Latest / Masters in Business / The Concept of Return Stacking with Corey Hoffstein

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The Concept of Return Stacking with Corey Hoffstein · Masters in Business

• 0:02
  Speaker 1: Bloomberg Audio Studios, podcasts, radio news. This is Master's in
• 0:11
  Speaker 1: Business with Barry Ridholds on Bloomberg Radio. This week on
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  Speaker 1: the podcast another extra special guest. Corey Hofstein is one
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  Speaker 1: of these really fascinating quants who has just a really
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  Speaker 1: interesting background. Not only did he stand up a research
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  Speaker 1: shop from a dorm room in college and started selling
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  Speaker 1: model portfolios to fund managers, but eventually created a suite
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  Speaker 1: of first mutual funds and then ETFs, really pioneering the
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  Speaker 1: concept of return stacking. People have described that in the
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  Speaker 1: past as portable alpha. He does some really really interesting
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  Speaker 1: research and gets deep into the weeds on things like
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  Speaker 1: market structure, liquidly cascades, what really drives returns, how much
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  Speaker 1: should you be focused on alpha versus beta? But most
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  Speaker 1: fascinating of all, he is one of those rare quants
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  Speaker 1: who has the ability to take complex, sophisticated quantitative topics
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  Speaker 1: and make them very understandable for the average investor. If
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  Speaker 1: you're at all interested in concepts of things like portable
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  Speaker 1: alpha or return stacking, or just want to know how
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  Speaker 1: a quant looks at the world of investing and tries
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  Speaker 1: to decide where there are opportunities I found this conversation
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  Speaker 1: to be fascinating, and I think you will also, with
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  Speaker 1: no further ado, newfound research and returned stacked ETF suites.
• 1:54
  Speaker 1: Corey Hofstein, Corey Hofstein, Welcome to Bloomberg.
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  Speaker 2: Barry, thank you for having me. Very excited to be here.
• 2:01
  Speaker 1: I'm excited to chat with you about things besides watches
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  Speaker 1: and cars in real estate. Let's talk a little bit
• 2:07
  Speaker 1: about your background. You get a BS and Computer science
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  Speaker 1: from Cornell, a master's in computational finance from Carnegie mellon
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  Speaker 1: quantitative investing. Was was that the plan from the beginning?
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  Speaker 2: Absolutely not really not No. I grew up in the
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  Speaker 2: Super Nintendo generation, so I thought as a young man
• 2:27
  Speaker 2: that I was gonna make video games for a living.
• 2:29
  Speaker 1: Get out. Really I did.
• 2:31
  Speaker 2: And I taught myself to program when I was twelve.
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  Speaker 1: Huh.
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  Speaker 2: And all throughout late middle school and high school, I
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  Speaker 2: was programming games for my game Boy and developing game
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  Speaker 2: engines for the computer. I wrote my own programming language.
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  Speaker 2: I really thought I was on a path to go
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  Speaker 2: video games.
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  Speaker 1: For what was your game of choice? As a kid, I.
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  Speaker 2: Was a big Zelda fan.
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  Speaker 1: Okay, I really was.
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  Speaker 2: And it's funny I haven't played video games in probably
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  Speaker 2: over a decade.
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  Speaker 1: Same, And the really funny thing is so here the
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  Speaker 1: age difference. I remember sneaking out of high school during
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  Speaker 1: lunch with a buddy to go to the mall to
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  Speaker 1: first start playing Space Invaders, then Galaxa, then Missile Command,
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  Speaker 1: like these are all retro games. And then when I
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  Speaker 1: started as a trader Tuesday nights, the quote server would
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  Speaker 1: be taken offline and it would become a quake server,
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  Speaker 1: and we spent and you just get lost in it,
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  Speaker 1: and suddenly it's eleven o'clock and oh my god, I
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  Speaker 1: missed dinner. But that's really fascinating. Why didn't you become
• 3:31
  Speaker 1: a game programmer?
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  Speaker 2: As you mentioned, I ended up at Cornell for computer science,
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  Speaker 2: and as much as I love the curriculum, I looked
• 3:39
  Speaker 2: around at the people I was in my classes with
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  Speaker 2: and I said, oh, don I don't know if this
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  Speaker 2: is whom I want to spend with, whom I want
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  Speaker 2: to spend all of my time.
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  Speaker 1: That's hilarious in a cubicle.
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  Speaker 2: As it turns out, I like talking to people, I
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  Speaker 2: like interacting, and I just sort of grew and evolved
• 3:55
  Speaker 2: from there. This was the era two thousand and five
• 3:57
  Speaker 2: two thousand and six, all of my friends were looking
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  Speaker 2: to get banking roles. Everyone wanted to go work on
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  Speaker 2: Wall Street, and so I sort of caught the bug
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  Speaker 2: and saw, oh, there's this really interesting thing I'm learning
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  Speaker 2: about called quant right, and I really liked the application
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  Speaker 2: of math and statistics and computer science to markets, and
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  Speaker 2: I just caught the bug. And that's where I said, Okay,
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  Speaker 2: I think that's where I want to spend my career.
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  Speaker 2: And so graduating right into two thousand and nine, right
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  Speaker 2: out of the financial crisis, I said, I don't think
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  Speaker 2: I'm going to get a job. Let me see if
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  Speaker 2: I can go to grad school continue this education. And
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  Speaker 2: that's how I ended up at Carnegie Mellon.
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  Speaker 1: So let's talk a little bit about the timing there.
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  Speaker 1: You're a Cornell six to nine, you're a Carnegie Mellon
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  Speaker 1: O nine to eleven, but you start Newfound Research in
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  Speaker 1: eight Well, what was this a dorm room? It is
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  Speaker 1: the next Dell computer.
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  Speaker 2: It was. It was very accidental. I never actually intended
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  Speaker 2: to still be running this business sixteen years later. Truthfully,
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  Speaker 2: I named it Newfound after a lake my family used
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  Speaker 2: to visit in New Hampshire. It was truly a throwaway name.
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  Speaker 2: But in college I was working on some quantitative research
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  Speaker 2: models and happenstance we were talking about luck earlier got
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  Speaker 2: introduced to a local asset manager outside of Boston who
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  Speaker 2: saw what I was working on and said, this is
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  Speaker 2: really interesting. Would you license these models to me. I'm
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  Speaker 2: a broke college student who needs some beer money. Yeah,
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  Speaker 2: And he said, I don't have any cash to pay
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  Speaker 2: you with, but I'll pay you in basis points. I
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  Speaker 2: did not know what a basis point was. I said, sure, man, whatever,
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  Speaker 2: I'm going to grad school.
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  Speaker 1: But by the way, most college kids pay for beer
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  Speaker 1: money through quantitative model diviso.
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  Speaker 2: That's right.
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  Speaker 1: I mean, I think that's a generational thing, and why not?
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  Speaker 2: Why not?
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  Speaker 1: I don't know what a basis point is.
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  Speaker 2: I didn't even know what a basis point was. And
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  Speaker 2: so we get this contract written and I go off
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  Speaker 2: to grad school, assuming I would go work at a
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  Speaker 2: big bank doing sales and trading in some quant role.
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  Speaker 2: And he ended up running a strategy based on my
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  Speaker 2: research models that went from zero to several billion dollars.
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  Speaker 1: Get out of here and a couple of basis points on.
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  Speaker 2: That is a lot to add up, and it afforded
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  Speaker 2: me the opportunity. It was interesting because this was a
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  Speaker 2: big transition time in Wall Street where a lot of
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  Speaker 2: the jobs I had been trained for when I went
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  Speaker 2: through that graduate school program, who, by the way, today
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  Speaker 2: looks nothing like the program I went through. It was
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  Speaker 2: all about pricing credit default swaps. No it trades credit
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  Speaker 2: default swaps anymore. So I'm looking on the other side
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  Speaker 2: of this and I'm seeing all the jobs I wanted
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  Speaker 2: to apply for disappear. And my father was an entrepreneur.
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  Speaker 2: I always had the idea that I would do something entrepreneurial.
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  Speaker 2: And I said, you know, young, naive, brash, twenty year old,
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  Speaker 2: I said, well, I got a business that's already paying me.
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  Speaker 2: Why don't I just keep doing this? And that's where
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  Speaker 2: the journey began.
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  Speaker 1: Right out of grad school, you just continued. Did you
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  Speaker 1: even look at jobs? Did you apply.
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  Speaker 2: Places I did not?
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  Speaker 1: You just said, ah, I could be my own boss.
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  Speaker 2: That's what happens in your early twenties. You have that
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  Speaker 2: sort of brash arrogance.
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  Speaker 1: That's amazing. So you have this one set of model,
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  Speaker 1: it's generating revenue. What was the next step? How did
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  Speaker 1: you turn this into a sort of quirky idea that is,
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  Speaker 1: creating a little bit of revenue into an actual business.
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  Speaker 2: Yeah, so that was that was a lot of stumbling
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  Speaker 2: in the dark, candidly. So on the other side of
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  Speaker 2: that contract is I got paid basis points, but I
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  Speaker 2: had a confidentiality agreement with this firm, And so as
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  Speaker 2: those assets grew, I'm now a young twenty year old
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  Speaker 2: going out trying to go to other asset managers saying, hey,
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  Speaker 2: I have this quantitative research. It helps power billions of
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  Speaker 2: dollars of decisions. And they'd say, well, who are your clients?
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  Speaker 2: And I'd say, I can't tell you.
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  Speaker 1: You gotta trust me on this.
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  Speaker 2: And you gotta trust me. And as you know, again
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  Speaker 2: a young twenty year old, I'm sure I got laughed
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  Speaker 2: out of a lot of offices. And there's a very
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  Speaker 2: long story here that's better told over beers. But as
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  Speaker 2: it turns out, the reason that asset manager was able
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  Speaker 2: to raise so much money was because they had taken
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  Speaker 2: signals I had sent them, turned them into rant a
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  Speaker 2: back test, miscalculated that back test, and then ran around
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  Speaker 2: telling everyone it was a live strategy.
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  Speaker 1: Oh really, So it sounds like trouble.
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  Speaker 2: Sounds like trouble. So to about twenty thirteen, I was
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  Speaker 2: doing a lot of this research. I had sort of
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  Speaker 2: started to move into more subadvisory index provider roles and
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  Speaker 2: all of a sudden SEC comes knocking. And by the way,
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  Speaker 2: at that point, that client was at thirteen billion dollars.
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  Speaker 1: Wait, so your you just provide the model. You have nothing,
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  Speaker 1: what's soever to do with how they marketed, who the
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  Speaker 1: clients are, how they run it.
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  Speaker 2: It's just a model, yes, and by and by the agreement,
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  Speaker 2: I wasn't I wasn't even supposed to be in the
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  Speaker 2: equation at all. I've never been introduced. No one knew
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  Speaker 2: who I was. Somehow, no one in due diligence ever
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  Speaker 2: asked them about any of this, right, And so thirteen
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  Speaker 2: billion dollar firm gets a knock from the SEC, and
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  Speaker 2: the SEC says, okay, you're calling this a live track record,
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  Speaker 2: show us the audious.
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  Speaker 1: The trade cracks record and it only goes back to nine.
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  Speaker 2: And then you can imagine everything unraveled from there. And
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  Speaker 2: so in twenty thirteen, I'm staring down my largest client.
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  Speaker 2: All of a sudden it becomes obvious this is fraud.
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  Speaker 1: Now by the way, how did the fund actually perform
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  Speaker 1: when it was live?
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  Speaker 2: Quite well, right, I mean that's why I gathered so
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  Speaker 2: many assets.
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  Speaker 1: So that's the crazy thing, is what led the Because
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  Speaker 1: normally the SEC gets called in when somebody's losing money
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  Speaker 1: and they're pissed, not hey, we're making money, but I'm
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  Speaker 1: not sure I love this marketing.
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  Speaker 2: Just a routine exam. You know, you run an RIA.
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  Speaker 2: The SEC just comes knocking every once in a while
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  Speaker 2: to say, hey, you just want to make sure the
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  Speaker 2: compliance programs all set up. It happens every once in
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  Speaker 2: every couple of years. And at that point they were
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  Speaker 2: due for their routine exam. They had gone from nothing
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  Speaker 2: to twelve billion. It was time for the SEC to
• 9:38
  Speaker 2: come kick the tires with what should have been a
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  Speaker 2: very routine This is you know, dot the ice across
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  Speaker 2: the t's. Oh no, it turns out you've got a
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  Speaker 2: fabricated track record that, by the way, you miscalculated your
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  Speaker 2: back test and it's an inflated fabricated track.
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  Speaker 1: Well that's really a problem. That's really they ever come
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  Speaker 1: knocking to you and said, hey, we uh.
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  Speaker 2: It wasn't just knocking, because what happened.
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  Speaker 1: Is, oh that subpoena is frightening, isn't it.
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  Speaker 2: It was a subpoena, and as a twenty I guess
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  Speaker 2: I must have been twenty three twenty four at the time.
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  Speaker 2: Getting a subpoena from the SEC.
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  Speaker 1: I'll get that'll wake you up.
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  Speaker 2: Yeah, that'll that'll get.
• 10:12
  Speaker 1: The ice coffee, go right to the subpena.
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  Speaker 2: And the gentleman who ran the firm that was my
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  Speaker 2: client was was so convincing to the industry that he
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  Speaker 2: had done nothing wrong during the SEC investigation. He grew
• 10:26
  Speaker 2: the business from twelve billion to twenty five billion to.
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  Speaker 1: Get out of here.
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  Speaker 2: Yes, wow, yes. And so during that time it's even
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  Speaker 2: more basis points. Oh they stopped paying me that they did,
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  Speaker 2: they stopped paying me. Needless to say, the SEC ran
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  Speaker 2: a very aggressive investigation. I got subpoena. My life got
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  Speaker 2: caught up in this SEC investigation, and I said, all right,
• 10:46
  Speaker 2: I've got two choices. I can leave this industry and
• 10:49
  Speaker 2: go go move to Silicon Valley. I got a computer
• 10:52
  Speaker 2: science degree. There's some good stuff going on out there.
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  Speaker 2: Or I can plant my flag and prove to people
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  Speaker 2: I did nothing wrong research here. And so that's actually
• 11:02
  Speaker 2: when I started blogging I started writing a weekly research
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  Speaker 2: quantitative research report, just to say hey, look there's there's
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  Speaker 2: something real here. Had a couple of employees. We started
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  Speaker 2: publishing our research, getting out there more and slowly use
• 11:18
  Speaker 2: that the transition to be, you know, we're more active
• 11:20
  Speaker 2: on social media. Started the podcast a few years later,
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  Speaker 2: just tried to try to say there's no there's nothing,
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  Speaker 2: there's no fraud here. We were not the problem.
• 11:29
  Speaker 1: Hey, it's just a model, and we get we solved
• 11:31
  Speaker 1: it to them that the problem is what they did
• 11:33
  Speaker 1: with it. How did the SEC investigation resolve with you guys?
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  Speaker 2: No issues?
• 11:38
  Speaker 1: Right?
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  Speaker 2: Right? So they I mean anyone who's gone through this,
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  Speaker 2: so I suspect the vast majority of people have not you. Eventually,
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  Speaker 2: the SEC never says you're.
• 11:46
  Speaker 1: All right, You're okay. They just they stopped calling.
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  Speaker 2: And then you ask for a letter that says, hey,
• 11:51
  Speaker 2: can I get some resolution, And they say we've determined
• 11:54
  Speaker 2: we're you know, we're not pursuing further inqueries into you.
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  Speaker 2: And so I've got a nice letter framed from the
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  Speaker 2: SEC that that says precisely that.
• 12:01
  Speaker 1: So framed framed on the wall.
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  Speaker 2: Yeah, the other side did not end so well as
• 12:06
  Speaker 2: you can imagine they were bankrupt a year later and
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  Speaker 2: twenty five billion dollars flew out to the wind.
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  Speaker 1: Wow. So that's an amazing story. I had no idea
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  Speaker 1: about that. I want to just go back a little
• 12:19
  Speaker 1: bit to Carnegie Mellon. You graduate with this quantitative background,
• 12:27
  Speaker 1: you went into your own shop. What did your classmates do?
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  Speaker 1: Where did they go?
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  Speaker 2: They went all over? A lot of them went to
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  Speaker 2: big banks, A lot of them went to buyside hedge funds.
• 12:37
  Speaker 2: Some of them went to places like Citadel to trade
• 12:42
  Speaker 2: options market makers. I mean they really when you when
• 12:46
  Speaker 2: you talk about what is quant right, what you what
• 12:49
  Speaker 2: you learn? You learn everything from how to price structured products,
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  Speaker 2: You learn the math that can help you with with
• 12:57
  Speaker 2: market making operations, you learn the technology. It's a really
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  Speaker 2: broad field. And so what ends up happening is people
• 13:02
  Speaker 2: just sort of scatter to all parts of the industry.
• 13:05
  Speaker 1: Huh. I know you are not especially keen on back.
• 13:09
  Speaker 2: Testing now, definitely not keen on it.
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  Speaker 1: So here's the question. How much did this experience affect
• 13:17
  Speaker 1: the way you look at back testing honest back testing,
• 13:21
  Speaker 1: really looking at the numbers versus exaggerating returns and making
• 13:27
  Speaker 1: up the claim that something's live when it's not.
• 13:30
  Speaker 2: I think my view of this has changed over time.
• 13:33
  Speaker 2: I've become I've always been very skeptical a back test
• 13:35
  Speaker 2: for all the reasons quants normally are. I think quants
• 13:38
  Speaker 2: perhaps did a disservice to this industry and making it
• 13:42
  Speaker 2: easier to show people back tests, right. I have a
• 13:46
  Speaker 2: theory unfounded. No one's ever confirmed this, but I always
• 13:49
  Speaker 2: sit around and wonder, why does Blackrock pay MSCI so
• 13:53
  Speaker 2: much money and indexing, you know, when Blackrock could clearly
• 13:56
  Speaker 2: run all these strategies themselves.
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  Speaker 1: The historical track record now and it's so that's live.
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  Speaker 2: Really Arrah Finra, one of the other regulators prohibits you
• 14:04
  Speaker 2: from showing a back test for a mutual funder in ETF.
