Full Transcript: Andrew Beer on Managed Futures
Why a Complex Strategy is Actually Very Simple
Justin: Andrew, welcome back to Excess Returns.
Andrew: I’m so happy to be back guys. Thank you.
Justin: We we’re coming off of Thanksgiving. We were talking about cooking and speaking of cooking, you’re doing some cooking in the managed futures, ETF or managed futures, hedge fund, replications space with a lot of your strategies.
And, we’re gonna work through, some of those strategies today, but specifically. You are involved with the I-M-G-P-D-B-I managed futures ETF, which is ticker symbol DBMF. You also have another ETF out there that you advise on ticker symbol QALT, and then you recently announced, which we were talking about right before the podcast, started a new partnership with Simplify, which we’ll talk to you about.
So all good stuff and you’re having a lot of success. A lot of adoption with the, these alternative strategies that you’ve been on the forefront of. So, so congratulations to you.
Andrew: Well, thank you. Thank you. I hope we’re just getting started. So, yeah. It’s, but it’s great to be back here to, to be able to talk about it all.
Justin: Yeah. Awesome. Thank you. And so our audience, is very wide ranging and so I think we, we’ll start today is just with some of the basics. Maybe we don’t spend too much time there, but it’s good to do always a refresher with strategies that people might not be that familiar with. And you’re a great person to explain that.
And then we’ll kind of get into. Some of the stuff that’s important to you, some of the things you’ve been talking about, the rush to complexity with some of these strategies and maybe the hidden risks and things like that. And then also just how these types of approaches can work within a diversified portfolio and why they offer such a important ingredient when it comes to sort of different types of diversification.
So, lots to cover with you in the next hour or so. But to start, let’s just kind of. Have you explained like, I’m in second grade, or maybe I’m a sophomore in high school, or whatever it might be. Like, what, how would you explain what managed futures actually is?
Andrew: So, so it it, it is, it is normally very hard to explain.
So the moment, the moment you go into the weeds on it, so it, it is at its core, like I think anybody looking at it would think, wow, this is a complicated strategy. You’ve got a bunch of quants who are. Building models and then looking at prices across all the, all these different asset classes.
And, and so one of the ways in which I talk about it is I’m not, so, I’m not a quant, right? I have a, a long history in the hedge fund industry. I’m fine with numbers, but I don’t program, I don’t, I didn’t, I didn’t go get a PhD in economics. So, so I think what the question people often ask me is, okay, so you’ve got this strategy that from the outset looks like a black box.
Like how did you get comfortable with it? And, and, and, and the way that I’ve gotten comfortable with it, which is just, and kind of the simplest explanation of it, is it’s kind of like a crystal ball. It’s that simple. That, that, that whatever these guys are doing, the complexity underneath the hood is sometimes they get a clear view of what the world’s gonna look like in a year or two.
And they invest and they make money on it. And so, just to give you an example, so we’ve been doing this now for about a decade, but if, if I was like a human manager talking about my portfolio and some of the successes we’ve had or, or you guys are writing about it or somebody who’s writing about it, they would say like, oh, aren’t those the guys who started shorting treasuries in September of 2020?
Like before inflation hit in the middle of COVID? they, could see something that nobody else could see. And then, oh, the dollar took off over the next couple of years as inflation come, came back and they were right early, early and right contrarian, early and right on those trades. last year we were buying gold below 3000.
Okay? So what people want when they think about these kinds of strategies is they want to hear that somebody was contrarian early and right. And that’s where the big money is made. Now, the thing about this strategy is the way this strategy, by the way, when I say a crystal ball, by the way, sometimes a crystal ball can be very cloudy, right?
So like sometimes it can look more like a snow globe than a crystal ball. But, but, but, but, but every now and then you get a very clear view of what the future’s gonna look like. And for an allocator and for an investor, it’s so important because those big, those, those key events, those big. Ways in which you have an opportunity to make money are things that traditional portfolios just have not been very good at giving you exposure to.
And so I think, I think with the strategy that the most interesting thing about it is that, and look, we can go into the nuts and bolts of exactly what people do on it. I don’t think it matters at the end of the day, I think what people care about when they’re looking at my portfolio is good. I know what my stocks are gonna do.
I know what my bonds are gonna do. Wh what can I add to my portfolio that’s going to, that’s gonna add something more than the cost of moving it away from my stocks or bonds? And so I think, I think that’s the nature of diversification. And so I sort of as a, as an outsider, fell in love with this space 10 years ago.
‘cause I thought. God, it’s so unusual what this does, and if you can start to add it into people’s portfolios, then you can make, not, not not a thousand people or, or a bunch of big pension plans or, or big family offices better off, but you can make millions of individual investors better off as a result of it.
So that’s about as high level as I can be, which is basically, what you care about is something that can give you a view on the future and manage as a strategy actually sometimes feels like a a, a functioning crystal ball.
Justin: Yeah. So it sounds like the strategy has the ability to go to all different types of asset classes, which I just want you to spend a minute on maybe talking through what those other asset classes are, maybe the top ones that most managed future strategies are getting some exposure to and how does it.
What is the signal, what is the mechanism that strategies go about doing that? Like how are they selecting those, various asset classes?
Andrew: Sure. So, so, okay. If you think about kind of the broad. Investment world, you’ve got four major asset classes, right? Equities are easy. We all know about equities. then you’ve also got rates.
Okay? So again, we open Bloomberg in the morning or whatever, and we want to know like our, it’s a 10 year treasury going up or down, what’s happening to my bonds in my portfolio. Then you move from there, you go into commod. Okay, well, we care whether gold is going up or down, whether oil is going up or down.
These are kind of indicators of the macro world. And then the last one, which is a little bit more esoteric, particularly for Americans who tend to have a very dollar centric view of the world, is what’s happening in the currency markets, right? So equities, rates, commodities and currencies. Now, what funds in this space do is they are often looking at 200 subsets of these markets.
So yes, they may be looking at the s and p 500 for equities, but they also might be looking at the, for Japan or the Thai stock market or all sorts of different individual markets in the same way. They may look at gold, but then also look at platinum and silver and all sorts of other things. And, so, so years ago I started a, a commodity business.
