Welcome to Top Traders Unplugged. In markets, success doesn't come from predicting what happens next. It comes from being prepared for what you can't predict. In each episode, we go deep with some of the world's most thoughtful minds in investing, economics, and beyond to understand how they think, how they prepare, and how they decide, and the experiences that shaped how they see the world. No noise, no shortcuts, just real conversations to help you think better and invest with confidence. Welcome back to this week's edition of the Systematic Investors Series with Alan Don and I, Neel's Caster Lastenware. Each week we take the pulse of the global market through the lens of a Rolls-based investor. Alan, it is wonderful to be back with you. I know you just told me it is nice and warm in Dublin. The summer has arrived, it seems. Summer has arrived for sure. Yeah, we're getting some good sun-chirin, not quite as bad as continent of Europe, but it's definitely been warm the last couple of weeks and in my attic office here, it's definitely been hitting some records this week, 29 degrees or something like that. So a little bit cooler today, so I'm hopefully I'll be okay for the next year or at least. Exactly. I was telling you that I sit in a basement where I do my recording and that actually is quite nice in the summer, not so nice in the winter, but it's really nice at this time of year. Anyways, we've got, as usual, solid lineup of topics, a couple of new papers actually. And one of them, in particular, would say is quite fascinating and we're going to get into all of that. But before we do, I am very curious to hear what has hit your radar in the last few weeks. Anything exciting? Well, at that time of year, everybody's heading off to the beach and looking for recommendations for summer reading. So I've been reading a couple of different books. But one that's been very interesting is the book about Jeremy Grantham and the making of a permabair or something like that. And it's written with Edward Chancellor who's been on top Raiders' unplugged. So I think Edward Chancellor has written it, but he worked with Jeremy to write it. So it's it's I'm kind of only a probably a bit a quarter of the way through it, but already a lot of interesting little anecdotes. And I mean, I've always read Jeremy Grantham's, you know, his investment outlooks and, you know, the last dance was a famous one he had there a few years ago. But I was reading it for probably about 10, 15 years, but didn't really know that much of Adam and his background and how he kind of managed portfolio. Always assumed he was kind of a fundamental bottom up kind of a stock picker, you know, fundamental value. You know, his letters were always kind of a fundamental valuation and he was always bearish. But a few things that I've learned, which were quite interesting from reading the book, is one him and one of his earlier firms, not GMO, were early proponents of passive investing. So this is going back quite a long time. And there were also early pioneers of quant investing. So that was news to me. I didn't realize he, you know, he's a quant basically or he spent a lot of his time doing quant. And also that they had the use momentum and trend type strategies as well. And it was quite good advocates for them in that they could saw great complementarity between value and momentum. And there were kind of early pioneers in terms of quant investing. And there's a couple of interesting anecdotes about their kind of quant experience, weren't a build an early kind of quant equity model based on a couple of fundamental factors for a client to client with the IMF. And didn't do very well and then it kind of parked and came back to it, made a lot of improvements. And then it did very well and they were happy with it. And then over the course of the next 10 years, they spent, you know, 10 years tinkering with it, trying to enhance it. You know, all brought in modifications, all that they felt were valid and made sense and they couldn't improve it. So it's just kind of an interesting anecdote from obviously this is the kind of challenge that we hear from managers all the time. You can open enhancements new ideas. Beyond a certain level very often it's difficult to improve on a model. And another anecdote you had was they found this other factor called the neglect factor. So a stock was kind of neglected by the market. So it didn't have a lot of endless coverage was, you know, I suppose small cap without endless coverage, something like that. They did research and found this was a very strong factor that they were going to combine with value and momentum. And they had done the research and they implemented and the silly say implement it didn't work for six years or something and then they had to park it. So again, another experience that you hear, you know, with quantum managers of doing the research, it all makes sense. And then you put it on and it doesn't work. So it just shows you how timeless these experiences are of running a quant and systematic strategies. He's talking about these experiences from the 1980s, 1990s and you know, we still encounter them today. Yeah. No, I mean, that's actually a very interesting indeed. And it sounds like Alan, you should reach out and get him on your on your series for sure. But joking aside, and I certainly remember a little bit in the same vein that during that kind of quote unquote, and I don't really like the term, but the CTA winter, then everybody knows which decade I'm talking about. I certainly remember going out to a lot of meetings and people were kind of expecting, oh, so what changes have you made to the model? And we kind of think, well, we haven't really made any changes to the model because we don't think there's anything wrong with the model. It's just that at the moment, there's just not a lot of trends. So so we I fully understand this thing about where you spend a lot of time, but you realize that it's not a lot you can do to really move the needle in terms of that, which is hard for people to believe because they think, oh, this, all this new technology clearly, there are ways you can just keep improving, but maybe not always. Now I know we were to I know you had something slightly different on your radar, which we're going to come to in a second. But on my radar, it was a little bit related because I saw a story this morning on Bloomberg. I thought it was quite funny that some of the really big retailers in the US have started offering their popular products, but in smaller size, not in bigger size, but in smaller size. So that it actually becomes a bit cheaper for people to buy off. Obviously, I'm sure that they're actually getting a bad deal or worse deal. I'm sure of that. But when I think about the US and going there as a kid and all of that, I was always impressed about the