• 14:08
  Speaker 2: But if it's an index DTF, which is a regulatory term,
• 14:12
  Speaker 2: if it's truly an index DTF, you were allowed to
• 14:15
  Speaker 2: show the index, presuming it's a third party index provider.
• 14:19
  Speaker 2: So what black Rock can do is say this is
• 14:21
  Speaker 2: an index ETF, it's index to this MSCI or SMP
• 14:24
  Speaker 2: smart beta product, and by the way, here's the thirty
• 14:27
  Speaker 2: year back tests. And of course that back test outperforms
• 14:30
  Speaker 2: the market. And I think that helped fuel the smart
• 14:32
  Speaker 2: beta boom of the twenty tens, and so I don't
• 14:35
  Speaker 2: think there's anything implicitly wrong with back tests if done well.
• 14:38
  Speaker 2: I think the problem is back test became a marketing.
• 14:40
  Speaker 1: Tool, Yeah, no doubt about it, and the SEC rules
• 14:42
  Speaker 1: on back tests have just changed to the point that
• 14:47
  Speaker 1: when I show a chart of the S and P
• 14:49
  Speaker 1: five hundred or or VTI like, I have to be
• 14:53
  Speaker 1: really circumspect in how I describe it. Here's how the
• 14:57
  Speaker 1: total market return has performed over the past thirty years.
• 15:01
  Speaker 1: That's about the most I can say versus, Hey, you know,
• 15:06
  Speaker 1: if you have a portfolio with ABCDE, here's what you
• 15:10
  Speaker 1: can expect. Like, the pushback we've gotten on some marketing
• 15:13
  Speaker 1: materials kind of surprised me. I understand they're trying to
• 15:18
  Speaker 1: create like a big no fly zone to avoid the
• 15:21
  Speaker 1: sort of problems that the guy who abused your model did,
• 15:26
  Speaker 1: but it's kind of like, aside from the fact that
• 15:29
  Speaker 1: past performance isn't necessarily relevant to what the world's going
• 15:31
  Speaker 1: to look like in the future, that's that's a very
• 15:35
  Speaker 1: different thing than Wait, I can't just show a chart
• 15:38
  Speaker 1: I don't understand.
• 15:39
  Speaker 2: Well, and I'm sympathetic to the point that a lot
• 15:41
  Speaker 2: of clients, whether they're advisory clients or my clients who
• 15:45
  Speaker 2: would be advisors and institutions, will ask the question, Okay, well,
• 15:48
  Speaker 2: how would this have performed during these different market stress scenarios,
• 15:53
  Speaker 2: And that's what a back test would, in theory show you,
• 15:56
  Speaker 2: And not being able to tell them or show them
• 15:58
  Speaker 2: makes it harder for them to do due diligence to
• 16:00
  Speaker 2: understand how it may have behaved right. And so there
• 16:03
  Speaker 2: are ways in which I think back tests can be
• 16:05
  Speaker 2: used appropriately. I understand the blanket no from FINRA, and
• 16:10
  Speaker 2: I understand the SEC's position on it because it can
• 16:13
  Speaker 2: be used in such a manipulative fashion. But I do
• 16:16
  Speaker 2: think it makes it it's easy to abuse, it makes
• 16:18
  Speaker 2: it hard to do thoughtful due diligence in certain cases.
• 16:21
  Speaker 1: I'm trying to get a sense of how your investment
• 16:24
  Speaker 1: philosophy developed. I recall reading that you were developing a
• 16:28
  Speaker 1: stock screener and you were focused on value based models
• 16:33
  Speaker 1: and discovered that they would get justice she'll act during
• 16:37
  Speaker 1: downturns as the growth stocks did. Tell us a little
• 16:41
  Speaker 1: bit about how screening led you to develop your philosophy
• 16:45
  Speaker 1: and what your thoughts are on momentum and trend.
• 16:49
  Speaker 2: So very early on in my career, again, I was
• 16:52
  Speaker 2: doing a lot of this on my own. I sort
• 16:55
  Speaker 2: of self discovered factor investing and was basically you using
• 17:00
  Speaker 2: statistical screens to try to find cohorts of stocks that
• 17:04
  Speaker 2: would behave in different ways.
• 17:06
  Speaker 1: And just to clarify, when you say factor investing, we're
• 17:08
  Speaker 1: really talking about FAMA, French factors, not necessarily smart beta
• 17:13
  Speaker 1: type stuff.
• 17:14
  Speaker 2: All of the above. All the above, I didn't I
• 17:16
  Speaker 2: didn't even know what it was at the time. I
• 17:18
  Speaker 2: was just trying to say, Hey, if I find a
• 17:20
  Speaker 2: basket of stocks and all the CEOs are bald, how
• 17:23
  Speaker 2: does that behave right versus oh, these all have positive momentary.
• 17:26
  Speaker 1: I got a great ticker for that ets yeah, balt.
• 17:28
  Speaker 2: I don't think anyone's used it yet. So I was
• 17:31
  Speaker 2: looking at all sorts of things, which is sort of
• 17:33
  Speaker 2: classical equity quant type work. And I've always sort of
• 17:39
  Speaker 2: had a tilt, just personality wise, towards capital preservation. And
• 17:44
  Speaker 2: there was one conversation very early in my career, this
• 17:47
  Speaker 2: was actually two thousand and seven, where I was interviewing
• 17:50
  Speaker 2: with an asset manager and I pre meeting asked them
• 17:53
  Speaker 2: what they thought of the market, and he gave me
• 17:55
  Speaker 2: the most bearish prognostication I had ever heard. And again,
• 17:59
  Speaker 2: I was very in my career. I didn't live through
• 18:01
  Speaker 2: the dot com fallout from a career perspective. I said
• 18:05
  Speaker 2: to him, well, what are you going to do? And
• 18:06
  Speaker 2: he was a small cap value manager, and he said nothing.
• 18:09
  Speaker 2: My job is to provide small cap value exposure. If
• 18:12
  Speaker 2: it's not appropriate for the client, the financial advisor should
• 18:17
  Speaker 2: make that decision. And so I said, well, I talked
• 18:19
  Speaker 2: to some financial advisors and they said, well, how in
• 18:21
  Speaker 2: the world should we know when to take our clients
• 18:23
  Speaker 2: out of small cap value. That's the manager's job. And
• 18:27
  Speaker 2: I said, well, in my opinion, no one's protecting my
• 18:30
  Speaker 2: capital here, and so I started really looking into statistical
• 18:34
  Speaker 2: models that I thought could help preserve capital. On the downside.
• 18:38
  Speaker 2: Value had worked incredibly well in the dot com era,
• 18:41
  Speaker 2: but my thought there was there was nothing inherent in
• 18:43
  Speaker 2: value itself that was necessarily protective in terms of the
• 18:47
  Speaker 2: type of crisis that could unfold. And so I ended
• 18:49
  Speaker 2: up discovering trend following and following in love with trend following,
• 18:54
  Speaker 2: which is the idea that it sounds naive, but as
• 18:58
  Speaker 2: prices have historically gone up, they tend to persist in
• 19:01
  Speaker 2: that direction, or if prices start to fall, they tend
• 19:03
  Speaker 2: to persist in that direction. And there's a little bit
• 19:05
  Speaker 2: of a statistical edge you can use there to try
• 19:08
  Speaker 2: to really clip your downside risk.
• 19:11
  Speaker 1: The challenge is always the transition from the uptrend to
• 19:14
  Speaker 1: the down trend, which is why you have portfolio managers
• 19:18
  Speaker 1: and allocators arguing who is responsible. The reality is nobody
• 19:22
  Speaker 1: wants that job because it's thankless and practically impossible. Very
• 19:27
  Speaker 1: few people seem to have come up with a formula
• 19:30
  Speaker 1: that works from one cycle to the next.
• 19:33
  Speaker 2: That's absolutely right. There's very few, I would argue, probably
• 19:37
  Speaker 2: no consistent predictors of any sort of economic or market cyclicality.
• 19:43
  Speaker 2: What you have is maybe some statistical indicators that give
• 19:46
  Speaker 2: you a slight bit of an edge. But when you
• 19:48
  Speaker 2: talk about just a slight bit of an edge being
• 19:52
  Speaker 2: played on, say a big position like the S and
• 19:54
  Speaker 2: P five hundred in your portfolio, and you're only going
• 19:56
  Speaker 2: to play that edge realistically three or four times in
• 19:59
  Speaker 2: your life, that's a very low breadth bet that's going
• 20:03
  Speaker 2: to have a really big impact. It's just not smart
• 20:07
  Speaker 2: on a math basis to do that, and it's certainly
• 20:09
  Speaker 2: not smart from a career risk perspective.
• 20:11
  Speaker 1: I'm so happy you said that, because I frequently find
• 20:15
  Speaker 1: myself wanting to respond to these claims on Twitter sample
• 20:21
  Speaker 1: set of three. Who cares? You know how every time
• 20:24
  Speaker 1: you look at the history of recessions, Hey, twentieth century recessions,
• 20:27
  Speaker 1: what is it? Twelve fourteen? Even that not a lot
• 20:30
  Speaker 1: of numbers. And are you saying the recession in twenty
• 20:35
  Speaker 1: twenty is similar to recession in the nineteen fifties. It's
• 20:38
  Speaker 1: such a different world. That you mentioned the dot com implosion.
• 20:44
  Speaker 1: The reason value held up was that was such a
• 20:47
  Speaker 1: sector collapse. What was the NAZAQ one hundred down eighty
• 20:50
  Speaker 1: one eighty two percent? And the S and P five
• 20:53
  Speaker 1: hundred was down something like a fraction of that, I
• 20:57
  Speaker 1: want to say, less than half, And then the Dow
• 21:00
  Speaker 1: held up really well, down thirty five percent something like that.
• 21:03
  Speaker 2: Well, and if you go back to the history, it's
• 21:05
  Speaker 2: because most of those value stocks had already sold off
• 21:07
  Speaker 2: forty or fifty percent in ninety nine, right, right, they
• 21:10
  Speaker 2: were in.
• 21:11
  Speaker 1: The late nineties. Anyway, they did poorly while the money
• 21:13
  Speaker 1: rolled into the big cap growth and technology media and
• 21:20
  Speaker 1: telecom exploded.
• 21:21
  Speaker 2: So this story came out that O value is defensive
• 21:25
  Speaker 2: because it has this valuation buffer to it.
• 21:28
  Speaker 1: In that one example.
• 21:30
  Speaker 2: But people extrapolated that one example, right, They took a
• 21:34
  Speaker 2: point and they drew a line, and then what happened
• 21:36
  Speaker 2: in two thousand and eight, Well, most naive value portfolios
• 21:40
  Speaker 2: are stuffed with financials, right, and value just got destroyed. Right.
• 21:45
  Speaker 1: So the obvious question to someone who makes that claim is, well,
• 21:49
  Speaker 1: how to value doing the nineteen seventies not especially well?
• 21:52
  Speaker 1: Look at the utilities, look at big oil compani as well.
• 21:55
  Speaker 1: But that was all about inflation. Okay, but you said
• 22:00
  Speaker 1: this is so it's a it's a hedge except when
• 22:02
  Speaker 1: there's inflation. What are the other exceptions that I always
• 22:06
  Speaker 1: come back to the sample set of three, sample set
• 22:09
  Speaker 1: of five. I need a sample set of a you know,
• 22:11
  Speaker 1: let's revisit this in the year three thousand. We'll have
• 22:13
  Speaker 1: enough data to be able to look at it.
• 22:16
  Speaker 2: So I have sort of philosophical view on this, which is,
• 22:18
  Speaker 2: if I knew that value worked to protect my capital
• 22:23
  Speaker 2: in every single recession, and I thought the market was efficient,
• 22:28
  Speaker 2: then I shouldn't be able to predict recessions, because if
• 22:30
  Speaker 2: I can predict a recession and I know value works,
• 22:33
  Speaker 2: then I've outperformed the market. So you know there's there's
• 22:36
  Speaker 2: an inherent limit here based on how efficient you think
• 22:39
  Speaker 2: the market is. And I'll tell you I think the
• 22:41
  Speaker 2: market's pretty darn.
• 22:42
  Speaker 1: Efficient, mostly kind of sort of eventually efficient. It gets
• 22:45
  Speaker 1: their event what's the Benjamin Graham quote. In the short run,
• 22:50
  Speaker 1: it's a voting machine, but a long run, it's a
• 22:52
  Speaker 1: wighing machine. That's the mostly efficient, eventually efficient market hypothesis.
• 22:58
  Speaker 1: So so given that, let's talk a little bit about
• 23:03
  Speaker 1: things like portable alpha. You've done a lot of work
• 23:07
  Speaker 1: in this, a lot of research. First, give us a
• 23:09
  Speaker 1: quick definition of isolating beta and alpha. What does portable
• 23:13
  Speaker 1: alpha mean?
• 23:14
  Speaker 2: If you're all right with it, I'm actually going to
• 23:16
  Speaker 2: answer this in a round about fashion type by saying,
• 23:19
  Speaker 2: what problem are we trying to solve here? First and
• 23:21
  Speaker 2: foremost right, and the problem we're trying to solve with
• 23:25
  Speaker 2: terms like portable alpha or return stacking is what I
• 23:29
  Speaker 2: would call the funding problem of diversification. It's a bit
• 23:33
  Speaker 2: of a mouthful. So what do I mean by that?
• 23:35
  Speaker 2: Most clients, whether they're individuals or institutions, have some sort
• 23:40
  Speaker 2: of benchmark, a policy portfolio, some strategic acid allocation that
• 23:45
  Speaker 2: they start with. They're typically not starting with just a
• 23:47
  Speaker 2: blank piece of paper. It's mister and missus Jones. You
• 23:51
  Speaker 2: are sixty forty investors, sixty percent stocks, forty percent bonds.
• 23:56
  Speaker 2: But we think that we want to go beyond that
• 23:58
  Speaker 2: and introduce diversifying assets or diversifying strategies. It's going to
• 24:02
  Speaker 2: use gold as an example. Well, to put gold in
• 24:05
  Speaker 2: the portfolio, it's not, it's not just addition. Diversification is
• 24:08
  Speaker 2: a problem of addition through subtraction.
• 24:11
  Speaker 1: What are you selling in order to buy that?
• 24:12
  Speaker 2: I need to make room and that creates two problems.
• 24:15
  Speaker 2: The first is it creates a return hurdle problem. Whatever
• 24:20
  Speaker 2: I'm selling that gold in this example needs to outperform
• 24:26
  Speaker 2: to have that portfolio, or at least keep up with
• 24:28
  Speaker 2: over the long run for that portfolio to not underperform
• 24:31
  Speaker 2: the benchmark. Right, So if you do that.
• 24:33
  Speaker 1: So if you do that, you've even if you've gotten
• 24:35
  Speaker 1: the same performance, you've reduced the risk because through the
• 24:39
  Speaker 1: addition of a diversifying asset.
• 24:41
  Speaker 2: Right, But there's a risk there Let's say I think
• 24:43
  Speaker 2: gold is going to keep up with stocks over the
• 24:44
  Speaker 2: long run, so I sell my stocks to make room
• 24:47
  Speaker 2: for gold, and it doesn't turns out my forecast is wrong. Well,
• 24:51
  Speaker 2: there's a real opportunity cost there, right, So you've got
• 24:54
  Speaker 2: you've got a modeling hurdle rate that you need to
• 24:57
  Speaker 2: figure out when you're adding diversifiers. Is behavioral, and this
• 25:02
  Speaker 2: is where most people understand stocks and bonds better than
• 25:05
  Speaker 2: they understand alternatives or alternative strategies. Alternatives and alternative strategies
• 25:11
  Speaker 2: tend to be less tax efficient, more opaque, and so
• 25:15
  Speaker 2: just like stocks can have their lost decades, alternatives often
• 25:18
  Speaker 2: have their lost decades, and people are very unwilling to
• 25:22
  Speaker 2: stick with those diversifying alternatives during lost decades, which means
• 25:26
  Speaker 2: that when the diversification benefits eventually come around, their performance chasing.
• 25:30
  Speaker 2: And so you see these huge what are called behavior
• 25:33
  Speaker 2: gaps in the returns of alternative investment strategy categories because
• 25:38
  Speaker 2: investors aren't sticking with them. So the return that they
• 25:41
  Speaker 2: realize what's called the investor return, tends to be hundreds
• 25:45
  Speaker 2: of basis points behind the actual investment return. So the
• 25:49
  Speaker 2: question is how do we solve this. Well, it turns
• 25:51
  Speaker 2: out institutions have solved this problem for forty years using
• 25:55
  Speaker 2: this concept of portable alpha, which is to say, well,
• 25:59
  Speaker 2: instead of making room in the portfolio, can we use
• 26:01
  Speaker 2: some financial engineering to take that alternative and just layer
• 26:06
  Speaker 2: it on top of our portfolio.
• 26:07
  Speaker 1: In other words, you're using the underlying sixty forty as
• 26:12
  Speaker 1: a basis for borrowing in order to add a different
• 26:16
  Speaker 1: asset class on top of it. Yeah.
• 26:17
  Speaker 2: I think actually the easiest way for most people to
• 26:19
  Speaker 2: understand this, without getting into the world of derivatives like
• 26:22
  Speaker 2: futures and swaps, is to think about buying a house.
• 26:25
  Speaker 2: Let's say Eve a million dollars and you want to
• 26:27
  Speaker 2: buy a million dollar house. There's really two ways you
• 26:29
  Speaker 2: can do that. You can just go buy the house
• 26:31
  Speaker 2: for cash, and then over time your return is just
• 26:34
  Speaker 2: equal to the return of the house. Or you can
• 26:37
  Speaker 2: go to the bank and get a mortgage. Put two
• 26:39
  Speaker 2: hundred thousand dollars down, get an eight hundred thousand dollars mortgage.
