The Important Lesson a Quant Manager Learned in 2020

or should we just move on anyway? You know, it's it's just this crisis, this huge crash, this incredible rally that never seems to end in the middle of a pandemic and so forth. It's just like, there's no obvious, uh historical analogy to what we've just seen that I can think of. Well, I think what was really interesting about last year was that we basically saw an entire economic and to some extent, financial crisis and a recovery, so a sort of complete economic cycle all squeezed into

less than a year. And if you think, I mean, the trajectory of everything was quite similar to the two thousand eight financial crisis. You have the sharp market sell off in March, and then you had the central banks come in and stabilize things, and then you had a slow recovery or a recovery in markets. But again, the big difference was that it all happened in the space of months versus years before. Yeah. No, I actually I

think that's right. You could characterize two thousand and twenty as essentially a full cycle that really got compressed into the span of a few months early. Yeah, exactly. So anyway, it's still pretty unusual, even if even if you could sort of describe it using words that were familiar with it's pretty unusual. But what that means is, you know, for investors, obviously we have this incredible rally. Stocks are at all time high, but you know, I think a

lot of people missed it. A lot of people throughout the summer saying, oh, we're going to get the second the second dip in the market that's coming in eight time soon. You talk to sort of wealthy investors and um sort of high net works, there was a lot of caution under exposure to the gains and so forth.

So while the headlines were very impressive, I don't think there's any doubt that, you know, there probably aren't actually a lot of people that saw their portfolios really match or really you know, let's just say, I think there are probably a lot of people whose portfolios don't match the headline games. Yeah, I think that's right. And I think there's probably a sense in markets, or at least professional investors in markets, that what happened wasn't really what

they expected or what they were necessarily prepared for. So we already mentioned that everything unfolded really really quickly. So even if you were well positioned going into March, you've taken a little bit of risk off the table, you might not have been expected expecting the markets to recover as quickly as they did. I think there's also the

sense of dissatisfaction with what has rallied. I think a lot of people are not not upset, but I think there's a sense that the stupid stuff has gone up a lot more than some other things, which again, like that's the kind of thing that tends to upset professional investors. Right. In fact, that actually was one of the themes of which is that you know, like you know, the back of the spring, we got the we had the Virtual

Buffet shareholder meeting. He was, like many people remarked that he was like very negative on the market in a way that he usually isn't. And then at the same time you had like the Dave Portnoy's of the world absolutely killing it in part by picking scrabble letters out of a scrabble tile is out of a box and picking stocks, and all these people are like, yeah, you know, I'm I'm not too busy these days. I'm gonna sign up our Robin Hood account making a fortune, you know,

all kinds of confounding dynamics to make the market. You know, the market always is very efficient machine to driving people insane. But I think really took the cake at that. Yeah, I think that's exactly right. I've always said that. But the market is a great technology for humbling people, making a smart people feel h feel less smart. But anyway, yeah, you can be wrong every day. Yeah, I'm very excited

about our guests. We're going to talk about some of the lessons learned from We're going to be speaking with

Corey Hofstein. He has the c i O the asset management firm Newfound Research, really sort of active publisher of research publisher on Twitter talking about ideas in quantitative finance trend following various ideas such as that portfolio construction and a really interesting thread at the end of last year talking about essentially the costly lessons learned of what happens when you experience a market that is kind of basically

unlike anything else before. So Corey, thank you very much for joining us, Thank you for having me here, really excited.

What do you describe Newfound Research? What your general approaches, how you would describe it, and uh, yeah, like essentially the aims of your investment strategy when we say that Newfound Research is a quantitative asset management firm, So everything we do we try to focus on creating systematic investment strategies, but our predominant focus historically has been really on risk

mitigation through diversification. But our view is that diversification is not just limited to what you invest in, but also how you make those investment decisions and when those decisions are made, and so we think better risk management is really possible through a greater breadth of diversification. Now, historically, for us, what that has meant is we've tried to play a more siloed role in investor portfolios by offering what we would consider to be resilient and robust. Trend

following strategies predominantly focused on equity markets. So unlike most saying managed futures programs that will apply trend following strategies to commodities and currencies and rates and equities around the world, we really focused exclusively on the equity side of the equation because that's where we saw most investor risk in a traditional sixty portfolio. So, how did that work out for you in because you've been UM, You've been pretty

vocal on Twitter about um poor performance last year? How exactly did that strategy fit into a year? And what went wrong? Well, So, so we won't we won't bury the lead here. It did not go well. But I think if we were to back up and say, how would we expect a trend following strategy to perform during one of the fastest market reversals in history, both from peak to trough and then trough to peak again, we generally wouldn't expect the trend following strategy to do very