huge size. You go into a McDonald's and I mean, you drink, you could hardly carry the drink. So it was so big. But now apparently it's going the other way around. And maybe that's the shift we're going to see. And I guess it's also in a sense a sign of the fact that lots of people who are struggling who simply can't pay normal prices. So quite relevant. We don't need to go into the whole inflation point right now because I think it might come up later. But the other thing, which oddly enough is also something that is relevant for our discussion later today. And I don't know if you saw this, but I think it was yesterday or maybe this morning in the financial times that it was announced that the CME group is going to now offer a different new contract for oil. And it's only going to be based on 10 barrels instead of a thousand barrels, meaning the tick size, I guess the contract size would be a lot lower. And this is, I'm sure in order to drive more retail money into that where they can trade these things. But the challenge I have, there's going to be another angle to this in a few minutes when we talk about one of the papers today. But the other thing I was just thinking of was, is it really a good idea sometimes that we just want to get more and more retail money into some of these markets that way you can really get burned if you don't know what you're doing. And I'm thinking specifically about the craze around silver last year. A lot of people got got in quite late. I have a feeling it wasn't the professionals that bought them, bought the highs. And you often hear about that. So is this search in retail products a good idea? I know it might sound a little bit biased because I come from the quote unquote professional world where we traded in our business. So it's not to exclude people, but sometimes not all, I think, financial instruments are meant to be traded by everyone. I don't know if you have any thoughts about these things or what you see. I guess to see me as trying to compete in the new environment, you know, I guess you could say, you know, it's not all bad. I mean, obviously we've had micro contracts being available on different markets. Certainly S&P and then they brought in on the yield curve and stuff like that and a gold as well as a one-end contract. So I mean, it certainly helps if you're, you know, even if you're kind of a semi pro and you're kind of a small portfolio, it's definitely helpful from that perspective. I mean, I think reach out can find ways to speculate on these markets somehow, you know, the oil ETF. I can't remember exactly what it was called, but you know, you know, and that ran
to challenges, obviously, when oil went and. - When is not the one that went negative? - Yes, you know, so I mean, and equally you can trade on spread betting, obviously, here, you know, with smaller amounts, you can speculate on oil anyway, even if you can't directly trade a contract. So I guess, see me as recognized, and it is a segment of the market now, and they wanna offer product for that segment. - Yeah, yeah. No, I'm not surprised that they do it. It's just sometimes, but you're right. I mean, it's probably inevitable. What's also inevitable is that we're going to talk about trend following and CTAs right now, because, I mean, we are about a week into the third quarter, but I thought it probably makes sense to hear your thoughts a little bit about the first half of this year. My trend parameter yesterday closed at 50, which is a decent, strong number, even though I will say the first week or so of July has been quiet to a little bit soft for managers. And obviously the last couple of days we've had some reversals now again, given the renewed bombing campaigns happening in the Middle East. So definitely been some changes in some of the directions in especially in energies, but overall not a bad first six months for the CTA world, but with some dispersion. And not that I have a fully clear picture of the situation as of yet, it looks to me that people who did non-trend stuff inside the strategies probably did a little bit better, some of them somewhat better. But on the other hand, people who traded alternative markets, which obviously became very popular a few years ago, they struggled and a number of the names came out negative with very few exceptions, such as ISAM who did well, but some of the other big names not so well. So those are kind of some of my takeaways. You sit on the allocator side, you monitor it from a different vantage point. What are your takeaways, Alan? - I mean, looking at the year today, it's definitely been a good year so far. I mean, solid returns. Obviously, if we were to go back to the middle of May, it looked even better. We've kind of drove a little bit of a draw then since then. And my sense was kind of across the managers, I was monitoring in June. I thought they were generally a bit more negative than the next, I think the next is there, less than a couple of percent. And my sense was across more, obviously more negatives and positives. So I think certainly June was interesting from a dispersion perspective as you say, non-trend may have been a factor. I think we had a lot of reversals and commodities in June. Obviously, you know, links to the Middle East change in tone there was one thing, but equally metals, aluminium, copper, and then also, you know, markets like soybean oil, but you know, we're kind of also related to that. And then it's kind of late June and July, things like corn rebounding. So, I mean, in the commodity space, I think there's been good opportunities, you know, earlier in the year, particularly in precious metals. And as we've seen, kind of later in the first half of the year, maybe some challenges. So I think net net, you know, it still feels like a good environment, plenty of direction movement, plenty of volatility. And, you know, it was looking like a very good year at one point, but still certainly better than average year to date, I would say, you know, we're looking at the returns year to date. - You know, what I was reminded of a little bit when I just looked at the price action to some degree of the markets, right? So we had this massive surge in energy markets a few months ago. And also in other commodities, obviously precious metals had been doing pretty well, coming into this year and so on and so forth. And you did see a number of experts coming out on Bloomberg, CNBC, whatever the channels are called, saying that this looks like the beginning of another commodity super cycle, as you would expect. Now, if you think back, that's exactly what happened in 2022 after the Ukrainian war started, right? So around sort of March, April, that's where all of this was taking place and some of the markets, especially the metals, the base metals were surging and then it all collapsed, right? And I'm kind of