’s with rates going up. You know, the the conversations about with rates going up, the market is doing the job for the Fed, the Fed doesn’t have to raise any more, but they’re definitely not not lowering rates anytime soon. And then Powell surprised the crap out of everybody on November 1. And so then rates start to plummet from there. It’s a huge whipsaw. Which because by the time if you think from a trend following perspective, right, you basically have steadily rising rates since since April. And so if you’re a short term model, you’re short rates, if you’re a long term model, you’re really short rates, and then it starts to go down. Now one of two things can happen either Powell can say, they can start to Jawbone I thought they were going to they’re gonna jawbone and say the markets gotten too far ahead of itself. You know, it’s something something something, and, and in which case, the short term guys would have been caught flat footed. But instead, what happened was he basically piled on, you know, he had that second thing where you said, Yeah, we’re done. And, and then and then the market, you know, again, because it’s not just the change in fundamental information. It’s people racing to catch up, you know, allocators all over the world who have had no duration going
Jeff Malec 1:04:08
into it, especially the end of the year. Maybe have some
Andrew Beer 1:04:11
Oh my God, they don’t want to sit for their investing committees and look like they missed it. So yeah, my there Look, yeah, look, yeah. December 14.
Jeff Malec 1:04:18
And then and what did your book look like? So we, I think we mentioned before you were only in 10 positions ever, right? Yep. So for most of that most of that pain experience was, what the 10 year, the third year, which bonds are part of those 10?
Andrew Beer 1:04:33
Right, what’s the it’s the twos 10s and 30s. And it was across the board. Yeah, I mean, it was that way. You know, the funny thing about last year, and I think this is sort of interesting is is to us, at least when we looked at it, it was truly a one trademark. So interestingly, the very best replication we came up with last year was not a 10 factor model. It was not a 15 factor model. It was a one volume factor. It was the two year it was the two year treasury, the two year treasury, everything, everything in the markets was moving on the basis of whether what they thought was going to happen to short term US interest rates. And you had a correlation of 93 or 94%. And you just you just tracked along this action, CTA index. Obviously, we wouldn’t run that as a strategy because the moment we implemented it will fail miserably. Because, you know, the market Gods hate that stuff. It’s too cute. But the but it was just it was just really boring. So basically, you know, it wasn’t just when the reversal happened, it also cascaded through currency markets. You know, if you’re short, the yen, and then Powell says that the rate hikes are over, guess what’s going up the yen? So, you know, so with men or futures, you know, when they lose money, this is when it’s usually because they have a lot of, instead of having three or four different distinct clusters, you’ve got kind of one big cluster expressed with lots and lots of different positions. And that’s what happened last year.
Jeff Malec 1:06:09
Two things on that one, to having the three rate markets, twos, 10s, and 30s, isn’t? How do you square that with the concept of like, No, we’re just trying to have one market per sector or one, right, when they’re clustering, and I want to, I want to identify that cluster with one market, or doesn’t have to be one, obviously. So
Andrew Beer 1:06:27
the the research that we did about from 2000 to 2015 2016, was to do this? Well, you need all four asset classes, equities rates, currencies, and commodities. And that’s but even within the context of that, now, the first models, we ran for only four factors, one in each market. And I published the short note and institutional investor last year showing the results of that.
Jeff Malec 1:06:53
It one one market, per sector, one mark,
Andrew Beer 1:06:56
one market, one instrument per market. Yeah. And, yeah, look, it worked. It works embarrassingly Well, for a business that sells itself on, on on complexity
Jeff Malec 1:07:09
on 78. Market. Yeah, yeah.
