E2. Secrets of Private Equity, Cocoa Trends & Optimal CTA Portfolio Weights

Corey Hoffstein 0:00

y. I am of the view that post: 2008

It's just they've come up with a structure by which they can stick with that.

Rodrigo Gordillo 0:56

I mean, the insight is bang on. I sincerely doubt I'll

Corey Hoffstein 1:01

go get my tint oil hat.

Rodrigo Gordillo 1:03

Done that it was done explicitly. Hello, and welcome to the GetStack Investment podcast, where we delve into the exciting new world of return stack. Join us as we break down complex financial concepts and through accessible insights, speak with leading experts in the space, and analyze real world applications for sec. Get stacked is here to help you break out of a traditional portfolio construction mold and get you to start thinking differently about the path to success investment.

Speaker 3 1:34

Corey Hoffstein is the co founder and chief investment officer of new found research and Rodrigo Gordillo is the president and portfolio manager of Resolve Asset Management Global. Due to industry regulations, we will not discuss any funds managed or sub advised by these firms on the podcast. All opinions expressed by podcast participants are solely their own opinion and do not reflect the opinion of neither newfound research or resolve as management Global. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of these firms may maintain positions and securities discussed in this podcast.

For more information, visit returnstack.com

Rodrigo Gordillo 2:23

Alright, everybody. Back again, the whole team episode 2 of what we are now calling the Get Stacked Investment podcast. Today, we are joined with Corey Hoffstein, CIO of Newfound Research, Adam Butler, CIO of Resolve Asset Management Global Michael Philbrick, CEO of Resolve Asset Management Global, and myself, president of Resolve Asset Management Global. And we have a lot of interesting topics, return stack topics to talk about today. How's everybody doing?

Corey Hoffstein 2:51

The first topic of the day, Rod, where did the name get stacked come from? Who which one of you geniuses? Well, we should do that one.

Adam Butler 2:58

I think that was, like,

Rodrigo Gordillo 2:59

of Corey. Like, are you kidding me? It might show me your biceps about it. Yeah. Exactly.

Okay.

Michael Philbrick 3:04

You can see the upper packs right through the shirt here. Come on.

Rodrigo Gordillo 3:07

Yeah. It's gotta be from the I

Corey Hoffstein 3:09

feel like that's an attack me.

Rodrigo Gordillo 3:11

By the

Michael Philbrick 3:11

way, how is your pet chair doing, bud? Yeah.

Corey Hoffstein 3:13

For the for those who don't know, I tore my peck off about 3 months ago. You know, it's still not there. So

Michael Philbrick 3:19

Oh, no. Oh,

Rodrigo Gordillo 3:20

no. So it's still not their meeting that was supposed to it's supposed to kinda grow out again. It's Oh, no.

Corey Hoffstein 3:25

It'll never make a record. I I am permanently impaired my body building career is over. I cannot get this captioned.

Rodrigo Gordillo 3:32

storm in the first quarter of: 2024

Pretty fantastic, but What if your best market or the best markets of the deep traders ends up being the only P and L that you see? So anybody have I know we've all kinda talked about it and tweeted about it, but, Corey, you wrote up some of this content. When do you start us off with your Hoffstein that? In that space?

Corey Hoffstein 4:26

Yeah. 1st, let's acknowledge, I mean, firms like Mulvaney who are profited profiting massively from this trade. I mean, I think they're up. Correct me if I'm wrong, north of 120% in Q1. A huge percentage of which is is driven by cocoa.

And I think it it shows the dispersion between classical trend following and and more quantity of trend following. Where classical trend following managers tend to allocate a certain amount of capital to a trade and let that trade grow whereas quantitative managers allocate a certain amount. Risk budget in a in a quantitative sense. And so what you've seen is as Coco went to the moon, so did its volatility, which meant for more quantitative traders, that position size got smaller and smaller. And if you actually look at the open interest in Coco over time, It peaked in as sense declined even though that trend got stronger.

And so I think you can see a lot of quantitative traders haven't necessarily captured the fullness of the trend because they didn't do what more classical trend followers have done since the seventies, you know, really doing that sort of outlier hunting type. Trade. So I think it just highlights again. In theory, we're all trend following, but the ways in which trend following is done can lead to massive immersion. And and one of the questions we received all throughout Q1 was, well, if you're missing these trades like Coco Corey think wheat was another really big Hoffstein Q1 that that played well Corey long crypto, you know, if you're not trading those markets, can you still replicate the performance of the industry at large, if you're looking at returns like the Barclays Top 50 or or the or the soc gen trend index or the broader soc gen CTA index.

And I and I think The results are are an emphatic yes. One of the simple tests I did is I said, well, rather than seeing whether the process works from there's a lot of statistical noise, but, like, if I just had a crystal ball, and I could look forward in time and use just nine key futures markets, things like US equities and gold and oil, and sort of the the major markets. And I wanted to replicate The future returns of something like the soft gen trend index, how close could I get? Because in theory, that soft gen trend index is made up of players who are trading things like Coco. And the answer was with the crystal ball with just 9 factors, you could get very, very close to replicating those returns.

So, you know, I think there's a lot of potential reasons why that's the case. Which I'm sure Adam probably has a whole

Adam Butler 6:57

Well, what does Radame mean you get close to replicating the returns?

Corey Hoffstein 7:00

Yeah. So so basically, like, as a very simple test, what I did is I said, Well, February was a month, for example, where Coco spectacular returns, I looked at the SocGen Trend Index daily returns of the SocGen Trend Index. And I said, Let me formulate one portfolio looking at those foreign returns. Let me use these 9 futures markets and come up with a replicating portfolio that I'm gonna assume I'm gonna hold constant throughout that whole month just to try to track that index closely. And the daily returns were very, very close.