thinking, hmm, the last month or so, you kind of seem more or less the same picture in the commodity space. Now, interestingly enough, later today I am recording with one of our favorite commodity experts, Adam Rosenswag, and that's gonna come out in only a few days, so on Wednesday, but we know historically because we can see the data that actually 2022 turned out to be a really great year for CTAs. I'm not predicting, I'm not making a prediction here. But it is interesting, some of the similarities at least in terms of the narrative, the price action and so on and so forth. Is that, is there something you've noticed or is that just. - Yeah, I think a couple of things. I mean, I think when the conflict kicked off in the Middle East and in March, everybody was scrambling to understand the straight of our moves and how significant is this? And I think I listened to a lot of podcasts that around that time, he our own, other ones. - Sure. - And there was a general sense on this, this is a big problem and that this problem is looming in weeks, it just isn't solved. That was my takeaway from listening to all of these years. And this, and that maybe the relevant parallel was something like COVID, that this is coming and when it's gonna come, it's gonna hit hard. Clearly it wasn't a case, so it's like, well, what happened? Then, I mean, obviously after the fact we got explanations around Chinese oil demand decline because they were able to tap in store on reserves. And some of the oil flows were able to be re-rooted via pipelines, et cetera. So the market was able to withstand this for a matter of weeks or a couple of months. So, I mean, that narrative is still out there that if the disruption persisted, that there's still a problem. But it did make me think, certainly that the predictions were pretty pessimistic at the time. That's not to say that we're wrong. I mean, the we're wrong in a sense that, the problem did go on for a couple of months and we never hit that point of really big spikes. Bosch, so maybe it was just a warning shot. Maybe those fundamental challenges are there. In another scenario, maybe China wouldn't be in that position to release its own oil supplies, although it has to, maybe domestic demand might be stronger. So, yeah, that was my kind of big takeaway from that period, Bosch. But equally, it's not just the Middle East. I mean, be interesting to hear what Adam has to say in your podcast because obviously Copper is a good reflection of the AI team and that trend. And that's not going away in the Capix plans of the hyperscators and all of those people investing in data center buildings are just escalating from here. So that's a fundamental, that's a demand side as both a supply side story that hasn't gone away. So, yeah, so I think it's not just supply disruptions, it's there is a big demand story there too. - Yeah, no, no, I completely agree. And that's the beauty of what we do, Ellen, is we don't actually have to predict what was going to happen. Anyway, we'll follow it closely for sure. Now, before we move on to your topics, let me just quickly run through the data here. This is as I've Tuesday, the 7th of July, Peter 50 down about 23 basis points in July, still up 7 1/2 for the year, start to NCT index down 46 basis points in July, still up 8.9% for the year, the trend index pretty close down 58 basis points in July, and still up 8 1/2 for the year. And the short term traders index down 0.42%, but still up 4.65% so far this year. In the traditional world, also a little bit of softness, MSCI world, equity index down 27 basis points as of last night, up 9.65% for the year, the US aggregate bond index down 56 basis points for the month, up only a quarter percent or so this year. And then the S&P total return is down 21 basis points up about 10% so far this year. But again, when I look at the price action for the past week, there's been a couple of decent moves, but it's mainly been something like Coco that keeps sort of searching now, suddenly after it was in a big downtrend for a while, but the energy markets also seem to have had some decent moves, but not crazy moves, I would say. Anyways, I kind of alluded to it that you had kept something away from me, namely your the story that you're going to be doing.
that you were meant to talk about on the Eured Ar had been, we've moved that to the macro view. So I'm excited to hear what's hiding in the macro view. - Well, maybe we'll get to that in a moment, but I just wanted to talk with in the whole macro, we always kind of take a few moments to talk about what's interesting from a macro perspective. And the thing I wanted to focus on this time was really, obviously we've had a change at the Fed and we've had Kevin Orish has now come in, we had his first news conference, press conference, which was interesting. And we're already seeing a few changes, I think, at the Fed, we had a shorter statement after the June meeting. We had a different type of press conference, he didn't really say anything of substance about his view on the economy, very much was evasive on that. And he did not see, submit a dot into the dot plot. So we're seeing changes there already. And I think it's interesting, he has commissioned these task forces or he's in the process of doing so. And one is around communication. And this seems to be a big issue for him, communication. He's not a fan of forward guidance. He doesn't like it, he thinks it can kind of put the Fed in a bit of a box, the markets have become overly reliant on it. And it's interesting, Alan Greenspan passed away there recently. And Orish just seemed to be a fan of Greenspan. And obviously Greenspan was famous for kind of not giving much away. And it's called was something along the lines of, if you think you've understood what I've said, you've misheard me. So that was, he didn't want it to be kind of pinned down or he wanted to be kind of evasive. So at the press conference, Orish mentions this idea that he wants to kind of the markets to draw their own inferences about the data. As opposed to the markets being totally consumed, but trying to anticipate what the Fed is doing, they were, you know, and forgetting about what's the actual data, he wants the markets to kind of guide the Fed. And it's actually an interesting idea that and it goes back to that kind of Greenspan era. Because I remember when I came into the markets first in the '90s, there was this idea that, you know, sometimes the Fed might raise rates or curates. And people would say, well, that's just, well, they're just validating what the market has already priced. You know what I mean? That very often you would get a move in bond yields or whatever. And reflecting the fundamentals and the Fed would effectively validate that. So that's kind of the idea he's getting at. So it's worth considering, you know, where