well in a in a fast reversal market. That's sort of the expectation going in. So when we walk away from the year and say, well, the trend following strategy didn't do well in I don't think, given how played out, that should be unexpected, but I do think it should cause us to pause and say, well, this type of strategy was really designed to help protect investors against meaningful drawdowns. We just saw a really meaningful drawdown and it didn't

work particularly well. Are there lessons here that we need to think about? Has has market structure changed? Is there something we need to do differently in our portfolio? What is the next drawdown going to look like? I want to get into sort of like what you saw as the year progressed, but before we get to that specifically, and then of course the lessons from that, but before

we get to that specifically. For listeners, how would you describe the theoretical basis for a trend following strategy, And whether it's in equities, whether it's in rates, currencies, commodities. Why is there theoretically premium to be harvested with strategies that are sort of built around following some measure of a trend? So I think there's really two primary arguments

that are out there that could be supported. I think in many of the futures markets, there's an argument that trend followers are liquidity providers to hedgers, that ultimately hedgers are going to be trying to place trades that lock in their profit, and that trend followers are ultimately providing the liquidity to those players, and therefore, in providing that liquidity, they should earn a premium. So I think there's a

reasonable argument there in the managed future space. I think the second argument that often comes around, and I certainly believe in this one, is that there are certain risk limits that firms tend to hit during periods of market stress. That market stress periods are just fundamentally different than normal

market environments. And so what that means is that while markets may for the most part be a random walk, these non linear response functions that that firms have to make, that they have to cut risk, that they have to raise capital UH in certain market environments creates trends during periods of stress, and that they're very procyclical in nature.

That as the market starts to sell off, firms are forced to de risk, which puts more downward pressure on markets and continues them to force the sell off UH. And so you get this sort of crisis trend type exposure. And that's ultimately what we're trying to exploit, particularly when it comes to trying to manage risk. So with that framework in mind, can you describe how you were positioned going into the big sell off in March and then

how you started changing the portfolio. I'm assuming we started changing the portfolio or um the strategy, the systematic process that you were actually using as the month kind of unfolded. Absolutely, So as we went into March, what we really saw was that the majority of our trend signals remained positive late February. So what we're really looking at, just to be very clear for listeners, is we were looking at a cross section of different trend signals on US equity sectors.

So that was really where the primary signals are coming from in terms of managing risk in our portfolio. And as we sort of went into late February, we started to see some sectors turn off, their trend signals turned negative. It really wasn't until say March thirteenth or fourteenth, that

the majority of the trend signals turned off. And so for our portfolio, even if we implement those signals on a daily basis, ultimately, what it sort of looks like it was a dimmer switch that as the market started to roll over, we started decreasing our exposure to equities sort of ultimately minimize that exposure right around late March UM, so there was a buffer there. I should be very clear.

I think our portfolio compared to the SMP five hundred, we had sort of reduced the draw down by about a thousand and fifteen hundred basis points, which was great for the time. The problem was, as the market rebounded very quickly, the trend types of trend following signals we were looking at which were a little bit slower in nature, looking for those sort of prolonged nine month type trends, Uh,

we're slower to get back in. And so almost all of that draw down buffer that we had created was erased within a two or three week period, and the market kept ripping upwards, and by the time that the trends turned back positive in the portfolio repositioned back into equities,

there was a meaningful delay in exposure. So do you think that you could have changed some of the parameters of the trends that you were following and maybe had a better performance, or was there something inherent in having this trend following strategy, the systematic process that made it difficult to be nimble in an exceptionally quick market sell off and then recovery. Well, I think that that's a really great question because there's sort of two sides of

the answer. There's the what I'll say is the investment professional answer, which is with hindsights, certainly, and I think even in real time, we recognize that the nature of the draw down was extraordinary and very different than what we had seen in the past. Um, So that's gonna be my sort of portfolio manager answer, which is, yes, we were seeing things that made us think the way in which our trend following signals work this draw down

may be very very different. If I sort of silo that and then say, well, what is my asset manager answer, which is I run an asset management firm, and I have clients who are allocating to me for a very specific style of exposure. They know that it's longer term trend following. I have a fund prospectus that says it's a certain type of trend following. Can I actually override

that in an extreme situation? Well, yes, I do, as a PM have ultimate discretion, But there are a lot of hurdles that you need to overcome to really have the justification to do that, and you're gonna certainly have to answer to your clients if you're wrong, and so it becomes a difficult trade off to make. In many ways, you are prohibited from making large changes if you have painted yourself in a corner, both in the way you have legally described your mandate as well as the way

you've communicated your mandate to your clients. This is this is super interesting because in theory, these signals that you've built your strategy off of it from years and years

realms and realms of market data. To make the call that, say, you know, in a in a very fast moving market, to make the call to say, well, maybe these aren't working anymore is very bold either way, because, as you point out, you would look very bad if people invested their money with you because you had this sort of strict rule follow approach or the sort of general rule follow up approach and then you unplugged it and then

