Transcript: Corey Hoffstein on Return Stacking
The transcript from this week’s, MiB: Corey Hoffstein on Return Stacking, is below.
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This is Masters in business with Barry Ritholtz on Bloomberg Radio
Barry Ritholtz: This week on the podcast, another extra special guest, Corey Hoffstein, is one of these really fascinating quants who has just a really interesting background. Not only did he stand up a research shop from a dorm room in college and started selling model portfolios to fund managers, but eventually created a suite of first mutual funds. And then ETFs really pioneering the concept of return stacking. People have described that in the past as portable alpha. He, he does some really, really interesting research and gets deep into the weeds on things like market structure, liquidity cascades, what really drives returns, how much should you be focused on alpha versus beta. But most fascinating of all, he is one of those rare quants who has the ability to take complex, sophisticated, quantitative topics and make them very understandable for the average investor. I, if you are at all interested in concepts of things like portable alpha or return stacking, or just want to know how a quant looks at the world of investing and tries to decide where there are opportunities. I found this conversation to be fascinating, and I think you will also, with no further ado, newfound research and returned, stacked etf suites. Corey Hoffstein. Welcome to Bloomberg.
Corey Hoffstein: Barry, thank you for having me. Very excited to be here.
Barry Ritholtz: I’m excited to chat with you about things besides watches and cars and real estate. Let’s talk a little bit about your background. You get a, a BS in computer science from Cornell, a master’s in computational finance from Carnegie Mellon. Quantitative investing was, was that the plan from the beginning?
Corey Hoffstein: Absolutely not really. It was not. No, I grew up in the Super Nintendo generation, so I thought as a young man that I was gonna make video games for a living
Barry Ritholtz: Get out. Really?
Corey Hoffstein: I did. And I taught myself to program when I was 12 and all throughout late middle school and high school, I was programming games for my Game boy and developing game engines for the computer. I, I wrote my own programming language. I really thought I was on a path to go make video games for a living. What,
Barry Ritholtz: What was your game of choice as a kid?
Corey Hoffstein: I was a big Zelda fan. Okay. I really was. And it was, it’s funny, I, I haven’t played video games in probably over a decade.
Barry Ritholtz: Same. And the really funny thing is, so here’s the age difference. I remember sneaking out of high school during lunch with a buddy to go to the mall to first start playing Space Invaders, then Galaxa, then Missile Command, like these are all retro games. And then when I started as a trader, Tuesday nights, the quote server would be taken offline and it would become a quake server. Ah. And we spent, and you just get lost in it, and suddenly it’s 11 o’clock, and oh my God, I missed dinner. But that’s really fascinating. Why didn’t you become a game programmer?
Corey Hoffstein: As, as you mentioned, I ended up at Cornell for computer science, and as much as I love the curriculum, I looked around at the people I was in my classes with and I said, oh, I don’t, I don’t know if this is whom I wanna spend with whom I wanna spend all of my time.
Barry Ritholtz: That’s hilarious.
Corey Hoffstein: In a cubicle, as it turns out, I like talking to people, I like interacting. And I just sort of grew and evolved from there. This was the era, 2005, 2006, all of my friends were looking to get banking roles. Everyone wanted to go work on Wall Street. And so I sort of caught the bug and saw, oh, there’s this really interesting thing I’m learning about called Quant. Right. And I, and I really like the application of math and statistics and computer science to markets. And I just caught the bug. And that’s where I said, okay, I think that’s where I wanna spend my career. And so graduating right into 2009, right out of the financial crisis, I said, I don’t think I’m gonna get a job. Let me see if I can go to grad school, continue this education. And that’s how I ended up at Carnegie Mellon.
Barry Ritholtz: So let’s talk a little bit about the timing there. You’re Cornell oh six to oh nine, you’re Carnegie Mellon, oh nine to 11, but you start newfound research in oh eight. Were you, what was this a dorm room launch? Was this the next Dell computer?
Corey Hoffstein: It was, it was very accidental. I never actually intended to still be running this business 16 years later. Truthfully, I named it newfound after a lake. My family used to visit in New Hampshire. It was truly a throwaway name. But in college I was working on some quantitative research models and happened stance. We were talking about luck earlier, got introduced to a local asset manager outside of Boston who saw what I was working on and said, this is really interesting. Would you license these models to me? I’m a broke college student who needs some beer money. Oh yeah, for sure. And and he said, I, I don’t have any cash to pay you with, but I’ll pay you in basis points. I did not know what a basis point was. I said, sure, man, whatever. I’m going to grad school. But
Barry Ritholtz: By the way, most college kids pay for beer money through quantitative model development. That’s right. I mean, I think that’s a generational thing. And and why not?Not?
Corey Hoffstein: I didn’t know what a basis point is. [That’s amazing.] I didn’t, I didn’t even know what a basis point was. And so we, we get this contract written and I go off to grad school assuming I would go work at a big bank doing sales and trading in some quant role. And he ended up running a strategy based on my research models that went from zero to several billion dollars,
Barry Ritholtz: Get outta here. Even a couple of basis points on that. It’s a lot of beer money.
Corey Hoffstein: It started to add up. Yeah. And, and it afforded me the opportunity. What was interesting is this was a big transition time in Wall Street where Yeah, a lot of the jobs I had been trained for when I, when I went through that graduate school program, who by the way, today looks nothing like the program I went through, it was all about pricing credit default swaps. Right? No one trades credit default swaps anymore. So I’m looking on the other side of this and I’m seeing all the jobs I wanted to apply for disappear. Right. And my father was an entrepreneur. I always had the idea that I would do something entrepreneurial. And I said, you know, young, naive, brash, 20-year-old. I said, well, I got a business that’s already paying me. Why don’t I just keep doing this? Right. And that’s where the journey began,
Barry Ritholtz: Right Outta grad school. You just continue. You, did you even look at jobs? Did you apply places? I did not. You just said, ah, I could be my own boss.
Corey Hoffstein: That’s what happens in your early twenties. You have that sort of brash arrogance that,
Barry Ritholtz: That, that’s amazing. So, so you have this one set of models, it’s generating revenue. What was the next step? How did you turn this into a sort of quirky idea that is creating a little bit of revenue into an actual business?
Corey Hoffstein: Yeah. So that was, that was a lot of stumbling in the dark, candidly. So on the other side of that contract is I got paid basis points, but it, I had a confidentiality agreement with this firm. And so as those assets grew, I’m now a young 20-year-old going out trying to go to other asset managers saying, Hey, I have this quantitative research. It helps power billions of dollars of decisions. And they’d say, well, who are your clients? Can’t. And I’d say, I can’t tell you.
Barry Ritholtz: You gotta trust me on this
Corey Hoffstein: And you gotta trust me. And as you know, again, a young 20-year-old, I’m sure I got laughed out of a lot of offices. And there’s a very long story here that’s better told over beers. But as it turns out, the reason that asset manager was able to raise so much money was because they had taken signals. I had sent them, turned them into ran, ran a back test, miscalculated that back test, and then ran around telling everyone it was a live strategy.
Barry Ritholtz: That sounds like trouble.
Corey Hoffstein: So throughout 2013, I was doing a lot of this research. I had sort of started to move into more sub advisory index provider roles, and all of a sudden SEC comes knocking. And by the way, at that point, that client was at $13 billion. Wait,
Barry Ritholtz: So you are, you just provide the model. You have nothing whatsoever to do with how they market it, who the clients are, how they run it. It’s just a model.
Corey Hoffstein: Yes. And by and by the agreement, I wasn’t, I wasn’t even supposed to be in the equation at all. Right. I’ve never been introduced. No one knew who I was. Somehow no one in due diligence ever asked them about any of this. Right. And so, $13 billion firm gets a knock from the SEC and the SEC says, okay, you’re calling us a live track record. Show us the auditing,
Barry Ritholtz: Show us the trades track record, and, and it only goes back to oh nine. And
Corey Hoffstein: You can imagine everything unraveled from there. And so in 2013, I’m staring down my largest client, all of a sudden it becomes obvious. This is fraud right now, by the way.
00:09:05 [Speaker Changed] How, how did the fund actually perform when it was live
00:09:09 [Speaker Changed] Quite well, right? I mean, that’s why it gathered so many assets.
00:09:12 [Speaker Changed] So, so that’s the crazy thing is what led the s ’cause normally the SEC gets called in when somebody’s losing money and they’re pissed. Not, Hey, we’re making money, but I’m not sure I love this marketing.
00:09:23 [Speaker Changed] Just a routine exam. You know, you run an RIA, the SEC just comes knocking every once in a while to say, Hey, just wanna make sure the compliance program’s all set up. It happens every once in a, every couple years. And, and at that point, they were due for their routine exam. They had gone from nothing to 12 billion. It was time for the SEC to come Right. Kick the tires with what should have been a very routine. Right. This is, you know, dot the i’s cross the T’s. Oh, no. Turns out you’ve got a fabricated track record that by the way, you miscalculated your back test and it’s an inflated, fabricated track record.
00:09:52 [Speaker Changed] Well, that’s really a problem. Isn’t that’s really a problem. Did they ever come knocking to you and said, Hey, we,
00:09:58 [Speaker Changed] It wasn’t just knocking. ’cause what happened is,
00:10:01 [Speaker Changed] Ooh, that subpoena is frightening, isn’t it?
00:10:03 [Speaker Changed] It was a subpoena. Yeah. And as a 20, I guess I must have been 23, 24 at the time, getting a subpoena from the SEC
00:10:09 [Speaker Changed] That’ll get put. That’ll wake you up. Yeah,
00:10:11 [Speaker Changed] That’ll, that’ll definitely wake,
00:10:12 [Speaker Changed] Wake you the ice you up coffee. Go right to the subpoena.
00:10:14 [Speaker Changed] And, and the gentleman who ran the firm that was my client was, was so convincing to the industry that he had done nothing wrong. Right. During the SEC investigation, he grew the business from 12 billion to 25 billion.
00:10:29 [Speaker Changed] Get it outta here. Yes. Wow.
00:10:31 [Speaker Changed] Yes. And so during that time,
00:10:32 [Speaker Changed] And that’s even more basis points.
00:10:34 [Speaker Changed] Oh, they stopped paying me at that point. Oh, they did. They stopped paying me, needless to say, the SEC ran a, a very aggressive investigation. I got subpoenaed, my life, got caught up in this SEC investigation. And I said, all, I’ve got two choices. I can leave this industry and go, go move to Silicon Valley. I got a computer science degree. Right. There’s some good stuff going on out there. Or I can plant my flag and prove to people I did nothing wrong. Right. There’s quality research here. And so that’s actually when I started blogging, I started kidding. Writing a weekly research, quantitative research report just to say, Hey, look, there’s, there’s something real here. Had a couple employees. We started publishing our research, getting out there more, and slowly used that to transition to be, you know, we were more active on social media. Started the podcast a few years later, just try to try to say there’s no, there’s nothing, there’s no fraud here. We were not the problem.
00:11:29 [Speaker Changed] Hey, it’s just the model. And we gave, we sold it to them. Exactly. The problem is what they did with it. How did the SEC investigation resolve with you guys?
00:11:38 [Speaker Changed] No issues. Right, right. So they, they, I mean, anyone who’s gone through this, so I suspect the vast majority of people have not. You eventually, the SEC never says you’re
00:11:46 [Speaker Changed] Coming. All right. You’re okay. They just stopped
00:11:48 [Speaker Changed] Calling. They, they stopped calling. And, and then you ask for a letter that says, Hey, can I get some resolution? And they say, we’ve determined we’re, you know, we’re not pursuing further inquiries into you. And so I’ve got a nice letter framed from the SEC that, that says precisely that. So
00:12:02 [Speaker Changed] Framed, framed on the wall.