• 26:43
  Speaker 2: You're going to get the return of the house minus
• 26:46
  Speaker 2: whatever the cost of financing is, and then you're going
• 26:48
  Speaker 2: to have eight hundred thousand dollars in cash with which
• 26:51
  Speaker 2: you can do whatever. If you were to take that
• 26:54
  Speaker 2: eight hundred thousand dollars in cash and invest it in, say,
• 26:57
  Speaker 2: mortgage backed securities, you'd probably offset your cost off financing,
• 27:01
  Speaker 2: and your return there would be equal to your return
• 27:04
  Speaker 2: of just buying the house, ignoring taxes. But if I
• 27:07
  Speaker 2: were to take the eight hundred thousand dollars and then
• 27:09
  Speaker 2: invest it and say gold, well, now my return is
• 27:12
  Speaker 2: going to be equal to the return of the house
• 27:15
  Speaker 2: minus the mortgage plus gold. I've effectively stacked the return
• 27:18
  Speaker 2: of gold on top of my house. We do the
• 27:23
  Speaker 2: same concept in institutional portfolio management in portable alpha, but
• 27:28
  Speaker 2: instead of using a mortgage, you use derivatives like futures
• 27:31
  Speaker 2: and swaps, and instead of replacing a house, you're replacing
• 27:35
  Speaker 2: exposure like the S and P five hundred or treasuries,
• 27:38
  Speaker 2: where historically it's been really hard to beat the market
• 27:41
  Speaker 2: and so it's not worth putting capital at work there.
• 27:44
  Speaker 1: So, in other words, you're not owning the S and
• 27:46
  Speaker 1: P five hundred, you're owning a derivative that gives you
• 27:48
  Speaker 1: the right to approaches the SMP five hundred at a
• 27:50
  Speaker 1: specific price that's a fraction of what owning all five
• 27:54
  Speaker 1: hundred stocks would cost. And then you take that money,
• 27:57
  Speaker 1: that capital and buy other diversifiers and theoretically other holdings
• 28:04
  Speaker 1: that will generate above market returns.
• 28:06
  Speaker 2: Exactly. So you could say, instead of buying a million
• 28:08
  Speaker 2: dollars of the S and P five hundred, I'm going
• 28:11
  Speaker 2: to take fifty thousand dollars use it as cash collateral
• 28:14
  Speaker 2: to buy S and P five hundred futures a million
• 28:17
  Speaker 2: dollars of S and P five hundred futures, which will
• 28:19
  Speaker 2: give me the total return.
• 28:20
  Speaker 1: So that'll be equivalent. You'll get the same minus whatever
• 28:23
  Speaker 1: the cost of the derivative.
• 28:24
  Speaker 2: Minus whatever the cost of the derivative is the embedded
• 28:26
  Speaker 2: cost of financing, and then I can take the rest
• 28:28
  Speaker 2: of that capital and invest it wherever I want. Now,
• 28:31
  Speaker 2: you have to be careful here, right, This isn't a
• 28:33
  Speaker 2: free lunch. You need to think about the operational risks.
• 28:36
  Speaker 2: You need to think about the diversification. This is implicitly leverage.
• 28:40
  Speaker 2: Leverage is a tool that accentuates both the good and
• 28:43
  Speaker 2: the bad. We want to accentuate the benefits of diversification,
• 28:46
  Speaker 2: not double down on the same risk.
• 28:48
  Speaker 1: I'm immediate. My immediate thought was, Hey, why can't I
• 28:52
  Speaker 1: take that derivative and go all right, if it's going
• 28:56
  Speaker 1: to cost me fifty K, why can I go two
• 28:59
  Speaker 1: x with three x four? And people do that right,
• 29:03
  Speaker 1: which is great until it's not.
• 29:04
  Speaker 2: Which is great until it's not right. And so for us,
• 29:07
  Speaker 2: when we think about these concept of portable alpha and
• 29:10
  Speaker 2: return stacking, we think they are incredibly efficient ways to
• 29:13
  Speaker 2: get diversification into your portfolio, to get alternative return streams
• 29:17
  Speaker 2: that can both enhance returns and potentially reduce risk. But
• 29:21
  Speaker 2: you need to be really careful about what you're introducing,
• 29:25
  Speaker 2: particularly because during a liquidity crisis you tend to see
• 29:28
  Speaker 2: correlations go to one, and you need to be aware
• 29:31
  Speaker 2: of the leverage risk that's embedded.
• 29:33
  Speaker 1: So eight oh nine, that sort of portable alpha probably
• 29:37
  Speaker 1: didn't do great.
• 29:38
  Speaker 2: Yeah, so let's talk about eight oh nine, and let's
• 29:40
  Speaker 2: talk about why we don't call this portable alph and
• 29:42
  Speaker 2: why we've rebranded it as return stacking. This concept goes
• 29:47
  Speaker 2: back to the nineteen eighties with PIMCOH and got really
• 29:50
  Speaker 2: popular in the early two thousands. What institutions realized, as
• 29:53
  Speaker 2: they said, I mean, you know these stats like the
• 29:55
  Speaker 2: back of your hand, it is really hard to beat
• 29:58
  Speaker 2: the S and P five hundred. If I have a
• 30:01
  Speaker 2: bond benchmark and forty percent of that as treasuries, how
• 30:04
  Speaker 2: am I supposed to What am I supposed to do
• 30:06
  Speaker 2: with all that dead asset? Well, what I can do
• 30:09
  Speaker 2: is I can use derivatives to get that exposure, either
• 30:12
  Speaker 2: the SMP five hundred or those treasuries, and then I'll
• 30:15
  Speaker 2: use my freed up cash and I'm going to go
• 30:16
  Speaker 2: invest in some hedge fund that I think is going
• 30:19
  Speaker 2: to give me uncorrelated alpha. Right, maybe the hedge fund
• 30:23
  Speaker 2: does relative value volatility trading, something with some sizzle, right right.
• 30:28
  Speaker 2: And what's interesting is when you think about it, what
• 30:30
  Speaker 2: the math does is I say, okay, I'm getting the
• 30:31
  Speaker 2: S and P five hundred beta, and I'm stacking the
• 30:33
  Speaker 2: return of this hedge fund on top. And now I
• 30:36
  Speaker 2: can sort of That's why it's called portable alph I
• 30:38
  Speaker 2: can port the alpha of this hedge fund on top
• 30:40
  Speaker 2: of the S and P five hundred instead of fishing
• 30:42
  Speaker 2: in the same pond as everyone else. But what happens
• 30:45
  Speaker 2: during a crisis.
• 30:47
  Speaker 1: Well, everybody has to raise capital because the there's anyone
• 30:50
  Speaker 1: with leverage is starting to get margin cross.
• 30:52
  Speaker 2: See, you have four big problems that happen in two
• 30:54
  Speaker 2: thousand and eight. Your first problem is if you were
• 30:57
  Speaker 2: stacking this stuff poorting it on top of the SMPFI
• 31:00
  Speaker 2: five hundred and the S and P five hundred lost
• 31:02
  Speaker 2: fifty percent from two thousand and seven to the bottom
• 31:05
  Speaker 2: in two thousand.
• 31:05
  Speaker 1: And nine fifty six and chain fifty six.
• 31:08
  Speaker 2: And change, and you only posted five ten percent is collateral.
• 31:13
  Speaker 2: You're getting a margin call. So you did better if
• 31:15
  Speaker 2: you stacked it on ballns.
• 31:17
  Speaker 1: Uh huh.
• 31:17
  Speaker 2: Not so wealthy stacked it on equity. So there's one problem.
• 31:20
  Speaker 2: Folks who stacked it on equities were getting margin calls. Well,
• 31:22
  Speaker 2: what do you do when you get a margin call?
• 31:24
  Speaker 2: You rebalance your portfolio. Basically, that's that's what you have
• 31:27
  Speaker 2: to do. So what they had they went to all
• 31:30
  Speaker 2: the institutions, went to the hedge funds, and the hedge
• 31:32
  Speaker 2: funds said, well, well bad news. Not only have we
• 31:36
  Speaker 2: lost money too, but we're gating redemptions. You can't have
• 31:40
  Speaker 2: your money back. So all of a sudden, they tried
• 31:43
  Speaker 2: to rebalance to meet their margin calls, and what they
• 31:46
  Speaker 2: had invested their cash and was not giving them their
• 31:48
  Speaker 2: cash back.
• 31:48
  Speaker 1: And nobody markets this is not portable alpha.
• 31:52
  Speaker 2: Right, and so they can't rebalance, they get the margin call,
• 31:56
  Speaker 2: they lose the exposure to the beta. The last small
• 31:58
  Speaker 2: wrinkle was a lot of this wasn't done with exchange
• 32:01
  Speaker 2: drade of futures. It was done with total return swaps
• 32:03
  Speaker 2: with banks. And if your counter party was Lehman Brothers,
• 32:07
  Speaker 2: even if you handled things perfectly, where does your swap stand?
• 32:10
  Speaker 1: Right?
• 32:11
  Speaker 2: So as you can imagine post two thousand and eight,
• 32:14
  Speaker 2: this concept which was I think if I'm corrected, I
• 32:18
  Speaker 2: think it was twenty five percent of major US pensions
• 32:20
  Speaker 2: and institutions were implementing portable alpha pre two thousand and eight.
• 32:23
  Speaker 2: That that large, that it was a significant amount, and
• 32:26
  Speaker 2: at least fifty percent of it when surveyed, we're looking
• 32:29
  Speaker 2: to implement portable alpha. Uh huh post two thousand and eight,
• 32:32
  Speaker 2: I mean, I think it was called a synthetic risk grenade.
• 32:35
  Speaker 2: It just the reputation was destroyed.
• 32:38
  Speaker 1: And synthetic risk grenade. That's a great ban a college.
• 32:43
  Speaker 2: Absolutely right, absolutely, and and so like many things you
• 32:49
  Speaker 2: lived through two thousand and eight, the language was right,
• 32:53
  Speaker 2: no derivatives, no shorting, no leverage. I mean that was
• 32:55
  Speaker 2: on product brochures at that point, huh, people really didn't
• 32:59
  Speaker 2: want to talk about this stuff, and so it sort
• 33:02
  Speaker 2: of disappeared. Except there are still institutions that are doing this,
• 33:08
  Speaker 2: and they've figured out ways that are much better operationally,
• 33:12
  Speaker 2: or they figured out other ways to get the leverage. So,
• 33:14
  Speaker 2: for example, private equity, we've seen a huge increase in private.
• 33:18
  Speaker 1: Equity trillions, literally trillions.
• 33:20
  Speaker 2: Private equity returns are basically just levered public equity returns.
• 33:24
  Speaker 1: Uh huh.
• 33:24
  Speaker 2: So instead of now me saying, let me get my
• 33:27
  Speaker 2: leverage by getting a swap with a bank, I can
• 33:29
  Speaker 2: take my public equity get my leverage by taking my
• 33:32
  Speaker 2: public equity putting it in private equity. If I put
• 33:35
  Speaker 2: twenty cents in, it looks like thirty cents of exposure.
• 33:39
  Speaker 2: And I can take some freedop capital and go invest
• 33:40
  Speaker 2: in a hedge fund. Now I don't ever get margin
• 33:43
  Speaker 2: called anymore and ps on volatility laundering to steal a
• 33:46
  Speaker 2: quote from Cliff Astness on the private side, And so
• 33:49
  Speaker 2: people have figured out all these very clever ways, and
• 33:51
  Speaker 2: I don't mean clever in a bad way, but clever
• 33:53
  Speaker 2: ways to keep portable alpha. Because it's a great theoretical
• 33:56
  Speaker 2: concept that just had implementation issues in two thousand to
• 34:00
  Speaker 2: re implement it very thoughtfully, and folks like Jonathan Clinton,
• 34:04
  Speaker 2: who's the CIO of Delta's pension, credits it for taking
• 34:08
  Speaker 2: Delta's pension from near bankruptcy to being overfunded in the
• 34:12
  Speaker 2: last eight years. He gives full credit to Portable Alpha
• 34:15
  Speaker 2: as being the reason why.
• 34:16
  Speaker 1: No kidding, that's really that's really interesting. So you mentioned
• 34:20
  Speaker 1: private equity. We're not going to talk about private credit
• 34:23
  Speaker 1: or private debt. But it's the same sort of continuum
• 34:26
  Speaker 1: that Cliff Do I say, complains about volatility laundering. It's like, hey,
• 34:32
  Speaker 1: if you don't get a daily mark or a tick
• 34:34
  Speaker 1: By tick mark, volatility is irrelevant. We'll let you know
• 34:38
  Speaker 1: what it's worth. Sort of sort of thing. But you've
• 34:42
  Speaker 1: talked about systematic alternatives. How do you define systematic alternatives?
• 34:49
  Speaker 1: And is this the approach that anyone who wants exposures
• 34:53
  Speaker 1: to aults should be using.
• 34:56
  Speaker 2: So this is where I have my own strong personal view.
• 34:59
  Speaker 2: So system matic alternatives to me are active investment strategies
• 35:04
  Speaker 2: that are implemented in a non discretionary manner. Right, Probably
• 35:08
  Speaker 2: these way to describe systematic tends to be you're using
• 35:10
  Speaker 2: computer models to make the decisions and implement the decisions
• 35:14
  Speaker 2: on an ongoing basis. These tend to be things like
• 35:19
  Speaker 2: strategies that will trade futures contracts long and short based
• 35:23
  Speaker 2: on different signals. Those signals might be trend signals, they
• 35:26
  Speaker 2: might be carry signals. They might be value or momentum,
• 35:30
  Speaker 2: and you're going long and short things like oil or
• 35:34
  Speaker 2: gold or Japanese yen, or you might be trading them
• 35:37
  Speaker 2: as spreads against one another. And the idea of many
• 35:40
  Speaker 2: of these sort of systematic macro strategies is to use
• 35:43
  Speaker 2: these signals to capture a lot of the macro trends
• 35:47
  Speaker 2: that are unfolding that you know, your big macro traders
• 35:51
  Speaker 2: would try to capture in a more discretionary fund. What's really,
• 35:55
  Speaker 2: in my opinion, attractive and appealing about them is that
• 35:58
  Speaker 2: they tend to be very uncorrelated to equities and bonds
• 36:03
  Speaker 2: over the long run, and particularly during a crisis, because
• 36:07
  Speaker 2: that's where you often see the opportunities manifest for big
• 36:11
  Speaker 2: strong moves, either positive and flight to safety assets or
• 36:15
  Speaker 2: the ability to short and profit from things that are crashing.
• 36:18
  Speaker 1: Huh. Really intriguing. This kind of ties in with a
• 36:24
  Speaker 1: quote of yours that I want to ask later, but
• 36:27
  Speaker 1: I might as well bring it back to this risk
• 36:30
  Speaker 1: cannot be destroyed, only transformed. Explain.
• 36:34
  Speaker 2: I don't think I'm the only person who has said this.
• 36:37
  Speaker 2: In fact, I once found a very similar quote in
• 36:40
  Speaker 2: an investment book from the nineteen eighty So this is
• 36:42
  Speaker 2: not a quote that should be attributed to me. It's
• 36:44
  Speaker 2: a general concept, and this is something I actually picked
• 36:47
  Speaker 2: up in my graduate school studies when we were going
• 36:50
  Speaker 2: through this education of pricing structured products. And what became
• 36:55
  Speaker 2: apparent to me is, in many ways, the role of
• 36:58
  Speaker 2: the financial industry is to identify risk, extract risk, package it,
• 37:04
  Speaker 2: price it, and transfer it to someone who's willing to
• 37:06
  Speaker 2: hold it. That is what we do when we raise
• 37:10
  Speaker 2: a round of equity financing. Right, you're transferring some risk
• 37:14
  Speaker 2: to someone else, so that risk is never really destroyed.
• 37:18
  Speaker 2: Everything you do, whether it's in your portfolio or investment
• 37:21
  Speaker 2: decisions you make, has a trade off. And sometimes that
• 37:25
  Speaker 2: trade off is just an opportunity cost. Sometimes it's very
• 37:28
  Speaker 2: explicitly higher volatility or lower downside. But everything we do
• 37:32
  Speaker 2: has a trade off. There's really no free launch, right.
• 37:35
  Speaker 2: So when I look at something like portable Alpha, I
• 37:38
  Speaker 2: say Okay. The opportunity is I don't have to try
• 37:41
  Speaker 2: to beat the S and P five hundred by picking
• 37:43
  Speaker 2: stocks better, which has historically proven to be largely a
• 37:46
  Speaker 2: fool's Errand I can try to beat the SMP by saying, well,
• 37:50
  Speaker 2: let me just get the SMP and I think gold
• 37:52
  Speaker 2: is just going to be positive over my thirty year horizon.
• 37:55
  Speaker 2: Let me just stack some gold on top. Okay, that's
• 37:57
  Speaker 2: a win. Where's the risk? Well, again, I'm introduced. I'm
• 38:01
  Speaker 2: using leverage. Leverage isn't inherently bad, but there are risks
• 38:04
  Speaker 2: that I've now introduced for making this trade off. And
• 38:07
  Speaker 2: so yes, I get some diversification benefit, but there's some
• 38:11
  Speaker 2: liquidity risks and operational risks I really need to be
• 38:14
  Speaker 2: aware of. And so it's to me, it's it's trade
• 38:15
  Speaker 2: offs all the way down.
• 38:17
  Speaker 1: And it's worked out for places like Delta's pension.
• 38:20
  Speaker 2: Funds Delta, there are a large number of public pensions
• 38:24
  Speaker 2: as well that have used this ipers Ohio police and
• 38:28
  Speaker 2: fire mosers. I mean, this is I want to say,
• 38:32
  Speaker 2: like one of the and what's interesting is they don't
• 38:34
  Speaker 2: want to talk about it. Oh really, now, the public pensions,
• 38:37
  Speaker 2: it's in all their public filings, so you can go
• 38:39
  Speaker 2: find this right, but a lot of them don't want
• 38:42
  Speaker 2: to talk about it because either hey, this is our
• 38:44
  Speaker 2: this is what's working for us, and we need to
• 38:45
  Speaker 2: beat our competitors right or again it just portable alpha
• 38:49
  Speaker 2: has this bad label to it from two thousand and eight,
• 38:54
  Speaker 2: and people don't want to see it, and so they're
• 38:57
  Speaker 2: sort of finding ways to hide it.
• 38:59
  Speaker 1: So we'll talk about return stacking in a moment, but
• 39:05
  Speaker 1: I want to stay with some of the research that
• 39:08
  Speaker 1: you did, and let's talk about liquidy cascades, which our
• 39:14
  Speaker 1: mutual friend Dave Natick has described a new lens on
• 39:18
  Speaker 1: reality that I think people should be thinking about. I
• 39:22
  Speaker 1: love that description. Tell us what your liquidity cascade work found.