did this idea of transparency and forward guidance come from in the first place? Like, why was it a thing before? And actually it was Bernanke back into 2000s, who was a big proponent of more transparent communications and more, and I guess forward guidance. And he had two speeches back in 2004, which kind of laid out the reasons for this. And I suppose a lot of it was, you know, a product of the time, you know, at that stage, they didn't have the use of tools like QE. So they were very conscious that the Fed could control short term interest rates, but not necessarily long term interest rates. So the use of communications was seen as part of the tools that they had to try and influence long term rates. So, you know, if anybody in the market at the time would remember phrases like when they were about to raise rates to might say that we're going to be patient in raising rates or if they were unhold, the word, you know, the code was developed that they would say things like rates would be low for a considerable period. So the market became to understand what this meant. But the overall objective was to try and use communications to influence long term rates, because obviously that's the one doing QE. There's also a sense that, you know, more shocks created more volatility, which was seen to be a bad thing. And then certainly as we got into the kind of the, you know, financial crisis here and post financial crisis here, the whole point about committing to keeping rates low for a long time was a key part of the arsenal of their unconventional policy too. So you could say maybe the world has changed now and maybe that's worse, it's justified that, you know, a different era now justifies a different approach. And, you know, what he wants is obviously the market to make its own inferences about, about, you know, what's the, where rates should be going based on the economic data. I mean, it does create the questions, what might that mean for us? What might it mean for the markets, for investors? You know, simplistically, would suggest more volatility because there's going to be more uncertainty. The Fed's not going to be telling us, you know, weeks in advance that it's likely, it's going to be a reason, right? You know, for a long time in the last couple of years, it was, you know, kind of leaked to Nick Timmerayah said the Wall Street Journal of what was going to happen and the markets could digest it. That era seems to be over now. And, you know, can the markets infer, you know, from the economic data alone? It remains to be seen. A lot of people have grown up now in the markets just, you know, listing to the Fed and operating on what they say. It could be good for trends as another factor because if you think about, you know, if the Fed starts a tightening cycle and then they put it into SEP, what we think rates are going to be a 1% higher in years time, the market kind of factors in a full tightening cycle straight away. Whereas, if it's going to be more incremental, it's going to take time for the market to infer the extent of a tightening cycle, you know, so that could be more, if information is digested more incrementally. You know, you might see a bigger term premium on bond markets as well because of this, because of the uncertainty. And while there are good aspects to it, it does also create maybe a bit more a little less accountability, you know, we won't get to hear exactly why the Fed has done everything. We may not hear the full debate. I mean, they're reviewing everything. So, you know, certainly the impression from the last press conference was, you know, don't expect as much detail from wars as we are used to from J. Powell and his predecessors. So, I think it's interesting. I think it could mark an era of, as I say, more volatility and potentially good for trends. I mean, the era factor just in relation to wars at the moment, that's interesting. He spoke at a European conference. And, you know, I think the initial impression was, he was hawkish at the first meeting. Then when he spoke in Europe, he said that inflation risks are coming down. And the big dilemma that he's facing and this was the article that was on my radar, you know, it was in the Wall Street Journal recently about how the AI trade is fueling inflation across so many different products from iPhones to Nintendo consoles, but basically pushing up the price of memory and chips and pushing up, obviously, the price of electricity, et cetera. And this is the big dilemma that warsh faces now in that, you know, and it goes back to the Greenspan dilemma of the 1990s. When you get a productivity shot, there's a supply element and a demand element. We're experiencing the demand element now. So demand is pushing up prices. The supply side is the productivity gain that is expected to come down the line. And this is what War is just talking about. Are you saying, you know, well, we believe that we'll get a disinflationary impulse down the line, but we don't know when it is. So it is quite an interesting dilemma. And do you raise rates now to kind of cool the demand from the AI Capix boom, even though you think it's going to be disinflationary down the line? I don't know. I think the market is going to go on with the whole case narrative, but we'll have to wait and see. I think I'm kind of a little more skeptical on that. I'm not sure maybe that War is as hopeless as the market inferred from this first press conference. No, I think that definitely remains to be seen. And of course, you know, Brunank, you may have started this thing about narratives and so on the soulful, but a discussion about narratives. But of course, there was also a book written by I think Robert Schiller called narrative economics about 10 years ago, because narrative had become super important. Yes. And speaking on the whole inflation point, I mean, not a very nice person he got from Apple raising their prices 20, 25% in a day. Yeah. I imagine with their size, it's going to be showing up somewhere in the inflation numbers. So interesting times indeed, thanks for thanks for that. And I agree with, I mean, I think for me, maybe the more interesting part about the changes, maybe not so much this thing about the narrative side, whether they give long press conferences not, I'm actually quite interested in what are they going to change in terms of the economic data they want to publish, because I think more, a lot of people are kind of reliant on certain data and may even have built models based on certain data. So what happens when you can't get that? Or it's completely restructured and is calculated in a very different way. That's going to be interesting as well. What is also going to be interesting, the other three papers we have time for today, two of them we've kind of lumped together, one from our friends at Aspect and one from St. Louis.