And what, what, what struck me about the commodity markets is that you have these people who know those markets better than any other. I mean, you can’t believe how well they know these small segments of, of the markets. And, and they often had the great information edge. They knew something nobody else would do, would know.
And so what happened is, is, is, they would know that supply and demand were outta balance. They’d start buying some, so something would be a 10 for a long period of time. And they’d be buying it up to 11. And a lot of people who owned it at 10 think, wow, great. It’s gone up 10%. Maybe I should, maybe I should sell some, maybe I should get out.
Maybe I should. And, and yet they’re buying more at 11 and then they’re, it goes up to 12 and they’re still buying more. And so what, what prices across these different asset classes can, can, can sometimes be a window into is that somebody knows something, somebody knows the world is changing and, and, and they’re willing to.
Keep buying something as it goes up, or they keep selling something as it goes down and in, in, in kind of quant, statistical world, those are called trends. So, peop more people like it at, at at 12 than they like it at 10. Okay. And they’re, and they’re still buying it. That’s a trend. Okay. And trends happen for two reasons.
The other happened because the world is actually changing. Okay. Nvidia is a very different company than it was three years ago, right? I mean, there is legitimate demand for more legitimate demand for what, what Nvidia is doing today than there was three years ago. But then there’s also, the second factor is also sentiment.
People are gaga crazy about Nvidia and AI and, and so, so pri information and, and sentiment will, will, will, will drive prices changes over time. It’s the changes in information that’s the crystal ball component of it. that’s when, that’s when in, in the summer of 2020, when, when treasuries, remember 10 year treasuries were yielding 50 basis points.
And a lot of very serious people thought treasury yields were gonna go negative. We’re gonna be in a world of global deflation for years to come. And, but other people knew differently and, and they got down to 50 basis points. They started climbing back up to 70 basis points by September. That little window was enough of a signal for the people who invest in the space to basically make the argument, the deflation trade is over. It’s time to be on the other side of it, the beginning of an inflation trade. So if you’re in your, second year business school class and you’re taking a class on, finance or whatever, they tend to say like, markets are perfectly efficient or reasonably efficient, and past prices are not indicative of, of, of future performance.
Usually that’s true, but sometimes somebody knows something and so, so that’s what I found so appealing about the strategy. It’s a way to basically tap into. The a people who know these different local markets that are making bets Now, it doesn’t work all the time, obviously, and that’s the, that’s the challenge of it.
But when it works, it works unbelievably well.
Justin: One of the, things that you’re talking about is the importance and how these ads sort of a level of diversification to a portfolio, particularly during maybe a time of stress or change or some disruption in the market or some trend that’s happening.
Do you have any, and I know there’s. thousands or tens of thousands of these managed futures type strategies. I mean, you run yours specifically, but just in terms of like the long-term evidence, of integrating, and we’re talking generally now, so it might not be even a question that’s answerable, but is there any, like, how would, like a sharp ratio, the risk adjusted return of a, diversified, let’s say 60 40 portfolio, how would that be improved?
By integrating one of these strategies. Obviously there’s different weightings you can have, but I’m just talking in general here. If you can comment on that and if the, if the evidence, and I think the evidence is pretty strong, that, that these strategies can be extremely good in terms of offering diversification.
Why do you think, investors haven’t sort of embraced or utilized more of these strategies so far, in today’s market?
Andrew: No. So, so, so we fell in love with it from a statistical perspective. Right, and, and, and, and the, the two statistics that are very, very rare in a single strategy are that it has no correlation.
It truly marches to the beat of its own drum. It has no correlation to either stocks or bonds. For a long time, stock and bonds, again, had either zero or slightly negative correlation during the great, so the, the, the 2000, 2000 tens, you really didn’t, I mean, bonds were a fantastic diversifier against stocks.
They just kind of steadily went up with the great bond bull market. They like no volatility, they never went down. but um, but, but this decade or the past 10 years have been something of a disaster. Right. You’ve had a negative sharp ratio for bonds, for the Bloomberg gag, and you’ve had a, a draw down, not a 4% draw down, but like a 20% draw down across, across bond portfolios.
So, so. If you can bring something into a portfolio from a statistical perspective that has zero correlation to stocks and bonds and tends to do the best when the markets are at their worst. So the.com crisis, the, GFC in 2008, the return of inflation in 2022, when that is very, very powerful from a modeling perspective.
Right? And so if you go to your financial advisor and you say, just kind of run me a. An an unconstrained portfolio. That’s everything you have in my portfolio today, plus managed futures as a strategy. Managed futures will be like 20, 25%. Like it’s that valuable. The problem is it’s a quantitative, long, short term to base block box.
It is. It is a highly technical strategy run by quants who like to talk to other engineers about all of their quant. modeling improvements that they’ve made. And, and, and so you get, you kind of run into this wall where it’s good for the portfolio, but it’s hard to explain why somebody should be happy about that.
And I always tell this story, I was asked to, to come to London two or three years ago and give a speech in front of like the equivalent of RIAs in London. And I had 12 slides that went through all the diversification benefits of the strategy. and again, I mean this has been, I mean, it’s done this for 50 years, right?
So it’s not, it’s a, this is a structurally sound way of, of generating alpha, we kind of call it. And, I got through false slides of all those, diversification benefits and I, and, and my 13 slide is basically, and none of your clients are really gonna care because I said no one is going to give you a hug after 20 years for raising their sharp ratio by 0.05.
Right. The, the reality is you live client meeting to client meeting client conversation to client conversation. And, and if you can’t find a way to talk to them, if you can’t explain the difference between, I don’t know, stocks and bonds or, or ETFs versus mutual funds or whatever, it’s, it’s, how are you gonna explain this strategy?
And, and, and I think the people who are in the space, I mentioned kind of, it’s a space. Populated by engineers. they’re used to talking to allocators who are very technically sophisticated. They don’t have to sell them on modeling and, mean variance optimizers and efficient frontiers and things like that.
They’re already bought into it, and what they want to hear are, are, what are the cool, what are the cool new statistical things you’ve done. In, in your models. And so the lang, a lot of the language around the space is I, is is around, Hey, we’ve got the best black box, what? And his black box, well, it’s my black box is better than his black box.