Andrew Beer 1:07:10
But, but we are very, very, very, we try very hard not to fool ourselves. And the great problem in modeling is how easy it is to fool yourself that you found something special, sustainable. So we looked at a million different ways, we looked at different combinations of random instruments. And I think, I think what got me comfortable, you know, the first guy that I worked for he wrote this book called margin of safety. And, in a sense, on the statistical side, you know, we’re trying to find something that has what we’d call statistical margin of safety. If you, if we took our 10 factors, and replace them with 10, different factors, our results don’t change very much. If we changed our window lengths that we’re looking at over time, it doesn’t change very much we change the weight so that for somebody who’s modeling is our measures of stability, and durability. And then is there a kind of an underlying rationale behind it. So we so we wanted to we’re trying to find a balancing act, we want to expand it. So we get more diversified exposure. And there’s sometimes you know, sometimes happening like, like this month, we’re we’ve been long, the s&p 500, and short emerging markets against it. Working great and trying to trade right, that would that would be an awful lot better than just having the s&p 500. It, you know, knowing these markets, it could hurt us in a month or a week or something. But so it was really an end. And we were also very sensitive from day one to liquidity and execution costs. So we’re fairly big, we probably got a billion and a half dollars and managed futures strategies. And my guess is relative to anybody else in this space with those kinds of assets. We are a very unattractive prime brokerage client. Yeah, because we only we just don’t trade the stuff that they make a lot of money on.
Jeff Malec 1:09:10
So let’s quick go over the 10 markets, so to 10, Tuesdays, Thursdays,
Andrew Beer 1:09:17
crude oil, gold ephah and emerging markets, and then Euro Yen.
Jeff Malec 1:09:24
And then so the ephah and emerging must be your finished markets. Yes. Out of those those features. Yeah. And then this popped into my head is we’re saying that so if 23 was bad, because basically there were a bunch of disburse rather dispersion expanded, and there was some outlier moves. Like you could argue that that whole post 22,000 a great period for managed futures. Volatility came down fed cut rates to zero that whole period, that zero rate period, I could argue made it all one tray A kind of right like things, you didn’t have all these multiple bets, especially in trend following portfolios. So if you modelled it during that period, any concern that if that Jan, Feb kind of right we start to see way more dispersion do you have to expand the portfolio?
Andrew Beer 1:10:16
Yeah we’re we we we look all the time and whether we should one of the things that and we will expand that if we feel like we need to. And there’s a good underlying base for the I’ll give you an example like in it in I think September 2021, maybe September 20, natural gas was up like 34%. And oil didn’t move much. Right. So going into that, the way our models would see it was basically, let’s say you’ve got $1 natural gas at $1 and crude oil, we’re gonna see, you know, 1.2 point $2 of crude oil or something like that, basically, and, and so, so our exposure didn’t participate at all. And when we read it, and we said, what if we had was like, why did we have to perform the the stock density index last month? It was pretty obvious, right? It’s like, okay, well, because we don’t have crude oil. So if we’d have crude oil, instead, we’d have natural gas at a 7% position. And so we would have made two points. So now the question is, okay, do we think September is unusual? Or is there a reason to believe that somehow, crude oil and natural gas, which are normally very similar, yeah, are now somehow going to be moving in a lot of different directions, and we didn’t think there was any fundamental or economic reason. And so you know, then we go back, and we look at 20 years of history, and we say, Let’s do it again, you know, what, if we’d had natural gas, would it have made the models function much better, and our conclusion and our conclusion, whenever we look at this stuff, almost has always been sure there gonna be periods of time when it helps. And there’ll be periods of time when it hurts? And in some, does it meaningfully improve our correlations? Does it mean meaningfully improve our returns, so we have a pretty high bar for changing it. And, you know, when I talked to clients about it, I said, you know, the measure of success, where we started doing a seven and a half years ago, and we haven’t changed a thing, right, and we’ve outperformed maybe 90% of the constituents of the SOC Gen Z candidate since we started because if you do a little bit better, a little bit better, a little bit better, a little bit better over time, you kind of climb your way up from the second quartile up well up into the first quartile. And the, but that’s very unusual in quant land, because usually they come to you and say, oh, you know, we’ve made all these great changes to the model, you only make changes to the models, things not working. You know, you don’t say, Oh, can we have this thing? It’s, we’re killing it on these trades. But we’re gonna we’re gonna park them aside for now, because we think it’s too much of a good thing. So we’re going to introduce these new things on top of it. So it makes it very hard if you’re trying to evaluate something over a long term perspective. And the investors we want, you know, are thinking about, I want this in my portfolio for 10 years, because I can look back and see 23 years of history, the space and however long we’ve been doing it. For for those guys. Consistency, and stability has been quite important. So our goal would be our hope would be 10 years from now, we can say we still haven’t changed the model. Because if we’re saying that it means it’s been working well enough that we don’t have to.