The daily correlation was spot on. The total return of the period was very close. In other words, you know, suggesting there wasn't a huge amount of change in the replicating portfolio over that period of what it took to track that index, but also that You didn't need to trade anything more than these 9 major contracts to have actually replicated the returns. Again, if you had a crystal ball, we don't always have a crystal ball crystal ball, or if you do, mine's pretty cloudy. But it wasn't like not having cocoa was not meaningful in terms of not being able to realize the result.

Adam Butler 8:04

Yeah. So, I mean, 1 first of all, it's what one month. Right? So it's one one major trend breakout, cocoa.

Corey Hoffstein 8:11

By the way, I should mention March was the same. So February March. Same same.

Adam Butler 8:15

And I think this also illustrates that, you know, most of the queue line, right, the trend index and the CTA index Corey both they track the largest managers. Several of these managers are in the billions of AUM. Right? And so and, you know, they may trade a smaller number of markets, you know, not all large Trend followers trade 400 markets. Some of them trade much less.

Like, you know, Dunn is on the record as trading a more limited universe of markets. Right? But when you trade a lot of markets or when you're very large size, you're gonna be constrained in the amount of capital that you're gonna be able to deploy to any single instrument in the portfolio. Right? So it's just not going to, on an isolated basis, have that much impact on this large, you know, AUM weighted index.

Right? Obviously gonna wreak havoc on the dispersion of the funds within the index over that time frame. Because there's gonna be some funds that have relatively small investment universes. You know, they trade only a couple dozen securities, for example, like, Mulvaney is kind of on the record is the only trade, like, less than 30 markets. Right?

Cocoa is one of them. Well, if you trade less than 30 markets, and one of the markets you trade has a bonanza trend. And like you say, you don't scale back your risk, as the all of that trend takes off. And as that position in your portfolio begins to represent, an excruciatingly large amount of the total portfolio. You know, you can envision a over 2 or 3 months with a trend as large as the cocoa trend, you put the trend on at a certain level of risk.

2 weeks later, 3 weeks later, the position grown massively relative to all the other position in the portfolio, it may even represent, like, be larger than the portfolio was before you put it on. That single position And now that position is completely wagging the the dog of the entire portfolio. Right? So you've got managers like this that you know, they happen to trade the market that that broke out. They caught the trend.

They didn't scale back the risk. And then you've got these multibillion dollar funds that you know, nay trade coco. It's one of few hundred positions, or because they're so large, it actually can only be a very small proportion of their total portfolio, etcetera, and that will dictate the relative performance within that. Index in that time period. Right?

So there's a lot of lock in the surface.

Michael Philbrick: 11:06

Well, a lot of luck in there. And I I think something that's underreported is the fact that Coco before this occurrence didn't trend.

Rodrigo Gordillo: 11:14

It is one of

Michael Philbrick: 11:14

the worst trending assets for consideration. So how many people were still getting their face ripped Hoffstein to get a trend in Coco when it didn't happen And what were the deleterious effects of getting chopped and sliced and diced while trying to follow a trend following situation in Cocoa for 20 years? It's quite possible you just made back all of the money that you lost over a couple of decades of trying to follow a trend in cocoa and have been losing 2, 3, 4, 5, 6 percent a year hidden in the context of your other assets. Right? So when you look at Coco and you look at the personality of cocoa, it had not trended.

For a couple of decades. Yeah. And so there was a an Albatross that those funds that were using trend on that particular asset class carried And some of that, they got back, and some of that may have been profit above that. We don't really know. It's great when lightning strikes, though, and everyone wants it.

And it becomes a, you know, a topic of conversation.

Rodrigo Gordillo: 12:25

It's a great that we can get into.

Michael Philbrick: 12:27

I'll just one last thought to really good point out to you guys is this also gets into the version around the asset managers and replication versus trying to pinpoint managers. So I'll throw that back to you guys to discuss.

Adam Butler: 12:38

I I

Corey Hoffstein: 12:38

got some numbers here just to just to Yeah. Russell numbers out. Alright. So, Mike, to your point, going back so one of the things I actually love to look at is the socgen trend indicator. I'm not sure.

nd they take it back to early: 2000

s. It then from the bottom of: 2022

Rodrigo Gordillo: 13:49

And in fact, I know some so talking about who's benefited from this and who hasn't, there has been a handful of CTAs that booted cocoa out because it clearly had some sort of seasonality Corey to them that that didn't lend itself to trending.

Michael Philbrick: 14:03

And they're I wish I had never followed the range of that.

Corey Hoffstein: 14:06

Yeah. Who I wish never used seasonality is the lesson there.

Michael Philbrick: 14:09

I wish it. No. It's not even seasonality. It's just yeah. This is a it's a hard behavioral thing.

Rodrigo Gordillo: 14:15

Whatever. 20 years

Michael Philbrick: 14:16

if something doesn't work.

Corey Hoffstein: 14:17

Let's talk about the traditional trend followers quincere. So shout out to Scott Phillips on Twitter because he he wrote about this. And I think this is a really great point where he said in the last year, Coco's prices. When he wrote this in April, so 2 weeks ago, he said Cocoa's price is up 4 x on the year. Coco's vol is up 40 x.

Right? So think about that. If you're a quant trader, the position size you would have put on a year ago, if you did not unwind that position at all today, the position size is now a 160 times what the initial position size would have than that you would put on today on a vol adjusted basis. Like, if you were saying for the same risk size, it's a 160 times what you would put on today. Right?

Mulvaney, right, so this this trade that keeps growing and growing and growing, Scott sort of backed out Mulvaney's position size if you assume that most of the profit in March came from Cocoa, which he's an allocator to Mulvaney, and said the majority of it looks like it came from Cocoa. He said that their position went up a $109,000,000 for the month. Basically means that the entire notional value of Mulvaney's fund right now is in Coco. That position size has gotten so big. And they hold more than 10% of the daily volume of crypto.