systematica. And then the third one is from a number of people, but I think I don't know all of them are associated with CFM, but it's a very interesting paper. So I think we may spend more time on that than we will on the first two, nevertheless, when good people put out papers, we want to highlight them. So tell us a little bit about what you found interesting in the aspect and systematica papers and maybe set kind of the tone for what they're actually about. Yeah, so I mean, there are two papers that are basically making the case for trends and strategies, but from, I guess, different perspectives. I mean, the aspect paper is about the changed macro world, the changed macro regime, which we've spoken about before, but I suppose re-epicizes many of these themes that the last 25 years were effectively anomaly in terms of kind of abundant energy and the piece driven from globalization, et cetera. And now we are seeing kind of structural breaks in markets such as bonds are less reliable, diversified for equities, store of value, such as a dollar being reassessed and redefined, you know, the surging demand for gold from central banks. And I suppose commodities as much more strategic assets and then given that backdrop trend following has been a great way to kind of reflect and play on those themes as a diversifier, as a strategy that is adaptive for regime change, as a strategy that gives access to commodity exposure in a managed way. So I think they were all important points. I mean, one thing that got me thinking on this paper is like everybody kind of looks at this kind of supply shocks and talks about oh, if we get shocks like an energy, people always think it's an energy shock and that would be bad for bonds and equities and it's that kind of scenario that you might need other things in your portfolio, but it's not just an oil shock that we need to think about. There are other kinds of shocks that you know, we could have a shock in other commodity markets such as the copper market or in food prices, etc. that could be disruptive and be negative for traditional assets because I say that because a lot of people say well net world has changed. We're not in the 70s anymore. We're not as reliant and oil and you know, we had what we had in Iran and it didn't get us so disruptive for oil. But so the point is is not just we're not just talking about oil, we're talking about commodities and we're generally and we could have shock cells where you know, we could have a fiscal shock or a fiscal problem in the bond market. They could impact bonds and equities and where else can you find sources of diversification in that stage or in currencies and we could see, you know, we could see a huge dollar decline or a huge dollar rally, which could be disruptive for traditional assets as well. So I think all of those are relevant. You know, when thinking about these kind of supply shocks, the systematic paper takes it, makes the case for trend from a different perspective. It's along the lines of the total portfolio approach, what we're hearing a lot more about now. You know, and this is again, I recognize and I suppose the the failings and the drawbacks of strategic asset allocation and particularly in the current environment where again, where bonds are less diverse of our and in this paper, they kind of highlight the shift in the stock bond correlation, but also that many other hedge fund strategies, you know, take give you a lot of equity risk and as those private equity. So it's about finding the true diversifiers, you know, the likes of equity, more can you talk is a good diversifier, but it's unlikely to give you that convexity. So the trends can so in terms of, you know, diversification and what they call dynamic risk management, they're making the case for trend as complementary to equity market neutral, you know, in terms of building out portfolios that are more, you know, balanced from a risk perspective. So I think the two papers are good in terms of summarizing those points and, you know, probably things that we have spoken about before, but we're maybe restating those points with a different lens. Yeah. So when I think about, I mean, obviously these are, as you say, these are not necessarily new things that has come out in these two papers, but when I think about it, maybe I think about these things a little bit differently in a sense that when you look back and we always talked about the 64-digit portfolio, 60% equities, 40% bonds. And the way I thought about sort of portfolio construction was more about maybe the assets you should own, so to speak. What I think this narrative, this, these, not just these papers, but generally where the discussion seems to be going is not so much which assets you should have in your portfolio, but more about the kind of the behavior you should own or have kind of the exposure, not so much the underlying asset. I know obviously you like the talk about these sort of behavioral exposures, regimes. So I think there'll be more of that. And I hope that investors and larger investors will, will be start thinking more about that. So they're not kind of stuck, which I guess the total portfolio approach is kind of also a way to get away from the silos where you could only stay in a very narrow lane. Now, it's much more about the impact that Sega Strategy has on the total portfolio, not so much about how it does relative to a few other similar type strategies. So maybe we just need to get used to talking about more about which would be good for us because we've always argued that there is a behavioral element in why trend following works so to speak. Okay, let's move on to maybe the feature of this conversation so to speak. Is trend still your friend? Is the paper a microstructure account of the demise of short term trend following? Now, it's definitely a detailed paper. It is by a number of people, Judith Kuth, Sultan, Isla, Adam, Ray and Jean-Philippe Poucheau, well known to many people, Chairman of CFM, previous guest on the podcast and highly respected, of course. Now, what I like about this paper and I admittedly have not sort of studied it probably as detailed as you have, but what I like about the paper overall and why I think it's such an important paper is that it puts validity and depth to something that certainly we've talked about on the show for many years, namely this very simple observation that short term trading doesn't seem to work as well anymore, but not really being very specific about it. Just noticing that short term managers haven't done that well, some have gone out of business, and if we look at our own models and signals, we've certainly noticed that parameter settings have probably become longer, slower systems have done well, all of those discussions we've had. So that's the interesting thing that we finally have something that is well done, well researched, that kind of dives into this and try to explain what it is we've been observing why that could be the case. So if I can teed up like that to you, Ellen, and maybe you can tell us much more about this wonderful paper. Yeah, no, it's definitely a really interesting paper. And as you say, it's getting to a heart, to the heart of something we've been looking at and debating in markets for a while, not just, you know, you had the kind of the more sluggish performance of trend generally for a period, and then also the challenges for fast trend as well. And we've talked about some of the explanations and some of the potential explanations. And I guess what's interesting in this paper is they also look at some of those ideas as well and are dismissive of them as well, you know, the classic. And maybe we should talk about the classic one too. Yeah, you know, acid. We remember we used to hear the industry has got too big, you know, so that was the source of the degradation in returns, but actually that's not consistent with the evidence in terms of AUM and kind of stagnated for a few years in the industry. And actually, you know, the growth with the growth of the equity in futures markets, the CTA footprint would have been declining over time. So that's not true. And then also the electrification of markets is another thing. And you know, if you look at, say, the electrification of futures, interest rate futures markets has come along and has had no impact on the profitability of those.