And then, then the other person goes, is actually my black box is better than his black box. I think it’s a terrible way to look at the space because, because, because I don’t think, I don’t think anybody wants black boxes. So, so I think what they want is in 2022, do you have a strategy that’s early contrarian and Right.
And goes up 20% when everything else is down. Like that’s what they want. And the next year when it doesn’t work as well, they, they want an explanation as to, okay, so I’m, it is not gonna do it every year, obviously, but how do I. there’s gonna be more crises like this. 27 may be a terrible crisis.
26 might be a terrible crisis. We’ve still got December to work through, so, so, people want to be told about the outcomes and why it fits in their portfolio and why it’s gonna help them, and how it’s gonna help them grow their assets and sleep at night. And I am almost single-handedly leading that charge in that I think this should and will become a mainstream.
Allocation allocation across portfolios. but it requires a real shift in how you talk about it.
Jack: It’s funny because I’ve, I’ve kind of been sitting in your seat. ‘cause we use, in all of our diversified portfolios that have stocks and bonds, they all have managed futures. Now, we do it a hundred percent and like when I’m talking to clients about it, like I’ve learned that what I need to talk about is the what, like what this actually does in the real world.
And what I need to not talk about is the how. because I get into, oh, it’s so cool. They can do this and they can do this. And like all they’re hearing is complexity, complexity, complexity, complexity. Like the clients are not excited at all about that. But when you talk about what it actually does in the real world, the diversification benefits it provides, and how it often at least can do well when the stock market’s down, when you need it the most, like that’s what people care about.
And it’s like getting away from that complexity and getting to that is the key to this whole thing.
Andrew: Oh, completely. And, and, and if you think about like, the great benefit, right? So a, a model, the fact that your clients are in model portfolios in the first place, right, is a relatively recent invention, right?
In the 1970s or 1980s, or even 1990s, if you went to an advisor, they were often picking individual stocks for you and building bond letters. and so, and so, this whole idea of the value of diversification has been disseminated through the advisor community, the asset allocator community. And one of the core principles of it is don’t overreact to flare ups in information.
Right? So liberation day happens. Don’t panic, don’t dump all your stocks, whatever, because, and, and you’ve, for most people, you’ve set it up structurally, so. The way that we’re gonna manage that is we’re not gonna even look at the portfolio until once a quarter. And then by the way, we’re, and when we make adjustments to it, we’re gonna make them slowly, right?
And so I had this, I had this really funny experience with it in, oh, and so, so, so, so the benefit of the strategy, just as it compliments the rest of what you do, is that it actually can move fast. And it can jump on things. And I, so I had this, I had this incredible experience in, in early 2021, January, 2021.
I wrote a little note about the possibility of the return of inflation and, and I said, basically like if you’ve got a model portfolio and inflation comes back, you’ve kind of got a problem. And I, if you’ve, if you’re in a 60 40 portfolio, you got 40% of your bond, of your, of your assets in something that’s, if inflation comes back, it’s gonna get killed.
Basically, and I went on and talked to a lot of advisors about it, and, and I, and I was using an example of this great hedge fund manager named Stan Druckenmiller, had talked about it and, and, and I said, look, the guy’s got a really good track record, for like 30 or 40 years of getting this kind of stuff right.
And, and I said, what are you gonna do about it? And most people said, well, nothing yet. Nothing yet because we’ve seen these flashes and we’ve seen these head fakes and, and I remember talking to somebody at the end of 2021 about it. Now remember, end of 2021, you people have been talking about inflation now for months and months and months and months, right?
And, and, and they were dialing up their bond exposure at the end of 2021 because equities had gone up, but bonds hadn’t. And so in order to rebalance, they were selling their equities and adding more bonds. At the moment, inflation was coming back. So, so model portfolios are incredibly valuable to the average investor because you, you get diversification.
You don’t focus on the, the day-to-day vagaries of, of, of, some tweet that’s, blown up the markets or some geopolitical event that causes these short term disruptions. But they do have the, the slowness does have a disadvantage. Only at specific times. And those are, and that’s when the world changes a lot.
when we go from a functioning financial system in 2006, early 2007, to basically having no financial system by the end of 2008, that 18 months was very, very, very hard for traditional allocators. and, 2022 was like that. So, so, so the value of it, of a strategy is that, when the world’s gonna change like that, even if it’s a cloudy crystal ball.
It’s, it’s, it’s valuable to have in your portfolio. And so I think, I think the way, back to Justin’s question, we all know the statistical benefits of the space and, and what fascinating thing is, so about three years ago, I started to make this big pitch that this would just become, as, as, as, as people are developing this now, this like 20% alts bucket, it used to be just kind of stocks and bonds.
And now even people who were very, very late to the game are adding this 20% alts bucket. The question is, what do you put into it? And, and my argument was, 3% of the 20 will be managed futures. And that was a very radical idea three years ago. Fidelity says it now. BlackRock says it now. Invesco says it now.
Like, like the big asset allocators. They’re realizing the, the, the, the, the, the benefits of the strategy and they’re adding it. But, and I think this is where you get back into the human element of it. it’s, it’s, you need a narrative around it to explain to people how this is gonna make their lives better.
And, and I think that’s been a real challenge for the space. And I’m, look every day I’m trying to get a little bit better at and, and, and, and find a way. ‘cause without that, look, if, if leveraged buyouts were still called leveraged buyouts, they wouldn’t be the asset class that they are. But private equity, that sounds a lot better, a lot safer, junk bonds became high yield.
so I think, I think the, the, the narrative component of it is critically important.
Jack: Yeah, that, that narrative gets it, like the most, the biggest challenge I’ve seen with clients, which is the idea of line item risk, which is, people are so anchored on stocks and bonds, like if anything’s going up and down with stocks and bonds, they can kind of explain it.
They can be like, oh, stocks went up, or bonds went up, and that, that explains what this other thing is doing. to your point before there’s zero correlation with this. So basically I can’t use stocks and bonds to explain what this is doing. Yeah. And that becomes a challenge during the periods. It can be a really, really great thing in 2022, but it can, it can be a challenge during the periods where it’s just different and you sort of have to explain.