Like, their ability to exit this trade is very limited. There's a significant amount slippage that would happen if they tried to liquidate. So, again, it you know, like, yep. Great win. Kudos to them up, up a 124%, but funds that tend to operate like that.

Also, and there's a great RCM article about this, about these sort of classical trend followers tend to have much more significant draw downs Oh, yes. Than than the more quantitative trend followers who again

Michael Philbrick: 16:05

What's that called? The momentum? There's the drawdown at the end of the trend at That's really

Rodrigo Gordillo: 16:10

Yeah.

Corey Hoffstein: 16:10

You know, Mulvaney, EMC, Dunn, Chesapeake, all great trend followers, all except for actually Chesapeake, I think their max drawdown is around 30. The rest drawdowns between 50 60%. You know, which

Michael Philbrick: 16:23

I mean, and to to some degree, that that's for the allocator and adviser to see a position size that's doubled and to now reweight that within the portfolio, spreading that across the other trend followers Corey spreading that across the other asset classes. That's the right thing to do here. You have thing that's gone up that, I mean, that much in the portfolio now represents more risk in the portfolio. So allocators should not, you know well, I will leave it to the allocator to decide, but in a rebalancing scenario, you would rebalance back to

Corey Hoffstein: 16:54

the original. Think about if all of a sudden, Mulvaney starts to get a bunch of people who are saying, well, I wanna rebalance. Right? That's the curse of winning is that's where the capital comes from. So you get a bunch of redemptions because you won They have to start cutting their position size.

Michael Philbrick: 17:07

Rebalance early. Alligators and and advises rebalance early.

Rodrigo Gordillo: 17:11

You don't wanna be the one that's gonna steal us.

Corey Hoffstein: 17:14

The cocoa price because they have to start selling some of that position off.

Rodrigo Gordillo: 17:17

Yeah. Now what's been interesting about all of this too is that when we talk about cocoa, there's actually 2 cocoa Right? There's London, Cocoa, and there's US Cocoa. And one of the things as we dug deep into this is what we found is that it US Cocoa tends to not have auto correlation Corey has not exhibited auto correlation for this whole period of time. But yet, London Coco does have positive auto correlation.

So if anybody was yeah. And they are they're they do look similar if you just kinda eyeball it. But you're are you are able to find a positive P and L in London Cocoa using traditional trend models in a way that you wouldn't with US Cocoa. And that tends what we when we did some analysis, we found that that 30% around 30% of the variance between US Coca Cola and London, the difference has to do with it can be explained by seasonal effects, which we're gonna dig deeper into our research, but I I thought that was also right, that it wasn't that one one has worked and one has not in a traditional CTA sense.

Adam Butler: 18:19

I think that the take home, right, because it can sound a little bit like we're beating up Mulvaney. I have to say I would not have the risk tolerance for that. Is it this way outside my my comfort zone, but kudos. Everyone that invested in Mulvaney, presumably understood the way that they invest. And they absolutely out of the park and, you know, should be congratulated, but it does serve to highlight some of the major differences in construction and the randomness that's involved in the results of different trend strategies from month to month, year to year, etcetera.

Right, which makes it just really hard to judge what was skill and what was locked in over over even very long stretches of time. So emphasizing again the importance of having a deep understanding of process and expectation rather than trying to make decisions based on past performance.

Rodrigo Gordillo: 19:19

And also the size

Michael Philbrick: 19:20

of the capital that you're managing. Well, if if you're an allocator that got billions and you can allocate to 20 different trend followers and reallocating rebalance between them. That's one set of circumstances. If you're a registered investment adviser and it has who wants to put some trend in, and wants to think about getting something that's gonna capture the kind of meatiness of that muscle movement, right, get you know, I wanna be kind of in the middle of distribution. I don't wanna be on the high end, and I also don't wanna miss the whole thing.

So thinking through that process, you you've gotta kind of pick your products slightly differently Corey your allocation mechanism. Sorry, Rod.

Rodrigo Gordillo: 19:59

Go ahead.

Michael Philbrick: 19:59

Yeah. No.

Rodrigo Gordillo: 19:59

I was just gonna have to say I was gonna say a similar thing that We gotta define what the value of the different approaches are. When I talk with, there's a few trend followers that just trade their own PA. Let's say, you know, a few $1,000,000 of their own PA. They're not constrained by any sort of quant risk management necessity. They have a a large tolerance for draw downs.

They will be conviction weighted Hoffstein and they do exhibit some alpha when I've looked at their performance. They're still 90% correlated to the trend index. But they do outperform it from an alpha perspective. Now as you get bigger, you can still do that, especially if you're able to trade different markets or look at different trends, blah blah blah, but when you're looking to when you're looking at trend replication strategies, what you're really trying to capture, like you said, Mike, is that kind of big muscle movement, the thitty middles, something that is doesn't have a positive risk, Corey why is it non correlated when you need it to be the most non correlated provide that offset when it does. And largely speaking, the big handful of asset classes within a trend following strategy is likely to be able to capture that going forward.

Right? It doesn't need cocoa in order to provide those characteristics. And so, yes, you can find alpha. It'll be in the smaller end. It'll be the guy's trade different markets.

And then sometimes one is not all of them, but I've seen condition weighted Corey risky advice. It CTAs make a lot of money over time doing that.

Michael Philbrick: 21:25

Hell, yeah. That's super hard.

Rodrigo Gordillo: 21:27

Yeah. That's that hard. Allocation.

Michael Philbrick: 21:30

The when it's that hard, try to keep it allocation. Through, you know, 20 years of minus 2 a half percent contribution of Coco. Like, it those are I've, yeah, I definitely believe they have premium because that's hard as that's hard a f.