Jeff Malec 1:13:36
And how many people do run into that just blows their mind? Like, wait, no, you can’t do this with 10 markets. What are you talking about? And you’re a month delay or right, you rebounds weekly or month, we brought weekly. So you’re a week behind? By definition up to a weekend.
Andrew Beer 1:13:50
We because it because let’s face it, a lot of daily data. So we’re seeing Friday’s numbers by the time he rebounds on Monday, but we’re looking at a couple of weeks. So there’s a week or two of delay it and when you when you just sort of average it out. It was smart allocators, like PhD caliber allocators who are seasoned grizzled hedge fund allocators think what we do is obvious. Yeah.
Jeff Malec 1:14:22
Marketing, like okay, you put this in a nice package and are selling it? Yeah,
Andrew Beer 1:14:25
it’s like it’s they’ve, some of them have done the same analysis themselves. And and it doesn’t, it doesn’t surprise them at all. It if your job is to pick individual funds you know, it’s it’s more challenging for people to to buy into it because a lot of their manager selection is around the 10% that makes this guy different for the next guy. Right? And, and people in the space you know, First when I started going on podcast, as after the ETF was launched, early 2022. I do the single top traders unplugged with with Neil’s from, from Don Capital One. And in a lot. I think people in this case were very skillful. And they were high, they were highlighting a lot of the limitations of the strategy. And we’re very open about the limitations of strategy. So it’s not like it’s, but it was. But I think it’s caused a shift in thinking. And the reason I wrote that thing and institutional investor was because people would say, you know, 10, is you’re not getting enough diversification with 10. You need more than that. And I said, Well, actually, you’re not that far off, if you do for as well. So part of, you know, a part of my job, though, is that, as you know, what we’re doing is is a bit different, you know, it requires a lot of time talking to people and explaining it and why we made the decisions that we made. But again, and I think also, like, I think it’s also, for me, it’s talking to an audience, that where we can be helpful.
Jeff Malec 1:16:03
And then my flip side of that question is how, what percent of your assets do you think don’t even know that it’s replication? Or don’t they’re just seeing a number and knowing the category and like, what you’re doing? I think,
Andrew Beer 1:16:13
I think I’ve spoken to most of our investors. You know, I think I think the investors fall into, I’d say, probably, maybe three broad buckets, I think there are there are some people we have who just probably see the numbers and invest in it, it’s easy to invest in the CTF, and they just go by another group are more sophisticated, and we have these one on one conversations about what we’re doing. And often they think, okay, you know, it’s, it does something very valuable very efficiently, but I want to pair it with something else, you know, you know, look, I mean, hey, it’s, that’s, I mean, Min HL or PIMCO will do better. And then Austin, November, and December will do better than this month, like there’s sort of predictable, so it can be kind of one plus one is 2.2. So we’re just become a tool in their portfolios. And I think the third group, though, are people who, even though they’re investing in a quantitative product, like if I was an equity Long, short manager, you know, they wouldn’t be trying to look over my shoulder and say to T, calculate EBIT da correctly there. Yeah. How do I know he’s reading that footnote correctly? Exactly. Right. They, they hear me talk about how we tried to build something, you know, first for ourselves, and one of our most important clients, and then brought it into an ETF, why we make decisions that we make, you know, how that there are human beings who don’t sleep a whole lot, because they want to make sure this thing is doing what it’s supposed to be doing. And if we can be very clear about what its objectives are, how we think it can work in their portfolios, then whether nobodies can’t have replication, the number of instruments just doesn’t really matter. You know, it’s like, it’s like, Oh, I’m not going to invest that in that equity manager, he’s only got 17 positions that 43 You know, just it’s, it’s, well, he must,
Jeff Malec 1:18:05
you mentioned that because that is often articles of like, they’re not really doing anything, they’re only in four positions are right for some of these equity, hold
Andrew Beer 1:18:13