So do, do you have any tips in terms of how you explain things during periods like that in terms of getting people to stick with it?
Andrew: Yeah. So, so, so it’s actually part of the evolution of our business, right? And so, so people understand how the background of the business when we looked at this space, okay, my, my partners are great quants.
And when we looked at this space, we thought, well, we could, we could kind of do what these guys do, we could build our own models and pursue it. The, the problem that we, there are two problems that we have with it. One is that, it, there was a lot of, unpredictability. So it’s like, it’s like trying to pick the best.
Stock in a particular area, trying to pick the best model, kind of had the same problem. So you could get it really ready, you could get it really wrong. The, the second issue was that we thought it was a very inefficient way to invest, right? So if, if somebody called you tomorrow and said, I just spoke to 50 Micro Cap, CEOs and, and they all think the economy is falling apart and, and they’re desperately trying to sell their own stocks about it, your answer is not gonna be like, oh, well I better go try to short those 50 micro cap companies.
You are gonna be like, get me out of the s and p 500. Okay. Because, because the tide, the, the tsunami is cresting over me. And so when we looked at this space, we thought, wow, an incredibly valuable signal, this, this idea of this kind of crystal ball. The problem is that, that, that I don’t need to 40 or 50 bets, to bet that inflation is going up.
To bet that gold is coming back, to, to, to bet on the, these kind of big macro themes. So, so, so what we do is we basically look at the space overall by looking at the, the, the, what the top managers in the space are doing, and then condensing it down to this really simple portfolio of just 10.
major markets. So we care whether the s and p is going up or down, whether the 10 year treasury, whether, the yen kind of big, those big things, golden oil. And so, so, so the crazy thing about what we do is that it’s so efficient relative to these hedge funds around fees and everything else is, it does about 300 basis points a year better.
And, and in a sense, rather than creating one of these active strategies, it’s not my opinion, we just basically just build this, this. This, this, this model, this box basically, that tells us what’s, what the weights are every week. We haven’t changed it in 10 years that we started doing it. Now, the next evolution of our business, which I think gets back to the question that that you’re asking Jack, is how do we take this from a strategy that feels risky, feels riskier than it is, and make it something that feels less risky?
And, and, and so a bit over a year ago, we ended up creating an index around what we do. And so I just told you about the space that’s really valuable. Now, imagine a space that’s really valuable, but 300 basis points more valuable just through efficiency and they can be accessed in an ETF or other, other client friendly vehicles.
And so my belief is that, so for instance, when you invest in gold and gold goes down 4%, my guess is clients are not like we should be selling gold. ‘cause it went down 4%. even if, if, if tech stocks go down 10% or 20%, again, it’s, there’s a belief that this should be part of my portfolio. It should stay in my portfolio.
I don’t have to stare it every day and decide when to get out before something bad happens. Right? So this perception of risk in this space is, is much higher. I think if you approach it as an asset allocation decision. Not as a manager selection decision. And my recommendation would be you start with this index that we created, the index, which has data back to 2002, and you say, that’s what we’re trying to access here.
And then you invest in a product, an ETF, that tracks that index and you use that index in your client reporting. Okay, what you now have is, okay, the space went down 4%, not my guy went down 4% because then everyone’s like, what’s wrong? Like, it’s something, it’s like a, this is, the cracks spreading underneath, underneath my feet.
So, so I think, I think you get the narrative right and then you approach it as an asset class decision. And then if you offer a product that has keywords around it, index based, passive. Low fee, tax efficient, right? Then for most investors who are used to hearing that around, GLD or, things that are, are, are ways of getting exposure to these different asset classes in return streams, but in a, what feels and looks very client friendly, I think it helps people.
You, you take all those three things together and it, and it helps to open the asset class to people who otherwise might be. adverse to investing in it.
Jack: And it just takes time, with people becoming familiar with it. Like, one of the things I was thinking, one of the questions we were gonna ask you about, which you just sort of got into, is this idea that if you look at the managed futures ETFs that are out there, their performance can be all over the charts, in any given year.
And so people don’t, but like then I think of myself as an equity investor and I’m like, the, the large cap growth guy in the small cap value guy, their performance is really, really different. So it’s not really anything that’s different, it’s just because it’s a new asset class. I think people have to get like comfortable with the same exact thing being wrapped around that, if that makes sense.
Yeah. Well
Andrew: I, so I think, I mean, I think one of the things that the space does, so, so this is kind of getting into the weeds a little bit, but the space overall, people spend a lot of time in energy trying to talk about why there are black box is different from the other black box, right? And I’m like, I don’t think people do that with, like, if you bring in three large cap managers, none of them.
Kind of, we will sit and kind of spend as much time dumping on the other two managers as, as the, as, as, as people tend to do in this space. ‘cause it’s always, it’s always, I made this modeling decision and they’re fools for not doing it is kind of like the attitude in it. And it’s, so, it’s funny, I was, I was actually just in a conference with a bunch of these guys and, and, and they’re all sitting around the table and they’re like fierce arguments going back and forth about these different modeling techniques.
And, and my, my last comment on one was I said, I said, guys, I think, I don’t think this is good for the space. Right. I think if you walk in again and they say, well, they’re not trading Malaysian palm oil fools. Like, fine, okay, you’re talking to an institutional investor who’s got a guy at a consulting firm on the other side of the table who loves this stuff and lives and breeds it fine.
I’m much more interested in the person who’s got, a few million dollars of net worth and the zillions of people like that. Who could have this in their portfolio and have a better investment outcome in a year, like 2022 or over the next 20 years. by virtue of having this in their portfolio, which we know we, we, we know, we know is valuable.
And for that person, I just don’t think it helps to, to, to, to dive into the weeds and ‘cause it just, I, I mean, try explaining to my sister like, what a, what a Wheat Futures contract is. I mean it, that is so far afield of her knowledge base. And she’s got a, she’s got a real invested portfolio.
But again, it’s, it’s all about what, it’s like, why, why should I take X percent of my hard earned money and put it into this thing and be happy about it? so look, this, this is my, this is, I mean, the, kinda the broader business plan that I made, that I laid out. 10 or 15 years ago was, for God’s sakes, can we make investing in alts easy?