Corey Hoffstein: 21:44

Can I just add a point on the replication front, though, because there was another piece of research I wanted to highlight that came out in q 1 from Quantica, which is another trend firm? And I I thought they had some really fascinating research on this idea of, like, how how many markets do you need to trade? Are are you a better trend follower if you're doing teen verse 25 versus 50 versus 100 markets? Now the way they did this was they had very generic trend following your rules and and much more of the quantitative style of trend following, much less of the Mulvaney. By the way, I certainly didn't mean to be dismissive of Mulvaney.

Talk about Yep. Absolute.

Michael Philbrick: 22:18

What's the difference between freezing?

Corey Hoffstein: 22:19

I iron stomach to sit through that risk. I couldn't do it. But so what they did is they said, let me come up with these generic trend following rules and then let me, you know, run those same rules using a a 15 market approach, a 25 market approach, 50, a 100. And and how does the performance compare in different years? And the lens with which they look at it at that performance through was based upon what they call the number of independent bets driving the p and l.

t that means for you know, in: 2022

rend followers. So years like: 2022

Well, it's

Rodrigo Gordillo: 24:10

yeah. I go ahead. Finish up.

Corey Hoffstein: 24:11

Just to finish, Where all those extra markets seemed to matter more was in the year where there were no clear trends, and you weren't getting chopped up in just a few trends that weren't working, you had more of your risk budget diversified across more stuff, and we're likely to find things that offset those, you know, the p and l. And so it was more it actually seemed to be From a risk management perspective, the diversification was better, but in those years that, like, the SocGen Trend Index really ripped, Those are the years that just having a couple of markets to trade got you the vast majority of the return.

Rodrigo Gordillo: 24:50

Can I just clear something up?

Corey Hoffstein: 24:52

Do you Absolutely.

Rodrigo Gordillo: 24:53

The best performing years were the ones where there were the least amount of independent bets.

Corey Hoffstein: 24:58

Yep.

Rodrigo Gordillo: 24:58

And what and and and overweight of 1 or 2 of them. So that's exactly. And we've done principal component decomposition as well. And I remember it was years ago, so I had them correct me if I get this wrong, but within the manage which within the the future space, you get, on average, around 13 unique bets, but it could be as low as 3 and as high as 20. I just don't know what the correlation between having a lot of bad serve versus us.

Yeah.

Corey Hoffstein: 25:25

So so that's exact. So they're they're sort of ran between, like, 5 and and I think. And what they found was, like, those years that had 5, those are the years of really strong CTA returns. Yeah. And the years of 50, Not very strong CTA returns.

It was just that the the the CTA's that were trading a 100 markets tended to do better in those environments. Than than the CTS were trading 10 markets because they just didn't have any diversification. Nothing was working, and they were in sort of that they just had more risk cost and stuff that wasn't working.

Michael Philbrick: 25:55

Yeah. S and P 500, 500 stocks, but it's one market. There's one set of institutional buyers and sellers. There's a set flows that come from the various sources of capital. Now think about a futures a managed futures portfolio of cocoa wheat, the energy complex, precious metals, also stocks, bonds, currencies, So when you roll through the independent bets and the independent market participants that are responding to the independent hackeders of each market.

Did we have a drought in wheat? Do we have too much wheat? Where are we, in the meat side of things? So the number of independent bets to diversify our portfolio is incredibly important. And I think, Adam, you always have that formula measured as to how much you can improve the sharpe ratio of a portfolio with the independent bets.

Maybe you can you pull out of your brain there?

Adam Butler: 26:49

Fundamental law of active management. Right. Which is just that that alpha, the function of, or information coefficient an information ratio is a function of the information coefficients of the skill of the manager, the degree to which your bets correlate with being on the right side of the market. Times the bread Corey bread, the good proxy for bread is number of independent bats in the portfolio. And I I was gonna say A lot that analysis a lot depends on how the portfolio is constructed.

If you're constructing it naively, like, if you're just holding all of the markets in equal risk, for example, right, that you can easily have a portfolio that has a lot of equity markets, a lot of bond markets, a lot of currency crosses versus the dollar, and those from a risk standpoint in years when macro kinda defines the a major trend or 2 1 or 2 major trends, Then, obviously, those portfolios are gonna have massive loadings on those, this small number of factors. If you take a more thoughtful approach to portfolio construction, you will never allow your portfolio to load too heavily on those concentrated bets. Right? So if you were to even wait by, you know, equal risk contribution or some kind of robust being variance optimization, then presumably you would see a lot less of that because you you just would never be allowed Corey the portfolio would never be allowed to have such concentrated positions in those single factors.

Michael Philbrick: 28:26

Right.

Rodrigo Gordillo: 28:27

Yeah. And look, and and speaking of diversification, another topic that we wanted to touch upon on the CTA space was in the last quarter, We saw a lot of the CTA space load heavily on equities, and equities have been doing well. Especially from the concept from the perspective of return stacking, it feels like a scary thing to have a 100%, let's say, in equities and then on a trend following strategy that has a big loading on equities, and the big fear was like, you're just doubling up on the S and P 500 risk. But the reality is that it's really tough to discern the impact of a single security or set of security in a well diversified CTA portfolio, if you don't understand where all the other bets are pointing. Right?

And so in spite of that being true. And also the, the second thing that people forget is that if it does get it wrong, you know, these systems have stop losses, and they have ability to get out and turn it around fairly quickly. And I we saw a lot of that in during COVID, whether we caught off-site, and then we're able to get out quickly. But from the perspective of, hey. I see a big position here.