• 39:29
  Speaker 2: So this was research I wrote in twenty twenty after
• 39:32
  Speaker 2: coming out of the twenty twenty crisis, and it was
• 39:36
  Speaker 2: born from the view that while there was a very
• 39:39
  Speaker 2: real exogenous economic event that caused the market to sell off,
• 39:45
  Speaker 2: the day to day of what I was seeing happening
• 39:47
  Speaker 2: in markets seemed to be endogenous. In other words, there
• 39:52
  Speaker 2: was so much volatility and there was so much mispricing
• 39:55
  Speaker 2: that didn't seem to be a reaction to fundamental changes
• 40:00
  Speaker 2: the world. It just seemed to be, Oh, there's someone
• 40:02
  Speaker 2: got liquidated and had to sell immediately, sell down a
• 40:05
  Speaker 2: large levered position, and there's someone who couldn't meet a
• 40:07
  Speaker 2: collateral call. And so it made me take a step
• 40:10
  Speaker 2: back and say, is there something about the market structure,
• 40:14
  Speaker 2: the way market micro structure has evolved over time that
• 40:19
  Speaker 2: I don't understand that there are some of these maybe
• 40:23
  Speaker 2: lurking risks that we've implemented. And so there were three
• 40:28
  Speaker 2: I'm gonna call them conspiracy theories for lack of a
• 40:30
  Speaker 2: better word, that the hang out there as to what
• 40:32
  Speaker 2: has broken.
• 40:33
  Speaker 1: The market rationalization rationalizations, Yeah, to.
• 40:36
  Speaker 2: Be kind to the people that believe them, And so
• 40:38
  Speaker 2: the idea of the paper was I was going to
• 40:40
  Speaker 2: explore them as objectively as I could. The big three
• 40:45
  Speaker 2: as I saw them, were FED intervention and a decade
• 40:48
  Speaker 2: of zero interest rate policy causing people to take on
• 40:51
  Speaker 2: too much risk, forcing them up the risk curve there was,
• 40:56
  Speaker 2: and then obviously the concept of a FED put being
• 40:58
  Speaker 2: tied in there. Then there was the right as a
• 41:00
  Speaker 2: passive investing not just active versus passive in the type
• 41:05
  Speaker 2: of price discovery that was happening, but truly how we
• 41:08
  Speaker 2: trade indexed products at a market micro structure level was
• 41:13
  Speaker 2: that changing stocks aren't traded individually anymore. They're traded as
• 41:17
  Speaker 2: big baskets the way market makers are. There's now really
• 41:20
  Speaker 2: just a handful of big market makers rather than a
• 41:22
  Speaker 2: large cohort. Is that making markets more fragile? And then
• 41:26
  Speaker 2: the impact of derivatives? Right? And I think we saw
• 41:29
  Speaker 2: this as an example for people with game Stop, where
• 41:33
  Speaker 2: you had what I would call social gamma, this acceleration
• 41:36
  Speaker 2: through Reddit of people buying out of the money call
• 41:39
  Speaker 2: options to drive through leverage, the price higher because market
• 41:44
  Speaker 2: makers were forced to hedge. Right. Do you see that
• 41:47
  Speaker 2: less specifically at game Stop, But do you see that
• 41:49
  Speaker 2: at a grander scale when you have a huge amount
• 41:52
  Speaker 2: of structured products being issued in Asia and Europe, or
• 41:56
  Speaker 2: you have all these sort of uses of leverage among institutions?
• 42:01
  Speaker 2: Have we gotten again to a point of fragility? And
• 42:04
  Speaker 2: what liquidity Cascades ultimately argued was anyone who thinks it
• 42:09
  Speaker 2: was just their one thesis was probably wrong it.
• 42:12
  Speaker 1: Now I want to just stop you for a second,
• 42:15
  Speaker 1: interrupt you for a second and point out how often
• 42:18
  Speaker 1: are big complicated situations, you know, Jacques cu'es it's that
• 42:25
  Speaker 1: one thing. The world is much more complex than that.
• 42:28
  Speaker 1: It's I remember looking at the causes of the financial crisis.
• 42:31
  Speaker 1: I found dozens of them. When the inflation surge took
• 42:35
  Speaker 1: up in twenty one and twenty two, like people wanted
• 42:38
  Speaker 1: to point a finger, there were dozens of factors, including
• 42:42
  Speaker 1: consumers who said, oh, that's fifty percent more. Yeah, I
• 42:45
  Speaker 1: don't care, I'm gonna buy one. Consumers drove inflation as
• 42:48
  Speaker 1: much as fiscal stimulus and all these other things. So
• 42:52
  Speaker 1: how how broad a conclusion did you reach that it's
• 42:57
  Speaker 1: never just one thing?
• 42:59
  Speaker 2: To your point, I think people look into a world
• 43:02
  Speaker 2: of incredibly complex nonlinear relationships and they want a single
• 43:07
  Speaker 2: linear explanation and it's just not possible.
• 43:10
  Speaker 1: That's the narrative fallacy. They want to clean little storyline
• 43:14
  Speaker 1: in a bow, and that's not how the universe.
• 43:16
  Speaker 2: Wor all of these things interact. And so what I
• 43:18
  Speaker 2: came out of the research piece with was not my view.
• 43:22
  Speaker 2: Actually the intro of the research piece, I said, I'm
• 43:24
  Speaker 2: not going to tell you what my view is. I'm
• 43:26
  Speaker 2: going to walk through this objectively as I can, and
• 43:29
  Speaker 2: I'm going to paint a picture at the end, it's
• 43:31
  Speaker 2: up to you as the reader to determine, for lack
• 43:34
  Speaker 2: of a better phrase, how full I am right, you know, so.
• 43:37
  Speaker 1: What did you find out with those three facts? Or
• 43:39
  Speaker 1: those three so the FED, passive and derivatives.
• 43:43
  Speaker 2: So with those three factors, what I ultimately argued was
• 43:46
  Speaker 2: that they operate in somewhat of a cycle. Right, FED
• 43:50
  Speaker 2: zero interest rate policy is in many ways, as explicitly
• 43:54
  Speaker 2: stated by the FED, trying to move people up the
• 43:57
  Speaker 2: risk curve. And as people moved up the risk curve,
• 44:00
  Speaker 2: they were trying to find ways to harvest yield or
• 44:03
  Speaker 2: save money, a move into things like passive thing, a
• 44:07
  Speaker 2: move into tax efficient vehicles like ETFs. That we're having
• 44:11
  Speaker 2: a profound impact on the way things are traded in
• 44:13
  Speaker 2: the market. You're having a consolidation of market makers that
• 44:17
  Speaker 2: leads to potentially increasing fragility or or lack of liquidity.
• 44:22
  Speaker 2: One of the things I thought was really interesting in
• 44:24
  Speaker 2: March twenty twenties. People always talk about market makers pull
• 44:27
  Speaker 2: the plug right right, markets go crazy. They're not running
• 44:30
  Speaker 2: a charity. They're going to pull the plug when things
• 44:33
  Speaker 2: aren't going well.
• 44:34
  Speaker 1: Or at least lower their their bidass spread wide them out,
• 44:36
  Speaker 1: So yeah.
• 44:37
  Speaker 2: They're going to wide them out and they're going to
• 44:38
  Speaker 2: thin the order book volume. What I thought was interesting
• 44:41
  Speaker 2: that people don't often talk about is they're actually capacity constrained.
• 44:46
  Speaker 2: They have a balance sheet, and there was I think
• 44:50
  Speaker 2: it was Vertu during March twenty twenty that actually was
• 44:54
  Speaker 2: trying to raise three hundred and fifty million dollars just
• 44:56
  Speaker 2: so they could keep making markets wow because they had
• 44:59
  Speaker 2: run out of balance sheet. And you go, well, actually,
• 45:01
  Speaker 2: if these institutions are so important to the way our
• 45:04
  Speaker 2: markets function, should they have a line to the Fed?
• 45:08
  Speaker 1: Yeah, that makes sense, right.
• 45:10
  Speaker 2: I've never heard anyone talk about it, right, right, But
• 45:12
  Speaker 2: if you need them there and there's only three or
• 45:14
  Speaker 2: four key market makers left, right, we need to make
• 45:17
  Speaker 2: sure that they have healthy balancees. They are systematically important
• 45:20
  Speaker 2: institutions that.
• 45:21
  Speaker 1: They need a line somewhere. But the Fed's mandate isn't
• 45:25
  Speaker 1: the smooth operation of the NICY. The Fed's mandate is
• 45:29
  Speaker 1: low inflation and full employment.
• 45:31
  Speaker 2: So it's a little little struck things like that. And
• 45:34
  Speaker 2: again I don't think any of them are the cause,
• 45:36
  Speaker 2: but you start to see some of this fragility creep up,
• 45:39
  Speaker 2: and then as people right are moving up the risk curve,
• 45:42
  Speaker 2: They're trying to find ways to also protect themselves, so
• 45:46
  Speaker 2: they're taking on more derivative strategies. We saw this massive
• 45:49
  Speaker 2: boom and derivatives. We saw an adoption of things leverage
• 45:53
  Speaker 2: strategies with parity and trend following and alternatives. And again
• 45:58
  Speaker 2: I don't look at the boogeyman and say the market
• 45:59
  Speaker 2: sell off and it's risk parody's fault. But I look
• 46:02
  Speaker 2: at I say, well, if risk parity and managed futures
• 46:05
  Speaker 2: are selling off, and at the same time, you have
• 46:08
  Speaker 2: all these massively levered positions via puts that market makers
• 46:12
  Speaker 2: are having to hedge, all that can act in coordination
• 46:15
  Speaker 2: to make a sell off more violent. And then sort
• 46:19
  Speaker 2: of you go full circle to the FED stepping back
• 46:21
  Speaker 2: in lowering interest rates and kicking the whole cycle off.
• 46:24
  Speaker 2: And so what I painted a picture of at the end,
• 46:26
  Speaker 2: the reason I called it a liquidity cascade was I
• 46:28
  Speaker 2: painted it was this empty Escher painting.
• 46:30
  Speaker 1: Of famous Wall the waterfall, and.
• 46:34
  Speaker 2: Then it magically climbs back up and each part of
• 46:36
  Speaker 2: this it was the FED sort of is at the
• 46:38
  Speaker 2: bottom of the waterfall, and then flight to passive alternative
• 46:43
  Speaker 2: sort of investment strategies and the role of derivatives is
• 46:46
  Speaker 2: at the top, and then some exogenous effect causes the
• 46:49
  Speaker 2: market to crash, the crash becomes more violent, fed steps
• 46:53
  Speaker 2: in and the cycle kicks off again.
• 46:54
  Speaker 1: So I have so many interesting questions for you. I'm
• 47:00
  Speaker 1: kind of fascinated by your the way you look at
• 47:04
  Speaker 1: the market structure and what's driving things, because for me,
• 47:08
  Speaker 1: the thing I'm looking at during those various processes is,
• 47:14
  Speaker 1: and you reference this earlier are is all the individual
• 47:17
  Speaker 1: decision making that takes place within the context of some
• 47:22
  Speaker 1: financial stress, which, as we've seen, tends to lead to
• 47:27
  Speaker 1: cognitive challenges, behavioral problems, bad decision making. That human element
• 47:33
  Speaker 1: in the middle tends to react. You know, it's it's
• 47:37
  Speaker 1: oversimplifying it, calling it fight or flight. But hey, that's
• 47:41
  Speaker 1: what your lizard brain is telling you. And it doesn't
• 47:44
  Speaker 1: matter if you're running a billion dollar hedge fund or
• 47:46
  Speaker 1: pension fund. Most people are gonna go through the same
• 47:50
  Speaker 1: sort of panicky response. It's really interesting that you're focusing
• 47:55
  Speaker 1: on the structure and how does the structure accommodate the
• 47:59
  Speaker 1: bad behave that we.
• 48:00
  Speaker 2: See you are right that there is absolutely panic and
• 48:04
  Speaker 2: lizard brain and I don't mean that in any sort
• 48:06
  Speaker 2: of derogatory way. If their survival instincts of actually it
• 48:10
  Speaker 2: is what it is, I don't think they're irrational. I
• 48:12
  Speaker 2: think ergodicity economics would argue you have to protect your
• 48:15
  Speaker 2: capital to survive. What So I'll give an example here
• 48:20
  Speaker 2: of where I think it's a very specific example, sort
• 48:22
  Speaker 2: of like the market maker's example, but it's something that
• 48:24
  Speaker 2: happened in March twenty twenty that is obviously wrong. And
• 48:28
  Speaker 2: so Vanguard has their mutual funds, and they offer ETFs
• 48:33
  Speaker 2: as a share class of their mutual funds. So if
• 48:36
  Speaker 2: you buy the mutual fund or the ETF, you are,
• 48:38
  Speaker 2: in theory getting the exact same return because it's the
• 48:41
  Speaker 2: same underlying pool of.
• 48:42
  Speaker 1: Capital minus the tax advantage of the ETF.
• 48:46
  Speaker 2: Absolutely yep, their bond fund. During March twenty twenty, there
• 48:51
  Speaker 2: was a two day period where the ETF traded I
• 48:54
  Speaker 2: believe it was up to a six or seven percent
• 48:56
  Speaker 2: discount to the mutual fund. That's a little weird because
• 49:00
  Speaker 2: it's the exact same pool of capital.
• 49:02
  Speaker 1: Right, So difference being you can only trade mutual funds.
• 49:06
  Speaker 1: At the end of the day, you have to make
• 49:07
  Speaker 1: a specific phone call to buy or or just reach
• 49:11
  Speaker 1: out to whoever your custodian is.
• 49:13
  Speaker 2: Yep.
• 49:14
  Speaker 1: Whereas the ETFs are quoted.
• 49:16
  Speaker 2: In today, but even at the end of day M
• 49:19
  Speaker 2: that discrepancy existed. It wasn't just interday that was. That
• 49:22
  Speaker 2: was the NAB of the mutual fund versus the price
• 49:24
  Speaker 2: of the ETF.
• 49:25
  Speaker 1: Which had a higher trading volume. I'm going to guess
• 49:27
  Speaker 1: the ETF.
• 49:28
  Speaker 2: The ETF certainly had a higher trading volume, but the
• 49:32
  Speaker 2: underlying problem is that the bonds weren't pricing. The bond
• 49:38
  Speaker 2: market froze up, so when the mutual fund struck NAB
• 49:41
  Speaker 2: at the end of the day, the NAB was based
• 49:43
  Speaker 2: on ill liquid quotes of bonds that hadn't traded. The
• 49:46
  Speaker 2: ETF was basically saying, we don't believe those quotes. We
• 49:51
  Speaker 2: think the quote should be much lower, and we're going
• 49:53
  Speaker 2: to price much lower.
• 49:53
  Speaker 1: That's right.
• 49:54
  Speaker 2: There's an interesting free option here. If you are a vanguard.
• 49:58
  Speaker 1: By the ETF seldomctual.
• 50:00
  Speaker 2: Funds well, so because you can't short a mutual fund.
• 50:03
  Speaker 2: The way it would work is you would just always
• 50:05
  Speaker 2: hold the mutual fund, wait for a crisis to come around,
• 50:08
  Speaker 2: and then jump from the mutual fund to the ETF, right,
• 50:12
  Speaker 2: and you basically pick up this free spread based on
• 50:15
  Speaker 2: the fact that the mutual fund is priced incorrectly. Stuff
• 50:19
  Speaker 2: like that shouldn't happen.
• 50:21
  Speaker 1: Why do you say that, I always go back and
• 50:23
  Speaker 1: forth with this. It's not like computers and algorithms are
• 50:29
  Speaker 1: running this. It's irrational primates who are pushing the cell
• 50:34
  Speaker 1: or buy button.
• 50:35
  Speaker 2: Let me rephrase that. Things like that don't happen except
• 50:38
  Speaker 2: within a crisis, okay, and they represent opportunity in a
• 50:41
  Speaker 2: crisis because it is definitively mispriced, and if markets are efficient,
• 50:47
  Speaker 2: there shouldn't be miss pricings like that. That's a very
• 50:50
  Speaker 2: You shouldn't have two things that are literally the exact
• 50:52
  Speaker 2: same basket attached to the same underlying trading six percent apart.
• 50:56
  Speaker 2: Unless there's true limits to arbitrage here. You could argue
• 51:00
  Speaker 2: you can't short the mutual fund and buy the ETF.
• 51:02
  Speaker 2: It's it's hard to arm that spread. But again, anyone
• 51:06
  Speaker 2: trading any bond mutual fund could have jumped to Vanguard's ETF,
• 51:10
  Speaker 2: waited for the price appreciation, and benefited. And again, in
• 51:13
  Speaker 2: a crisis, there's so much information coming at you you
• 51:15
  Speaker 2: might not have seen the opportunity. But I look at
• 51:18
  Speaker 2: a lot of little things like that, and I go,
• 51:20
  Speaker 2: markets mostly function correctly the vast majority of the time.
• 51:24
  Speaker 2: But when you see that fragility pop up in a crisis,
• 51:27
  Speaker 2: uh huh, just is it pause for concern about how
• 51:30
  Speaker 2: things are currently structured? Just a question.
• 51:32
  Speaker 1: So I'm not saying it's broken. So to response to that, first, hey,
• 51:37
  Speaker 1: give the Nobel Prize Committee props for offering a prize
• 51:42
  Speaker 1: to Fama and Schiller the same year. It's like, yeah,
• 51:46
  Speaker 1: markets are mostly efficient. Fama is right except when they're not,
• 51:50
  Speaker 1: and Schiller's right. So that's number one. Number two. I
• 51:54
  Speaker 1: have a vivid recollection of sitting in a canoe with
• 51:58
  Speaker 1: Jim Bianco in August of nine, and Bianca was the
• 52:02
  Speaker 1: first person to describe the FED response to the crisis
• 52:08
  Speaker 1: as the first person I read, and this was really early. Hey,
• 52:13
  Speaker 1: the FED has made cash trash. They want you out
• 52:16
  Speaker 1: of bonds, they want you into equities. Maybe it's gonna
• 52:20
  Speaker 1: take people a while to figure this out. But he
• 52:23
  Speaker 1: was the first person to come up with Tina right
• 52:26
  Speaker 1: and said, people are gonna have to stampede into equities.