00:12:03 [Speaker Changed] Yeah. The, the other side did not end so well, as you can imagine. They were bankrupt a year later and $25 billion flew out to the wind.
00:12:12 [Speaker Changed] Wow. So that’s an amazing story. I had no idea about that. I wanna just go back a little bit to Carnegie Mellon. You graduate with this quantitative background. You went into your own shop. What did your classmates do? Where did they go?
00:12:31 [Speaker Changed] They went all over. A lot of them went to big banks. A lot of ’em went to buy side hedge funds. Some of them went to, to places like Citadel to trade. Right. Become options market makers. I mean, they really, when you, when you talk about what is quant, right? What you, what you learn, you learn everything from how to price structured products. You learn the math that can help you with, with market making operations. You learn the technology. It’s a really broad field. And so what ends up happening is people just sort of scatter to all parts of the industry.
00:13:05 [Speaker Changed] Huh. I know you are not especially keen on back testing.
00:13:10 [Speaker Changed] Well, now, now definitely not keen on it.
00:13:12 [Speaker Changed] So here’s the question. How much did this experience affect the way you look at back testing? Honest back testing, really looking at the numbers versus exaggerating returns and, and making up the claim that something’s live when it’s not.
00:13:29 [Speaker Changed] Yeah. I think my view of this has changed over time. I, I’ve become, I’ve always been very skeptical of, of back tests for all the reasons quants normally are. I think quants perhaps did a disservice to this industry and making it easier to show people back tests. Right. I have a theory unfounded, no one’s ever confirmed this, but I always sit around and wonder why does BlackRock pay MSCI so much money in indexing, you know, when BlackRock could clearly run all these strategies themselves. You, you
00:13:58 [Speaker Changed] Have a historical track record. Well, and it’s, that’s life really.
00:14:01 [Speaker Changed] Finra, finra, one of the other regulators Right. Prohibits you from showing a back test for a mutual fund or an ETF. But if it’s an indexed etf, which is a regulatory term, if it’s truly an indexed ETF, you are allowed to show the index, presuming it’s a third party index provider. So what BlackRock can do is say, this is an indexed ETF, it’s indexed to this MSCI or s and p smart beta product. And by the way, here’s the 30 year back test. And of course, that back test outperforms the market. Right. And I think that helped fuel the smart beta boom of the 2000 tens. And, and so I don’t think there’s anything implicitly wrong with back test if done well, I think the problem is back test became a marketing tool.
00:14:40 [Speaker Changed] Yeah. No doubt about it. And the SEC rules on back tests have just changed to the point that when I show a chart of the s and p 500 or, or VTI, like, I have to be really circumspect in how I describe it. Here’s how the total market return has performed over the past 30 years. That’s about the most I can say. Versus, Hey, you know, if you have a portfolio with a B, C de, here’s what you can expect. Like the pushback we’ve gotten on some marketing materials kind of surprised me. I understand they’re trying to create like a big no fly zone to avoid the sort of problems that the guy who abused your model did. But it’s kind of like, aside from the fact that past performance isn’t necessarily relevant to what the world’s gonna look like in the future, that’s, that’s a very different thing than, wait, I can’t just show a chart. I don’t
00:15:38 [Speaker Changed] Understand. Well, and, and I’m sympathetic to the, to the point that a lot of clients, whether they’re advisory clients or or my clients who would be advisors and institutions will ask the question, okay, well how would this have performed during these different market stress scenarios? And that’s what a back test would, in theory show you. And not being able to tell them or show them makes it harder for them to do due diligence to understand how it may have behaved. Right. And so there are ways in which I think back tests can be used appropriately. I understand the blanket no from FINRA and, and I understand the SEC’s position on it because it can be used in such a manipulative fashion. Right. But I do think it makes it,
00:16:16 [Speaker Changed] It’s easy to abuse,
00:16:17 [Speaker Changed] It makes it hard to do thoughtful due diligence in certain cases.
00:16:21 [Speaker Changed] I’m trying to get a sense of how your investment philosophy developed. I recall reading that you were developing a stock screener and you were focused on value-based models and discovered that they would get just as shellac during downturns as the growth stocks did. Tell us a little bit about how screening led you to develop your philosophy and what your thoughts are on, on momentum and trend.
00:16:49 [Speaker Changed] So, very early on in my career, again, I was doing a lot of this on my own. I, I sort of self discovered factor investing and was basically using statistical screen screens to try to find cohorts of stocks that would behave in different ways.
00:17:06 [Speaker Changed] Now. And just to clarify, when you say factor investing, we’re really talking about pharma french factors, not necessarily smart beta type stuff or
00:17:14 [Speaker Changed] Both? All of the above. All, all of the above. I didn’t, I didn’t even know what it was at the time. I was just trying to say, Hey, if I find a basket of stocks and all the CEOs are bald, how does that behave? Right? Versus, oh, these all have positive momentum.
00:17:26 [Speaker Changed] I I got a great ticker for that ETS Yeah.
00:17:28 [Speaker Changed] Bald. I don’t think anyone’s used it yet. So I was looking at all sorts of things, which is sort of classical equity quant type work. And I’ve always sort of had a tilt just personality wise towards capital preservation. And there was one conversation very early in my career, this was actually 2007, where I was interviewing with an asset manager and I pre-meeting, asked them what they thought of the market. And he gave me the most bearish prognostication I had ever heard. And again, I was very early in my career, I didn’t live through the.com fallout from a career perspective. I said to him, well, what are you gonna do? And he was a small cap value manager. And he said, nothing, my job is to provide small cap value exposure. If it’s not appropriate for, for the client, the financial advisor should make that decision.
00:18:17 And so I said, well, I talked to some financial advisors and they said, well, how in the world should we know when to take our clients outta small cap value? That’s the manager’s job. And I said, well, in my opinion, no one’s protecting my capital here. And so I started really looking into statistical models that I thought could help preserve capital on. The downside value had worked incredibly well in the.com era. But my, my thought there was there was nothing inherent in value itself that was necessarily protective in terms of the type of crisis that could unfold. And so I ended up discovering trend following and following in love with trend following, which is the idea that, and it sounds naive, but as prices have historically gone up, they tend to persist in that direction. Or if prices start to fall, they tend to persist in that direction. And there’s a little bit of a statistical edge you can use there to try to really clip your downside risk.
00:19:11 [Speaker Changed] The, the challenge is always the transition from the uptrend to the downtrend, which is why you have portfolio managers and allocators arguing who’s responsible. The reality is nobody wants that job ’cause it’s thankless and practically impossible. Very few people seem to have come up with a formula that works from one cycle to the next.
00:19:33 [Speaker Changed] That’s absolutely right. There’s very few, I would argue probably no consistent predictors of, of any sort of economic or market cyclicality. What you have is maybe some statistical indicators that give you a slight bit of an edge. But when you talk about just a slight bit of an edge being played on, say a big position like the s and p 500 in your portfolio, right? And you’re only gonna play that edge realistically three or four times in your life. Right? That’s a very low breadth bet. That’s gonna have a really big impact. It’s just not smart on a math basis to do that. And it’s certainly not smart from a career risk perspective.
00:20:11 [Speaker Changed] I’m so happy you said that. ’cause I frequently find myself wanting to respond to these claims on Twitter, a sample set of three, who cares? You know how e every time you look at the history of recessions, hey, 20th century recessions, what is it? 12, 14 even that not a lot of numbers. And are you saying the recession in 2020 is similar to recession in the 1950s? It’s such a different world. The, you mentioned the.com implosion, the reason value held held up was that was such a, a sector collapse. What was the NASDAQ 100 down 81. 82% and the s and p 500 was down something like a fraction of that, I wanna say less than half. And then the Dow held up really well down 35%, something like that.
00:21:03 [Speaker Changed] Well, and if you go back to the history, it’s because most of those value stocks had already sold off 40 or 50% in 99. Right? Right. They were
00:21:10 [Speaker Changed] In the late nineties anyway. They did poorly while the money rolled into the big cap growth and, and technology media and telecom exploded.
00:21:21 [Speaker Changed] So this story came out that, oh, value is defensive because it has this valuation buffer to it
00:21:28 [Speaker Changed] In that one example.
00:21:30 [Speaker Changed] But people extrapolated that one example, right? They took a point and they drew a line. And then what happened in, in 2008? Well, most naive value portfolios are stuffed with financials.
00:21:42 [Speaker Changed] Right.
00:21:43 [Speaker Changed] And, and value just got destroyed. Right?
00:21:45 [Speaker Changed] So, so the obvious question to someone who makes that claim is, well, how did value do in the 1970s? Not especially, well look at the utilities, look at big oil companies. Well, but that was all about inflation. O okay. But you said this is so it’s a, it’s a hedge except when there’s inflation. What, what are the other exceptions that I always come back to the sample set of three sample set of five. I, I need a sample set of a, you know, let’s revisit this. In the year 3000 will have enough data Yeah. To be able to look at
00:22:15 [Speaker Changed] This. So, so I have sort of philosophical view on this, which is if I knew that value worked to protect my capital in every single recession, and I thought the market was efficient, then I shouldn’t be able to predict recessions. That’s right. Because if I can predict a recession and I know value works, then I’ve outperformed the market. So, you know, there’s, there’s an inherent limit here based on how efficient you think the market is. And I’ll tell you, I, I think the market’s pretty darn efficient,
00:22:42 [Speaker Changed] Mostly kind of sorta of eventually efficient. It gets there event, what’s the Benjamin Graham quote in the short run? It’s a voting machine, but in, in, in the long run it’s a wing machine. Yep. That’s the mostly efficient, eventually efficient market hypothesis. So, so given that, let, let’s talk a little bit about things like portable alpha. You, you’ve done a lot of work in this, a lot of research. First, give us a quick definition of isolating beta and alpha. What does portable alpha mean
00:23:14 [Speaker Changed] If you’re all right with it? I’m actually gonna answer this in a roundabout fashion. Go ahead. By, by saying what problem are we trying to solve here first and foremost, right? And, and the problem we’re trying to solve with terms like portable alpha or return stacking is what I would call the funding problem of diversification. It’s a bit of a mouthful. So what do I mean by that? Most clients, whether they’re individuals or institutions, have some sort of benchmark, a policy portfolio, some strategic asset allocation that they start with. They’re typically not starting with just a blank piece of paper. It’s Mr. And, and Mrs. Jones, you are 60, 40 investors, 60% stocks, 40% bonds. But we think that we want to go beyond that and introduce diversifying assets or diversifying strategies. It’s gonna use gold as an example. Well, to put gold in the portfolio, it’s not, it’s not just addition. Diversification is a problem of addition through subtraction.
00:24:11 [Speaker Changed] What are you selling? In order to buy the gold
00:24:12 [Speaker Changed] I need to make room. And that creates two problems. The first is it creates a return hurdle problem, whatever I’m selling. That gold in this example needs to outperform to have that portfolio or at least keep up with over the long run for that portfolio to not under underperform the benchmark. Right? So it creates a fer
00:24:32 [Speaker Changed] Rate. So if you do that, so if you do that, you’ve, even if you’ve gotten the same performance, you’ve reduced the risk ’cause through the addition of, of a diversifying asset.