Therefore, if x happens, then you will lose, it's much it's a much more complicated view. So since then, we've had a drawdown, and we haven't seen the the carnage that people expected. So what were the elements that we saw? The diversifiers that we saw take the opposite side of that bet in this in the last 4 months, Corey. I'm

Corey Hoffstein: 29:51

just gonna add add a number here for you, Rod, just looking at some socgen data. So over the last month, the S and P 500 is down a little over five percent. And despite carrying a pretty significant position in equities, long

Rodrigo Gordillo: 30:03

equities, the soc gen trend indicators up 5, CTA

Corey Hoffstein: 30:04

indexes up Yep. Just under 3 in the trend index is, just under 3. Right. So to your point, yes, it did look like we were We and other CTAs were carrying a lot of equity, but there was other stuff that worked, right? Short bonds has been a very profitable trade over the last month.

And commodities and currencies. Right? So looking, you know, month to date, for example, the turn was, like, right at the 29th. By look month to date at the socgen trend indicator, equities are about a 200 bp drag, basically being along the dollar has been a added a 100 bps, short bonds as added 50 bps and a variety of commodity exposures, right, long long the energy complex and long Gold copper. Silver, yeah, has added about 300 bps in the soft gen trend indicator.

So there's, right to your point, like, the portfolio operates as a whole. And very often, like, you can see a concentrated position. Oh, it looks like you're carrying a lot of equities on a single day. But you'll have a lot of other positions that from a risk perspective can be dramatically offsetting as the market dynamics change.

Michael Philbrick: 31:15

I think that's a good segue into the the one article. I wanna make sure we highlighted which was Corey. I shrunk the trend following by man. Which just went through the I've I've put it in the slack channel too if you guys wanna pop it up. I know I pretty sure we're all pretty familiar with it, but, you know, went through, hey.

d following what it does to a: 6040

So are we

Rodrigo Gordillo: 31:59

are we gonna get into the proper weighting of a trend following strategy? Are we gonna get It was some I'm just discussion in other podcasts about that.

Corey Hoffstein: 32:09

Is it is this my chance is this my chance to go at Andrew Bier here?

Rodrigo Gordillo: 32:12

Yeah. That's right. Andrew's waiting on the silence and waiting Yeah. Oh, yes. About him.

Andrew, come on in. Tell us what you think. But it was it was Corey those who are interested in what we're talking about, they're it's yes. I think AHL gas with top traders on plug, which is a great part of this space. Andrew Beer was asked what an ideal position would be.

And, you know, I I gotta say I know that that we talk about optimality, behavioral optimality, I think he was talking about a very low position, especially for those uninitiated, right, the advisors. Looking at a 4% allocation, I think, is what he recommended. Understanding that he's not gonna get more than that. And then the forget the host's name. But he pushed back.

He said that's crazy.

Michael Philbrick: 32:52

That's Neals. Yeah.

Rodrigo Gordillo: 32:54

Neals. He's like, that's crazy. That is absolutely not the optimal thing.

Adam Butler: 32:57

Well, when

Corey Hoffstein: 32:57

when you got someone like Neil's, 100% of his of this portfolio, his trend following having Andrew say 4%. Alright. But Andrew Taylor's point. Yeah. The average US financial adviser.

I think if you dollar weighted, their allocation to manage futures is, like, sub 20 basis points. Right? Now, that means there are some that have quite a bit in, and of the vast majority have none, here's point is if we can get everyone off 0, all of us trend followers are Corey happy Right. Now, again, how so let's let's talk about the behavioral aspects here. Did you does a man does someone wanna manage a 1% position?

Michael Philbrick: 33:33

No. No.

Corey Hoffstein: 33:34

It's not gonna benefit you, and it's only gonna make a raised eyebrows. So you need it large enough for it to make a difference. Not so large, it's gonna drive your client crazy. And especially if you're not stacking it, right? Not so large that it sticks out for a very long time when it stops behaving like stocks and bonds and stocks and bonds do well.

Rodrigo Gordillo: 33:55

Yeah. I think that's bang on. I think the look. When you're looking at it from a as a diversifier, it's tough to make an argument 4 or 4% position. Right?

You're just not gonna reduce the volatility of the drawdowns. It's just not gonna add.

Adam Butler: 34:07

But it isn't You're gentle. 4% ludicrous. Yeah. But it can't be missing

Rodrigo Gordillo: 34:14

the point.

Michael Philbrick: 34:14

Why bother? Because I think we have the behavioral aspect. Yeah. We have the behavioral aspect.

Adam Butler: 34:19

I don't think Marika will

Rodrigo Gordillo: 34:20

ask you.

Michael Philbrick: 34:20

That down to you.

Adam Butler: 34:21

Behavioral aspects. No.

Michael Philbrick: 34:23

The problem is the behavioral aspect, is a function of okay. You have a bunch of people that are subject to hurting. They are succumbing to the behavioral vulnerabilities in their portfolios. I'm, you know, can't help them, but we should not shy away from the fact that the allocation to this type of strategy should be far larger especially all with all the baby boomers and the accumulated assets that are going through decumulation, being in decumulation, and having a higher volatile port, higher Corey vol portfolio is extremely deleterious to the amount of money that you can take out. We have investment stewards who are well educated and are underexposed to this, we see it through the growth and shrinking of the CTA complex in and of itself Bad performance, less allocation, good performance, more allocation.

That's at an institutional level. So we're not just talking RIAs here. This is kinda like Corey. Come on, guys. Get with it.

Wait.

Corey Hoffstein: 35:25

I like the hand raising.

Michael Philbrick: 35:27

Yeah. But I'm I'm just saying, so are you going to be someone who succumbs to the behavioral vulnerabilities, or are you somebody who's gonna get off 0 to a more meaningful position Yes. You're gonna have some tracking error. Those are things that you have to think of as a professional to keep your job. But, again, brought brought over to you.