• 52:30
  Speaker 1: We're gonna have a rally, and I said, it's funny.
• 52:33
  Speaker 1: I feel like the two of us are part of
• 52:35
  Speaker 1: the six blind men describing the elephant. Because to your
• 52:39
  Speaker 1: point about mispricing, I recall saying to him, I don't
• 52:44
  Speaker 1: know if you're right. I like that theory. But my
• 52:49
  Speaker 1: day job as a market historian is whenever stocks are
• 52:52
  Speaker 1: cut in half in the United States, that's a fantastic
• 52:55
  Speaker 1: entry point. And if you bring up well, what about
• 52:58
  Speaker 1: nineteen twenty nine. Yeah, you didn't get to the bottom
• 53:01
  Speaker 1: till thirty two, but even down fifty percent on the
• 53:03
  Speaker 1: way down to down eighty seven percent was still a
• 53:07
  Speaker 1: great entry point. And that's the exception. Every other time
• 53:11
  Speaker 1: you're cut in half in the United States, you have
• 53:14
  Speaker 1: to buy with both hands.
• 53:15
  Speaker 2: Well, and what's interesting to me there is you and
• 53:17
  Speaker 2: Jim are discussing. I love your analogy with the blindman
• 53:22
  Speaker 2: and the elephant. Jim is discussing a supply and demand concept,
• 53:25
  Speaker 2: and you're discussing a fundamental view.
• 53:28
  Speaker 1: Right. I see the world through a behavioral lens. He's
• 53:30
  Speaker 1: seeing the world with. There's the FED is going to
• 53:33
  Speaker 1: cause a giant increase in demand for equity is regardless
• 53:37
  Speaker 1: of what the supply is right, and guess what happens the.
• 53:39
  Speaker 2: Prices, and that'll drive prices up, and it causes many
• 53:43
  Speaker 2: fundamental people right to say markets are overvalued, missing the
• 53:47
  Speaker 2: fact that you had another market structure changed things like
• 53:50
  Speaker 2: a four to oh one k that was almost non
• 53:53
  Speaker 2: existent in the early two thousands. That's several trillion dollars.
• 53:55
  Speaker 2: Now you just have a stamp ped of buying every
• 53:58
  Speaker 2: single month and people being forced into markets as a
• 54:02
  Speaker 2: retirement vehicle, right, that is their savings account, particularly when
• 54:06
  Speaker 2: cash is returning nothing, and you have a dramatic shift
• 54:10
  Speaker 2: in supply and demand. And by the way, over the
• 54:12
  Speaker 2: same cycle, you saw fewer IPOs, so you're increasing demand
• 54:16
  Speaker 2: into public equities with fewer less supply.
• 54:19
  Speaker 1: Right at the same time, you have huge buybacks. Right.
• 54:23
  Speaker 1: A lot of people don't realize the wilsh of five
• 54:25
  Speaker 1: thousand is something like thirty four hundred stocks. It's like
• 54:28
  Speaker 1: totally misnamed. And the past twenty years have seen Yeah,
• 54:32
  Speaker 1: there's been a lot of stock issue in Silicon Valley,
• 54:35
  Speaker 1: but overall, the size of the share float that's out
• 54:38
  Speaker 1: there has shrunk another big and I don't know where
• 54:43
  Speaker 1: what the endgame of that is. Can you do that perpetually.
• 54:46
  Speaker 1: So I don't know what the deep public eyes public markets.
• 54:50
  Speaker 2: I don't know what the endgame of any of this is, Caniley,
• 54:53
  Speaker 2: But I know you've had folks like Mike green On
• 54:56
  Speaker 2: I think he was on even recently, who have strong
• 54:58
  Speaker 2: views about what Passive is doing. I don't have particularly
• 55:01
  Speaker 2: strong views in any direction. I just like asking the questions.
• 55:04
  Speaker 2: Maybe I lob out a little grenade and let other
• 55:06
  Speaker 2: people fight over it, but I think they're fascinating and
• 55:09
  Speaker 2: worthwhile questions because I think in many cases we just
• 55:13
  Speaker 2: accept we have some of the most wonderfully functioning liquid
• 55:16
  Speaker 2: markets in the world. We are truly privileged in the
• 55:19
  Speaker 2: US to have what we have. I don't think it
• 55:23
  Speaker 2: hurts us to ask are we overlooking anything? Is there
• 55:26
  Speaker 2: any way in which we are unintentionally designing ourselves into
• 55:31
  Speaker 2: a state of fragility?
• 55:32
  Speaker 1: It was pretty clear that people should have been asking
• 55:35
  Speaker 1: that question in the mid two thousands and just had
• 55:38
  Speaker 1: no idea the sort of miss aligned incentives and really
• 55:43
  Speaker 1: complex structures that, along with some the really we got
• 55:48
  Speaker 1: used to zero. But when Greenspan post nine to eleven
• 55:52
  Speaker 1: took rates down to under two percent for three years
• 55:56
  Speaker 1: and under one percent for a year that was really
• 55:59
  Speaker 1: we hadn't seen anything like that for decades and decades
• 56:03
  Speaker 1: and zero. No one knew how to deal with that.
• 56:05
  Speaker 1: And then once we started seeing negative you know bonds,
• 56:10
  Speaker 1: like well, you lend us money and you pay us
• 56:14
  Speaker 1: to hold it, like wait what? And I think that
• 56:17
  Speaker 1: caused all sorts of problems around the world, and people
• 56:22
  Speaker 1: just didn't know how to contextualize.
• 56:24
  Speaker 2: And to your point on behavior, I think something we
• 56:27
  Speaker 2: talked about earlier were the sample size here are small.
• 56:30
  Speaker 2: I think if you took the market to where it
• 56:32
  Speaker 2: was a decade ago and said Fed's bringing rates back down,
• 56:35
  Speaker 2: the world's bringing rates back down, people would look backwards
• 56:38
  Speaker 2: with the playbook and say, we're going to just do
• 56:39
  Speaker 2: all that again, right, and markets would not respond the
• 56:43
  Speaker 2: same way. They would probably do everything in an accelerated fashion,
• 56:46
  Speaker 2: but you wouldn't get the same result because people's behavior
• 56:49
  Speaker 2: would adapt to that previous sample. And so it's it's
• 56:53
  Speaker 2: very complex of how these things work.
• 56:56
  Speaker 1: A little reflexivity in that. Although you could make the
• 56:59
  Speaker 1: argument that in March twenty twenty, down thirty four percent
• 57:03
  Speaker 1: and it felt like six weeks, people look back to
• 57:08
  Speaker 1: nine and said, oh, I got to be a buyer
• 57:11
  Speaker 1: because the last time we saw a big crash, the
• 57:14
  Speaker 1: FED rescued the markets, or the FED did this and
• 57:17
  Speaker 1: ultimately led to that maybe rescue was too over simple.
• 57:22
  Speaker 1: But isn't this why everything eventually gets arbitraged away? Don't
• 57:27
  Speaker 1: the playback from the last cycle the playbook not work
• 57:30
  Speaker 1: in the next cycle because hey, we've kind of figured
• 57:33
  Speaker 1: this out.
• 57:34
  Speaker 2: I'm not sure we've ever figured it out, but again,
• 57:36
  Speaker 2: I think a lot of this does get does get
• 57:39
  Speaker 2: priced in. The whole idea of markets are they're supposed
• 57:41
  Speaker 2: to be efficient information discovery machines, and they have proven
• 57:44
  Speaker 2: to be tremendously powerful and efficient allocators of capital over
• 57:49
  Speaker 2: the long run. It's the best machine we've gotten, so
• 57:51
  Speaker 2: I certainly wouldn't bet against that machine.
• 57:53
  Speaker 1: Let's talk a little bit about your ETFs and return stacking.
• 57:58
  Speaker 1: Starting with the first question is why pivot from pure
• 58:03
  Speaker 1: research to managing assets? And why if you're managing assets,
• 58:08
  Speaker 1: did you go into the ETF side of it.
• 58:11
  Speaker 2: The shift from pure research to managing assets, I think
• 58:14
  Speaker 2: is one that a lot of people ultimately make. When
• 58:18
  Speaker 2: you're just providing research, you really don't have any control
• 58:20
  Speaker 2: over distribution, messaging. Often you don't have control over how
• 58:24
  Speaker 2: your research is being used, and if you're the one
• 58:26
  Speaker 2: doing the research, you often have the best idea of
• 58:30
  Speaker 2: how it should be implemented, or at least you believe
• 58:32
  Speaker 2: you do. It's not quite like selling data or raw data.
• 58:35
  Speaker 2: You're selling a manipulated form of data that you think
• 58:38
  Speaker 2: potentially has some edge or some utility, and you want
• 58:41
  Speaker 2: to make sure that gets expressed correctly. And then frankly,
• 58:44
  Speaker 2: there's probably a little bit of ego in there, going Okay,
• 58:47
  Speaker 2: I want to get closer to the action. I actually
• 58:49
  Speaker 2: want to implement the portfolios that I want to implement.
• 58:51
  Speaker 2: I think I've got some good ideas for bringing some
• 58:55
  Speaker 2: strategies to market. And so over time we went from
• 58:59
  Speaker 2: will provide research search to will be an index provider too,
• 59:03
  Speaker 2: will be a subadvisor, to we'll launch our own funds
• 59:08
  Speaker 2: and I will say to my discredit I originally launched
• 59:11
  Speaker 2: a suite of mutual funds right, which was for someone
• 59:14
  Speaker 2: who grew up in the world of ETFs and was
• 59:17
  Speaker 2: helping run ETF model portfolios. Talk about a dumb business move.
• 59:22
  Speaker 1: What motivated you to go mutual funds over ETFs?
• 59:26
  Speaker 2: So it was twenty thirteen, and what concerned me about
• 59:31
  Speaker 2: standing up ETFs is at the time we didn't have
• 59:35
  Speaker 2: firms like ETF architect or our friend West Gray or
• 59:39
  Speaker 2: Title that were helping with the administration. My concern of
• 59:43
  Speaker 2: setting up my own ETF was that I was going
• 59:46
  Speaker 2: to have to handle all the inter date trading of
• 59:48
  Speaker 2: the creation of redemption baskets. It was going to require
• 59:51
  Speaker 2: me to hire a whole op staff that I candily
• 59:55
  Speaker 2: didn't have the experience or know how to manage. And
• 59:57
  Speaker 2: I said, versus the mutual fund.
• 1:00:01
  Speaker 1: Which is a little simpler, little clean.
• 1:00:02
  Speaker 2: Which is a little simpler, little cleaner, and there was
• 1:00:04
  Speaker 2: a well trodden path of bringing mutual funds to market.
• 1:00:07
  Speaker 2: So that was twenty thirteen, and again I just didn't
• 1:00:10
  Speaker 2: feel like being the one who was going bush whacking
• 1:00:12
  Speaker 2: to figure out how to do this. I should have.
• 1:00:15
  Speaker 1: How long did it take you to realize, Hey, ETFs
• 1:00:18
  Speaker 1: are a more efficient especially if there's any sort of turnover.
• 1:00:21
  Speaker 1: ETFs are a more efficient model, and I can make
• 1:00:25
  Speaker 1: this work at a similar price.
• 1:00:27
  Speaker 2: So I absolutely knew from day one ETFs were a
• 1:00:30
  Speaker 2: more efficient model. I think it probably took me two
• 1:00:33
  Speaker 2: or three years to say I've chosen the wrong vehicle,
• 1:00:37
  Speaker 2: not just from a tax efficiency perspective, but from an
• 1:00:42
  Speaker 2: appetite perspective. Twenty thirteen, people really started to go, I
• 1:00:47
  Speaker 2: don't even want to talk about mutual funds anymore. If
• 1:00:50
  Speaker 2: it's not in an ETF, don't talk to me. By
• 1:00:53
  Speaker 2: twenty seventeen, twenty eighteen, we were having conversations with firms
• 1:00:56
  Speaker 2: that said, we only invest in ETF's ETF model portfolios only.
• 1:01:00
  Speaker 2: And by the way, I've got a whole spiel on
• 1:01:01
  Speaker 2: this that I think that's just as misguided. Strategy and
• 1:01:05
  Speaker 2: structure need to be aligned, and there are some strategies
• 1:01:09
  Speaker 2: for which the ETF I think is definitively the wrong structure.
• 1:01:12
  Speaker 2: It's a whole different conversation. But I ultimately said, I
• 1:01:17
  Speaker 2: am you look at the flows. You can just look
• 1:01:18
  Speaker 2: at a map of the flows and say I am
• 1:01:20
  Speaker 2: selling into a dying industry. I am in the wrong
• 1:01:23
  Speaker 2: product wrapper. And so I ultimately made the decision to
• 1:01:27
  Speaker 2: shut down every fund and restart the whole company.
• 1:01:32
  Speaker 1: So as opposed to just converting them, you went that way,
• 1:01:36
  Speaker 1: the exit and the relaunch. Yeah, because part by twenty seventeen,
• 1:01:39
  Speaker 1: WES was doing a number of ETFs, a number of
• 1:01:42
  Speaker 1: other people and other organizations made it. I don't want
• 1:01:45
  Speaker 1: to say painless, but less painful to stand up in ETF.
• 1:01:48
  Speaker 2: Absolutely absolutely, Yeah. I ultimately said, I think there are
• 1:01:52
  Speaker 2: decisions I made wrong from a structure perspective, and I
• 1:01:55
  Speaker 2: think there are decisions I made wrong from an actual
• 1:01:58
  Speaker 2: product perspective. And this is where I think things can
• 1:02:01
  Speaker 2: sometimes get a little weird in this industry where a
• 1:02:04
  Speaker 2: guy like me who's a quant wants to always talk
• 1:02:07
  Speaker 2: about investment strategy. But I was listening to a podcast
• 1:02:11
  Speaker 2: the other day, an old podcast from Patrick O'Shaughnessy actually,
• 1:02:13
  Speaker 2: and he said this quote that was basically, an investment
• 1:02:16
  Speaker 2: product is more than the sum of its returns. And
• 1:02:19
  Speaker 2: what he meant by that is when people buy an
• 1:02:21
  Speaker 2: investment product a fund, yes, they're often talking about the
• 1:02:25
  Speaker 2: investment strategy in the returns, but there's also a utility
• 1:02:29
  Speaker 2: that often we don't talk about in this industry. So
• 1:02:32
  Speaker 2: why are high dividend yield products so popular? All the
• 1:02:37
  Speaker 2: math tells us we should not buy high dividend yield stocks.
• 1:02:40
  Speaker 2: They are typically an underperforming style of value, and yet
• 1:02:45
  Speaker 2: there are billions, tens of billions if not hundreds of
• 1:02:48
  Speaker 2: billions of dollars in high dividend yield ETFs because people
• 1:02:54
  Speaker 2: are expressing a utility that they just like getting that
• 1:02:58
  Speaker 2: dividend paid to them ever month. Could they synthetically create
• 1:03:02
  Speaker 2: that their own dividend, Absolutely, but they're lazy for back
• 1:03:06
  Speaker 2: of the lack of a letter word, and they like
• 1:03:07
  Speaker 2: the consistency, and there's utility in that, even though it's
• 1:03:10
  Speaker 2: from a return perspective suboptimal. And that's hard for people
• 1:03:13
  Speaker 2: like me sometimes to look at and say, no, I
• 1:03:18
  Speaker 2: need to teach you to do a better way. Let
• 1:03:21
  Speaker 2: me educate you as to why you're wrong instead of
• 1:03:23
  Speaker 2: saying no. That actually has really good product market fit
• 1:03:25
  Speaker 2: for what the end buyer wants. And so I think
• 1:03:28
  Speaker 2: I had made some poor product design decisions.
• 1:03:34
  Speaker 1: So let's talk a little bit about what return stacking is,
• 1:03:39
  Speaker 1: how it's similar and different to portable alpha. Let's start out.
• 1:03:43
  Speaker 1: You wrote a really well received white paper on the
• 1:03:46
  Speaker 1: entire concept of return stacking. Give us this simple explanation
• 1:03:51
  Speaker 1: of what this is.
• 1:03:53
  Speaker 2: It's all credit goes to my colleigu Rodrigo Gordillo for
• 1:03:55
  Speaker 2: coming up with the phrase return stacking, because I think
• 1:03:58
  Speaker 2: it's it's a more generalized form, but I think it's
• 1:04:01
  Speaker 2: much more approachable than portable alpha. Right, portable alpha, you
• 1:04:05
  Speaker 2: need to understand what alpha is. What is porting do?
• 1:04:08
  Speaker 2: If I say I'm stacking returns, I'm stacking the returns
• 1:04:12
  Speaker 2: of gold on top of the SMP, you can probably
• 1:04:15
  Speaker 2: guess that one plus one equus two. It sort of
• 1:04:18
  Speaker 2: sounds like math, and that's effectively what we're trying to do.
• 1:04:20
  Speaker 2: It goes back to the problem we were talking about
• 1:04:21
  Speaker 2: earlier of trying to solve this addition through subtraction issue
• 1:04:27
  Speaker 2: with diversification. How do I get an industry that disagrees
• 1:04:33
  Speaker 2: on everything except for diversification is good to add more
• 1:04:37
  Speaker 2: diversification to their portfolio? Right? You talk to anyone and
• 1:04:41
  Speaker 2: they'll say, yeah, all else held equal, we want more diversification.
• 1:04:44
  Speaker 2: Then you go look at their portfolio. It's basically the
• 1:04:46
  Speaker 2: S and P five hundred in bonds and there's nothing
• 1:04:49
  Speaker 2: necessarily wrong with that. But the question is can we
• 1:04:52
  Speaker 2: go further to introduce diversifiers that can improve both the
• 1:04:57
  Speaker 2: consistency with which we can achieve our outcomes and the
• 1:05:00
  Speaker 2: return potential. And so return stacking at its core is
• 1:05:03
  Speaker 2: trying to take the institutional concept of portable alpha and
• 1:05:07
  Speaker 2: bring it downstream. Because institutions to implement that concept have
• 1:05:11
  Speaker 2: to buy futures and swaps and manage all these separate accounts.
• 1:05:15
  Speaker 2: What we've tried to do is prepackage that concept into
• 1:05:19
  Speaker 2: a suite of ETFs.