00:24:41 [Speaker Changed] Right? But there’s a risk there. Let’s say I think gold is gonna keep up with stocks over the long run. So I sell my stocks to make room for gold and it doesn’t, turns out my forecast is wrong. Well, there’s a real opportunity cost there, right? So you’ve got, you’ve got a modeling hurdle rate that you need to figure out when you’re adding diversifiers. The second is behavioral. And this is where most people understand stocks and bonds better than they understand alternatives or alternative strategies. Alternatives and alternative strategies tend to be less tax efficient, more opaque. And so just like stocks can have their lost decades, alternatives often have their lost decades. And people are very unwilling to stick with those diversifying alternatives during lost decades. Which means that when the diversification benefits eventually come around their performance chasing. And so you see these huge, what are called behavior gaps in the returns of alternative investment strategy categories because investors aren’t sticking with them. So the return that they realize what’s called the investor return tends to be hundreds of basis points behind the actual investment return. So the question is, how do we solve this? Well, it turns out institutions have solved this problem for 40 years using this concept of portable alpha, which is to say, well, instead of making room in the portfolio, can we use some financial engineering to take that alternative and just layer it on top of our portfolio?
00:26:07 [Speaker Changed] In other words, you’re, you’re using the underlying 60 40 as a basis for borrowing in order to add a different asset class on top
00:26:17 [Speaker Changed] It. Yeah. I think that actually the easiest way for most people to understand this without getting into the, the world of derivatives like futures and swaps is, is to think about buying a house. Let’s save you a million dollars and you wanna buy a million dollar house. There’s really two ways you can do that. You can just go buy the house for cash and then over time your return is just equal to the return of the house. Or you can go to the bank and get a mortgage, put $200,000 down, get an $800,000 mortgage, you’re gonna get the return of the house minus whatever the cost of financing is. And then you’re gonna have $800,000 in cash with which you can do whatever. If you were to take that $800,000 in cash cash and invest it in say, mortgage backed securities, you’d probably offset your cost of financing and your return there would be equal to your return of just buying the house, ignoring taxes.
00:27:07 But if I were to take that $800,000 and invest it and say gold, well now my return is gonna be equal to the return of the house minus the mortgage plus gold. I’ve effectively stacked the return of gold on top of my house. Same con, we do the same concept in institutional portfolio management in portable alpha, but instead of using a mortgage, you use derivatives like futures and swaps. And instead of replacing a house, you’re replacing exposure like the s and p 500 or treasuries, where historically it’s been really hard to beat the market. And so it’s not worth putting capital at work there.
00:27:44 [Speaker Changed] So in other words, you’re not owning the s and p 500, you’re owning a derivative that gives you the right to purchase the s and p 500 at a specific price. That’s a fraction of what owning all 500 stocks would cost. And then you take that money, that capital and buy other diversifiers and theoretically other holdings that’ll generate above market returns.
00:28:05 [Speaker Changed] Exactly. So you could say instead of buying a million dollars of the s and p 500, I’m gonna take $50,000, use it as cash collateral to buy s and p 500 futures, a million dollars of s and p 500 futures, which will give me the total return. So
00:28:20 [Speaker Changed] That’ll be equivalent. You’ll get the same minus whatever the cost of the derivative
00:28:24 [Speaker Changed] Minus whatever the cost of the derivative is, the embedded cost of financing. And then I can take the rest of that capital and invest it wherever I want. Now you have to be careful here, right? This isn’t a free lunch. You need to think about the operational risks. You need to think about the diversification. This is implicitly leverage. Leverage is a tool that accentuates both the good and the bad. Right? We want to accentuate the benefits of diversification, not double down on the same risks. My
00:28:48 [Speaker Changed] Immediate, my immediate thought was, Hey, why can’t I take that derivative and go, all right, if I, if it’s gonna cost me 50 K, why can’t I go two x or three x or four x?
00:29:00 [Speaker Changed] And people do that, right? Right. And
00:29:02 [Speaker Changed] Which is great until it’s not,
00:29:04 [Speaker Changed] Which is great until it’s not. Right. And so for us, when we think about these concept of portable alpha and return stacking, we think there are incredibly efficient ways to get diversification into your portfolio to get alternative return streams that can both enhance returns and potentially reduce risk. But you need to be really careful about what you’re introducing, particularly because during a liquidity crisis, you tend to see correlations go to one. And you need to be aware of the leverage risk that’s embedded.
00:29:33 [Speaker Changed] So oh 8, 0 9, that sort of portable alpha probably didn’t do great.
00:29:38 [Speaker Changed] Yeah. So let’s talk about oh 8, 0 9, okay. And let’s talk about why we don’t call this portable alpha and why we’ve rebranded it as return stacking. Right?
00:29:45 This concept goes back to the 1980s with PIMCO and got really popular in the early two thousands. What institutions realized is they said, I mean, you know these stats, like the back of your hand, it is really hard to beat the s and p 500, right? If I have a, a bond benchmark and 40% of that is treasuries, how am I supposed to, what am I supposed to do with all that dead asset? Well, what I can do is I can use derivatives to get that exposure, either the s and p 500 or those treasuries, and then I’ll use my freed up cash and I’m gonna go invest in some hedge fund that I think is gonna give me uncorrelated alpha, right? Maybe the hedge fund does relative value volatility trading something with some sizzle, right? Right. And what’s interesting is, when you think about it, what the math does is I say, okay, I’m getting the s and p 500 beta and I’m stacking the return of this hedge fund on top. And now I can sort of, that’s why it’s called portable alpha. I can port the alpha of this hedge fund on top of the s and p 500 instead of fishing in the same pond as everyone else. But what happens during a crisis?
00:30:46 [Speaker Changed] Well, everybody has to raise capital. ’cause the, there’s anyone with leverage is starting to get margin calls, right?
00:30:52 [Speaker Changed] You have four big problems that happen in 2008. Your first problem is if you were stacking this stuff, porting it on top of the s and p 500 and the s and p 500, lost 50% from 2007 to the bottom in 2009
00:31:06 [Speaker Changed] 56 and change
00:31:07 [Speaker Changed] 56 and change, and you only posted 5%, 10% as collateral. See ya, you’re getting a margin call. So you did better if you stacked it on bonds, not so well if you stacked it on equity. So there, there’s one problem, folks who stacked it on equities were getting margin calls. Well, what do you do when you get a margin call? You rebalance your portfolio. Basically that’s, that’s what you have to do. So what they had, they went to, all the institutions went to the hedge funds and the hedge funds said, well, well, bad news, not only have we lost money too, but we’re gating redemptions, you can’t have your money back. So all of a sudden they try to rebalance to meet their margin calls. And what they had invested their cash in was not giving them their cash back.
00:31:48 [Speaker Changed] And nobody markets this as not portable alpha,
00:31:51 [Speaker Changed] Right? And so they can’t rebalance, they get the margin call, they lose the exposure to the beta. The last small wrinkle was a lot of this wasn’t done with exchange trade of futures. It was done with total return swaps with banks. And if your counterparty was Lehman Brothers, even if you handled things perfectly, where does your swap stand? Right? So as you can imagine, post 2008, this concept, which was I think if my, if I, if I’m correct, I think it was 25% of major US pensions and institutions were implementing portable alpha pre 2008. That,
00:32:23 [Speaker Changed] That large, that meant it
00:32:25 [Speaker Changed] Was a significant amount and at least 50% of it when surveyed were looking to implement portable alpha post 2008. I mean, I, I think it was called a synthetic risk grenade. I, it just, the reputation was destroyed. And
00:32:39 [Speaker Changed] Synthetic risk grenade that that’s a great band, a college club
00:32:43 [Speaker Changed] Band, absolutely rightly. Absolutely. And, and so like many things you lived through 2008, the language was right. No derivatives, no shorting, no leverage. I mean, that was on product brochures at that point, huh? People really didn’t want to talk about this stuff. And so it sort of disappeared except there are still institutions that are doing this and they figured out ways that are much better operationally or they figured out other ways to get the leverage. So for example, private equity, we’ve seen a huge increase in private equity.
00:33:19 [Speaker Changed] Trillions, literally trillions
00:33:20 [Speaker Changed] Private equity returns are basically just levered public equity returns. So instead of now me saying, let me get my leverage by getting a swap with a bank. I can take my public equity, get my leverage by taking my public equity, putting it in private equity. If I put 20 cents in, it looks like 30 cents of exposure and I can take some freed up capital and go invest in a hedge fund. Now I don’t ever get margin called anymore. Right? And PS on volatility laundering to steal a quote from Cliff Asness right? On the private side. And so people have figured out all these very clever ways, and I don’t mean clever in a bad way, but clever ways to keep portable alpha. ’cause it’s a great theoretical concept that just had implementation issues in 2008, right? To re-implement it very thoughtfully. And folks like Jonathan Glyden, who’s, who’s the CIO of Delta’s pension credits it for taking Delta’s pension from near bankruptcy to being overfunded Wow. In the last eight years. He, he gives full credit to portable alpha as being the reason why.
00:34:16 [Speaker Changed] No kidding. That that’s really, that’s really interesting. So you mentioned private equity, we’re not gonna talk about private credit or private debt, but it’s the same sort of continuum that cliff do I say complaints about volatility laundering? It’s like, hey, if you don’t get a daily mark or a tick by tick mark, volatility is irrelevant. It, we’ll, we’ll let you know what it’s worth sort of sort of thing. But you’ve talked about systematic alternatives. How do you define systematic alternatives and and is this the approach that anyone who wants exposures to alts should be using?
00:34:56 [Speaker Changed] So this is where I have my own strong personal view. So systematic alternatives to me are active investment strategies that are implemented in a non-discretionary manner, right? Probably the easiest way to describe systematic tends to be you’re using computer models to make the decisions and implement the decisions on an ongoing basis. These tend to be things like strategies that will trade futures contracts long and short based on different signals. Those signals might be trend signals, they might be carry signals, they might be value or momentum. And you’re going long and short things like oil or gold or Japanese yen, or you might be trading them as spreads against one another. And the idea of many of these sort of systematic macro strategies is to use these signals to capture a lot of the macro trends that are unfolding that, you know, your big sys, your big macro traders would try to capture in a more discretionary fund. What’s really, in my opinion, attractive and appealing about them is that they tend to be very uncorrelated to equities and bonds over the long run and particularly during a crisis because that’s where you often see the opportunities manifest for big strong moves, either positive and and flight to safety assets or the ability to short and profit from things that are crashing.
00:36:18 [Speaker Changed] Huh. Real really intriguing. The, this kind of ties in with a quote of yours that I, I want to ask later, but I might as well bring it back to this risk cannot be destroyed, only transforms explain.
00:36:34 [Speaker Changed] I don’t think I’m the only person who has said this. In fact, I once found a very similar quote in a, in an investment book from the 1980s. So this is not a quote that should be attributed to me. It’s a, it’s a general concept. And this is something I actually picked up in my graduate school studies when we were going through this education of pricing structured products. And what became apparent to me is in many ways the role of the financial industry is to identify risk, extract, risk, package it, price it, and transfer it to someone who’s willing to hold it. That is what we do when we raise a round of equity financing, right? You’re transferring some risk to someone else. So that risk is never really destroyed. Everything you do, whether it’s in your portfolio or investment decisions you make has a trade off.