positions for a long time. But it’s but you know, things like when you’re, it’s hard not to do things in this business. Yeah. You know, and that’s, that’s one of the that’s one of the things that plagues quant investing
Jeff Malec 1:18:22
are not to add bells and whistles. And
Andrew Beer 1:18:25
yeah, I mean, so look, you mentioned the bottom up replication stuff that you know, a lot of that sort of with banks in the mid 2000s, early to mid 2000s. And, and the stuff they generated on average
Jeff Malec 1:18:37
was garbage, the ruins Bohemia platforms and all the risk for your
Andrew Beer 1:18:41
platform. I mean, this is this stuff had negative Sharpe ratios. On average, it was the the studies that were done showed that they’d show you back tested number, it would go live, the Sharpe ratio would drop 60 or 70%. And so But why, right, the incentive structure is all wrong. Yeah, you’ve got you’ve got quants, there who have 37 different products, there’s great pressure to crank out the next one, you make it look as good as it can the market it goes guys tried to go sell it, they hope it works. You’re probably not going to be at the bank in three years. When we just get
Jeff Malec 1:19:14
stuff on the shelf, we’re getting stolen.
Andrew Beer 1:19:17
It’s not surprising, it’s pretty bad. You know, I mean, the fact that I’m the fool who got into this business, you know, 10 years before, it was interesting. It actually gives me some gravitas that you know, I I am. This is not something we just jumped into to try to sell somebody of our product.
Jeff Malec 1:19:44
And last bit here, along those lines, what do you think the limits of replication are? Like? We both know what guy here in Chicago does, like venture capital replication and he’s working on healthcare replication. I was at a talk where the guy’s like, here’s how you can and trade lithium futures, when there are no lithium futures by replicating it with copper and short gold, whatever it was. So like, what are your thoughts on just some of that more esoteric stuff of? Are there limits to it? Or what are the dangers of that array of like, hey, I can replicate x by doing why?
Andrew Beer 1:20:18
Yeah so the only the only one I know, well, it’s private equity replication. You’re talking about DSC out there. Oh, those guys are great guys. And terrific firm. And they’ve been doing and they’ve actually made some important innovations in in in what they’ve done. The net, they have, I think, a very credible way of going about this. The when you look at private equity, it’s a lot harder than it sounds. There are some there’s a what this whole industry, the problem is whole industries, we have a massive selection or survivorship bias problem, in that when something is working, you will have no problem finding out about it. When it stops working. People bury it quietly and hope you never don’t look too hard, then so you can go back and look at some credible people who launched private equity replication products that did much, much much worse. Same thing with the risk premium products. Right? If you went to an AQR or BlackRock, and said, you know, as they were launching their multistrike products and said, What do you think is the probability that you’ll be down 30%? peak to trough in the next year or two? They would have told you impossible zero, right? It’s impossible. We’re doing 6% A year with a 6%, standard deviation, no correlation, anything. And then it happened. Right? If that was a stock picker, that’s the guy who is first three picks are frauds. Yes. And so but so private equity replication has scan have some of those issues people have tried to do so lithium is nothing but lithium futures. They may or they may not work. The but
Jeff Malec 1:22:00
Well, there are none. That’s what
Andrew Beer 1:22:03
I’m saying. But you know, like, like, like, like, so our sense is that replication works very well, in at least the way we do it in very limited circumstances. And I never went down the private equity route. Because I, I think you’re taking away the thing that people liked the most about private equity, the in and I’ve had enough conversations with people who had at institutions, who their very favorite thing about private equity is, it doesn’t go down as much. And they mark it up, and it’s slow moving, and they don’t have to watch it every day. They don’t get any surprise calls from investment committee members figure out what’s going on. They love that it’s not work to work it. Yeah. And so you make it liquid,
Jeff Malec 1:22:45
when you can replicate that, like, hey, just turn off your computer and don’t look at this thing.