Like, I mean, so much brain damage goes into which funds and, and oh, it’s really expensive, but is it worth it? Or whatever. Can, can we just make it as simple as buying a a, a low cost ETF and yes, do more complicated things if you want to, but as a starter kit, can we have a simple plug and play solution that gets you.
Essentially what you’re looking for from a diversification perspective. And, and then, and, and that I think the industry has never really been able to do. And that’s, that’s sort of our vision of, of where, of where, where we’re trying to get to.
Jack: And in terms of this becoming mainstream, how important is the fee component?
‘cause you talked about you have an index, there’s going to be a product at some point that’s gonna be lower fee. Yeah. Using that index. In terms of getting your average person, ‘cause I, one of the things I’ve definitely noticed is everybody is very, very fee conscious these days. Like, they don’t care if the, after fees, the thing is outperformed significantly.
It’s just like, I’m, I’m gonna pay low fees. So how important is that part of it in terms of making this mainstream?
Andrew: So I, I think it depends on what you mean by mainstream and who you’re talking to. so the, the part of the market that I spent a lot of time thinking about, so, so, and for compliance and regulatory reasons, I can’t talk.
Very specifically about products that we’re involved in managing. but, but, but we, we do sub advise a large managed futures et TF that has an 85 basis point expense ratio, right? And, and it would be a great addition to lots and lots outs in et TF, right? And, and so what I set out to basically prove was that if you ask a typical alligator and you say, all right, if I can get into the hedge funds, it’s gonna gimme this kind of return.
If I can’t get into hedge funds, it’s gonna gimme that minus couple, the mutual fund version’s gonna gimme that minus 200 and the ETF version is not even worth investing in. And what I wanted to show is that actually we could do better than hedge funds in an ETF with, with transparency. And we’ve done that.
the, But, okay. Now imagine you have, you’re, you’re running a model business that 10 years ago you said, We think ETFs are a better mousetrap. They’re more tax efficient, they’re very low cost. Vanguard is in their setting pricing, which is helping everybody. We’re gonna put together a, a, a portfolio for you that’s gonna be 60 40 or a variant of it, of low cost ETFs.
Now. You look at that whole port. So now you’ve been sold, you and a hundred thousand other people have been sold that low cost index based ETFs that are more tax efficient are a way for you to grow your assets more reliably over time. Right? So Bogleheads basically doing that now, somebody comes along and says, I can make it better with an 85 basis point active ETF.
That is a, is basically a simpler, cleaner, prettier version of lots of black boxes. It’s, the conversation doesn’t even start. And so, so, so I’ve been fascinated with this multi-trillion dollar audience, and Bloomberg’s published great data on this. Like the average, I mean, 80% of ETFs or something are still below 20 basis points in expenses.
So I’m always interested in, in, in seeing if there’s a way to build products for what we call greenfield markets, where nobody has exposure to it already. So I think for an audience like that. 85 basis points is a non-starter, but, but 20 or 35 gets interesting to them. I think if you can, a lot of those things are very, very tax, sensitive.
there are certain things you can do on, on, I mean, again, there’s this huge intersection between ETFs and kind of sophisticated derivatives and, and tax planning. If you can make it more tax efficient, it opens up a whole new segment of the market. so, on the other hand, there are other parts of the market where.
I think having an 85 basis point ETF, when your competitors are 170 basis point mutual funds, you should clean up in that market. so it really depends on, I mean, we think about kind of the, the, the, the retail, US wealth management landscape. It’s a highly fragmented, highly balkanized world out there.
And so what I’ve always said is, is, you can be a niche. Product and, and, and figure out how to address certain subsets of that, of that market and still find yourself with $50 billion.
Jack: Is it this idea of the rush to complexity, and you wrote about this and how everybody, and we’ve talked about it a little bit earlier, how everybody’s getting more and more complexity strategies.
I mean, is that a response to the lower fee products becoming available now? Like, I’ve got My edge has to be better than your edge, so everybody just gets more and more complicated.
Andrew: Yeah. so, so I, I think the. Look, I, I, I, I made it out of that, that conference with hedge fund managers alive, so I can now be a little bit bolder in my statement.
Look, I, I think, I think the dirty secret of this space is that people figured out a way to do this like 50 years ago, and it, and it, and it just works better than a lot of the things that people have tried to innovate and bring to it. So, and it, the way you think about it as an asset allocator is there’s a beta here.
An alter, it’s not, it’s not a beta like stocks, but there’s a return stream here of the strategy, which call it a beta, call it an alternative beta, call it a risk emia. and the, when I talked about kind of the inefficiency of doing it the old fashioned way. I think what’s happened is over the past 15 years you’ve had a, a, it, it was a relatively cushy business 15 years ago.
It was hedge funds competing with hedge funds, competing with hedge funds for money from investors who didn’t really care what they paid. And over the past 15 years. some asset managers, a QR kind of blazed a path on this by all of a sudden cutting fees and kind of trying to make it more client friendly.
They call themselves the, the fair fee hedge fund guys, which applies in certain circumstances, maybe more than others. and, and some other people started offering, weren’t considered lower cost mutual funds, and then banks came out with their own kinds of products and, some firms started to cut their fees aggressively.
So, so in, in a broader, and then we come along like we’re kind of ruining the party, so. In, in a broader world where these people feel pressure to justify higher fees, the, the, the gut response has, has been to say, look at all these new things I’m doing that you can’t do with simpler products. The, the terrible irony of it is I think a lot of those new things that they’ve introduced are actually hurting their investors.
so. So our history was that, we, we launched this way of copying these big hedge funds. We beat ‘em in 20 16, 17, 18, 19, 20, 21, and 20 10, 22. And we underperformed ‘em in 2023. And, and, and so the hedge funds came out and said, ah, we knew, like, it, it was only gonna work for a period of time.
It was only a, this, this, we were waiting for it, it’s now it’s gonna, bro, break. And they were kind of doing this little victory dance. And then we’ve done much better than them at 24 and 25. And so I think, I think it’s, it’s, it’s the, I think there is this existential crisis in this space is why would you pay up for complexity?