00:37:23 And sometimes that, that trade off is just an opportunity cost. Sometimes it’s very explicitly higher volatility or lower downside. But everything we do has a trade off. There’s really no free launch, right? So when I look at something like portable alpha, I say, okay, the opportunity is I don’t have to try to beat the s and p 500 by picking stocks better, which has historically proven to be largely a, a fool’s errand, right? I can try to beat the s and p by saying, well, let me just get the s and p and I think gold is just gonna be positive over the, over my 30 year horizon. Lemme just stack some gold on top. Okay, that’s a win. Where’s the risk? Well, again, I’m introdu, I’m using leverage. Leverage isn’t inherently bad, but there are risks that I’ve now introduced for making this this trade off. And so yes, I get some diversification benefit, but there’s some liquidity risks and operational risks I really need to be aware of. And so it’s, to me, it’s, it’s trade-offs all the way down.
00:38:17 [Speaker Changed] And it’s worked out for places like Delta’s Pension Fund,
00:38:20 [Speaker Changed] Delta, there are a large number of public pensions as well that have used this Iers, Ohio Police and Fire Mosers. I mean, this is, I I wanna say like one of the, and what’s interesting is they don’t wanna talk about it. Oh really? Now the public pensions, it’s in all their public filings. You can go find this, right? But a lot of ’em don’t want to talk about it because either, Hey, this is our, this is what’s working for us and we need to beat our competitors. Right? Or again, it just portable Alpha has this bad label to it from 2008 and people don’t want to see it. And so they’re sort of finding ways to hide it.
00:38:59 [Speaker Changed] So, so we’ll talk about return stacking in a moment, but I wanna stay with some of the research that you did and let’s talk about liquidity Cascades whi which our mutual friend Dave Ick, has described a new lens on reality that I think people should be thinking about. I I, I love that, that description. Tell us what lis your liquidity cascade work found?
00:39:28 [Speaker Changed] So this was research I wrote in 2020 after coming out of the 2020 crisis. And it was born from the view that while there was a very real exogenous economic event that caused the market to sell off the day to day of what I was seeing happening in markets seemed to be endogenous. In other words, there was so much volatility and there was so much mispricing that didn’t seem to be a reaction to fundamental changes in the world. It just seemed to be, oh, there someone got liquidated and had to sell immediately, sell down a large levered position, and oh, there’s someone who couldn’t meet a collateral call. And so it made me take a step back and say, is there something about the market structure, the way market micro structure has evolved over time? That I don’t understand that there are some of these maybe lurking risks that we’ve implemented. And so there were three, I’m gonna call ’em conspiracy theories, for lack of a better word, that sure. That hang out there as to what has broken the market.
00:40:34 [Speaker Changed] Rationalizations rationalizations as
00:40:36 [Speaker Changed] Well as to Yeah. To be kind to the people that believe them, right? Right. And so the idea of the paper was, I was going to explore them as objectively as I could. The big three as I saw them, were fed intervention and a decade of zero interest rate policy causing people to take on too much risk, forcing them up the risk curve there was, and then obviously the, the concept of a fed put being tied in there. Then there was the rise of passive investing, right? Not just active versus passive in the type of price discovery that was happening, but, but truly how we trade indexed products at, at a market micro structural level was that changing stocks aren’t, you know, traded individually anymore. They’re traded as big baskets the way market makers are. There’s now really just a handful of big market makers rather than a large cohort.
00:41:23 Is that making markets more fragile and then the impact of derivatives, right? And I think we, we saw this as an example for people with, with GameStop where you had what I would call social gamma, this acceleration through Reddit of people buying outta the money call options to drive through, leverage the price higher because market makers were forced to hedge, right? Do you see that less specifically at GameStop? But do you see that at a grander scale when you have a huge amount of structured products being issued in, in Asia and Europe, or you have all these sort of uses of leverage among institutions? Have we gotten again, to a point of fragility and, and what liquidity cascades ultimately argued was anyone who thinks it, it was just their one thesis was probably wrong.
00:42:12 [Speaker Changed] It Now I want to just stop you for a second, interrupt you for a second and point out how often are big complicated situations? You know, Jacques, it’s that one thing. The world is much more complex than that. It’s, I remember looking at the causes of the financial crisis, I found dozens of ’em when the inflation surge took up in 21 and 22, like people wanted to point a finger, there were dozens of factors, including consumers who said, oh, that’s 50% more. Yeah, I don’t care. I’m gonna buy one. Consumers drove inflation as much as fiscal stimulus and all these other things. So how, how broad a conclusion did you reach that it’s never just one thing.
00:42:58 [Speaker Changed] I, to your point, I think people ha look into a world of incredibly complex non-linear relationships and they want a single linear explanation and it’s just not possible. All things,
00:43:10 [Speaker Changed] That’s the narrative fallacy, all of things. They want a clean little storyline in a bow, and that’s not how the universe works.
00:43:16 [Speaker Changed] All of these things interact. And so what I came outta the research piece with was not my view. I actually, the intro of the research piece, I said, I’m not gonna tell you what my view is. I’m gonna walk through this ob objectively as I can, and I’m gonna paint a picture at the end. It’s up to you as the reader to determine, for lack of a better phrase, how full a I am. Right. You know?
00:43:37 [Speaker Changed] So what did you find out with those three factors? So those three factors. So the fed, passive, and derivatives.
00:43:43 [Speaker Changed] So, so with those three factors, what I ultimately argued was that they operate in somewhat of a cycle, right? Fed zero interest rate policy is in many ways as explicitly stated by the Fed trying to move people up the risk curve, right? And as people moved up the risk curve, they were trying to find ways to, to harvest, yield, or save money, a move into things like passive a thing, a move into tax efficient vehicles like ETFs that were having a profound impact on the way things are traded in the market. You’re having a consolidation of market makers that leads to potentially increasing fragility or, or lack of liquidity. One of the things I thought was really interesting in, in March, 2020 is people always talk about market makers pull the plug, right? Right. Markets go crazy, they’re not running a charity, right? They’re gonna pull the plug when things aren’t going well. Right?
00:44:34 [Speaker Changed] Or at least lower their, their bid ass spread wide amounts of Yeah. They’re
00:44:37 [Speaker Changed] Gonna wide ’em out and they’re gonna thin, thin the order book volume. What I thought was interesting that people don’t often talk about is they’re actually capacity constrained. They have a balance sheet and there was, I think it was virtu during March, 2020 that actually was trying to raise $350 million just so they could keep making markets. Wow. Because they had run out of balance sheet. Wow. And you go, well actually, if these institutions are so important to the way our markets function, should they have a line to the Fed?
00:45:08 [Speaker Changed] Yeah, that makes sense. Right?
00:45:10 [Speaker Changed] I’ve never heard anyone talk about it. Right. Right. But if you need them there, and there’s only three or four key market makers left, right? We need to make sure that they have healthy balance sheets. They’re, they’re systematically important institutions. They,
00:45:21 [Speaker Changed] They need a line somewhere. But the Fed’s mandate isn’t the smooth operation of the nice e the fed’s mandate is low inflation and full employment.
00:45:31 [Speaker Changed] So, so it’s a little, little struck, things like that. And, and again, I don’t think any of them are the cause, but you start to see some of this fragility creep up. And then as people right, are moving up the risk curve, they’re trying to find ways to also protect themselves. So they’re taking on more derivative strategies. We saw this massive boom in derivatives. We saw an adoption of things, a leverage strategies, risk parity and, and trend following and alternatives. And again, I don’t look at the boogeyman and say the market sells off and it’s risk parity’s fault. Right? But I look at it and I say, well, if risk parody and managed futures are selling off, and at the same time you have all these massively levered positions via puts that market makers are having to hedge all that can act in coordination to make a sell off more violent. And then sort of you go full circle to the fed stepping back in, lowering interest rates and, and kicking the whole cycle off. And so what I painted a picture of at the end, the reason I called it a liquidity cascade was I painted, it was this Mc Escher painting of, of sort
00:46:31 [Speaker Changed] Of famous, the waterfall.
00:46:33 [Speaker Changed] The waterfall, and then it magically climbs back up, right? And, and each part of this, it was the fed sort of is at the bottom of the waterfall and then flight to passive alternative sort of investment strategies. And the role of derivatives is at the top. And then some exogenous effect causes the market to crash. The crash becomes more violent fed steps in and the cycle kicks off again.
00:46:54 [Speaker Changed] So, so I, I have so many interesting questions for you. I’m kind of fascinated by your, the way you look at the market structure and what’s driving things. Because for me, the thing I’m looking at during those various processes is, and you referenced this earlier, are is all the individual decision making that takes place within the context of some financial stress, which as we’ve seen, tends to lead to cognitive challenges, behavioral problems, bad decision making. That human element in the middle tends to react, you know, it’s, it’s oversimplifying it, calling it fight or flight. But hey, that’s what your lizard brain is telling you. And it doesn’t matter if you’re running a billion dollar hedge fund or a pension fund, most people are gonna go through the same sort of panicky response. It’s really interesting that you’re focusing on the structure and how does the structure accommodate the bad behavior that we see
00:48:01 [Speaker Changed] You are right. That there is absolutely panic and lizard brain. And I don’t mean that in, in any sort of derogatory way. No. It’s, I think that their’s, theirs survival instincts, I actually don’t. It’s what it is. I don’t think they’re irrational. I think ity economics would argue you have to protect your capital to survive. What? So I’ll give an example here of where I think it’s a very specific example, sort of like the market maker’s example, but it’s something that happened in March, 2020 that is obviously wrong. And so Vanguard has their mutual funds and they offer ETFs as a share class of their mutual funds. So if you buy the mutual fund or the ETF, you are in theory getting the exact same return. ’cause it’s the same underlying pool of capital
00:48:43 [Speaker Changed] MI minus the tax advantage of the ETF.
00:48:46 [Speaker Changed] Absolutely. Yep. Their bond fund, during March, 2020, there was a two day period where the ETF traded, I believe it was up to a six or 7% discount to the mutual fund. That’s a little weird because it’s the exact same pool of capital,
00:49:02 [Speaker Changed] Right? So, so difference being, you can only trade mutual funds. At the end of the day you have to make a specific phone call to buy or sell or just reach out to whoever your custodian is. Yep. Whereas the ETFs are quoted
00:49:16 [Speaker Changed] Intraday. But even at the end of day, that discrepancy existed. It wasn’t just intraday. That was, that was the nav of the mutual fund versus the price of the ETF,
00:49:25 [Speaker Changed] Which had a higher trading volume. I’m gonna guess the ETF.
00:49:28 [Speaker Changed] The ETF certainly had a higher trading volume, but the, the underlying problem is that the bonds weren’t pricing.
00:49:37 [Speaker Changed] Oh,
00:49:37 [Speaker Changed] Okay. The bond market froze up. So when the mutual fund struck nab, at the end of the day, the nav was based on illiquid quotes of bonds that hadn’t traded. The ETF was basically saying, we don’t believe those quotes. We think the quotes should be much lower and we’re gonna price much lower. That’s right. There’s an interesting free option here. If you are a vanguard,
00:49:58 [Speaker Changed] Buy the ETF sell the mutual fund.
00:50:01 [Speaker Changed] Well, so it, because you can’t short a mutual fund, the way it would work is you would just always hold the mutual fund, wait for a crisis to come around and then jump from the mutual fund to the ET TF. Right? And you basically pick up this free spread based on the fact that the mutual fund is priced incorrectly. Stuff like that shouldn’t happen.