they continue to work absolutely. And I think that's where there is this um potential problem between right the way you should manage a portfolio and isolation versus the way you're managing a portfolio when it's others, other people's money and you have potentially a legal obligation to them both in the way again, the way you describe your portfolio, or again if it's a it's a forty X mutual fund or something like that, your prospectus is going to

be varying degrees of restrictions. And if you write an overly restrictive investment strategy summary, then it's really going to prohibit you from making changes even if you think you should make them. And what we ultimately found this year was when we did decide that there were changes we wanted to make, even enacting those changes and giving ourselves the flexibility took months and months and months of prospectus updates and operational updates to be able to implement those changes. So,

you know, it's it's interesting you say that UM. You know, earlier you were talking we were talking about, okay, why

does trend following work? And as you pointed out, during extreme periods, UM market has become less of a random walk and there are certain mandates that investors have of UM that you know, either catalyzed selling or for selling or prevent the sort of normal market reaction in what you just described about your own fund, just the mechanics of say, updating the perspective, the perspectives and the legal

requirements around that. Are you a sort of microcosm of I guess why profits can be made at various times by different players in the market, because there's a range of players like yourself that in different times simply cannot you know, for various sort of structural regulatory things, client mandate things cannot change fast enough. I mean, is this sort of what we're talking about basically of why opportunities exist?

I absolutely think so. I think when you look at different areas of the market, what you will find is that there are price and sensitive buyers and sellers, particularly around certain points. I would argue that our thesis played out exactly as we thought it would in March, in the sense that I leave that there was a true procyclical cascade of de risking that occurred across various market players that fed into each other in a very rapid

and violent fashion. Our problem was that we were just expecting it to occur over a much slower time horizon than it did, and so the speed at which our trend models were going to adapt to the markets was more designed for a two thousand and two thousand two or two thousand eight type environment. To see the market unwind so quickly, and I will say our our trend models, which are dynamic in nature, did speed up very quickly. So I think we did a fairly reasonable job on

helping mitigate the downside. But to then have central banks step in and unleash a playbook that took them two years to develop from two thousand seven to two thousand nine and unveil it in two weeks, well, you don't want to say this time is different, but certainly it

is different. Right for them to be able to do that and have the confidence to do that and think about the policy implications from a narrative perspective and how that reinvigorates confidence within the markets, I think it really

was different this time. I want to talk a little bit more about your market thesis, but before we do, can you I mean you have you have this overall view of the markets and this idea of a cascading effect depending on available liquidity and risk appetite, so you can see a bunch of players in the market kind of step away at precisely the moment you would argue that they probably need to be providing liquidity, and that kind of creates this bad feedback loop for the overall market.

How did your models actually incorporate or where your models hindered by incorporating data from previous years? So the financial crisis, is that why they weren't able to adapt as fast? Or is that why you were sort of operating on a different time scale. I guess what I'm trying to get at is how much just having an investment strategy that's actually based on historical data, based on evidence, how much does that hinder you when it comes to big

events that might be unexpected. I think there's really sort of two questions embedded in here. I think the first question is about the data itself, and I would argue for a type of strategy like ours, it's it's less about the data because the trend following strategy isn't necessarily going to incorporate information about two thousand eight. Where that

information creeps in is in the design of the strategy. Right, So, as a PM, my personal memory of two thousand eight and environments like two thousand and other market environments that I've studied to say this is the sort of trend horizon that I think is going to be most efficient for trying to mitigate those types of draw downs without the foresight or expectation that the next draw down may be rapid, violent and only take a month or two

to bounce back, right. And so I think it's not necessarily that it's in the data for a strategy like ours, but it is in the memory of the people who are designing the strategy. We can talk about quantitative and systematic all day long, but at the end of the day, there is a very human element that goes into designing these portfolios. Who are choosing what data is relevant and what sort of constraints or information they want to build

into it. Philosophically, I mean this gets to one of the bigger questions is you know, what do you what do you do with the human element? Because you know, one of the most popular you know, it's a cliche, they always say, you know, your motions are a terrible guide. They tell you to do to buy at the time up to sell at the bottom. And one of the most popular strategies for a lot of people these days is a very simple algorithm when you have money by

and never sell it. So basically this sort of this new dominant strategy is by every month by an ETF. Don't think about it, keep buying, keep buying, keep buying, keep buying. And so you know that's proven. That turned out to be a pretty good strategy in just absolutely whatever you do, don't sell. How do you think about, however, with more sophisticated strategies, the degree to which the human

element either needs to be brought in or excised. Well, if you'll allow me a little bit of a philosophical tangent, i'll answer. You know, I've long thought about this difference between what's really the difference between a systematic manager and a discretionary manager, And I think if you sort of go towards the absurd and say, well, let's allow a systematic manager to follow around a discreptionary manager and just