• 1:05:21
  Speaker 1: So, so you the white paper comes out, Wisdom Tree
• 1:05:25
  Speaker 1: launches a product related to this. Did you have anything
• 1:05:27
  Speaker 1: to do with that?
• 1:05:28
  Speaker 2: So back in twenty seventeen, you and I, I don't
• 1:05:31
  Speaker 2: know if you remember this, You and I were going
• 1:05:32
  Speaker 2: to Baron's round table, uh huh called what's next for ETFs?
• 1:05:37
  Speaker 2: And at that roundtable, I said, uh oh, I said,
• 1:05:41
  Speaker 2: I think what's next for etf are capital efficient ETFs.
• 1:05:45
  Speaker 2: And the example I gave was buy the you know,
• 1:05:49
  Speaker 2: instead of having a stock and bond fund, this fund
• 1:05:52
  Speaker 2: could buy the S and P and overlay with treasury futures.
• 1:05:56
  Speaker 2: And so if you give it a dollar, it's going
• 1:05:59
  Speaker 2: to give you, say, nine dents of the SMP and
• 1:06:01
  Speaker 2: sixty cents of treasury futures, giving you a ninety sixty
• 1:06:04
  Speaker 2: at one point five times lever at sixty forty. And
• 1:06:06
  Speaker 2: the idea there is, okay, you can put two thirds
• 1:06:09
  Speaker 2: of your money in that fund, get a sixty forty exposure,
• 1:06:12
  Speaker 2: and then you can take that one third of your
• 1:06:14
  Speaker 2: cash and do whatever. You can leave it in cash
• 1:06:16
  Speaker 2: if you just like sitting on cash, or you can
• 1:06:17
  Speaker 2: invest it in alternatives implementing portable alpha. Jeremy Schwartz, who's
• 1:06:23
  Speaker 2: a good friend of both of ours, showed that article
• 1:06:26
  Speaker 2: around internally. It was. We had a whole bunch of
• 1:06:28
  Speaker 2: Twitter conversations about it. Next thing you know, he says, Hey, Corey,
• 1:06:32
  Speaker 2: I'm launching a product on this, and the Wisdom Tree
• 1:06:34
  Speaker 2: and TSX fund was born.
• 1:06:35
  Speaker 1: I recall I recall Jeremy subsequently launching that. I hope
• 1:06:40
  Speaker 1: they at least tossed you a bone and consulting something.
• 1:06:45
  Speaker 2: Jeremy had me on a couple of podcasts to talk
• 1:06:47
  Speaker 2: about it.
• 1:06:47
  Speaker 1: There you go. I hope I didn't say anything too
• 1:06:50
  Speaker 1: stupid at that roundtable. I can remember that up on
• 1:06:52
  Speaker 1: sixty Avenue. Yeah, right, get by their offices.
• 1:06:55
  Speaker 2: That's right, it was. And I actually have been using
• 1:06:58
  Speaker 2: my headshot from that pracle since then, which.
• 1:07:01
  Speaker 1: I got a couple of great photos from that.
• 1:07:03
  Speaker 2: So I didn't realize this is like a Pulitzer Prize
• 1:07:06
  Speaker 2: winning photographer who Yeah, took our photos. They're the best
• 1:07:09
  Speaker 2: headshots I've ever had, same saying, and finally I said,
• 1:07:12
  Speaker 2: it's seven years later, I'm officially catfishing people with this photo.
• 1:07:16
  Speaker 2: I don't look anything like this anymore.
• 1:07:18
  Speaker 1: Every now and then I will see something show up
• 1:07:21
  Speaker 1: on a bio at some event for me and I'm like, dude,
• 1:07:25
  Speaker 1: that's twenty years old. I'm not only grayer and twenty
• 1:07:30
  Speaker 1: pounds lighter than then, but like, I look nothing like
• 1:07:33
  Speaker 1: that anymore. It's like, wow, we found that online. So yeah,
• 1:07:36
  Speaker 1: I know exactly what you're telling.
• 1:07:38
  Speaker 2: So I had to get rid of that one. So yeah,
• 1:07:40
  Speaker 2: So that was the birth of the NTSX fund, and
• 1:07:43
  Speaker 2: I was super happy to see Wisdom treat do that
• 1:07:45
  Speaker 2: because I really do believe that this is a whole
• 1:07:49
  Speaker 2: category of products that has not existed really before. There's
• 1:07:52
  Speaker 2: a couple of select examples, but really should be a
• 1:07:56
  Speaker 2: whole part of the industry. Because again, Institute have used
• 1:08:00
  Speaker 2: this concept for forty years and use it very effectively
• 1:08:05
  Speaker 2: to be able to say to an investor, hey, I
• 1:08:07
  Speaker 2: think a strategy like managed futures trend following adds a
• 1:08:10
  Speaker 2: lot of value to your portfolio, and no longer do
• 1:08:13
  Speaker 2: I have to sell some stocks and bonds to make room.
• 1:08:15
  Speaker 2: I can let you keep your stocks and bonds, and
• 1:08:17
  Speaker 2: I'm going to add a ten percent allocation on top.
• 1:08:20
  Speaker 2: When managed futures go through a lost decade like they
• 1:08:22
  Speaker 2: did in the twenty tens, the investor will barely notice
• 1:08:25
  Speaker 2: it and they'll be able to stay in it for
• 1:08:29
  Speaker 2: when man features does well in a year like.
• 1:08:30
  Speaker 1: Twenty So that's the behavioral component of this. How does
• 1:08:33
  Speaker 1: this differ just from straight up leverage? It sounds like
• 1:08:37
  Speaker 1: we're turn stacking has a big leverage component.
• 1:08:40
  Speaker 2: It is. It is absolutely leverage. I think the idea
• 1:08:44
  Speaker 2: here is, again leverage is a tool that accentuates the
• 1:08:46
  Speaker 2: good and the bad. We want to be very thoughtful
• 1:08:49
  Speaker 2: about what we're stacking on top. So if you're a
• 1:08:52
  Speaker 2: sixty forty investor, I certainly would not say use this
• 1:08:56
  Speaker 2: concept to stack more equities, You're probably just going to
• 1:08:58
  Speaker 2: get in trouble. But if you can use this concept
• 1:09:01
  Speaker 2: to stack diversifiers like commodities and gold, historically that hasn't
• 1:09:06
  Speaker 2: been an issue. And in fact, I would point to
• 1:09:08
  Speaker 2: the Bridgewater All Weather Fund right.
• 1:09:10
  Speaker 1: Who takes the twenty five percent gold.
• 1:09:12
  Speaker 2: And takes this concept to the extreme and runs with
• 1:09:15
  Speaker 2: significant amount of notional leverage with the idea they're trying
• 1:09:18
  Speaker 2: to risk balance all the variety of asset classes. And
• 1:09:22
  Speaker 2: it held up incredibly well during two thousand and eight
• 1:09:25
  Speaker 2: despite having so much leverage. And it's because they're using
• 1:09:28
  Speaker 2: leverage to unlock the benefits of diversification rather than using
• 1:09:32
  Speaker 2: leverage to amplify returns.
• 1:09:34
  Speaker 1: Gotcha, that makes a lot of sense. So you currently
• 1:09:36
  Speaker 1: are running five different return stacked ETFs. Do they each
• 1:09:41
  Speaker 1: have a different goal? How do different combinations work? And
• 1:09:45
  Speaker 1: what are we seven hundred eight hundred million dollars.
• 1:09:47
  Speaker 2: Just clipped over eight hundred million dollars launched I guess
• 1:09:50
  Speaker 2: eighteen twenty months ago. So we're very happy and pleased
• 1:09:54
  Speaker 2: with the growth, and I think it speaks to people
• 1:09:56
  Speaker 2: understanding what we're trying to do in this new form
• 1:09:59
  Speaker 2: of diversification, trying to build talking about getting a little
• 1:10:02
  Speaker 2: bit smarter on the product side.
• 1:10:04
  Speaker 1: Mm hmm.
• 1:10:05
  Speaker 2: One of the things I think I underappreciated earlier in
• 1:10:07
  Speaker 2: my career is that advisors and allocators want control in
• 1:10:10
  Speaker 2: their portfolio. And so with this new suite, what we've
• 1:10:13
  Speaker 2: tried to come out with is what I would call
• 1:10:15
  Speaker 2: very much a lego or building block approach, where each
• 1:10:18
  Speaker 2: product is very narrowly focused so that allocators can use
• 1:10:23
  Speaker 2: them how they want. So I'll just give two really
• 1:10:25
  Speaker 2: quick examples. We have one fund that for every dollar
• 1:10:29
  Speaker 2: you invest with US, we'll give you what is effectively
• 1:10:32
  Speaker 2: a dollar of passive large cap US equities plus a
• 1:10:35
  Speaker 2: dollar of a managed future's trend following strategy. We have
• 1:10:39
  Speaker 2: another fund that for every dollar you invest with US,
• 1:10:42
  Speaker 2: will give you a dollar of core US fixed income
• 1:10:45
  Speaker 2: plus a dollar of MANAED futures trend following same MANA
• 1:10:49
  Speaker 2: futures trend following on top, but one gives you the
• 1:10:51
  Speaker 2: S and P one gives you bonds as the bottom layer.
• 1:10:55
  Speaker 1: So that would allow someone to say, I want to
• 1:10:58
  Speaker 1: own both managed future and either I'm bullish and i
• 1:11:02
  Speaker 1: want equity, or I'm conservative and I'm embarish and i
• 1:11:05
  Speaker 1: want bonds.
• 1:11:05
  Speaker 2: I would go the other way, which is you're a
• 1:11:08
  Speaker 2: very aggressive investor, you're let's say a growth client eighty twenty.
• 1:11:12
  Speaker 2: You just have more equities around it's easier to potentially
• 1:11:16
  Speaker 2: overlay your equities than it is on bonds. Or you're
• 1:11:19
  Speaker 2: a very conservative investor, you just have more bonds around,
• 1:11:23
  Speaker 2: or you have a strong view that you can add
• 1:11:25
  Speaker 2: alpha in your bond managers. But you're never going to
• 1:11:29
  Speaker 2: beat the S and P five hundred. So take that
• 1:11:31
  Speaker 2: passive S and P five hundred and buy our fund.
• 1:11:33
  Speaker 2: You get the SMP back with the MANA features on top,
• 1:11:36
  Speaker 2: because you don't want to do it with bonds because
• 1:11:38
  Speaker 2: you think your bond manager is going to add value.
• 1:11:40
  Speaker 2: So again I'm being non prescriptive in the products I'm
• 1:11:44
  Speaker 2: bringing to market. I'm letting people say I like the
• 1:11:46
  Speaker 2: concept of adding an overlay. How I want to express
• 1:11:50
  Speaker 2: and where I want to express, and the size with
• 1:11:52
  Speaker 2: which I want to express. That's a conversation and a
• 1:11:55
  Speaker 2: dialogue we have when we consult with our clients.
• 1:11:57
  Speaker 1: So a couple of questions on that. First, who are
• 1:12:00
  Speaker 1: the typical clients are these institutions? Are they arias who
• 1:12:05
  Speaker 1: wants the sort of return stacking in their either their
• 1:12:09
  Speaker 1: core portfolio or any of their satellite.
• 1:12:12
  Speaker 2: Hold Yeah, it's really funny, so you would think potentially
• 1:12:15
  Speaker 2: with institutions, And we have lots of calls with institutions
• 1:12:17
  Speaker 2: and they all say the same thing, which is, we
• 1:12:19
  Speaker 2: love this and we also do it ourselves. We don't
• 1:12:22
  Speaker 2: need to buy an ETF. Really, they're doing it the
• 1:12:26
  Speaker 2: way they've historically done it, which is they have banking
• 1:12:28
  Speaker 2: relationships and they manage the futures and the swaps, and
• 1:12:31
  Speaker 2: so they don't need a product like an ETF. So
• 1:12:35
  Speaker 2: where we tend to see and have seen all the
• 1:12:37
  Speaker 2: flows is independent arias who are saying, I'm trying to
• 1:12:42
  Speaker 2: figure out how to get diversification. I like alternatives, but man,
• 1:12:47
  Speaker 2: it is hard to say to my client for the
• 1:12:50
  Speaker 2: fifth time when they point to that managed futures fund
• 1:12:52
  Speaker 2: as a line item and they say, why in the
• 1:12:54
  Speaker 2: world do we have this right? And you're saying, well,
• 1:12:58
  Speaker 2: because diversification.
• 1:13:00
  Speaker 1: In the next cycle, right.
• 1:13:01
  Speaker 2: Brian Portnoy says, diversification means always having to say you're sorry.
• 1:13:06
  Speaker 2: And if you are an advisor running a business and
• 1:13:08
  Speaker 2: you're saying sorry to your clients too much, that's a
• 1:13:11
  Speaker 2: great way to get fired. There's just real business risk there.
• 1:13:14
  Speaker 2: And so what we're finding is not only I think,
• 1:13:16
  Speaker 2: do we make a compelling value proposition of Hey, this
• 1:13:19
  Speaker 2: is an interesting way of trying to add returns to
• 1:13:22
  Speaker 2: your portfolio. The portable alpha sense. Do you think managed
• 1:13:24
  Speaker 2: futures generates two hundred three hundred basis points of excess
• 1:13:27
  Speaker 2: returns over time. Why are you picking stocks? Just buy
• 1:13:30
  Speaker 2: the S and P five hundred and add man futures
• 1:13:32
  Speaker 2: on top. But for the diversifiers, they're going, this is
• 1:13:35
  Speaker 2: a great way to introduce my alternatives without giving up
• 1:13:39
  Speaker 2: all the beta and having that return hurdle issue and
• 1:13:43
  Speaker 2: having that behavioral friction issue.
• 1:13:44
  Speaker 1: So you have US equity with managed futures, you have
• 1:13:50
  Speaker 1: US bonds with managed futures. What are the other ETFs?
• 1:13:53
  Speaker 2: We have a US equity plus what we would call
• 1:13:55
  Speaker 2: it a multi asset carry strategy. This is so managed
• 1:13:58
  Speaker 2: futures is typically done with trend following signals. It can
• 1:14:01
  Speaker 2: also be done with what's called the carry signal, which
• 1:14:04
  Speaker 2: is you can sort of think of carry as your yield.
• 1:14:06
  Speaker 2: What's the return you're going to get if the world
• 1:14:07
  Speaker 2: doesn't change, and so carry signals can be powerful predictors
• 1:14:12
  Speaker 2: of total returns. So it's just a different quant signal.
• 1:14:15
  Speaker 2: It behaves differently, trades a similar universe of currencies and
• 1:14:19
  Speaker 2: commodities and equities and rates around the world. So it's
• 1:14:23
  Speaker 2: long short just a different quant signal. So we have
• 1:14:26
  Speaker 2: a US plus that we have a bonds plus that
• 1:14:29
  Speaker 2: multi asse carry. And then the final piece is what
• 1:14:32
  Speaker 2: I consider to be our most flexible portfolio, which is
• 1:14:35
  Speaker 2: just you give us a dollar, We'll give you a
• 1:14:36
  Speaker 2: dollar of as passively allocated as we can global stocks,
• 1:14:40
  Speaker 2: plus a ladder of US treasuries. And the idea there
• 1:14:43
  Speaker 2: is not to say, let's stack bonds on top of
• 1:14:47
  Speaker 2: equities in your portfolio. The idea there is to say
• 1:14:51
  Speaker 2: that is an incredibly powerful capital efficiency tool that allows
• 1:14:55
  Speaker 2: you to stack whatever you want. So let me give
• 1:14:58
  Speaker 2: you a really quick example. Let's say you've got a
• 1:15:01
  Speaker 2: sixty forty portfolio sixty percent stocks, forty percent ponds. If
• 1:15:04
  Speaker 2: you sell ten percent of your stocks and ten percent
• 1:15:07
  Speaker 2: of your bonds and by ten percent of that fund,
• 1:15:11
  Speaker 2: that ten percent of that fund gives you both the
• 1:15:13
  Speaker 2: stocks and bonds back, and now you have ten percent
• 1:15:15
  Speaker 2: leftover in cash with which you can do whatever you want.
• 1:15:19
  Speaker 2: You could have it sit in cash and then sit
• 1:15:22
  Speaker 2: in tea bills, and the return of that portfolio would
• 1:15:24
  Speaker 2: be sort of the same as your sixty forty. But hey,
• 1:15:26
  Speaker 2: now you've got more cash on hand, you can do
• 1:15:28
  Speaker 2: some interesting things about self financing. Actually, because you're technically
• 1:15:32
  Speaker 2: borrowing from yourself. You can use that cash and you've
• 1:15:34
  Speaker 2: actually just taken a loan based on and it's very
• 1:15:37
  Speaker 2: attractive financing rates. The embedded rate of financing in these
• 1:15:40
  Speaker 2: futures is like T bills, So instead of borrowing from
• 1:15:42
  Speaker 2: a bank, you can actually borrow from yourself, or you
• 1:15:45
  Speaker 2: can take that cash and invest in something, hopefully for
• 1:15:49
  Speaker 2: diversification or return. But as long as whatever you're investing
• 1:15:52
  Speaker 2: in outperforms cash, you will have added value to your portfolio.
• 1:15:56
  Speaker 2: So let's say you love managed futures as a strategy,
• 1:16:00
  Speaker 2: but you don't like the way I implement Manch futures.
• 1:16:03
  Speaker 2: You love Cliff Assness at AQR, you love their fund, Well,
• 1:16:07
  Speaker 2: you can buy my Global Stocks and Bonds fund to
• 1:16:10
  Speaker 2: free up the cash to then invest in his Manch
• 1:16:13
  Speaker 2: Futures fund. And what you've effectively done is kept your
• 1:16:17
  Speaker 2: sixty forty hole and stacked his fund on top. And
• 1:16:21
  Speaker 2: so you can now stack whatever alternative asset class or
• 1:16:24
  Speaker 2: investment strategy you want with our tool.
• 1:16:28
  Speaker 1: Huh really really fascinating. The name of the company is
• 1:16:32
  Speaker 1: the Return Stacked ETF Suite. There are five different ETFs
• 1:16:37
  Speaker 1: on it. I have a couple of questions I've been
• 1:16:40
  Speaker 1: saving before we get to our favorite questions, and let's
• 1:16:44
  Speaker 1: start with something that I think is really kind of interesting.