00:50:21 [Speaker Changed] Why do you say that? I, I always go back and forth with this. It’s not like computers and algorithms are running this, it’s irrational primates who are pushing the sell or buy button.
00:50:35 [Speaker Changed] Let me rephrase that. Things like that don’t happen except within a crisis.
00:50:38 [Speaker Changed] Okay.
00:50:39 [Speaker Changed] And they represent opportunity in a crisis because it is definitively mispriced. And if markets are efficient, there shouldn’t be mispricings like that. That’s a ver you shouldn’t have two things that are literally the exact same basket attached to the same underlying trading. 6% apart unless there’s true limits to arbitrage. And here you could argue you can’t short the mutual fund and buy the ETF. It’s hard to, it’s hard to arve that spread. But again, anyone trading any bond mutual fund could have jumped to Vanguard’s ETF, waited for the price appreciation and benefited. And again, in a crisis, there’s so much information coming at you, you might not have seen the opportunity. Right. But I look at a lot of little things like that and I go, markets mostly function correctly the vast majority of the time. But when you see that fragility pop up in a crisis, just is it pause for concern about how things are currently structured? Just a question.
00:51:32 [Speaker Changed] So two,
00:51:32 [Speaker Changed] I’m not saying it’s broken,
00:51:33 [Speaker Changed] So, so two responses to that. First, hey, give the Nobel Prize Committee props for offering a prize to Fama and Schiller the same year. It’s like, yeah, markets are mostly efficient Fama’s, right. Except when they’re not and schiller’s. Right? So that’s number one. Number two, I have a vivid recollection of sitting in a canoe with Jim Bianco in August of oh nine. And Bianca was the first person to describe the Fed response to the crisis as the first person I read. And this was really early, Hey, the Fed has made cash trash, they want you out of bonds, they want you into equities. Maybe it’s gonna take people a while to figure this out. But he was the first person to come up with Tina, right? And said, people are gonna have to stampede into equities. We’re gonna have a rally. And I said, it’s funny, I, I feel like the two of us are part of the six blind men describing the elephant. ’cause to your point about mispricing, I recall saying to him, I don’t know if you’re right, I like that theory, but my day job as a market historian is whenever stocks are cut in half in the United States, that’s a fantastic entry point. And if you bring up, well, what about 1929? Yeah. You didn’t get to the bottom till 32, but even down 50% on the way down to down 87% was still a great entry point. And that’s the exception. Every other time you’re cutting half the United States, you have to buy with both hands.
00:53:15 [Speaker Changed] Well, and what’s interesting to me there is you and Jim are discussing, I, I love your analogy with, with the blind men and the elephant. Jim is discussing a supply and demand concept, and you’re discussing a fundamental view. Right?
00:53:28 [Speaker Changed] I see the world through a behavioral lens. He’s seeing the world with, there’s the Fed is gonna cause a giant increase in demand for equities regardless of what the supply is. Right? And guess what happens to prices?
00:53:39 [Speaker Changed] And that’ll drive prices up. And it cau so many, many fundamental people, right? To say markets are overvalued missing the fact that you had another market structure change things like a 401k that was almost non-existent in the early two thousands, that several trillion dollars. Now you just have a stampede of buying every single month and people being forced into markets as a retirement vehicle, right? Right. That is their savings account, particularly when cash is returning nothing. And you have a, a dramatic shift in supply and demand. And by the way, over the same cycle you saw fewer IPOs, right? So you’re increasing demand into public equities with fewer, less supply. Right?
00:54:19 [Speaker Changed] At the same time, you have huge buybacks. Right? The, a lot of people don’t realize the Wilshire 5,000 is something like 3,400 stocks. It’s like totally misnamed. And the past 20 years have seen, yeah, there’s been a lot of stock issuance on in Silicon Valley, but overall the size of the share float that’s out there ha has shrunk another big, and I, I don’t know how where, what the end game of that is. Can you do that perpetually?
00:54:46 [Speaker Changed] So I don’t know what the end
00:54:46 [Speaker Changed] Deep, deep public eyes, public markets,
00:54:50 [Speaker Changed] I don’t know what the end game of, of any of this is, candidly. But I know you’ve had folks like Mike Green on, I think he was on even recently, who have strong views about what passive is view. I don’t have particularly strong views in any direction. I just like asking the questions. Maybe I lobb out a little grenade and let other people fight over it. But I think they’re fascinating and worthwhile questions because I think in many cases we just accept we have some of the most wonderfully functioning liquid markets in the world. We are truly privileged in the US to have what we have. I don’t think it hurts us to ask, are we overlooking anything? Right? Is is there any way in which we are unintentionally designing ourself into a state of fragility? It,
00:55:32 [Speaker Changed] It was pretty clear that people should have been asking that question in the mid two thousands and just had no idea the sort of misaligned incentives and, and really complex structures that along with some, the really, we, we got used to zero. But when Greenspan post nine 11 took rates down to under 2% for three years and under 1% for a year, that was really, we hadn’t seen anything like that for, for decades and decades and zero. No one knew how to deal with that. And then once we started seeing negative, you know, bonds, like, well, you lend us money and you pay us to hold it. Like, wait, what? And I, I think that caused all sorts of problems around the world and people just didn’t know how to contextualize.
00:56:24 [Speaker Changed] And to your point on behavior, I think something we talked about earlier where, where the sample size here is small. I think if you took the market to where it was a decade ago and and said, feds bringing rates back down, the world’s bringing rates back down, people would look backwards with the playbook and say, we’re gonna just do all that again. Right? And markets would not respond the same way. They would probably do everything in an accelerated fashion, but you wouldn’t get the same result because people’s behavior would adapt to that previous sample. And so it’s, it’s very complex of how these things work.
00:56:55 [Speaker Changed] Well, a little reflexivity in that, although you can make the argument that in March, 2020 down 34% and it felt like six weeks people looked back to oh nine and said, oh, I gotta be a buyer. ’cause the last time we saw a big crash, the Fed rescued the markets, or the Fed did this and ultimately led to that. Maybe rescue is too over simple. But isn’t this why everything eventually gets arbitraged away? Don’t the playback from the last cycle, the playbook not work in the next cycle? ’cause hey, we’ve kind of figured this out.
00:57:33 [Speaker Changed] I’m not sure we’ve ever figured it out. But again, I think a lot of this does get, does get priced in the whole idea of markets are, they’re supposed to be efficient information discovery machines, and they have proven to be tremendously powerful and efficient allocators of capital over the long run. It’s the, it’s the best machine we’ve gotten, so I certainly wouldn’t bet against that machine. Let,
00:57:53 [Speaker Changed] Let’s talk a little bit about your ETFs and, and return stacking. Starting with first question is why pivot from pure research to managing assets and, and why, if you’re managing assets, did you go into the ETF side of it?
00:58:11 [Speaker Changed] The shift from pure research to managing assets, I think is one that a lot of people ultimately make. When you’re just providing research, you really don’t have any control over distribution messaging. Often you don’t have control over how your research is being used. And if you’re the one doing the research, you often have the best idea of how it should be implemented, or at least you believe you do. It’s not quite like selling data or raw data. You’re, you’re selling a manipulated form of data that you think potentially has some edge or, or some utility and you wanna make sure that gets expressed correctly. And then frankly, there’s probably a little bit of ego in there going, okay, I wanna get closer to the action. I actually want to implement the portfolios that I want to implement. I think I’ve got some good ideas for bringing some, some strategies to market. And so over time we went from, we’ll provide research to we’ll be an index provider to we’ll be a sub-advisor to we’ll launch our own funds. And I will say to my discredit, I originally launched a suite of mutual funds, right? Which was for someone who grew up in the world of ETFs and was helping run ETF model portfolios, talk about a dumb business move,
00:59:22 [Speaker Changed] What what motivated you to go mutual funds over ETFs?
00:59:26 [Speaker Changed] So it was 2013. And what concerned me about standing up ETFs is at the time we didn’t have firms like ET TF architect of our friend West Gray or or title that we’re helping with the administration. My concern of setting up my own ETF was that I was gonna have to handle all the intraday trading of the creation of redemption baskets. It was gonna require me to hire a whole ops staff that I candidly didn’t have the experience or know how to manage. And I said, versus the mutual fund,
01:00:00 [Speaker Changed] Which is a little simpler, a little cleaner,
01:00:02 [Speaker Changed] Which is a little simpler, a little cleaner. And there was a well trodden path of bringing mutual funds to market. So that was 2013. And, and again, I just didn’t feel like being the one who was going bush whacking to figure out how to do this, I should have, how,
01:00:14 [Speaker Changed] How long did it take you to realize, hey, ETFs are a more efficient, especially if there’s any sort of turnover, ETFs are a more efficient model and I can make this work at, at a similar price.
01:00:27 [Speaker Changed] So I absolutely knew from day one ETFs were a more efficient model. I think it probably took me two or three years to say I’ve chosen the wrong vehicle. Not just from a tax efficiency perspective, but from an appetite perspective. 2013 people really started to go, I don’t even want to talk about mutual funds anymore. Right? If it’s not an ETF, don’t talk to me. By 20 17, 20 18, we were having conversations with firms that said we only invest in ETFs, ETF model portfolios only. And by the way, I’ve got a whole spiel on this that I, I think that’s just as misguided strategy and structure need to be aligned. And there are some strategies for which the ETFI think is definitively the wrong structure. It’s a whole different conversation, but I ultimately said, I am, you look at the flows, you can just look at a map of the flows and say, I am selling into a dying industry. Right? Right. I am in the wrong product wrapper. And so I ultimately made the decision to shut down every fund and, and restart the whole company.
01:01:32 [Speaker Changed] So as opposed to just converting them, you, you went that way. The exit and the relaunch. Yeah. Because part of, and by 2017 Wes was doing a number of ETFs, a number of other people and other organizations made it, I don’t wanna say painless, but less painful to stand up in etf.
01:01:48 [Speaker Changed] Absolutely. Absolutely. Yeah. I ultimately said, I think there are decisions I made wrong from a, from a structure perspective. And I think there are decisions I made wrong from an actual product perspective. And this is where I think things can sometimes get a little weird in this industry where a guy like me who’s a quant wants to always talk about investment strategy. But I was listening to a podcast the other day, an old podcast from Patrick O’Shaughnessy actually. And he, he said this quote that was basically an investment product is more than the sum of its returns. And what he meant by that is when people buy an investment product, a fund, yes they’re often talking about the investment strategy and the returns, but there’s also a utility that they, that often we don’t talk about in this industry. So why are high dividend yield products so popular?
01:02:36 All the math tells us we should not buy high dividend yield stocks. They are typically an underperforming style of value. And yet there are billions, tens of billions if not hundreds of billions of dollars in high dividend yield ETFs because people are expressing a utility that they just like getting that dividend paid to them every month. Could they synthetically create that own their own dividend? Absolutely. But they’re lazy for back of a lack of a letter word. And they like the consistency. And there’s utility in that, even though it’s from a return perspective suboptimal. And that’s hard for people like me sometimes to, to look at and say, no, I need to teach you to do a better way. Let me, let me educate you as to why you’re wrong. Instead of saying no, that actually has really good product market fit for what the end buyer wants. And so I think I had made some poor product design decisions.
01:03:34 [Speaker Changed] So let’s talk a little bit about what return stacking is, how it’s similar and different to portable alpha. Let’s start out, you wrote a really well received white paper on the entire concept of return stacking. Give us the simple explanation of, of what this is.