Like, for, for, why are you trading 400 instruments, not 50 like most other strategies. You want people to concentrate their bets where they can make the most money Here there’s almost this, this like religion about, let’s touch as many markets as possible. ‘cause they sound cool. there was a, in, in, in this conversation, I was this, round table I was on, there was a discussion about the, I think it was the South African sunflower seed market or something, or sunflower oil market.
I was like, it’s like, no, that even existed. Literally. I mean, I think the three of us could corner that market if we wanted to. Like, so, so, yeah, so look, I, I think, I think that’s the way people have responded and I, I will tell you that there are allocators on the other side of the table who eat it up.
It’s what they want to hear. They want to hear about all these new innovations and stuff. look, I take a step back and say, somebody tells you all these innovations they’re doing today, the question should ask yourself why? Like, why did you do them three years ago? Why didn’t you do them five years ago?
We’ve had the same technology, we’ve had the same information. or are you doing it ‘cause something? And what you did is broken. so, so yeah, look, I think, I think, it’s been a very, very strange year. It’s been a tough year for this, for the space. You talk about a snow globe. I mean, Trump, Trump and I, one of my quotes was there’s noisy and then there is, Trump noisy as it relates to markets, like his ability to kind of swing markets around that.
I think the serotonin kick he gets from getting it has made it a very tough market to kind of tease out. What’s really happening and, and, and, whether the world is really changing or not. but, but it’s been an exceptional year for the simpler, more straightforward, more efficient approach.
Jack: I wanna ask you on the other side of that, ‘cause one of the things I, I struggled with when I first decided, like to use these is there, there are some, products I won’t name, but that go all the way to the other side of the spectrum, which is basically if I’m gonna diversify your stock and bond portfolio with managed futures, I won’t even put the stocks and bonds in there.
I, I will just put the other things we do and so therefore, if, we have some sort of sell off that the managed futures don’t catch up with, you’re more diversified. Do you, do you have any thoughts on that idea about like trying to eliminate those asset classes from a managed futures and how that plays into diversification?
Andrew: You mean like getting rid of equities as a, as a, yeah, I’m
Jack: saying basically equities and like there, there’s some ETFs that are out there that don’t use equities and bonds as an asset class within the managed futures program as the idea that if, if stocks and bonds are selling off and the managed futures don’t get the trend right, yeah.
You could be less diversified ‘cause they’re all selling off, the managed futures is losing money while stocks and bonds are losing money.
Andrew: So, so we, I mean this is sort of what I’m saying. Everybody has different ways of skiing it. now, now, now what I, what I have to say I like about that.
So simplify, who. is gonna launch an ETF using an index. This index that we created. they also have one, they have a $1.2 billion fund called, literally the ticker is actually CTA. And I’ve never had as much ticker envy as when they launched that. That’s a great, yeah, that’s a great ticker.
I didn’t, I did not think of that as a ticker in 2019. and, and so they exclude two of the asset classes. And it’s worked amazingly well, plus whatever it is that they’re doing. And, and so like they were up 24% last year. I mean, so, but if you take a step back, that to me is the equivalent, right?
Of a if, if somebody says to you, I’m a large cap stock picker, and I’ve got 90% overlap with the s and p 500, but I have a little more Oracle than the next guy. or a little less Oracle than the next guy. Like, like that to me is like, they just, it sort of raised the questions like, I’m sorry, why am I paying you?
I can do 90% of what you’re doing at five basis points over here. Like, why am I paying you 80 basis points or whatever you, whatever you wanna charge me. but then somebody comes to you and says, no, I’m very different. I’m in the large cap space. And you may already have your, your, s and p, your efficient s and p allocation, but I’m gonna make.
Big bets in, in, in different areas. So that’s, that’s what we call alpha beta separation, right? It’s somebody who is, you can get your exposure to this space and you can, and then you can find, you can make bets on people that you think are going to bring a different source of return. I think all that stuff.
So I think I’m all in favor of people coming up with different ways of approaching it. The, the challenges I have been looking at this space for a very long time, have absolutely no way of handicapping. What’s gonna work well and what’s not gonna work well on, on, on a going forward basis. Okay. So, I’ll just give you, one example.
So in, in 2021, an allocator came to us and said, he looked in great detail at our historical numbers and said, you’ve never made money in commodities, sorry. In currencies you’ve never made money. I, what I want you to build this for me with and just, and just strip out the, the, the currency allocation ‘cause it’s just been dead money for you.
Okay. The very biggest winning trade, almost the day after that conversation was in the currency markets for the next year. So it’s a very, very humbling exercise with these strategies. So again, you can make all those calls, but what I think is gonna happen is you’re gonna have people say, I want efficient strategy exposure.
Like the same way a Vanguard or something gave me efficient strategy exposure, and, but you as an allocator, if you have a view on it, you can add things around it. maybe you feel very, very strongly about, about, like CTA for instance has a lot of exposure to commodities and lots of different commodities, and you think that there are gonna be major opportunities in, in, in, in those markets over time.
You’ve got a great way of playing that in that, so you don’t have to do all or nothing. The, the, the, the, the, the bigger challenge, I think is when you have things that overlap very highly. With, with this idea of this kind of core beta that what we do. and, and that’s where I think it’s being more challenging for people because they’re looking at and saying like, okay, so it’s a lot cheaper and it has a lot better numbers.
Is it really worth it for me to be able to say, oh, look at this prestigious firm. I’m, I’m, I’m investing with and paying a lot more money over time. And, and, and look at their, their fact sheet that, tells me exactly how much money they’re making or losing on heating oil. again, there’s a market for that.
I just, I don’t think that’s the, I, I don’t think that that market’s gonna win over time.
Jack: And to your point, it’s like, it’s something like all of us that since the space is a little bit newer to your average investor, we just have to be comfortable with, like, we’re very comfortable with many different approaches in the equity space, but since Managed Futures is new, it’s almost like people wanna say, this is the way you have to do it, because it’s like this new thing.
But as we get more comfortable, I think people will, and they understand it better. People understand, to your point, there’s a lot of different ways to do this and for certain people one approach is gonna work and for certain people, another approach is gonna work.
Andrew: And look and, and, and I think, I think it really comes back to this, this.