markets. So I mean what they are proposing or what they're suggesting is actually that it's the volatility adjusted tick size, that that's a key variable for how conducive a market is for fast trend following. So what does that mean? You've got different markets of different tick sizes. So you know and and then you got to think about the tick size relative to the volatility of the overall market. So so for example the tick size in currencies has gotten very small of of lace you know and you know the euro is say 113,000, 113,0001. So the size or the value of a tick is small and even people probably trade it even less than that whereas in the bonds you know it's much bigger at interest rate markets it's much bigger and in certain commodity markets it's bigger as well. So I suppose the intuition behind this is that in the small tick size markets you tend to see less liquidity you know that the liquidity is there but it's not necessarily a punch that is at the kind of represented a bit offer whereas maybe in the past before you had the advent of high frequency trading you would see a large volume at the bit offer. So the point that they're making is that in the past you had a transmission mechanism for fast trend following whereby you know a trend follower would trade at decent size in these markets and then that would kind of set forward a series of events where the person receives that trade then trades in the market and that creates momentum in itself. So the way I think about this because I started in foreign exchange markets and in the 90s and the way the markets worked back then was if you were say a CTA going to buy dollar yen you called up bank from America or wherever it was and give me a price in dollar yen you know in 50. But it's safe you want any yard of dollars or 500 dollars that's you know that was a big amount right but they would quote a price for that so you could actually get a big trade on you might not want you because you might say well this bread is going to be wider but but but but the big banks would quote you a price for that. So if you go and buy you know a billion dollars or 500 million in one you know in one go what did the bank do then well the bank then they called up all of the other banks and they bought again and what did those banks do well they did the same thing and so the fact that a lot of trend followers would come on and execute size big size at that at that price put in place a momentum effect that they that and it's that this is the thesis of this paper that that momentum effect that comes from the actual trading was what is a key part of what drives trend following returns. Now they acknowledge it's not the only part but it's probably the most relevant part for for fast trend following they also touch about how you know behavioral factors like you know the speed of adjustment for different participants in the market and under reaction initially and then over reaction later these are the typical explanations of why trend following works but they're proposing another explanation that a big part of it was you can get it for fast trend to work you had to be able to get big trades on a reasonable cost and and then for them those trades to you know I suppose encourage more momentum in the markets which I think is makes sense I mean as I say from my experience in FX markets that's what you would have observed and they're saying well something changed around 2010 where you had a lot more high frequency traders and the banks basically took a step back from from warehousing risk like that so you wouldn't be able to get a big trade on like that and also it could be that that that CTA behavior has changed as well if you're if you think about it if all CTA is so you say okay we're not going to you know trade at the offer is they ever trying to buy the market will be very will be very slow in putting our trades in the market that creates that creates maybe arguably less momentum itself so they they they they look at the different explanations and what they find is interestingly that the variable that as I say that explains degradation in returns and fast trend following is this volatility just a tick size from the perspective that if you look at the performance of fast trend following it it's deteriorated in certain markets but not in all markets and you know there in in in the large tick size contracts fast trend following does seem to work so so actually you know the title is nearly a little bit not quite misleading but actually that was one of the interesting aspects of the paper when you get into it is that actually it's not saying the fast trending doesn't fast trend following doesn't work at all it's just said it doesn't work in these particular markets particularly equities and and currencies they've also they also or analyze the order books in in different markets right and another feature that they do see is that there used to be a lot more liquidity available for trend followers so if you're looking to to buy those planted liquidity there that's less the case now and that that that's since 2010 why is that is the liquidity providers are showing away from from from offering that liquidity and they've also found another interesting feature of this research is they found that counter trend trades had become more dominant in the markets in the last while and that's interesting because you might remember when we spoke to Toby Crabble a few weeks back this is something that he said as well that you know he wrote this book called opening range breakout and he was saying that you used to see a lot more follow through when you get a break in markets whereas now you tend to see you know a new low and then a reversal so markets seem to be much more mean reverting a short term time horizons and now if you delve into the paper and they're actually there there are there's an interest in chart if you look at performance I don't know if you have it there in front of you but I'm looking at I'm looking at figure 10 at the moment actually let me pull a figure 10 because I was looking at figure 10 as well and it's kind of striking and if you look at figure 10 what it shows you is this degradation for fast trend following and if which is the red line there when people go down load it but actually what struck me is that it very much didn't work for a decade so you can see that it's it's not working basically between 2010 and 2020 but since 2020 its performance has kind of improved again notwithstanding a little so is it the face is it the case of a structural change or is it the case what I'm we had a decade where it didn't work so that that's something that they don't address and the other thing that I think is interesting if you look at the large tick markets which is the chart on the right hand side you know fast trend is has actually been better like over the full periods it's 1995 which is really surprising and slow trend was quite challenged again kind of between 2008 it has picked up more recently so again that that's not addressed in in in the paper either so and actually you know if you look at the large tick there's no evidence of a CTA winter there at all for any time frame it's