01:03:52 [Speaker Changed] Yeah, so all credit goes to my colleague Rodrigo Gordillo, for coming up with the phrase return stacking because I think it’s, it’s a more generalized form, but I think it’s much more approachable than portable alpha, right? Portable alpha. You need to understand what alpha is. What does porting do? If I say I’m stacking returns, I’m stacking the returns of gold on top of the s and p, you can probably guess that one plus one equals two, right? It sort of sounds like math and that’s effectively what we’re trying to do. It goes back to the problem we were talking about earlier of, of trying to solve this addition through subtraction issue with diversification. How do I get an industry that disagrees on everything except for diversification is good to add more diversification to their portfolio, right? You talk to anyone and they’ll say, yeah, all else held equal, we want more diversification.
01:04:43 And then you go look at their portfolio and it’s basically the s and p 500 in bonds and there’s nothing necessarily wrong with that. But the question is, can we go further to introduce diversifiers that can improve both the consistency with which we can achieve our outcomes and and the return potential. And so return stacking at its core is trying to take the institutional concept of portable alpha and bring it downstream because institutions to implement that concept have to buy futures and swaps and manage all these separate accounts. What we’ve tried to do is prepackage that concept into a suite of ETFs.
01:05:21 [Speaker Changed] So, so you, the white paper comes out, WisdomTree launches a product related to this. Did you have anything to do
01:05:27 [Speaker Changed] With that? So back in 2017, you and I, I dunno if you remember this, you and I were on a Baron’s round table called What’s Next for ETFs. And at that round table I said,
01:05:39 [Speaker Changed] Uhoh,
01:05:40 [Speaker Changed] I said, I think what’s next for ETF are capital efficient ETFs. And the example I gave was buy the s you know, instead of having a stock and bond fund, this fund could buy the s and p and overlay with treasury futures. And so if you give it a dollar, it’s gonna give you say 90 cents of the s and p and 60 cents of Treasury Futures giving you a a 90 60 a 1.5 times levered 60 40. And the idea there is, okay, you can put two thirds of your money in that fund, get a 60 40 exposure, and then you can take that one third of your cash and, and do whatever. You could leave it in cash if you just like sitting on cash or you can invest it in alternatives implementing portable Alpha. Jeremy Schwartz is, who’s a good friend of both of ours showed that article around internally it was, we had a whole bunch of Twitter conversations about it. Next thing you know, he says, Hey Cory, I’m I’m launching a product on this. And, and the Wisdom Tree NTSX fund was born.
01:06:36 [Speaker Changed] I recall, I recall Jeremy subsequently launching that. I I I hope they at least tossed you a bone and and consulting something. Nothing.
01:06:44 [Speaker Changed] Jeremy had me on a couple of podcasts talk about it. All right,
01:06:47 [Speaker Changed] There you go. I hope I didn’t say anything too stupid at that round table. I can remember that. Up on sixth Avenue. Yeah. Right. Got by their offices.
01:06:55 [Speaker Changed] That’s right. It was, and I, I actually have been using my headshot from that article since then, which at this point I
01:07:02 [Speaker Changed] Got a couple of great photos from that. So
01:07:03 [Speaker Changed] I didn’t realize this is like Pulitzer Prize winning photographer who Yeah. Took our photos. They’re the best headshot I’ve ever had. Same, same. And finally, I said, it’s seven years later, I’m, I’m officially catfishing people with this photo. I don’t look anything like this anymore. Every
01:07:18 [Speaker Changed] Now and then I will see something show up on, on a bio at some event for me. And I’m like, dude, that’s 20 years old. I I’m not only grayer and, and 20 pounds lighter than then, but like, I look nothing like that anymore. It’s like, well we found that online, so yeah, I know exactly what you’re, what you’re talking
01:07:38 [Speaker Changed] About. So I had to, I had to get rid of that one. So yeah, so that was the, the birth of the NTSX fund and, and I was super happy to see WisdomTree do that. ’cause I I really do believe that this is a whole category of products that has not existed really before. There’s a couple of select examples, but really should be a whole part of the industry because again, institutions have used this concept for 40 years and use it very effectively to be able to say to an investor, Hey, I think a strategy like managed futures trend following adds a lot of value to your portfolio. And no longer do I have to sell some stocks and bonds to make room, right? I can let you keep your stocks and bonds and I’m gonna add a 10% allocation on top. When managed futures go through a lost decade like they did in the 2000 tens, the investor will barely notice it. Right? And they’ll be able to stay in it for when managed futures does well in a year like 25.
01:08:30 [Speaker Changed] So there’s a, that’s the behavioral component of this. How, how does this differ just from straight up leverage? It, it sounds like return stacking has a big leverage component.
01:08:40 [Speaker Changed] It is, it is absolutely leverage. I think the idea here is, again, leverage is a tool that accentuates the good and the bad, right? We wanna be very thoughtful about what we’re stacking on top. So if you’re a 60 40 investor, I certainly would not say use this concept to stack more equities, you’re probably just gonna get in trouble. But if you can use this concept to stack diversifiers like commodities and gold, historically that hasn’t been an issue. And in fact, I would point to the Bridgewater all weather fund, right? Who takes
01:09:10 [Speaker Changed] This, which is 25% gold and
01:09:12 [Speaker Changed] Takes this concept to the extreme and runs with significant amount of notional leverage with the idea they’re trying to risk balance all the variety of asset classes. And it held up incredibly well during 2008 despite having so much leverage. And it’s because they’re using leverage to unlock the benefits of diversification rather than using leverage to amplify returns.
01:09:34 [Speaker Changed] Gotcha. That makes a lot of sense. So you currently are running five different return stacked ETFs. Do they each have a different goal? How do different combinations work and what do we 700, $800 million? Yeah, just,
01:09:47 [Speaker Changed] Just clipped over $800 million launched I guess 18, 20 months ago. So we’re very happy and pleased with the growth. And, and I think it speaks to people understanding what we’re trying to do and, and this new form of diversification we’re trying to build, talking about getting a little bit smarter on the product side.
01:10:05 One of the things I think I underappreciated earlier in my career is that advisors and allocators want control in their portfolio. And so with this new suite, what we’ve tried to come out with is what I would call very much a, a Lego or building block approach where each product is very narrowly focused so that allocators can use them how they want. So I’ll just give two really quick examples. We have one fund that for every dollar you invest with us, we’ll give you what is effectively a dollar of passive large cap US equities plus a dollar of a managed futures trend following strategy. We have another fund that for every dollar you invest with us, we’ll give you a dollar of core US fixed income plus a dollar of managed futures trend following same managed futures trend following on top. But one gives you the s and p one gives you bonds as the, as the bottom layer.
01:10:55 [Speaker Changed] So, so that would allow someone to say, I wanna own both managed futures and either I’m bullish and I want equity, or I’m conservative and, and I’m bearish and I want bonds.
01:11:05 [Speaker Changed] I would go the other way, which is you’re a very aggressive investor. You’re let’s say a growth client 80 20, you just have more equities around, it’s easier to potentially overlay your equities than it is on bonds or you’re a very conservative investor, you just have more bonds around or you have a strong view that you can add alpha in your bond managers, but you’re never gonna beat the s and p 500. So take that passive s and p 500 and by our fund you get the s and p back with the managed futures on top because you don’t wanna do it with bonds. ’cause you think your bond manager’s gonna add value. So again, I’m being non-prescriptive and the products I’m bringing to market, I’m letting people say I like the concept of adding an overlay, how I want to express and where I want to express and the size with which I want to express. That’s a conversation and a dialogue we have when we consult with our
01:11:57 [Speaker Changed] Clients. So, so a couple of questions on that. First, who are the typical clients? Are these institutions, are they iass who wants this sort of return stacking in their, their either their core portfolio or any of their satellite holdings?
01:12:12 [Speaker Changed] Yeah, it’s really funny. So you would think potentially with institutions, and we have lots of calls with institutions and they all say the same thing, which is we love this and we also do it ourselves. We don’t need to buy an ETF. Really
01:12:24 They’re, they’re doing it the way they’ve historically done it, which is they have banking relationships and they manage the futures and the swaps and so they don’t need a product like an ETF. So where, where we tend to see and have seen all the flows is independent RIAs who are saying, I’m trying to figure out how to get diversification. I like alternatives, but man, it is hard to say to my client for the fifth time when they point to that managed futures fund as a line item and they say, why in the world do we have this? Right? And you’re saying, well, because diversification and the
01:13:00 [Speaker Changed] Next cycle,
01:13:01 [Speaker Changed] Right? Brian Portnoy says, diversification means always having to say you’re sorry. Right? That’s right. And if you are an advisor running a business and you’re saying sorry to your clients too much, that’s a great way to get fired, right? There’s, there’s just real business risk there. And so what we’re finding is not only I think do we make a compelling value proposition of, hey, this is an interesting way of trying to add returns to your portfolio in the portable alpha sense. If you think managed futures generates 200, 300 basis points of excess returns over time, why are you picking stocks? Just buy the s and p 500 and add managed futures on top. But for the diversifiers they’re going, this is a great way to introduce my alternatives without giving up all the beta, right? And having that return hurdle issue and having that behavioral friction issue.
01:13:44 [Speaker Changed] All right, so, so you have US equity with managed futures, you have US bonds with managed futures, what are the other ETFs?
01:13:53 [Speaker Changed] We have a US equity plus what we would call a multi-asset carry strategy, which, so this is, so managed futures is typically done with trend following signals. It can also be done with what’s called a carry signal, which is you can sort of think of carry as your yield, what’s the return you’re gonna get if the world doesn’t change. And so carry signals can be powerful predictors of total returns. So it’s a just a different quant signal. It behaves differently. Trades a similar universe of currencies and commodities and, and equities and rates around the world. So it’s long short, just a different quant signal. So we have a US plus that we have a Bonds plus that multi-asset carry. And then the final piece is what I consider to be our most flexible portfolio, which is just you give us a dollar, we’ll give you a dollar of as passively allocated as we can.
01:14:39 Global stocks plus a ladder of US treasuries. And the idea there is not to say let’s stack bonds on top of equities in your portfolio. The idea there is to say that is an incredibly powerful capital efficiency tool that allows you to stack whatever you want. So lemme give you a really quick example. Let’s say you’ve got a 60 40 portfolio, 60% stocks, 40% bonds. If you sell 10% of your stocks and 10% of your bonds and by 10% of that fund, that 10% of that fund gives you both the stocks and bonds back. And now you have 10% leftover in cash with which you can do whatever you want. You could have it sit in cash and in sit in T bills and the return of that portfolio would be sort of the same as your 60 40. But hey, now you’ve got more cash on hand.
01:15:28 You can do some interesting things about self financing actually. ’cause you’re technically borrowing from yourself. You can use that cash and you’ve actually just taken a loan based on, and it’s very attractive financing rates. The embedded rate of financing in these futures is like T-bills. So instead of borrowing from a bank, you can actually borrow from yourself or you can take that cash and invest in something hopefully for provide diversification or return. But as long as whatever you’re investing in outperforms cash, you will have added value to your portfolio. So let’s say you love Managed Futures as a strategy, but you don’t like the way I implement Managed Futures. You’ll love Cliff Asness at a QR. You love their fund. Well you can buy my Global Stocks and Bonds fund to free up the cash to then invest in his managed futures fund. And what you have effectively done is kept your 60 40 whole and stacked his fund on top. And so you can now stack whatever alternative asset class or investment strategy you want with our tool.