Rodrigo Gordillo: 35:45

Well, look. I've recently been rereading the 3 body problem. And because of that Netflix series, I wanna freshen up before I see how good or bad it was. But it's this from a game theoretical perspective, you know, I wanna I kinda feel like Andrew's playing it well. From a game theoretic perspective, this is not a single game.

Meet it with an advisor. You want a 20% allocation, and so you bid for that 20%. Here, you're breaking minds. You're not bending minds. Right?

And if we play this game forward a decade or 2. If you think about, first of all, that you think about a decade back, how many wire houses would allow advisors to have a big alternative position. That's gone from 5% to 10% to 20% to 30% is now allowed to be an alternative strategy. So the long game is that pie is gonna grow. You're competing with other alternatives, like long short equity, like private equity, private credit, So if you want a piece of the pilot, say a Corey is for, you don't wanna break minds.

And with the hopes that you keep on pushing the agenda without talking about it too hard, So that 10 years, 20 years from now, 50 percent of the portfolios are alternatives, and that 4 grows into a reasonable amounts.

Corey Hoffstein: 36:53

Well, and in fairness, and in fairness to Andrew Beard, he was not just saying, this is a 6040 investor that's gonna put 4% in Manage Futures. The expectation here was that 4% was part of a larger allocation to alternatives, Zach. And it that was gonna be alongside things like equity long short private equity and private credit. And we can have all the discussions we want as to what is actually an alternative and what matters and what should be sized up or down. But but it was not, hey, take your 6040 and add sent to Man's Futures, and and you're good.

atives, ever, and they have a: 6040

Right? I I have to say for their business. Because they will not have the confidence to stick with it. I I I'm very convincing. I will I bet I could get them there.

And within six months, they will blow out of their position and lose a whole

Michael Philbrick: 37:58

bunch of people. Out of sales. Right. Immediately. We're gonna have to I mean, in Coneman's book, God rest him.

He said, you know, when you have some facts and someone throws at you some nonsense, you throw the table over because you can't even enter tame the ridiculousness of the 4% allocation because it'll pollute your mind. We need to be thinking about this through the you know, do you wanna manage some stuff and be the guy who's in the seat? I get it. You need to keep your job. Your Vanguard salesman, low fees, 4%.

That's fine. I get it. We'll we'll we'll push the envelope on that. I'd like to, you know, make the argument that trend following is like the Dennis Rodman of the Chicago Bulls. Yeah.

It's different. Yeah. The guy shows up late. Yeah. He does things to a different drummer.

hat you thought you'd love in: 2000

Like, you know, this is not what you tell your kids. Well, everybody's doing it. You should just own the S and P 500. I don't

Rodrigo Gordillo: 39:20

So, look, that's what education is for. I think there's two things here. I think you can say exactly what you said in this medium and this format in white papers, in studies where people can see the Corey star and say, okay. I wanna get there, but I agree with Corey because we've experienced it. I, a 100% agree with Corey.

And and because we're good, we've gotten people to allocate 20, 30%. Sadly, at peaks often because it that's when they're motivated to do something to then see them, shit their pants for the next day, and then sell it all. And was one of those things where I could be careful, you know, with great power, with great sales power, Corey, comes great responsibility. I think Corey doesn't realize that. And so we can occupy.

Michael Philbrick: 40:01

If we had great sales power, we get them to buy and the drawdown.

Corey Hoffstein: 40:05

We get them all to light down 30. My son to swim. He's just as likely to drown in the deep end as the shallow end. I'm still starting him in the shallow end. Like, it's not like I'm just tossing him in the deep end.

Rodrigo Gordillo: 40:16

No. You gotta they have to look. The first of all, it's a difference between faith and, like, faith in the person versus faith in the strategy. Right? When you sell somebody, they have faith in the person who articulated the idea.

When you take give them time to look at it to feel through it, understand it to be able to articulate it to clients to come up with a conviction. And that takes months, if not years.

Corey Hoffstein: 40:40

This injection can't be rented. You can't rent a conviction.

Michael Philbrick: 40:43

And so rented, convicted, conviction right now in US securities.

Corey Hoffstein: 40:47

That's called performance chasing. I agree. Right.

Michael Philbrick: 40:49

Well, that's all I'm I and by the way, We all generally agree on this. I'm just representing the another side of this equation.

Adam Butler: 40:55

Aaron still stuck back on the fact that you guys said private credit and private equity Corey alternate.

Michael Philbrick: 41:01

Fair enough.

Corey Hoffstein: 41:02

I was trying to avoid that.

Rodrigo Gordillo: 41:03

Yeah. Just if it would

Adam Butler: 41:04

be I was not an overdraft.

Corey Hoffstein: 41:06

Hold on, Adam. Adam, I you'll like the did you catch my no. I hear you go. This is this is my recent thing on on Twitter that I said private credit and really more private equity was the way for institution to reintroduce portable alpha without having to manage leverage in their portfolios. So here's my take.

Alright. Here's my hot make. So if you if you look at private equity returns, right, they are basically equivalent to a 100 and 50% levered equity returns with all the beautiful volatility

Rodrigo Gordillo: 41:34

laundering and all of the leverage taken

Corey Hoffstein: 41:34

away from the risk of of the actual institutional allocator. If you look at how institutions are allocated on average, they still hold 7 to 15% in hedge fund strategies, alternative hedge fund strategies, but a huge swath of equity has gone into private equity. I am of the view that post 2008, whether they did it knowingly or not, they were able to move from equity into private equity. Drink down that equity piece by holding private equity, which is giving them the implicit leverage, and allocate that freed up capital to hedge funds. And if you unwind and look through, they're effectively stacking the hedge fund alpha the same way they were pre 2008 with portable alpha.

It's just they've come up with a structure by which they can stick with it.

Rodrigo Gordillo: 42:25

I mean, the insight is bang on. I sincerely doubt

Corey Hoffstein: 42:30

I'll go get my tinfoil hat.