I know, I, I, I think the thing that we as asset managers, often have to remember is that for somebody on your side of the table, all these strategies are elective at the end of the day. and so we’ve gotta help you not just to make the statistical decision, but also to, to help frame how to talk about it in the context with your clients.
So your clients appreciate it and, and they want. And, and, and they appreciate you for bringing it to them. And like it’s, it, it’s ultimately about, like, it’s, it’s, this is such a human business and, we invest with people that we trust and we, and, and, and money is such a complicated matter for people that I just, I, I think that there is this, this wide open opportunity to take this strategy.
That again, comes off as so complicated and and hard to explain, and it feels so risky to people. It’s really not like, I mean, the worst draw down over 25 years in the strategy is like 16%. Okay? I mean, which is still, it’s not nothing, but I mean, remember, bonds went down 20% plus in 2022, stocks go down. 16% every couple of years.
so, it, it, a lot of it is about the messaging and talking to people and understanding and, and kind of understanding what, what, what they expect from you as an advisor and, and, and what people expect from their models over time.
Justin: Most of this conversation has been around managed futures, but I did want to just touch on another strategy that you’re.
Involved in and, and talk about it in the context of, this alternative, these alternative type strategies, and that’s like hedge fund replication. So if you were to do exactly what you did with managed futures, like explain hedge fund replication, sort of in a simplified, Andrew Bear Way, how would you go about doing that?
Andrew: I think it’s just, I think, I think what you’re doing is you’re looking across this big pool of smart money managers and just, and trying to figure out. Their biggest and most important, bets on the world. and, and it’s the things we read about when you pick up the paper, where it’s, our, our, our managers more positive on European equities today.
it’s the, it’s the hurt on the street columns, on, in the Wall Street Journal. is, is, is it the end of the American exceptionalism trade? Is the dollar gonna be debased over time? And, and the thing is, those are, we would call ‘em sort of macro bets, but, but, but they’re really, they’re really investments designed to capitalize on, on, on big shifts in the world that are generally not being picked up by stocks and bonds.
If the answer was only like, I think the s and p is gonna go up 3% over the next five months. I mean, again, that’s not that interesting, but how else are you gonna get exposure to. the yen going from 110 to one 60, and since everything’s incredibly confusing in currency land, that actually means a huge decline in the yen.
or, or, or, or interest rates going up or down, or, what if the, what, if there’s a. Something that causes a supply shock in, in, in the, in, in, in, the crude oil markets and, and crude oil takes off. Like those are the big things we read about. And what replication is basically doing is, shining an electron microscope in a sense on a lot of big hedge fund managers to do this for a living and say, great.
Okay, you, I get it. You invest in hundreds and hundreds of underlying positions. What are the big themes? One of the big themes and, and replication is just the most reliable way we found to extract that data. because if you call him, if you call one guy, he will give you one view and you call another guy, he’ll give you another view.
This is just a way to kind of systematically, identify it across a large pool of managers. The reason it matters for the. When, when you’re, not a multi-billion dollar family or a family office or a a a pension plan, is that the portfolios, because they’re simple, because they’re very liquid, you can make ‘em work in an ETF and, and one of the great frustrations of the advisor community has been, is, is, is somebody comes along and they say, look, we’ve got this incredible strategy.
Look how well it’s worked for, years and years and years. And, don’t worry, it’s, it’s, it’s cost 200 basis points a year. But trust me, it’s gonna be worth it. Look how well it’s done over time. And the moment you invest in it does terribly. And, and so we, and, and, and that’s been about a lot of, hedge fund strategies where they tried to bring them into the, the greater wealth venture world.
Which by the way, it’s, it, look, this is a cautionary, if you look at the space, it’s a cautionary lesson about, about some of the ways in which people are trying to bring, Private credit into ETFs, for instance. maybe bringing, by the time they’re bringing you private equity deals, maybe the best opportunities have passed.
So, but that’s the way the business works.
Justin: And is the selection process looking at just the largest managers? Or how are you figuring out what strategy to what firm, what strategy to look at? How’s that happening?
Andrew: So we, so we, since, since we don’t know whether they’re gonna be the best ones going forward, we just look at the biggest.
and we pick an area and we say, let’s take 20, 30, 40, 50 of the largest managers in the space. And, and, and the way replication works is, in the same way you can analyze the price of a stock, well, we’re just analyzing the returns of the funds, to try to get a sense as to what’s been driving those returns.
and it turns out if you, if you, if you. Aim a very, very good statistical model at it. You can figure out what they’re doing. you can kind of rip, rip the lid off it. The other thing that makes it so, so, because it’s in, we do these like very, very liquid investible portfolios. You can put it into a daily liquid mutual fund, a daily liquid ETFA daily liquid use its fund if you’re in Europe.
And, And the last thing is that, and this was sort of our big innovation, was that I, because I used to talk about hedge fund fees over time. A lot over time, and I would say like, look, you’re happy you got 5% a year, but they were making 10. Okay. I mean, do you really feel like they should be taking five and you should be getting five at the end of the day?
And what, what replication does, it turns that into practice because like in the manner future space, in that example. We’ve been able to replicate 10, but do it so efficiently, we’ll give you nine or eight, not five. in other parts, there’s only it, it, this, by the way, replication works in very limited circumstances, and you have to kind of, that’s our expertise is knowing when it works, doesn’t work.
but in other strategies, you’re not gonna get, you’re not gonna get all. But I might be able to get eight for you or get nine. but, but again, if I could do an efficiency efficiently and with liquidity, it’s it can be a very, very powerful addition to, to a typical wealth management portfolio.
Jack: One of the interesting things I always like to talk, ask you when we get to talk to you is you get to see, because you are replicating hedge funds and you are replicating managed futures, you get to see what all these guys in aggregate at least are doing behind the scenes.
and that’s not necessarily gonna help us predict the market, but I am interested, there’s always some interesting data in there. As we look at the current market, like in terms of how these guys are positioned. And so I’m just wondering, like, as you look at that right now, is there anything that like stands out to you that’s interesting in terms of the positioning you see?