01:16:28 [Speaker Changed] Huh. Really, really fascinating. The name of the company is the Return Stacked ETF suite. There are five different ETFs on it. I have a couple of questions I’ve been saving before we get to our favorite questions. And let’s start with something that I think is really kind of interesting. During the pandemic, you did a video with Jason Buck where you were discussing like deep in the weeds research into NFTs and crypto and degenerate trading. Like I I, in fact, it might have come from nodding said, oh, you gotta watch this. This is hilarious. In a good way, not a sarcastic way. What was going on with crypto and NFT trading during the Covid Lockdowns?
01:17:15 [Speaker Changed] So Jason Buck is a good friend of mine. He runs Mutiny Funds and we started this podcast as, as you
01:17:20 [Speaker Changed] Do, mutiny funds,
01:17:21 [Speaker Changed] Mutiny funds.
01:17:22 [Speaker Changed] What? Wasn’t there another pod? Maybe it was he who was hosting it was Pirate Capital or
01:17:29 [Speaker Changed] What? Pirates of Finance. Pirates
01:17:31 [Speaker Changed] Of Finance.
01:17:31 [Speaker Changed] That’s, so that was Jason and I started that during the pandemic where okay, we weren’t allowed out of our houses anymore.
01:17:36 [Speaker Changed] I love that. I love that title of that podcast.
01:17:38 [Speaker Changed] So that was a fun one for us where we just said, you know, that was the era of, all right, on a Friday afternoon, let’s grab a beer, right? Chop it up, see what’s going on in markets. And for folks who weren’t paying attention to the crypto markets at that time, it was an absolutely Cambrian explosion of activity, right? You had all these retail traders who started trading crypto and the available functionality of what you could build in crypto really exploded. So you not only had NFTs, but you had all these were called protocols or applications that were doing all this interesting stuff. And it was a fascinating world to explore, not only from the what does this mean for the future, but there were some incredible trading opportunities for people who operated in traditional markets that you would see things and say that that shouldn’t be like that. Right? That’s wildly mispriced. And in any traditional market that wouldn’t exist. But okay, I’ll, I’ll put my money where my mouth is. And so there was a fun trading opportunity. I I certainly wouldn’t say I maximized it. Yeah, but
01:18:40 [Speaker Changed] You’re a computer science market structure guy. This is your sweet spot.
01:18:45 [Speaker Changed] And it’s just fun because it was almost by definition because of regulatory reasons, lots of parties couldn’t get involved. You had a market that was being dominated by retail. I don’t wanna say I lower information flow. Right? Right. More momentum driven
01:19:02 [Speaker Changed] Low information voters. It
01:19:04 [Speaker Changed] Just, the systems weren’t set up. There were limits to arbitrage. And so you had these situations where you said, oh, you can make a good deal of money here. And I had friends who dropped their careers in finance and said, I used to be a market maker for treasury futures and I’m now a market maker for crypto. And oh, now I’m retired two years later because the market’s that inefficient. Wow. And all I had to do was port the exact same skillset that was a bloodbath in traditional markets, right. Eking for every bip and it’s just, you’re just printing money and, and it was a very limited window that does not exist anymore. Right? Right. But there was this really fascinating window of, of both investor behavior and opportunity in what was developing and what it all could become.
01:19:46 [Speaker Changed] So, so I’m assuming you made a couple of shekels trading.
01:19:50 [Speaker Changed] We had, there were some fun trades, right? There were some fun trades.
01:19:54 [Speaker Changed] How, how quickly did you realize that window was closing and I’m assuming that was pre FTX and SBF and sand bankman freed and that that mayhem
01:20:05 [Speaker Changed] It was probably during the Luna collapse. Okay. And again, I apologize for folks who didn’t track the,
01:20:11 [Speaker Changed] So Luna is a stable coin that was supposed to just trade at a dollar, what’s his name very famously got a tattoo Yes. Of it. Novogratz Novogratz. And, and then suddenly the rug was pulled out and it turned out to not be all it was.
01:20:30 [Speaker Changed] Yeah. You had these reported to be right, these stable coins, which are a way for people to transact in what are effectively dollars on the blockchain, some of which are actually backed by dollars and others of which are fractionally backed or backed by a variety of assets. And then you had what was called algorithmically backed stable coins. And I don’t think there’s any success stories there. They all no blew up. Right. Mark
01:20:54 [Speaker Changed] Cuban,
01:20:54 [Speaker Changed] It’s almost Mark Cuban famously lost a bunch of money in one of those. Oh, did he? I didn’t know that. What it was called, I believe it was called Iron Finances was what the, it was called. And that, you know, again, when you have nothing backing a coin other than a systematic strategy that’s gonna try to buy and sell the coin to keep it within a peg, it just,
01:21:12 [Speaker Changed] Doesn’t that sound like portfolio insurance from the 87 crash is nothing new old again? Is it? It just, it’s just amazing that Oh yeah, we’ll find a way to just hedge it as, as the market starts rolling
01:21:24 [Speaker Changed] Off. So you had all this abundance of hot capital in this market that suddenly evaporated. You had very loud players like three arrows capital that was massively overlevered start to fall apart. And as that liquidity disappears, so with it do the abundant trading opportunities. And so that’s where it started to become clear to me. It just, the game was over. Right. It was a game of musical chairs. Right. And the music had stopped playing and I was like, I’m just gonna get outta the room. Right. Because I’m, I, you know, you can overtrade these things. No
01:21:55 [Speaker Changed] Say to say the very least.
01:21:56 [Speaker Changed] And also, it’s not my job. I actually do have a day job.
01:21:59 [Speaker Changed] Right. So, so that was kind of interesting. You’re, you’re also located in Florida, in South Florida. What’s it been like being a new dad in the midst of the west coast of Florida that really got shellacked by three consecutive heart? Everybody’s talking about Helene, but what was it, Debbie over the summer really did some big damage and then the middle one. So so it was like a triple hit.
01:22:29 [Speaker Changed] Yeah. I mean I live in the Tampa area and I, I moved there two years ago and I should have known something was wrong when I, I originally from Boston, it was moving from Boston, driving down and, and it was a hurricane showed up outta nowhere and I actually had to stop my drive halfway down and just hang out in North Carolina
01:22:46 [Speaker Changed] No more. Just,
01:22:47 [Speaker Changed] Well, well it’s one of those, they show up four or five days and you go, right, okay, I’m watching the path. And it became clear, I, you know, all my furniture is getting delivered right the day before the hurricane’s supposed to hit. I’ve got a pregnant wife who is accepting the delivery as I’m driving, you know, the car down. And, and it just, I was like, I should have left at that point. But most importantly, my family is, is safe. Our first floor of our house got completely destroyed. My car got totaled. It’s all overshadowed by how amazing being a father is. I, it is just, it’s hard to complain about any of that. Right. In the grand scheme of life. Of just, you know, I got a new kid and it’s amazing.
01:23:26 [Speaker Changed] What, what’s the rest of the neighborhood look like?
01:23:30 [Speaker Changed] It honestly is pretty devastating. Really. So down near the water, every single restaurant is just gone,
01:23:37 [Speaker Changed] Just gone, just gone. Like wiped off from
01:23:40 [Speaker Changed] The face of the air wipe wiped off. We had Wow. We had an eight or nine foot storm surge. Yeah. So
01:23:45 [Speaker Changed] Not quite sandy, but pretty close.
01:23:47 [Speaker Changed] Pretty close. So you can imagine all these beachfront tiki bars. Yeah. You know, under nine feet of water and then the tide goes out. It’s just, there’s
01:23:54 [Speaker Changed] Nothing left in anyway.
01:23:55 [Speaker Changed] It’s gone. You know, if you had a two story house in our neighborhood, your first floor was gone. And the second floor is what remains for those who had single story houses, which is the majority. Yeah. You know, everything ends up on the curb. Right. And so driving down our neighborhood for the last, I guess two months now, it’s just people’s lives Yeah. Are on the curb. And what people don’t tell you until you live this is that sea water is also mixed with sewage water. Yes. And so the whole place
01:24:28 [Speaker Changed] Wreaks.
01:24:29 [Speaker Changed] Right. And all the plants die ’cause they become so everyone’s garden. So you’re just driving around this place that looks like a trash hump dump as all the plants are dying and it smells awful.
01:24:41 [Speaker Changed] Right. I mean, but aside from that
01:24:43 [Speaker Changed] Wonderful place to live
01:24:44 [Speaker Changed] Are, are you going to, so you were, you were renting, right? Yes. So are you gonna stay there? Are you gonna relocate? What’s the thinking? You
01:24:51 [Speaker Changed] I, well you’re asking the wrong person. You should ask my wife. I don’t, I don’t have executive power here. Right. I think we will stay in the area. We really love where we live. St. Pete is a, is a wonderful area for us. We love raising our son there for the moment. We’ll see how it plays out.
01:25:08 [Speaker Changed] Alright. That’s really interesting. All right. My last two curve ball questions for you At Cornell, you played rugby. Tell us about that.
01:25:17 [Speaker Changed] Yeah, so I, I grew up as a lacrosse player. Got to Cornell and I mean the lacrosse program there is phenomenal. Right. That’s, I was never gonna make the team. I was,
01:25:27 [Speaker Changed] I knew that’s a serious, serious program. Yeah. And
01:25:29 [Speaker Changed] I’ve always enjoyed being athletic. So I was looking around what to do and
01:25:33 [Speaker Changed] Where else can I break bones besides lacrosse.
01:25:36 [Speaker Changed] Yeah. Well this is particularly dumb because in high school I actually played lacrosse and, and got a skull fracture. Nice. So all the doctors said stop playing sports. Right. They wouldn’t let me play soccer anymore ’cause I couldn’t head the ball. Really?
01:25:47 [Speaker Changed] Yeah. Oh, so that’s the serious skull fracture. Oh yeah. Yeah. I broke my nose playing soccer Yeah. In a collision. And just remember waking up flat on my back. But nobody ever said you should stop.
01:25:59 [Speaker Changed] Oh yeah. No. I had to get a spinal tap. I had Oh, really serious damage. I had brain fluid leaking out my ear. Right. This, this was a serious one. So anyway, so I wasn’t really supposed to play sports. And as I got to college, I thought about not playing anything and there was a club rugby team and I just said, you know, for how this sounds bad, but you’re like, you’re at an Ivy League school, it’s kind of like an a, it’s feels like an Ivy League ish sport. I was like, that would just be fun to go play rugby. Right. And it was a ton of fun and it was incredibly stupid of me. Right,
01:26:29 [Speaker Changed] Right. Broken fingers and ribs.
01:26:31 [Speaker Changed] No, I survived pretty well. Well, so I was, what’s what’s, you’ve only known me as, I’ve been older. I used to probably weigh 40 pounds less. Oh really? I was, yeah. In, in college I was a very thin guy. Yes. All of us were. And so they put me way out in the winger position where I just ran right up and down the field. And so I wasn’t really massively in the scrums, in the ru
01:26:51 [Speaker Changed] I gotcha. That, that’s interesting. And, and, and our final curve ball question, favorite Dungeons and Dragons monster and why? Oh, this. And you could guess where that question is. Yeah,
01:27:04 [Speaker Changed] I can guess where that one, well this one actually,
01:27:05 [Speaker Changed] So, so wait, let me give a little color. You are in a financial d and d game that’s been going on for years.
01:27:11 [Speaker Changed] So this is funny actually, if you’ll allow me Go ahead. Can I, can I bring this into the first, your last five questions? Sure. Because you’re, I believe the first of your last five questions you ask every guest is what content are you consuming? Right.