Rodrigo Gordillo: 42:31

It was done but it was done explicitly. Right? Cause this is No.

Corey Hoffstein: 42:34

It's funny. So I tweeted this, and I had some people who were institutional. I'll be like, Yeah. There was definitely a little bit of A little bit of was by a few people who knew what they were doing. Like, yeah, we actually are doing this on purpose.

I think the vast majority definitely Did not

Rodrigo Gordillo: 42:47

do it. That's a good point. That's awesome. I love that. And I think for the most part, this idea of when you allocate private equity.

Number 1, you're getting a a positive equity risk premium. That's lever 1.5 at a high and sometimes you just you have some high quality what I can test is that when private equity gets down to the retail level, whether it's for these, interval funds or whatever, that the quality of private equity that you're getting for the retail space is even going to match after fees and transaction costs. Even going to match the estimate.

Corey Hoffstein: 43:21

I will not even entertain this conversation. I don't even wanna go here. Yeah. I agree. I Corey.

Michael Philbrick: 43:28

It's I would I will not invest.

Corey Hoffstein: 43:30

I will not invest in any private equity fund that'll take my money. That it's that old, like, I won't be in any club that'll have me. Like, no. If if a hedge fund will take my money, it's not exclusive enough.

Rodrigo Gordillo: 43:40

That's right. At this level talk

Adam Butler: 43:42

on the fact that you think it's great that they moved from 0 to 7% edge funds and pick

Corey Hoffstein: 43:47

out the market topic. It's higher than 4%.

Rodrigo Gordillo: 43:51

It's a game theoretic of the 3 body problem, man. You gotta think decades ahead. You're thinking too nearby. This is gonna take a while. It's gonna take a while.

Well, I

Michael Philbrick: 44:00

I think each investor should reflect on the facts and make their own decisions and and advisors and allocators should do the same. And, you know, Swenson, when he was making these changes, all along the career of his career path was a law. Alright. And then he became popular and then he changed. So if you'd like to be alone, then you would do more.

If you need to be with the crowd,

Rodrigo Gordillo: 44:24

I think that's also speaks to the fact that the the way we're get they're getting structural alpha is from the types of structures that have the liquidity for these big pools of money to give. 2, if you were to grab Swenson and say, hey. I want you to do your best work. With this $200,000,000 portfolio, what are the chances that he'd be allocating in the same way? The the truth is that the ability if you give somebody the smartest ones and the ability to have all of their bets as liquid as possible versus all of their bets be as illiquid as possible, They would choose liquidity and transparency every single time.

It's the fact that you can't do that at that level of AUM that you can't First

Michael Philbrick: 45:06

of all, Swenson. Pioneered the endowment model and private investing when multiples were a quarter of what they are today. Yeah. All of that too. All of that.

So valuation is gravity. Sure. It determines future returns, and so we have a lot people chasing you down the model and laundering volatility and doing all the things that we're talking about, but they ain't doing it at two times cash flow.

Rodrigo Gordillo: 45:30

Right. So so there's definitely evaluation model, but my point is I think a lot of people look at the endowment model and say I want that. I want to have that so bad. I wanna be there, and then I can go and pitch that. But you don't want that.

You have the ability now, especially with this concept of return stack, and you have the ability to get non Corey stacks and have all the liquidity and just Yeah. Be able to know what's going on at at all times, right, without

Michael Philbrick: 45:53

But only do 4% of that, though.

Rodrigo Gordillo: 45:54

That's just let's just talk about speaking of education, man, ongoing education. Let's talk about that concept of using futures to stack and what you're gonna get for stacking. Right? So one of the topics that's been coming over up again. There's two areas here.

It's what does a futures contract give you for real? Right? Like, what you I buy a 10 year treasury What am I actually gonna get at the end of the year for that? Am I gonna get the price return? Am I gonna get the total return?

Am I gonna get the total return plus cat like, what if I were to use just the futures contract, what am I actually getting? I think people are confused by this when we talk about even stacking the S and P on top of some sort of bond ladder. What are you getting? So can anybody try to decompose that for me?

Adam Butler: 46:41

I think as punishment for the 3¢ he's committed here, Already on this show. Corey should have to answer that.

Corey Hoffstein: 46:47

What are what are the what's 3?

Michael Philbrick: 46:50

Private equity, 4% is fine. Those 2 are obvious.

Corey Hoffstein: 46:53

I think I think I'm just this is what happens when I show up as the only newfound guy on an all of this.

Adam Butler: 46:57

The third one was saying that you can replicate Manage Future for the 9 contracts. Things are gonna be we're gonna ain't gonna get heated, dude.

Corey Hoffstein: 47:05

I said in the that month, you could. Doesn't mean every month. Okay. Yeah. This one comes up a lot, you know, so so I think the intuition people have here is if I buy a treasury note futures, a 10 year US Treasury note futures, well, that future isn't paying me a coupon.

So it must be giving me the price return of the bond, not the total return of the bond. Or if I buy S and P 500 futures while I'm not getting paid the dividend, Right? So it must be the price return of the S and P 500, not the total return. And in fact, it is the total return that you are receiving in excess of the embedded financing rate that the futures are are charging you for the leverage that you're getting. And and the intuition here, in my opinion, requires recognizing that the way futures work, the way they are price has really nothing to do with the market's view of what's gonna happen in the future.

One of the core principles of financial markets, especially derivatives markets, is this idea that, quote, pricing is replication. But if I can replicate a trade the price of that replication gives me the price of the derivative instrument I'm trading. So what does that mean with futures? Well, Rod, I'm gonna pick on you and and use you as an example. Let's say you wanted to buy from me a 10 year US Treasury note 3 months from for a certain amount of money, What amount of money should we accept?