it's it's just kept working well for for for the whole period and so I think it's interesting I mean one thing that that strikes me you know what does it mean for CTAs I mean it means a few things doesn't mean that CTAs have to penalize you know the small tick contracts and be cognizant of this effect if you're going to trade faster and that's one thing and I mean some people will argue okay yes the returns in fast trend following have have deteriorated but there is still a value for it in terms of convexity and skew you know there have been papers from man around this so yes it's has to mean as good but still from the crisis outside perspective it can be can can still have a mirrorist but I think certainly the idea of adjusting exposures people obviously have done this for liquidity reasons before you know obviously when CTA is built portfolios to do penalize certain contracts from a liquidity perspective so maybe it's the next thing is penalizing from a tick size perspective I mean more broadly it is it's an interesting hypothesis that trend following works for two different reasons one is the behavior reason and the second is this momentum effect created by the trading itself and if the conditions the if the market microstructure is such that you can't get that momentum from the execution of the trend trades you don't get that short term momentum I mean it's certainly interesting it's kind of you know I think people will debate that but I think it's definitely intuitively makes sense to me what do you think so if someone came to me and said listen we have found out exactly why short term trend for our short term trend following doesn't it hasn't worked for the last twenty fifteen years loss I would not have thought of about something as unsexy as
as tick size. Let me just say that. That is not what I would expect. Could there be something about it? Well, I mean, for managers, it's fairly easy to test. We should go back and look at the, we can run short-term timeframes on our models. So that's the first thing we do. And I can say from what I see internally at done, yeah, I mean short-term timeframes on a classical trend following model has not been profitable whatsoever for the past 15 years and actually, and ties in well with 2009 as the break point. So I would agree with that observation completely. Now, I'm not going to argue against, you know, people like Jean-Philippe Bouchard because he's much smarter than I am, but I want to offer at least some, some other things. So first of all, if this is the case, we could run our own simulations based on markets with small tick size for the contracts and markets with large tick size and keeping the model consistent, we should see the same pattern that they found. So maybe that's something we should all do. Okay. If we are involved, especially if we're involved in short-term models, that would be relevant. Now the other thing that I can't help thinking about is to one, the environment, right? Did the environment change after 2009? Maybe because we had a big global financial crisis that ended in 2009 and we know that Central Bank has got much more involved and so on and so forth. Yes, it is true as well. The market participants started to change as well and correct me if I'm wrong here, Alan, wasn't 2009 also where they changed banks not being allowed to trade a lot on their own book and actually you had to outsource it. So you could argue that market participants perhaps changed as well and that has an effect. And finally, I would offer a third thing that could be relevant here, but I have no data on this and that's actually the rise of these multi-strat pot shops because my impression is that they are much more short-term, maybe not necessarily only in their holding period, but certainly also in the way they manage risk. I mean, you down a little bit, you get caught, you're down a little bit more, you get caught. And I happen to have lunch with a super interesting guy who are from that space this week. And he was basically saying, I don't think I'm saying anything confidential when I say this. And he was basically saying, you know, if you're one of the pods and you get a call on a Friday afternoon that you need to cut your risk by 50%. They give you two hours to cut that risk, right? So I can't imagine that the rise of the AUM in these pot shops has not had an effect on the short-term microstructure of the markets. So I would offer that as another explanation. I can't say the tick size is not part of the explanation. I think managers probably if they're interested, should test it. And I think it's obviously convincing piece of evidence they put forward. I just think there might be more to it. That would be my. Yeah, I think that they're fair points. I mean, the other thing I was thinking about, I mean, because obviously they're saying just to be clear, like for fast-trend, in general, it's. I mean, it's kind of equities and currencies are the two that have struggled. I mean, it's not just. They sign it specifically to the tick size, but in general, that's what it shows. I mean, the other thing we've had in equities has been zero TTEs, more volatility selling. So the market microstructure has changed in a few ways, as you say, more pot shops, shops, but also new products and structure product volatility. Can I offer one more thing? Yeah. I mean, if we think about it, let's just say that this is done using simulation, right? Let's just say that that's what you do. Clearly, I mean, if you take a contract, like we talked about in the very beginnings, now the CME group is coming out with a contract that's like significantly smaller. Well, I have a feeling that when you bring out a futures contract, I haven't checked fact check this, so don't take it as 100% sure. But I have a feeling oddly enough that the fees that you pay to trade those contracts are not going down. They're just the same, right? Do you get less exposure, but you pay the same transaction cost. So clearly, if you want to have the same exposure, but you choose to trade the small contract, you have to trade a lot more contracts. That means your commission costs go up significantly. Now, wouldn't that erode your performance? Of course, it would. So I think there are lots of moving parts in this that I'm, as I said, I haven't read the paper in details. I'm not familiar if that is already addressed and accounted for. But clearly, if you just say, yeah, we've just got to switch to smaller contracts, but we're going to take the same transaction cost model. Yeah, that's going to have an impact. Yeah. No, it just wanted to point that they say in the paper, I mean, they kind of slice it in a number of different ways. They also look at high volatility and low volatility and they actually find trends are better in low volatility. But then they also look at big one day moves and small one day move. And what you're saying is what's been eliminated specifically is trend followers ability to profit from large directional kind of one day moves. So when something big happens, the trend followers used to be able to get in on big size on those moves and get executed and profit from them. So that speaks to the