• 1:16:48
  Speaker 1: During the pandemic, you did a video with Jason Buck
• 1:16:53
  Speaker 1: where you were discussing deep in the weeds research into
• 1:16:57
  Speaker 1: NFTs and crypto and degenerate like I in fact, it
• 1:17:02
  Speaker 1: might have come from nadding said, oh, you got to
• 1:17:04
  Speaker 1: watch this. This is hilarious in a good way, not
• 1:17:07
  Speaker 1: a sarcastic way. What was going on with crypto and
• 1:17:11
  Speaker 1: NFT trading during the COVID lockdowns.
• 1:17:15
  Speaker 2: So Jason Buck is a good friend of mine. He
• 1:17:16
  Speaker 2: runs Mutiny Funds, and we started this podcast as he
• 1:17:20
  Speaker 2: has u UN funds Mutiny Funds.
• 1:17:22
  Speaker 1: What wasn't there another pod? Maybe it was he who
• 1:17:26
  Speaker 1: was hosting it was Pirate Capital.
• 1:17:29
  Speaker 2: Or Pirates of Finance, Pirates of Finance, So that was
• 1:17:32
  Speaker 2: Jason and I started that during the pandemic work we
• 1:17:34
  Speaker 2: weren't allowed out of our houses anymore.
• 1:17:36
  Speaker 1: I love that. I love that title of that podcast.
• 1:17:39
  Speaker 2: So that was a fun one for us where we
• 1:17:40
  Speaker 2: just said, you know, that was the era of all right,
• 1:17:43
  Speaker 2: on a Friday afternoon, let's grab a beer, chop it
• 1:17:45
  Speaker 2: up see what's going on in markets. And for folks
• 1:17:48
  Speaker 2: who weren't paying attention to the crypto markets at that time,
• 1:17:51
  Speaker 2: it was an absolutely Cambrian explosion of activity. You had
• 1:17:56
  Speaker 2: all these retail traders who started trading crypto, and and
• 1:18:00
  Speaker 2: the available functionality of what you could build in crypto
• 1:18:03
  Speaker 2: really exploded. So you not only had NFTs, but you
• 1:18:06
  Speaker 2: had all these we're called protocols or applications that were
• 1:18:10
  Speaker 2: doing all this interesting stuff. And it was a fascinating
• 1:18:12
  Speaker 2: world to explore, not only from the what does this
• 1:18:15
  Speaker 2: mean for the future, but there were some incredible trading
• 1:18:19
  Speaker 2: opportunities m hm for people who operated in traditional markets
• 1:18:22
  Speaker 2: that you would see things and say that shouldn't be
• 1:18:27
  Speaker 2: like that, that's wildly mispriced, and in any traditional market
• 1:18:31
  Speaker 2: that wouldn't exist. But okay, I'll put my money where
• 1:18:35
  Speaker 2: my mouth is. And so there was a fun trading opportunity.
• 1:18:38
  Speaker 2: I certainly wouldn't say I maximized it.
• 1:18:40
  Speaker 1: Yeah, but you're a computer science market structure guy, this
• 1:18:44
  Speaker 1: is your sweet spot.
• 1:18:45
  Speaker 2: And it's just fun. Because it was almost by definition
• 1:18:49
  Speaker 2: because of regulatory reasons, lots of parties couldn't get involved.
• 1:18:53
  Speaker 2: You had a market that was being dominated by retail.
• 1:18:58
  Speaker 2: I don't want to say I'll lower in flow, right,
• 1:19:01
  Speaker 2: more momentum driven.
• 1:19:02
  Speaker 1: Low information voters.
• 1:19:04
  Speaker 2: Just the systems weren't set up. There were limits to arbitrage,
• 1:19:07
  Speaker 2: and so you had these situations where you said, oh,
• 1:19:10
  Speaker 2: you can make a good deal of money here. And
• 1:19:12
  Speaker 2: I had friends who dropped their careers in finance and said,
• 1:19:16
  Speaker 2: I used to be a market maker for treasury futures
• 1:19:18
  Speaker 2: and I'm now a market maker for crypto and oh
• 1:19:21
  Speaker 2: now I'm retired two years later because the market's that
• 1:19:23
  Speaker 2: inefficient and all I had to do was port the
• 1:19:26
  Speaker 2: exact same skill set that was a blood bath in
• 1:19:29
  Speaker 2: traditional markets eking for every bip and it's just you're
• 1:19:33
  Speaker 2: just printing money. And it was a very limited window
• 1:19:35
  Speaker 2: that does not exist anymore. But there was this really
• 1:19:38
  Speaker 2: fascinating window of both investor behavior and opportunity in what
• 1:19:43
  Speaker 2: was developing and what it all could become.
• 1:19:46
  Speaker 1: So so I'm assuming you made a couple of shekels trading. Uh,
• 1:19:51
  Speaker 1: we had.
• 1:19:51
  Speaker 2: There were some fun trades, right, there were some fun times.
• 1:19:54
  Speaker 1: How quickly did you realize that window was closing? And
• 1:19:58
  Speaker 1: I'm assuming that was pre f X and SBFU and
• 1:20:02
  Speaker 1: Sam Bankman freed and that that mayhem.
• 1:20:05
  Speaker 2: It was probably during the Luna collapse. Again, I apologize
• 1:20:10
  Speaker 2: for folks who didn't track.
• 1:20:12
  Speaker 1: Luna is a stable coin that was supposed to just
• 1:20:15
  Speaker 1: trade at a dollar. What's his name very famously got
• 1:20:19
  Speaker 1: a tattoo, yes of it novograts and then suddenly the
• 1:20:26
  Speaker 1: rug was pulled out and it turned out to not
• 1:20:29
  Speaker 1: be all it was.
• 1:20:30
  Speaker 2: Yeah, you right, these stable coins which are away for
• 1:20:34
  Speaker 2: people to transact in what are effectively dollars on the blockchain,
• 1:20:38
  Speaker 2: some of which are actually backed by dollars and others
• 1:20:41
  Speaker 2: of which are fractionally backed or backed by a variety
• 1:20:44
  Speaker 2: of assets. And then you had what was called algorithmically
• 1:20:47
  Speaker 2: backed stable coins, and I don't think there's any success
• 1:20:51
  Speaker 2: stories there. They all blew up, right Mark Mark Cuban
• 1:20:56
  Speaker 2: famously lost a bunch of money in one of those
• 1:20:59
  Speaker 2: what was called it was called Iron Finances, was what
• 1:21:02
  Speaker 2: the it was called. And that you know, again, when
• 1:21:05
  Speaker 2: you have nothing backing a coin other than a systematic
• 1:21:08
  Speaker 2: strategy that's going to try to buy and sell the
• 1:21:09
  Speaker 2: coin to keep it within a peg, it just.
• 1:21:12
  Speaker 1: Doesn't that sound like portfolio insurance From the eighty seven
• 1:21:15
  Speaker 1: crash is nothing new old again? Is it just it's
• 1:21:19
  Speaker 1: just amazing that, Oh yeah, we'll find a way to
• 1:21:22
  Speaker 1: just hedge it as the market starts rolling off.
• 1:21:25
  Speaker 2: So you had all this abundance of hot capital in
• 1:21:28
  Speaker 2: this market that suddenly evaporated. You had very loud players
• 1:21:32
  Speaker 2: like three arrows capital that was massively over levered start
• 1:21:36
  Speaker 2: to fall apart. And as that liquidity disappears, so with
• 1:21:40
  Speaker 2: it do the abundant trading opportunities. And so that's where
• 1:21:43
  Speaker 2: it started to become clear to me. It just the
• 1:21:46
  Speaker 2: game was over. It was a game of musical chairs, right,
• 1:21:48
  Speaker 2: and the music had stopped playing, And I was like,
• 1:21:51
  Speaker 2: I'm just going to get out of the room, right,
• 1:21:53
  Speaker 2: because you know you can overtrade these things, no, to
• 1:21:56
  Speaker 2: say the very least. And also it's not my job.
• 1:21:58
  Speaker 2: I actually do have a day job.
• 1:21:59
  Speaker 1: Right, So that was kind of interesting. You're also located
• 1:22:05
  Speaker 1: in Florida, in South Florida. What's it been like being
• 1:22:10
  Speaker 1: a new dad in the midst of the west coast
• 1:22:14
  Speaker 1: of Florida that really got shellacked by three consecutive everybody's
• 1:22:20
  Speaker 1: talking about Helene, but what was a debbie over the
• 1:22:23
  Speaker 1: summer really did some big damage and then the middle one,
• 1:22:27
  Speaker 1: so it was like a triple hit. Yeah.
• 1:22:30
  Speaker 2: I mean, I live in the Tampa area and I
• 1:22:32
  Speaker 2: moved there two years ago, and I should have known
• 1:22:34
  Speaker 2: something was wrong when I originally from Boston and was
• 1:22:37
  Speaker 2: moving from Boston driving down and it was a hurricane
• 1:22:42
  Speaker 2: showed up out of nowhere, and I actually had to
• 1:22:43
  Speaker 2: stop my drive halfway down and just hang out in
• 1:22:45
  Speaker 2: North Carolina. R just heh, well, well it's one of
• 1:22:48
  Speaker 2: those they show up four or five days and you go, Okay,
• 1:22:50
  Speaker 2: I'm watching the path and it became clear, you know,
• 1:22:54
  Speaker 2: all my furniture is getting delivered the day before the
• 1:22:57
  Speaker 2: hurricane's supposed to hit. I've got a pregnant wife who
• 1:22:59
  Speaker 2: is accepting the delivery as I'm driving, you know, the
• 1:23:02
  Speaker 2: car down and and it just I was like I
• 1:23:05
  Speaker 2: should have left at that point. But most importantly, my
• 1:23:09
  Speaker 2: family is safe. Our first floor of our house got
• 1:23:12
  Speaker 2: completely destroyed, my car got totaled. It's all overshadowed by
• 1:23:16
  Speaker 2: how amazing being a father is. It's just it's hard
• 1:23:18
  Speaker 2: to complain about any of that in the grand scheme
• 1:23:22
  Speaker 2: of life of just you know, I got a new kid,
• 1:23:25
  Speaker 2: and it's amazing.
• 1:23:26
  Speaker 1: What what's the rest of the neighborhood look like.
• 1:23:30
  Speaker 2: It honestly is pretty devastating. So down near the water,
• 1:23:35
  Speaker 2: every single restaurant is just gone.
• 1:23:37
  Speaker 1: Just gone, just gone, like wiped off.
• 1:23:40
  Speaker 2: Wiped off. We had we had an eight or nine
• 1:23:43
  Speaker 2: foot storm surge.
• 1:23:45
  Speaker 1: Yeah, so not quite sandy, but pretty close.
• 1:23:47
  Speaker 2: Pretty close. So you can imagine all these beach front
• 1:23:50
  Speaker 2: tiki bars, you know, under nine feet of water, and
• 1:23:53
  Speaker 2: then the tide goes out.
• 1:23:54
  Speaker 1: It's just nothing left.
• 1:23:55
  Speaker 2: It's gone. You know, if you had a two story
• 1:23:59
  Speaker 2: house in our neighborhood, your first floor was gone and
• 1:24:01
  Speaker 2: the second floor is what remains. For those who had
• 1:24:04
  Speaker 2: single story houses, which is the majority, you know, everything
• 1:24:08
  Speaker 2: ends up on the curb. And so driving down our
• 1:24:12
  Speaker 2: neighborhood for the last I guess two months now, it's
• 1:24:16
  Speaker 2: just people's lives are on the curb. And what people
• 1:24:20
  Speaker 2: don't tell you until you live this is that sea
• 1:24:23
  Speaker 2: water is also mixed with sewage water, and so the
• 1:24:27
  Speaker 2: whole place reeks, and all the plants die because they
• 1:24:31
  Speaker 2: become so everyone's garden. So you're just driving around this
• 1:24:35
  Speaker 2: place that looks like a trash hump dump as all
• 1:24:38
  Speaker 2: the plants are dying and it smells awful. I mean,
• 1:24:42
  Speaker 2: but aside from that wonderful place. Alert, are you gonna
• 1:24:45
  Speaker 2: so you were you were renting?
• 1:24:47
  Speaker 1: Right?
• 1:24:47
  Speaker 2: Yes?
• 1:24:48
  Speaker 1: So are you gonna stay there? You can relocate? What's
• 1:24:50
  Speaker 1: the thinking?
• 1:24:51
  Speaker 2: Well, you're asking the wrong person. You should ask my wife.
• 1:24:54
  Speaker 2: I don't. I don't have executive power here. I think
• 1:24:57
  Speaker 2: we will stay in the area. We really love where
• 1:25:01
  Speaker 2: we live. Saint Pete is a wonderful area for us.
• 1:25:04
  Speaker 2: We love raising our sun there for the moment. We'll
• 1:25:08
  Speaker 2: see how it plays out.
• 1:25:09
  Speaker 1: All right, that's really interesting. All right, my last two
• 1:25:11
  Speaker 1: curve ball questions for you. At Cornell, you played rugby.
• 1:25:15
  Speaker 1: Tell us about that.
• 1:25:17
  Speaker 2: Yeah, so I grew up as a lacrosse player, got
• 1:25:21
  Speaker 2: to Cornell, and I mean the lacrosse program there is phenomenal.
• 1:25:24
  Speaker 2: I was never going to make the team.
• 1:25:26
  Speaker 1: I was, I mean a serious, serious program.
• 1:25:29
  Speaker 2: Yeah, and I've always enjoyed being athletics. So I was
• 1:25:31
  Speaker 2: looking around what to do and.
• 1:25:33
  Speaker 1: Where else can I break bones? Besides?
• 1:25:36
  Speaker 2: Yeah, well this is particularly dumb because in high school
• 1:25:38
  Speaker 2: I actually played lacrosse and got a skull fracture. Nice,
• 1:25:42
  Speaker 2: So all the doctor said stopped playing sports. They wouldn't
• 1:25:45
  Speaker 2: let me play soccer anymore because I couldn't head the ball.
• 1:25:47
  Speaker 1: Really yeah, oh so that's the serious skull frack. Oh yeah,
• 1:25:50
  Speaker 1: I broke my nose playing soccer, Yeah, in a collision
• 1:25:54
  Speaker 1: and just remember waking up flat on my back. But
• 1:25:57
  Speaker 1: nobody ever said you should stop.
• 1:25:59
  Speaker 2: Yeah, I know. I had to get a spinal tap.
• 1:26:01
  Speaker 2: I had had brain fluid leaking out my year. This
• 1:26:05
  Speaker 2: was a serious one. So anyway, so I wasn't really
• 1:26:08
  Speaker 2: supposed to play sports, and as I got to college,
• 1:26:11
  Speaker 2: I thought about not playing anything, and there was a
• 1:26:14
  Speaker 2: club rugby team, and I just said, you know, this
• 1:26:17
  Speaker 2: sounds bad, but you're like, you're at an ivy league school.
• 1:26:19
  Speaker 2: It's kind of like an it feels like an ivy
• 1:26:21
  Speaker 2: leaguage sport. Was like, that would just be fun to
• 1:26:22
  Speaker 2: go play rugby, right, And it was a ton of fun.
• 1:26:26
  Speaker 2: And it was incredibly stupid of.
• 1:26:28
  Speaker 1: Me, right, broken fingers and no.
• 1:26:31
  Speaker 2: I survived pretty well. So I was, what's what's you've
• 1:26:34
  Speaker 2: only known me as I've been older. I used to
• 1:26:37
  Speaker 2: probably weigh forty pounds less.
• 1:26:38
  Speaker 1: Oh really, I was.
• 1:26:39
  Speaker 2: Yeah, in college, I was a very thin guy, and
• 1:26:43
  Speaker 2: so they put me way out in the winger position
• 1:26:45
  Speaker 2: where I just ran ropping down the field and so
• 1:26:49
  Speaker 2: I wasn't really massively in the scrums in the ring.
• 1:26:51
  Speaker 1: I gotcha. That's interesting. And and our final curve ball
• 1:26:56
  Speaker 1: question favorite Dungeons and Dragons mind and why? And you
• 1:27:02
  Speaker 1: could guess where that question is?
• 1:27:03
  Speaker 2: Yeah, I can guess for that one.
• 1:27:05
  Speaker 1: This is actually wait, let me give a little color.
• 1:27:07
  Speaker 1: You're in a financial D and D game that's been
• 1:27:10
  Speaker 1: going on.
• 1:27:11
  Speaker 2: For years, so this is funny. Actually, if you'll allow me,
• 1:27:14
  Speaker 2: can I can I bring this into the first your
• 1:27:16
  Speaker 2: last five question? Sure? Because I believe the first of
• 1:27:20
  Speaker 2: your last five questions you ask every guest is what
• 1:27:22
  Speaker 2: content are you consuming?
• 1:27:23
  Speaker 1: Right? What are you watching? Listening?
• 1:27:25
  Speaker 2: And the problem is with a rapidly expanding business and
• 1:27:28
  Speaker 2: a young kid at home, I don't have time to
• 1:27:30
  Speaker 2: watch anything. But what I have carved time out in
• 1:27:34
  Speaker 2: my life for has been this Dungeons Dragons game. It's
• 1:27:38
  Speaker 2: hard to say with the serious face, right, but there
• 1:27:40
  Speaker 2: are seven of us in the industry who started five
• 1:27:43
  Speaker 2: years ago and we play weekly and it's three hours
• 1:27:46
  Speaker 2: and that sounds incredibly nerdy. But for those who have
• 1:27:49
  Speaker 2: never played Dungeons and Dragons is really a collaborative storytelling.
• 1:27:54
  Speaker 2: Right game. We have an unbelievable guy who runs the game,
• 1:27:58
  Speaker 2: who is just this imaginative world builder. So imagine, you know,
• 1:28:03
  Speaker 2: if you like fantasy or sci fi, you can run
• 1:28:05
  Speaker 2: it however you want. He builds these unbelievably complex worlds
• 1:28:09
  Speaker 2: that we get to explore as characters, and he has
• 1:28:12
  Speaker 2: a big narrative arc, but he's constantly adapting to how
• 1:28:15
  Speaker 2: we interact with the world. And then there's the randomness,
• 1:28:18
  Speaker 2: which is when you try to do something, you're rolling
• 1:28:20
  Speaker 2: dice and your success or failures based on the dice.