Sure. Well, look, I
Andrew: look, I think, and I think on the, on the, on the manner future side of the CTA side, some people call it, the fascinating thing has been, that, that they, so after Liberation Day, right, a typical macro strategist was basically having post-traumatic. Stress disorder for about two months.
Right. It was, it was, the, the, the, the inflation hit is about to happen. The economy’s about to go into recession. Okay. And then in the midst of all this, Trump starts a full frontal assault on the Fed. And it’s gonna, this is gonna drive, like a, like the mother of all bond market tantrums.
I mean, this is a period of hyster hysteria. The fascinating thing to me about these cold, rational models looking at price moves, is that somebody knew that was overstated. And you saw it in prices starting to go up. So since, I would say the summer, the, this tactical space has had a very, very much of a risk on view.
So to be long equities, expecting equities gonna continue go up, not at all worried about bond yields going up to be, to, to bet that gold is gonna continue its run because the dollars actually. Been behaving well with the exception of against gold and for a while, Bitcoin and, and, and, what else?
Also the yen, right? So these policies kind of play on the gen, which is a little bit esoteric. And so, so the tactical guys have been very, very risk on the more fundamental guys, the stock pickers, the, these guys are kind of paid to worry about long-term. Concerns. Right. And, and so they’ve been much more cautious this year.
They haven’t been negative, they haven’t been bearish, like, not like they were in 2022. but, but they’ve definitely been more cautious and they have had some views about, like shifting exposure to Europe, for instance, from the us. that like people have been talking for years and years about how cheap Europe is, and it’s the great opportunity, it’s the next great stock opportunity.
And it was like, and then they’re disappointed. They do it again. They’re disappointed. They do it again. They’re disappointed. But, but you’ve seen these smart money investors actually start to look outside the US more for opportunities. and so it, it, it’s been a fascinating, watching these two different kinds of portfolios because.
Some have been working well, like, like the fundamental guys have been getting it better. Other times the tactical guys have been getting it at other, and they’ve actually kind of ended up in roughly the same place here to date, which is sort of ironic.
Jack: Yeah, and it’s interesting like this, we may have a situation with international, we’ll see where you’ve got the trend guys and the fundamental guys together.
the fundamental guys have been saying it for a while. The trend’s positive. Now that that could be a situation where everybody kind of joins in on the international push.
Andrew: Well, and that, and that and, and that does happen, right? I mean, so, even, and that’s one thing I think when people forget about with correlations when you’re saying like, it’s, it’s like there are asset classes that can be, have low correlation to other things for a period of time and have high correlations in other periods of time.
But I think that’s what people are struggling with bonds right now. Is that bonds, structurally, were had negative correlation to equities for, for a very long period of time. Once inflation gets above a certain level, stock and bond correlations tend to go positive. And so if you are using bonds as a diversifier against equities and the risk of equities, that inflation comes back, that’s gonna hit both sides of your portfolio.
and, and so. again, it’s hard for people to adapt to that change. you look back at the past 25 years and you say, okay, I’ve got 20 years with a certain correlation structure, five years with a different correlation structure. Which do I want to make a bet on for the next 10 years? and, so look, these are, these are, nobody has a perfect crystal ball, right?
It’s, it’s, but what we’re all trying to do is get some sort of a view on the future. So that we can kind of figure out, at least in some ways, where the puck or multiple pucks are going and, and try to position our portfolios to be able to benefit from it. And, and as I think about this strategy, it’s a lot of people focus it on as a standalone strategy.
I’m gonna stare at, I’m gonna try to think about that. It’s, it’s a compliment. Like, it, it, it makes everything else. In your portfolio a little bit better ‘cause it fills a gap. And, so look, I think, I think the, the, the way the strategy goes mainstream is you’ll get a lot of big players will get behind it, which they’re doing now.
It’ll just start showing up in asset allocation models. Two, we’ll figure out a way to talk about it to people so that people look at it in their portfolio and they’re happy they have it, Um, three, we will figure out, we will build, invest in vehicles. That will make it easy to invest in. that remove, now again, you’re, you’re, you’re very skilled in this space and you’re very knowledgeable in this space.
95% of the people that I talk to, again, just want an easy answer to it. They don’t wanna spend a great deal of time worrying about three or 5% of their portfolio. They just want figure how to fill it. In the easiest, most efficient way, and then move on and worry about other parts of their portfolio and, and so, so if we can, if we can kind of solve all those issues, then what you’ll see is this space will, I think, will gradually just become a 3% allocation across more and more portfolios, 5% allocation, sometimes 10% allocation, depending upon how much, how much, protection you want in your portfolio.
Jack: Yeah. Well, I remember when we had Med Favor on, he said, if you believe in math, then you have to believe in this. You do. Which I, I think is kind of true.
Andrew: No, I say, look, it’s very rare to have a strategy that worked for 50 years. Right. That’s the other thing about it is like, is like you can find these great things and they come and go, but, but the incredible thing about this, when you get down to the nuts and bolts of what these guys are finding, right?
It’s the same truism. If, if people know something and the world is changing and they know it. It is like when we look at like, stock insiders are selling their stock, and it’s a sign that the market is about to roll over. Like it’s, it’s, we, we want to tap into that however we can, and we’re just trying to create a very, very efficient way of tapping into this particular.
cloudy crystal ball.
Jack: That, that might be my YouTube title by the way. The cloudy crystal ball, cloudy crystal ball. That could work very well on YouTube. It’s got, it’s got some, uncertainty in it. People like that whole thing. Yep. Well, Andrew, thank you so much for doing this. if people wanna find out more about you and all the, obviously a lot of things you’re up to, we’ve talked about here, where can they go?
Andrew: Please. Yeah, so, so I’m on LinkedIn. you can look at me. I think it’s still a picture of me and my dog. and, but please reach out to me and, and look, I’m, I’m, I’m, I’m very open to, connect with me on LinkedIn and then. If you have any specific questions about what we do, I please just reach out to me.
I just send me a message on LinkedIn and I’m very, very good at responding to people. we have a website, dbi.co. No, m or my firm is DBI. so we’ve got a bunch of material up there, but, but again, you’ll want, if you connect me on LinkedIn, you’ll, you’ll, you’ll, you’ll, get a pretty good flavor of, our view on the world.