liquidity, right? That speaks to the liquidity. Yeah, liquidity markets. But then they did look at liquidity as a variable itself. And that's what I know explain it across, actually. So so it's kind of a combination of liquidity and the and the contract characteristics is what they're suggesting. Yeah. I mean, without taking too big of a hole for both of us here, Alan, certainly for me, I'm kind of thinking here, okay, let's just say that you have a firm that needs to look at the needs to to execute a billion dollars of something, right? If you think about it, whether you trade with 10 people or you trade with two people, the the the loop it creates, right? The follow through it recreates whether 10 people have to go out and get a market. I mean, you would think that that pushes the price, right? Or whether it's two people doing it, I mean, intuitively, to me, I don't know if that makes a big difference. It's the same order size. So the question is not how many people do you trade with to me? It's more like how big is the size that you're trading vis a vis the total size of the market. But maybe I'm completely wrong here. So yeah, no, I mean, that's why I think that you know, people will debate us. I mean, maybe the argument is that you can't get, I mean, they do say that there is a suspicion that CJAs have actually disengage from short-term trading, which is actually true, which is true, which is the anecdote. Most of, you know, people are saying, you know, most of the trend followers say, well, we don't do much short-term because the evidence shows it's been too amazing for a long time. So I don't think it's actually been a big driver of returns. Their point is that the ability to capture that does move has, and but the trend signals have, sorry, they, they, so what we could say maybe, maybe what we could say is that in the short term, right, in the short term time frame, the participants have changed a lot, meaning you used to have more momentum type participants. Now, you may have more mean reverting type managers like high frequency or whatever, who's basically just trying to, you know, make a bit of money on on on the spread or whatever they're doing. So maybe we maybe that's part of the reason as well that in the last 20 years or so, the way the short term in specifically the short term time frames are made up in terms of who's, who's doing the trading, has changed from as well. Maybe CTA being, I mean, to do a little bit about the CTA behavior maybe changing too. I mean, if you think about it, if CTAs are kind of all very focused on best execute, well, obviously everybody's focused on best execute, but if you're not trying to, if you're passively buying as opposed to crossing the spreads, I mean that, you know, and they do touch on this as well, like you're kind of going to miss the big kind of break out moves because you're your passive. And then obviously if you want to execute, it's going to be expensive. So, I mean, that's another dimension to that they allude to as well. And then finally, maybe before we wrap up, I would say the final thing that I would have noted that's really changed in the last 15 years is actually how we execute, right? In the in the old days, we would print our tickets, we would look at them and then we would work the order kind of during the day or whatever. Nowadays, some people
will just go straight from the signal to the exchange and they incorporate some kind of algo to do the actual execution. And these algos definitely behave differently than what an individual trader would do because they're not emotional, for example, and they have patience and so on and so forth. So I think this is a very interesting topic and it's a great paper. I think there's more to it, but again, I'm not a quant, so easy for me to say. But really appreciate you digging into this and really, really appreciate all the authors for putting this out there. Absolutely. Now, definitely one of the more interesting additions to the whole debate around us. Yeah. Anything else you want to add before we wrap up, Alan? That's what I can think of now. No, I think we've done. I think we want to get into the football or something. Well, as long as Switzerland is part of the World Cup, I was definitely happy to get into football, but if they leave in the next round, maybe we won't talk about football anymore. Who knows? Anyways, this was great, really appreciated. And of course to everyone listening, please show your appreciation for Alan and all the other co-hosts by going to your favorite podcast, platform, leave, a rating and review because it really does help more people finding the podcast. Questions as usual for upcoming episodes. You can email them to
[email protected]. And next week, the one who will be answering questions should they arrive, will be you love, and along with a few other papers that he found that we will be digging into so stay tuned. And that's going to be another very educational conversation. From Alan and me, thanks ever so much for listening. We look forward to being back with you next week. And in the meantime, as usual, take care of yourself and take care of each other. Thanks for listening to Top Traders Unplugged. If you feel you learned something of value from today's episode, the best way to stay updated is to go on over to your favorite podcast platform and follow the show so that you'll be sure to get all the new episodes as they're released. We have some amazing guests lined up for you. And to ensure our show continues to grow, please leave us an honest rating and review. It only takes a minute, and it's the best way to show us you love the podcast. We'll see you next time on Top Traders Unplugged. This podcast expresses the views of its hosts and the guests appearing on the podcast as of the date of its recording. And such views are subject to change without notice. Top Traders Unplugged do not have any duty or obligation to update the information contained herein. Furthermore, Top Traders Unplugged make no representation to its accuracy, and it shall not be assumed that past investment performance is an indication of future results. Moreover, wherever there is a potential for profit, there is also the possibility of loss. This content is made available for educational purposes only and should not be used for any other purpose. The information contained in this podcast does not constitute and should not be construed as investment advice or an offer to sell or a solicitation to buy any securities or related financial instruments from its in any jurisdiction. That information contained herein concerning economic trends and performance is based on or derived from information provided by independent third party sources. Top Traders Unplugged may believe that the sources from which such information are obtained are reliable. However, Top Traders Unplugged cannot guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based. This podcast, including the information contained herein, may not be reproduced, copied, republished or posted in whole or in part in any form without the prior written consent of Top Traders [MUSIC PLAYING]
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