• 1:28:22
  Speaker 2: So the dice play a role in the story. And
• 1:28:25
  Speaker 2: so for me, that's been a really big outlet of
• 1:28:27
  Speaker 2: not only fun with the guys, but that's a lot
• 1:28:30
  Speaker 2: of content consumption in the sense of the story's playing
• 1:28:33
  Speaker 2: out in front of me, but also I get to
• 1:28:36
  Speaker 2: collaborate and be a creative part of the story creation.
• 1:28:38
  Speaker 2: So that's been a really special part of my life
• 1:28:41
  Speaker 2: for the last five years.
• 1:28:42
  Speaker 1: So that'll be our first question. Because you're not really
• 1:28:45
  Speaker 1: watching or streaming much, let's talk about mentors who helped
• 1:28:49
  Speaker 1: shape your career.
• 1:28:51
  Speaker 2: So there, I will say this ties to some of
• 1:28:55
  Speaker 2: the latter questions. I think one of the mistakes I
• 1:28:56
  Speaker 2: made early in my career is not appreciating how much
• 1:28:58
  Speaker 2: of an apprenticeship industry. This is, especially the more niche
• 1:29:01
  Speaker 2: you go into markets. There's just wisdom and experience that
• 1:29:06
  Speaker 2: it's hard to learn for yourself, and it's very easy
• 1:29:10
  Speaker 2: if you don't have that wisdom to knock yourself out
• 1:29:12
  Speaker 2: of the business from a performance perspective. And so I didn't.
• 1:29:16
  Speaker 2: I didn't understand that. I wish I had had more mentors.
• 1:29:19
  Speaker 2: What I will say is on the business side, my
• 1:29:21
  Speaker 2: father and my business partner are both phenomenal entrepreneurs, and
• 1:29:24
  Speaker 2: I learned a ton on the business side from them.
• 1:29:26
  Speaker 2: I will say I've been very fortunate reading and interacting
• 1:29:31
  Speaker 2: with folks like Cliff Astness and Auntie ielman In who
• 1:29:34
  Speaker 2: have been, you know, huge idols of mine and what
• 1:29:37
  Speaker 2: they've contributed to the industry and just been very open
• 1:29:40
  Speaker 2: to communicating with me. I would say, from an actual
• 1:29:44
  Speaker 2: practitioner perspective, have been big mentors.
• 1:29:47
  Speaker 1: Really really interesting both of them. At AQR. Yes, what
• 1:29:52
  Speaker 1: about books? What are some of your favorites? What are
• 1:29:54
  Speaker 1: you reading right now?
• 1:29:55
  Speaker 2: So again, not a lot of time to read. I
• 1:29:58
  Speaker 2: just got done listening to all Lord of the Rings
• 1:30:00
  Speaker 2: on audio. I do it to a lot of audio books.
• 1:30:04
  Speaker 1: And how was that on audio? As a post?
• 1:30:07
  Speaker 2: So Andy Serkis, who played Gollam, who's a phenomenal voice actor,
• 1:30:12
  Speaker 2: read all the books and he is so good at
• 1:30:15
  Speaker 2: like when he did Gandolf it sounded like Ian McKellen.
• 1:30:19
  Speaker 1: Really, he's doing voices.
• 1:30:21
  Speaker 2: He's doing voices, and it's just you know, again, if
• 1:30:25
  Speaker 2: you're not into that type of book, you're not going
• 1:30:26
  Speaker 2: to enjoy it. But he brings it to life with
• 1:30:29
  Speaker 2: such vibrancy that it's not someone just reading the book.
• 1:30:32
  Speaker 2: It's like he is. He's singing the songs, he's playing
• 1:30:35
  Speaker 2: the characters, he's giving it to you like a play.
• 1:30:38
  Speaker 2: It was just really, I mean, I got through all
• 1:30:40
  Speaker 2: three books very quickly, and I wish I had I
• 1:30:43
  Speaker 2: had more. So that's one I did just recently. And
• 1:30:46
  Speaker 2: I tend to do audio books because it's easier for
• 1:30:48
  Speaker 2: me when I go out for a walk or a
• 1:30:50
  Speaker 2: run to listen to that than it is for me
• 1:30:52
  Speaker 2: at the end of a day to say I'm gonna
• 1:30:54
  Speaker 2: get through ten pages of a book and then fall
• 1:30:55
  Speaker 2: asleep drooling on it.
• 1:30:58
  Speaker 1: I know what that is like our final two questions
• 1:31:02
  Speaker 1: what sort of advice would you give to a recent
• 1:31:05
  Speaker 1: college grad interested in a career in quantitative investment.
• 1:31:10
  Speaker 2: So I'll go back to what I just said, which
• 1:31:13
  Speaker 2: was and I was interesting. I was just at a
• 1:31:16
  Speaker 2: symposium at the College of Charleston, which is put on
• 1:31:19
  Speaker 2: for their students, and I said the same thing to
• 1:31:21
  Speaker 2: their students, which is, I'm loath to give advice. But
• 1:31:24
  Speaker 2: my experience was I wish I had a mentor. I
• 1:31:27
  Speaker 2: wish I had understood that for where I was trying
• 1:31:30
  Speaker 2: to go, I would have gotten there a lot faster
• 1:31:33
  Speaker 2: if I had found a hands on mentor and understood
• 1:31:36
  Speaker 2: that this is an apprenticeship industry. Whether you are looking
• 1:31:40
  Speaker 2: to do deep quant research or looking to build product
• 1:31:43
  Speaker 2: or run an ria, every side of it has so
• 1:31:47
  Speaker 2: many complicated facets that you have to navigate, from the
• 1:31:51
  Speaker 2: regulatory side to understanding the behavior of your clients, understanding
• 1:31:55
  Speaker 2: the markets and the microstructure and who's operating in them.
• 1:31:59
  Speaker 2: That trying to cover that all on your own, there's
• 1:32:02
  Speaker 2: a great chance you don't survive it. And so to me,
• 1:32:04
  Speaker 2: I wish I take that back. I've had a phenomenal career.
• 1:32:08
  Speaker 2: I'm very lucky. I wouldn't change a thing, but I
• 1:32:11
  Speaker 2: if I was doing it another path, I would have said, Man,
• 1:32:15
  Speaker 2: maybe I should have just gone to work at AQR
• 1:32:16
  Speaker 2: for a while. That might have jumped me forward, you know,
• 1:32:20
  Speaker 2: instead of stumbling in the dark for so long.
• 1:32:22
  Speaker 1: Except you would still be at AQR. If you worked
• 1:32:25
  Speaker 1: at AQR, the you.
• 1:32:26
  Speaker 2: Know what, I'm firsall, they wouldn't have hired me. Well,
• 1:32:29
  Speaker 2: they have a lot smarter people than me.
• 1:32:31
  Speaker 1: I'm kind of sad about the demise of Twitter because
• 1:32:36
  Speaker 1: it was this, at least in finance and finn twit
• 1:32:42
  Speaker 1: there was this ability to have conversations with people, whether
• 1:32:46
  Speaker 1: it was in public or just slipping into someone's DM
• 1:32:49
  Speaker 1: and chatting. That seems to have kind of faded away.
• 1:32:55
  Speaker 1: But like the twenty tens was a golden era of
• 1:33:01
  Speaker 1: I don't even know what else to call it, networking, mentorship, connections.
• 1:33:06
  Speaker 1: Just hey, you're right working on this, I did some
• 1:33:09
  Speaker 1: research on this. You might want to take a look
• 1:33:10
  Speaker 1: at it. Oh thanks, that's really like there was a
• 1:33:14
  Speaker 1: very level playing field of not even mentorship, just encouragement
• 1:33:23
  Speaker 1: from people. I kind of feel a little bit of
• 1:33:25
  Speaker 1: a loss that that's gone away. I don't know how
• 1:33:27
  Speaker 1: you like you were right in the thick of this,
• 1:33:29
  Speaker 1: as well as so many other people we know in common.
• 1:33:33
  Speaker 2: I'm still very active on Twitter, but it's a very
• 1:33:36
  Speaker 2: curated thing for me. What I find is, I like
• 1:33:41
  Speaker 2: I'm I'm in groups, for example, of forty to fifty
• 1:33:46
  Speaker 2: quants who can't disclose who they are and they don't
• 1:33:49
  Speaker 2: want to share a lot publicly, but you've built up
• 1:33:51
  Speaker 2: this trust with them that you can ask these questions
• 1:33:54
  Speaker 2: of things you're working on and get feedback from people
• 1:33:57
  Speaker 2: all across the industry in a way that I'm still
• 1:33:59
  Speaker 2: not sure I could find anywhere else. One of the
• 1:34:01
  Speaker 2: things I've noticed is back in the mid twenty tens
• 1:34:05
  Speaker 2: early twenty tens, the community was just smaller, and so
• 1:34:07
  Speaker 2: you could have a lot of conversations in public. As
• 1:34:10
  Speaker 2: Twitter grew and grew and grew, just the request for
• 1:34:14
  Speaker 2: your time became more and more. It used to be
• 1:34:17
  Speaker 2: I might have one some young person reaching out to
• 1:34:21
  Speaker 2: ask me a question. Now it might be twenty times
• 1:34:23
  Speaker 2: the volume, and it's just it's hard to be as
• 1:34:26
  Speaker 2: responsive and have the intimate connections I think you had
• 1:34:29
  Speaker 2: when it was a smaller community. So I know a
• 1:34:30
  Speaker 2: lot of people who there are Twitter has its problems,
• 1:34:33
  Speaker 2: but a lot of people who bemoan the loss of
• 1:34:35
  Speaker 2: that prior experience. I think it was a small community
• 1:34:37
  Speaker 2: aspect that has disappeared, and it's hard to rebuild that
• 1:34:40
  Speaker 2: unless you build your own WALLT.
• 1:34:42
  Speaker 1: Guying, There's no doubt that that's part of it. I've
• 1:34:45
  Speaker 1: also found that I spend much less time in like
• 1:34:49
  Speaker 1: the main open channel, and now everything is for me.
• 1:34:53
  Speaker 1: He has been lists driven, whether it's economics or markets
• 1:34:58
  Speaker 1: or I even create a create a separate list just
• 1:35:01
  Speaker 1: for charts and put a bunch of guys who were
• 1:35:05
  Speaker 1: technically oriented, and it like a lot of the worst
• 1:35:10
  Speaker 1: aspects of Twitter go away when you're in a curated
• 1:35:13
  Speaker 1: list of people who are like minded.
• 1:35:15
  Speaker 2: But you lose a bit of the serendipity discovery. Yes,
• 1:35:18
  Speaker 2: exactly right, and so then you're going, well, I hope
• 1:35:21
  Speaker 2: someone retweets something interesting so I can discover a new person.
• 1:35:24
  Speaker 2: And they're absolutely trade offs. Two.
• 1:35:25
  Speaker 1: I mean, so it wasn't summer of twenty four, it
• 1:35:28
  Speaker 1: was summer of twenty three. I went out to dinner,
• 1:35:31
  Speaker 1: I come back home and there was a password requests
• 1:35:37
  Speaker 1: made a change on Twitter that I hadn't make, and
• 1:35:40
  Speaker 1: I go to say, this is a me, They've already
• 1:35:43
  Speaker 1: given the account away to somebody else, like they're stupid.
• 1:35:47
  Speaker 1: First of all, making two factor authentication an option just
• 1:35:52
  Speaker 1: so idiotic. And it took three months to get the
• 1:35:55
  Speaker 1: account back, and I finally got it back, and some
• 1:36:00
  Speaker 1: of our mutual friends said, hey, you're not going to
• 1:36:03
  Speaker 1: recognize the place you missed, Like it's like when at
• 1:36:06
  Speaker 1: the last inning of a baseball game when everybody files
• 1:36:10
  Speaker 1: out and you're in there, you're in the bathroom and
• 1:36:12
  Speaker 1: you come back and where did everybody go?
• 1:36:14
  Speaker 2: I'll tell you during that period I had some fantastic
• 1:36:16
  Speaker 2: conversations with you over DM, so I you know, I
• 1:36:19
  Speaker 2: miss whoever that was.
• 1:36:22
  Speaker 1: It's really kind of you know, it's it's so weird
• 1:36:26
  Speaker 1: to feel like I never felt a loss when Facebook
• 1:36:30
  Speaker 1: changed the whole to use Corey Doctor's phrase incation of
• 1:36:36
  Speaker 1: places like eBay and Amazon and Google like it's annoying.
• 1:36:41
  Speaker 1: I don't love what's happened to Apple, although they're still
• 1:36:46
  Speaker 1: functional useful for me. Twitter is the first one where
• 1:36:49
  Speaker 1: it's like, man, this was really special in our space,
• 1:36:55
  Speaker 1: and then it's just gone away, And you know, there
• 1:37:00
  Speaker 1: are a lot of reasons to not be happy with
• 1:37:02
  Speaker 1: Elon Musk, not the least of which are the never
• 1:37:07
  Speaker 1: ending promises for products that don't seem to arrive with
• 1:37:11
  Speaker 1: any sort of reasonable timeline. But man, firing eighty percent
• 1:37:15
  Speaker 1: of the engineers and leaving a you know, a smoking
• 1:37:19
  Speaker 1: hulk behind, it's really kind of disappointing. I understand why
• 1:37:25
  Speaker 1: people don't love Twitter. I still have this like nostalgic
• 1:37:30
  Speaker 1: feel for when it was good. It was so good.
• 1:37:34
  Speaker 1: It's all right, all right? And our final question, what
• 1:37:37
  Speaker 1: do you know about the world of investing that would
• 1:37:39
  Speaker 1: have been useful to know when you were first launching
• 1:37:42
  Speaker 1: in eighth nine.
• 1:37:45
  Speaker 2: There's a phrase I have been repeating a lot in
• 1:37:48
  Speaker 2: the last year and a half at my own business,
• 1:37:52
  Speaker 2: which is, why are we playing the game on hard mode?
• 1:37:56
  Speaker 2: Play the game on easy mode? I mean that both
• 1:37:59
  Speaker 2: in the investment strategies we choose to pursue and the
• 1:38:06
  Speaker 2: products we want to bring to market. I'm not going
• 1:38:09
  Speaker 2: to talk so much to the products here, so I'm
• 1:38:10
  Speaker 2: happy to go into that on the investment strategy side.
• 1:38:13
  Speaker 2: I wish someone had just sat me down early in
• 1:38:15
  Speaker 2: my career and said low breadth bets you don't get
• 1:38:20
  Speaker 2: to repeat a lot. Don't do those type. Don't try
• 1:38:23
  Speaker 2: to time the market. I mean, like every young person
• 1:38:25
  Speaker 2: I spent a whole of course, I'm going to be
• 1:38:27
  Speaker 2: the one to crack the market and figure out how
• 1:38:28
  Speaker 2: to time it. It's a dumb low breadth bet. You
• 1:38:31
  Speaker 2: don't get to repeat a lot. It's like trying to
• 1:38:33
  Speaker 2: flip the coin three times in your life and guess
• 1:38:35
  Speaker 2: heads all three times. It's just very unlikely and when
• 1:38:38
  Speaker 2: you're wrong, there's a lot of damage. All right, So
• 1:38:41
  Speaker 2: be smarter about the type of strategy you're going to pursue.
• 1:38:44
  Speaker 2: By the way, the SMP five hundred is the hardest
• 1:38:47
  Speaker 2: universe to try to actively pick stocks in. Maybe don't
• 1:38:50
  Speaker 2: try to pick stocks there. Go play the game on
• 1:38:53
  Speaker 2: easy mode where there's a proven opportunity, rather than saying
• 1:38:58
  Speaker 2: having the ego to say no, I'm going to be
• 1:38:59
  Speaker 2: the to figure it out. There are people who can
• 1:39:02
  Speaker 2: beat the market. But even if I'm smart enough to
• 1:39:05
  Speaker 2: figure it out or can find that edge, why not
• 1:39:08
  Speaker 2: find it somewhere where it's easier. And so I think
• 1:39:10
  Speaker 2: for me, I wish earlier in my career someone had
• 1:39:13
  Speaker 2: really beaten into me. Are you just playing the game
• 1:39:15
  Speaker 2: on hard mode just because you want to? Or is
• 1:39:19
  Speaker 2: there an easier way to do this? At the end
• 1:39:22
  Speaker 2: of the day, you're trying to meet this objective. What
• 1:39:24
  Speaker 2: is the easiest way to meet it?
• 1:39:26
  Speaker 1: Huh? Really interesting, Corey, thank you for being so generous
• 1:39:31
  Speaker 1: with your time. We have been speaking with Corey Hofstein.
• 1:39:35
  Speaker 1: He is not only the CEO and CIO of Newfound Research,
• 1:39:39
  Speaker 1: but portfolio manager of Returned stack etf Suite. If you
• 1:39:44
  Speaker 1: enjoy this conversation, well, check out any of the previous
• 1:39:48
  Speaker 1: five hundred and forty we've had over the past ten years.
• 1:39:52
  Speaker 1: You can find those at Bloomberg, iTunes, Spotify, YouTube, wherever
• 1:39:57
  Speaker 1: you find your favorite podcast. And check out my new
• 1:40:00
  Speaker 1: podcast At the Money, short single topic conversations with experts
• 1:40:06
  Speaker 1: about subjects that affect your money, earning it, spending it,
• 1:40:09
  Speaker 1: and investing it At the Money, in the Master's in
• 1:40:13
  Speaker 1: Business podcast feed, or wherever you find your podcasts. I
• 1:40:18
  Speaker 1: would be remiss if I did not thank the Crack
• 1:40:20
  Speaker 1: staff who helps us put these conversations together each week.
• 1:40:23
  Speaker 1: My audio engineer is Meredith Frank. Anna Luke is my producer.
• 1:40:27
  Speaker 1: Sean Russo is my researcher. Sage Bauman is the head
• 1:40:30
  Speaker 1: of podcasts here at Bloomberg. I'm Barry Retolts. You've been
• 1:40:34
  Speaker 1: listening to Masters in Business on Bloomberg Radio.