01:27:23 [Speaker Changed] Podcast and Netflix, what are you watching? What are you listening to?
01:27:25 [Speaker Changed] And the problem is, with a rapidly expanding business and a young kid at home, I don’t have time to watch anything. But what I have carved time out in my life for has been this Dungeons Dragons game. It’s hard to say with a serious face. Right. But there are seven of us in the industry who started five years ago, and we play weekly and it’s three hours. And that sounds incredibly nerdy, but for those who have never played Dungeons and Dragons is really a collaborative storytelling Right. Game. We have an unbelievable guy who runs the game who is just this imaginative world builder. So imagine, you know, if you like fantasy or sci-fi, you can run it however you want. He builds these unbelievably complex worlds that we get to explore as characters. And he has a big narrative arc, but he’s constantly adapting to how we interact with the world.
01:28:17 And then there’s the randomness, which is when you try to do something, you’re rolling dice and your success or failure is based on the dice. So the, the dice play a role in the story. And so for me, that’s been a really big outlet of not only fun with the guys, but that’s a lot of content consumption in the sense of the stories playing out in front of me, but also I get to collaborate and be a creative part of the story creation. So that’s, that’s been a really special part of my life for the last five years.
01:28:41 [Speaker Changed] So, so that’ll be our first question because you’re not really watching or or streaming much. Let’s talk about mentors who helped shape your career.
01:28:51 [Speaker Changed] So there, I I will say, and this ties to some of the latter questions. I think one of the mistakes I made earlier in my career is not appreciating how much of an apprenticeship industry this is. Especially the, the more niche you go into markets, there’s just wisdom and experience that it’s hard to learn for yourself. And it’s very easy if you don’t have that wisdom to knock yourself outta the business. Right. From a performance perspective. And so I didn’t, I didn’t understand that I wish I had had more mentors. What I’ll say is on the business side, my father and my business partner are both phenomenal entrepreneurs. And I learned a ton on the business side from them. I will say I’ve been very fortunate reading and interacting with folks like Cliff Asness and Auntie Elman and who have been, you know, huge idols of mine and what they’ve contributed to the industry and just been very open to communicating with me. I would say from a, from an actual practitioner perspective, have been, have been big mentors. Huh.
01:29:47 [Speaker Changed] Really, really interesting. Both of them at a QR, right? Yes. What about books? What are some of your favorites? What are you reading right now?
01:29:55 [Speaker Changed] So, again, not a lot of time to read. I just got done listening to All Lord of the Rings on audio. Huh? I do to a lot of audio books. And
01:30:05 [Speaker Changed] How was that on audio as opposed to reading
01:30:07 [Speaker Changed] It? So Andy Cir, who played Gollum, who’s a phenomenal voice actor, read all the books and he’s so good at like, when he did Gandalf, it sounded like Ian McKellen, like really
01:30:19 [Speaker Changed] You could, he’s doing voices.
01:30:21 [Speaker Changed] He’s doing voices. And it’s just, you know, again, if you’re not into that type of book, you’re not gonna enjoy it. But he brings it to life with such vibrancy that it’s not someone just reading the book. It’s like he is, he’s singing the songs, he’s playing the characters, he’s giving it to you like a play. It was just really, I mean, I got through all three books very quickly and I, I wish I had, I had more. So that’s one I I did just recently. And I tend to do audio books ’cause it’s easier for me when I go out for a walk or run to listen to that than it is for me at the end of a day to say, I’m gonna get through 10 pages of a book and then fall asleep drooling on it.
01:30:58 [Speaker Changed] I know what that experience is like. Our final two questions. What sort of advice would you give to a recent college grad interested in a career in quantitative investing?
01:31:10 [Speaker Changed] That, so I’ll, I’ll go back to what I just said, which was, and I, it was interesting. I was just at a symposium at the College of Charleston, which is put on for their students. And I said the same thing to their students, which is, I’m lo to give advice, but my experience was, I wish I had had a mentor. I wish I had understood that for where I was trying to go, I would’ve gotten there a lot faster if I had found a hands-on mentor and understood that this is an apprenticeship industry. Whether you are looking to do deep quant research or looking to build product or run an RIA every side of it has so many complicated facets that you have to navigate from the regulatory side to understanding the behavior of your clients, to understanding the, the markets and the microstructure and who’s operating in them. That trying to discover that all on your own, there’s a great chance you don’t survive it. And so to me, I wish I, I take that back. I’ve had a phenomenal career. I’m very lucky I wouldn’t change a thing, but I, if I was doing it another path, I would’ve said, man, maybe I should have just gone to work at a QR for a while. That might have jumped me forward, you know, instead of stumbling in the dark for so long.
01:32:22 [Speaker Changed] Yeah. Except you would still be at a qr. Yeah. If you weren’t at a QR. The, you know what, I’m, I’m
01:32:27 [Speaker Changed] Kind. They, first of all, they wouldn’t have hired me. Well, they have a lot smarter people than me. I,
01:32:31 [Speaker Changed] I’m kind of sad about the demise of Twitter because, because it was this, at least in finance and Finw, there was this ability to have conversations with people, whether it was in public or just slipping into someone’s DM and, and chatting. That seems to have kind of faded away. But like the 2010s was a golden era of, I don’t even know what else to call it. Networking, mentorship, connections. Just, Hey, you’re right. Working on this. I did some research on this. You might want to take a look at it. Oh, thanks. That’s really like, there was a, a very level playing field of, of not even mentorship, just encouragement from people. I, I kind of feel a little bit of a loss that that’s gone away. I don’t know how you, like you were right in the thick of this Yeah. As well as, as so many other people we know in common.
01:33:33 [Speaker Changed] I’m still very active on Twitter, but it’s a very curated thing for me. I, what I find is I, like, I’m in, I’m in groups for example of 40, 50 like quants who can’t disclose who they are. Right. And they don’t wanna share a lot publicly, but you’ve built up this trust with them that you can ask these questions of things you’re working on and get feedback from people all across the industry in a way that I, I’m still not sure I could find anywhere else. Right. One of the things I’ve noticed is back in the mid 2000 tens, early 2000 tens, the community was just smaller. And so you could have a lot of conversations in public as Twitter grew and grew and grew, just the request for your time became more and more right. It used to be, I might have one, some young person reaching out to ask me a question. Now it might be 20 times the volume. And it’s just, it’s hard to be as responsive and have the intimate connections I think you had when it was a smaller community. So I know a lot of people who there are, Twitter has its problems, but a lot of people who, who bemoan the loss of that prior experience. I think it, it was a small community aspect that has disappeared. And it’s hard to rebuild that unless you build your own wall to curtain.
01:34:42 [Speaker Changed] No, there, there’s no doubt that that’s part of it. I I’ve also found that I spend much less time in like the main open channel and now everything is for me has been list driven. Yes. Whether it’s economics or markets or I even create a, create a separate list just for charts and put a bunch of, of guys who are technically oriented. And it, like a lot of the worst aspects of Twitter go away when you’re in a curated list of people who are like-minded,
01:35:15 [Speaker Changed] But you lose a bit of the serendipity discovery.
01:35:17 [Speaker Changed] Yes. Yes. Exactly
01:35:18 [Speaker Changed] Right. And so then, then you’re going, well I hope someone retweets something interesting so I can discover a new person. Right. And there are absolutely trade offs
01:35:25 [Speaker Changed] To it. I, I mean, so it was, it wasn’t summer of 24, it was summer of 23. I went out to dinner, I come back home and there was password requests made a change on Twitter that I didn’t make. And I go to say, this is a me. They’ve already given the account away to somebody else. Like they’re, they’re stupid, first of all making two factor authentication an option just so idiotic. And it took three months to get the account back. And I, I finally got it back and some of our mutual friends said, Hey, you’re not gonna recognize the place the, you missed. Like, it’s like when, at the last inning of a baseball game, when everybody files out and you’re in the, you’re you’re in the bathroom and you come back and where did everybody
01:36:14 [Speaker Changed] Go with? Well, I’ll tell you, during that period, I had some fantastic conversations with you over dm. So I, you know, I miss whoever that was.
01:36:22 [Speaker Changed] It, it’s really kind of, you know, it’s, it’s so weird to feel like I never felt a loss when Facebook changed the whole, to use Corey Rio’s phrase and ation of places like eBay and Amazon and Google. Like, it’s annoying. I’m, I I don’t love what’s happened to Apple, although they’re still functional useful for me, Twitter is the first one where it’s like, man, this was really special in our space. And then it’s just gone away. And you know, there, there are a lot of reasons to not be happy with Elon Musk. Not, not the least of which are the never ending promises for products that don’t seem to arrive with any sort of reasonable timeline. But man, firing 80% of the engineers and leaving a a, you know, a, a smoking hulk behind. It’s really kind of disappointing. I, I understand why people don’t love Twitter. I still have this like nostalgic feel for when it was good. It was so good. It’s all right. Alright. And our final question. What do you know about the world of investing that would’ve been useful to know when you were first launching in oh 8, 0 9?
01:37:45 [Speaker Changed] There’s a phrase I have been repeating a lot in the last year and a half at my own business, which is why are we playing the game on hard mode? Play the game on easy mode. And I mean that both in the investment strategies we choose to pursue and the products we wanna bring to market. I’m not gonna talk so much to the products here, though. I’m happy to go into that on the investment strategy side. I, I wish someone had just sat me down early in my career and said low breadth bets, you don’t get to repeat a lot. Don’t do those type of, don’t try to time the market. I mean, like every young person I spent a whole, of course I’m gonna be the one to crack the market and figure out to time it, it’s a dumb, low breadth bet. You don’t get to repeat a lot.
01:38:32 It’s like trying to flip the coin three times in your life and guess heads all three times. It’s just very unlikely. And when you’re wrong, there’s a lot of damage. Alright. So, so be smarter about the type of strategy you’re gonna pursue. By the way, the s and p 500 is the hardest universe to try to actively pick stocks in. Maybe don’t try to pick stocks there. Go play the game on easy mode where there’s a proven opportunity. Rather than saying, having the ego to say, no, I’m gonna be the one to figure it out. There are people who can beat the market, but even if I’m smart enough to figure it out or, or have can find that edge, why not find it somewhere where it’s easier? And so I think for me, I wish earlier in my career, someone had really beaten into me are, are you just playing the game on hard mode just because you want to? Or is there an easier way to do this? At the end of the day, you’re, you’re trying to meet this objective. What is the easiest way to meet it?
01:39:26 [Speaker Changed] Huh. Really, really interesting. Corey, thank you for being so generous with your time. We have been speaking with Corey Hte. He is not only the CEO and CIO of newfound research, but portfolio manager of Returned Stack ETF Suite. If you enjoy this conversation, well check out any of the previous 540 we’ve had over the past 10 years. You can find those at Bloomberg, iTunes, Spotify, YouTube, wherever you find your favorite podcast. And check out my new podcast at the Money Short single topic, conversations with experts about subjects that affect your money, earning it, spending it, and investing it at the money in the Masters in Business podcast feed or wherever you find your podcasts. I would be remiss if I did not thank the crack staff who helps us put these conversations together each week. My audio engineer is Meredith Frank Anna Luke is my producer, Sean Russo is my researcher. Sage Bauman is the head of podcast here at Bloomberg. I’m Barry Ritholtz. You’ve been listening to Masters in Business on Bloomberg Radio.
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