Andrew Beer 1:22:52
That’s not replicated. That that was Buffett’s argued at the s&p 500. Yeah, you know, he’s put it 5% The s&p 500. And don’t look at it. But they can’t not look at it. Right, because they have reporting. And, and so we didn’t do it. We didn’t do it for that reason. And I asked like, there’s some, I think there’s some arguments that there’s been a huge guys that I know in this space. I think there’s been a transfer of wealth when when the by the time you got into mid 2010 is the typical bond investor was so outclassed by the private equity guys, and they were so desperate to put money to work that you had these they were getting, you know, issuing bonds with no covenants. Yeah. And crazily risky companies with five or 6% yields, you know, these guys were designed to sweep up that opportunity. So, I think that, you know, the answer is that I think these things always change over time. And, and I just private equity of revolution, I think you can make it work. It’s not something we decide to really try to make work.
Jeff Malec 1:23:58
Awesome. I think we’ll leave it there. We’ve had it long enough. Any last thoughts before we go?
Andrew Beer 1:24:04
Though, I will look, I mean, I hope that your the whipsaw was was an anomaly. I hope the, you know, the, the firing on all cylinders at 2022. Okay. I mean, I personally, I think the world is going to be a lot more volatile. I think it’s a much harder to get diversification than it was for a long time, and it’s probably going to gonna continue. And, and, you know, there’s actually very good editorial in the Wall Street Journal today about the market seem kind of calm when you think about the smoke coming out of the, you know, the windows of various quarters of the world right now. Yeah, exactly. And so my guess is that we’re in one of those periods right now, where there was this collective sigh of relief that Powell wasn’t going to, you know, deliberately drive the economy into a ditch. But then now we’re going to start even as we’re seeing was, you know, maybe rate hikes are gonna be around Wait, the government that’s not going to stop spending money. Maybe people You know, are not going to stop spending his money. Money is as fast we thought I think you could see, I think it’s gonna be a challenging number of years, a lot of headwinds to pay soon. But
Jeff Malec 1:25:10
I was listening to a Chicago interview where the consumer in the grocery store, like the government saying inflation is down to three. This stuff price hasn’t changed. I’ve been coming here every week, the price of I can’t remember what he’s pointing at a can of soup or something’s like this price hasn’t changed. It’s not down at all. And so it’s like, thinking about the rate of change. Like we’re not going to wait into that. But yeah, we’ll have that right there. Like, prices are down. They’ve just stopped going up.
Andrew Beer 1:25:37
I mean, look, Powell is, you know, Powell may have pulled out the unthinkable. Yeah, right. I mean, I don’t know of a serious macro guy who thought you could, you know, land this plane on a postage stamp, which he may have done, or, you know, it’s or we’re gonna see some more interesting habits at this point.
Jeff Malec 1:25:59
But Awesome. Well, thanks, Andrew. It was great talking.
Andrew Beer 1:26:04
Thank you so much for having me on.
Jeff Malec 1:26:05
It’s great to talk you up next time in New York.
Andrew Beer 1:26:06
And I’ll be in Chicago next month. I’ll give you a shout. Awesome.
Jeff Malec 1:26:11
Appreciate it. All right. All right. That’s it for the show. Thanks to Andrew. Thanks to all of you listeners for giving us that two month break. I needed thanks to Jeff burger for producing please go subscribe. Be sure to catch us on the next episode. Peace.
This transcript was compiled automatically via Otter.AI and as such may include typos and errors the artificial intelligence did not pick up correctly.
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