Should we both accept that you're willing to pay and unwilling to receive to give you that US 10 year US Treasury note? Well, You and I could just think of some numbers, or I could go back to my desk and do some math and say, well, how would I hedge this trade? How would I ensure that I can deliver that bond to? Let's assume 10 year treasury notes are trading at par, a $100 face. So I will borrow a $100 and buy a 10 year US treasury note.

Over the next 3 months, I'm gonna collect the coupons. And at the end of 3 months, I'm just gonna hand you that treasury. You're gonna pay me whatever that money is And then I'm gonna go back and repay that initial $100 borrow plus any interest I owe. So the p and l of that trade is Whatever you agreed to pick me, plus the coupons, minus the $100 minus interest. And if markets are efficient, p and l of that trade should be driven towards 0.

Right? And and you can sort of rearrange those terms and say, well, all that has to equal 0. Well, that means that that amount you're willing to pay me should be equal to that $100 minus plus the interest minus coupon. Correct. They to map backwards my head.

Minus coupon. Excuse me. Plus, yeah, plus interest minus coupon. And what's what's important there is that, again, none of that has anything to do with the view. That we have.

Right? And it has everything to just do with what is the cost of replicating. And and the important points are that that interest is The interest that's embedded in the futures price, that's the that's the interest of cost of financing in the futures. But the larger that coupon is the lower that value that you're willing to pay me. Why?

Because that value is gonna roll up the futures curve towards spot, and you're gonna earn that coupon in the price return. And the same thing happens with Equities and dividends. A little bit different because dividends, they're getting forecasted out 3 months, and you may be right. You may be wrong, so maybe you have to charge a little bit of Corey premium there, depending on how certain those dividends are. But the idea there is that those yield elements are actually being captured in the return of the futures contract itself.

And so it is a total return vehicle minus that embedded cost of financing. The last thing I'll say then is, alright, what is that cost of financing? Well, again, assuming competitive markets, people who have access to cheaper financing, are gonna be able to do this trade and capture more profit. And so competitive market forces will typically drive this hedging trade. To the parties who can execute at the cheapest, those who can trade the underlying the cheapest, those who have access to the cheapest borrow, Corey something like treasuries, that's gonna be big banks who have access to overnight repo.

And so the overnight repo rate is actually the embedded financing rate in treasuries, which is his historically look ton like 1 to 3 month US Treasury.

Rodrigo Gordillo: 51:27

Yeah. It's just if anybody ever kind of questions where those return drivers come from. All they really need to do is do. Okay. I can buy a future contract.

What will the future contract delivery in 3 months give me? Okay. Now what do I need to do mathematically if I go to my bank and I need to borrow Corey, I need to buy a a security, need to understand what the future price of that is after coupons or dividends, if you're doing equities, whatever it is. If you do that math and you get a number that's different from the futures contract, then you have an opportunity to arbitrage. Right?

So you're like, you've figured something out. Great. I'm gonna go to the market. I'm gonna grab what I did here with the math. I'm gonna borrow the money from the bank.

I'm gonna buy this contract. And I'm gonna I'm gonna do the opposite trade within my futures contract, and I'm guaranteed for that to come in. Now that does happen And it happens by every market participant that that is playing that trade in a high frequency trader, any prop trader, they're constantly playing that game. That makes the rest of us who are just simply assuming that we're getting a fair price in the future space to get a a fair price in that future space most of the Right? So that's, I think, when it comes to a futures contract, all in all, is that what you're gonna get just to answer my own question from the beginning is, you're gonna get whatever the return of the of that contract.

Let's say the treasury note minus the cost of financing. That's what you're gonna get in the future contract. And that financing cost is gonna be the cheapest financing costs you can get. You can't get your bank to give you better pricing than that. And if you do, then there's an arbitrage opportunity there.

Corey Hoffstein: 52:55

And what you typically find is in instruments like the S and P Corey example, S And P Futures, the cost of financing is a little bit higher than the cost of financing in something like Treasury Futures. And historically, it's because it's harder to execute that arbitrage trade. Cost Corey to accumulate all the S and P 500 stocks, and those dividends are less certain. So the right that that that yield that were formed. You know, we had to come up with a price today, but that dividend yield in the future, well, you could run into a 2008, and all those dividends could get cut in the next 3 months.

Like, they're not all necessarily declared with certainty. We have a much more certainty about treasury coupons, and so there's gonna be potentially a little bit of risk premium baked in there. And so those sort of things mean, right, we can be thoughtful about how are we trying to achieve leverage in the cheapest way possible. Treasury futures have historically been one of those markets where we can get leverage in in some of the some of the cheapest borrow you can find on the planet, in my opinion.

Rodrigo Gordillo: 53:51

Perfect. So, look, we didn't get through everything we wanted to talk about today. Sadly, I have to get going, and we have an hour. So we're gonna try to keep this under an hour for the most part. Next time we have, I think one of the key things that we're gonna talk about next time is the inverted yield curve and how that's affecting futures and stacking and you know, why we should still or not be stacking based on the the future's yield curves to stick around for next month, make sure you are liking scribing, make sure you're getting that feed when we publish the next podcast.

In the meantime, anybody else have any announcements, anything else to say today?

Adam Butler: 54:27

To get up to that 4%, man.

Corey Hoffstein: 54:29

I I feel like I need to apologize to Adam and repair our relationship here. I'm not sure if you'll talk to me until we until next time we record.

Rodrigo Gordillo: 54:35

Yeah. You guys can hug it out after the recording. Alright. Thanks, all, and, we'll see you next time. If you're enjoying the podcast, please consider heading over to your favorite podcast platform and leaving us a rating or review and sharing us with friends or on social media.

It helps new people find us and helps us grow. Finally, if you'd like to learn of return stacking, please do head over to returnstack.com.