write down all the rules. Right, if you've ever looked at a discretionary manager's pitch book, there's always that upside down pyramid that talks about their universe and how they filter the securities they purchase, and so there is a process, and so that systematic manager could take that process and turn it into a set of rules and codify it and implement it, and then whenever those rules are broken, they could say to the discretionary manager, well, why do

you break those rules? And Okay, there's a new rule, and they could just keep layering that in and ultimately, if you sort of take that to its absurd conclusion, what that really means is discretionary managers are systematic managers, with the big difference that their value adds should come in the idiosyncratic decisions that they make, that they are breaking the core rules for a truly unprecedented reason. And if you reverse that, I think you could also argue

then that systematic managers are discretionary managers. But they're ultimately selling that optionality that they are foregoing ability to adapt their rules to an idiosyncratic environment. And the argument that they would make is the premium they're going to collect as they're avoiding the behavioral bias, and that there's an

edge there. But the down side, the skew that they're they're really selling might be, well, this time is different and the rules are broken, and now they're foregoing that optionality to adapt. And so I think that's in my mind the ultimate distinction between them whether they're selling that optionality or retaining it. So I mentioned that I wanted to dig in a little bit to your markets thesis, your grand markets thesis before the big sell off in March.

So you wrote this paper called Liquidity Cascades, and I read it today. It's really good, and it's sort of connects a lot of the different things that we've been

thinking and discussing on all loots. But primarily it's about this self reflexive relationship between central banks, markets and risk taking behavior, and this idea that you can get feedback loops like deep in the bowels of the financial system, one of the obvious ones being um the treasury trains that blew up in March and then sort of fed into the equity market. Could you describe that pisis a little more or what inspired you to put that together

in that way? Absolutely? So after March I took a step back and said, I think I'm fundamentally missing something in my understanding of markets. What I witnessed in March as we were watching markets day to day was what I thought were procyclical sell offs. That you were seeing a market that was being very heavily driven by hedging behavior extreme selling that did not seem connected to fundamentals

anymore to me. And so as we exited March, I said, I think I'm missing something in my personal understanding, and so I went out and I tried to survey all the different narratives I could find about what was really driving markets today. So I should be very clear that what I wrote in the Liquidity Cascades piece is not,

in my opinion, particularly novel research. I leaned very very heavily on the ideas of folks like Mike Green at Logica, or Chris cole Vaneer, Ben Sally, I know Ben Effort who has been on the podcast with you guys a few times before. Folks like that have identified a lot

of these different features. I think if I brought anything new to the table, it was simply trying to say that these are not all These ideas that they are presenting are not necessarily independent of each other, and in fact may have a knock on influence into each other. So to take a step back, what was the ultimate conclusion of Liquidity Cascades. Well, the way I saw it was there were a few big narratives out there that all sort of played into each other, and they all

played into each other in a big loop. And it's hard to know where the loop really started or ended, but I think sort of the easy place to begin is with the influence of central banks. The core idea being here that central banks have moved from referee to very active player in the market, and that by reducing the discount rate over time, they have forced investors up

the risk curve to pursue yield. The reason that occurs is because ultimately a lot of investors have far dated fixed dollar liabilities, they cannot afford to earn a lower expected return, and so they have to keep increasing their risk. So someone who was pursuing a seven or seven and a half percent return twenty years ago, thirty years ago could have just invested in US treasuries. Today it has to be a portfolio filled with equity like securities and

highly illiquid securities. And I'll come back to that illiquid part, But what it ultimately means is investors are bidding for riskier and riskier securities and moving into a more and more crowded trade. Now. Coincidental with that has been this

sort of change in market micro structure. Both moved from active to passive, and this has really been Mike Green's argument around the influence of passive investing in markets, but also a migration from um active discretionary mutual funds to indexed e t f s which are predominantly traded via baskets. And then finally, one of the things that facilitated all that was the rise of concentrated high frequency trading. So you have a very large change in the way that

liquidity is now being provided within markets. It's being provided by fewer and fewer players, and these high frequency traders are highly levered and capital constraint during periods of market stress. Final piece of the puzzle, at least the way I I've seen it, is that in moving up the risk curve, a lot of investors have tried to adopt what will

call volatility contingent strategies. So these are going to be strategy that are risk managing in some way so or their position sizing is going to be based on market volatility.

So this is gonna be things like risk parity strategies uh C T A S. I would argue the type of strategies that newfound has provided in the past fall into this camp UH target risk variable annuities, but even structured products out of Asia are sort of, in my opinion, a way that people are moving up the risk curve while touching into this volatility contingent space, explicit volatility selling, the adoption of covered calls among institutions in the US,

And what this ultimately means is that as investors move up the risk curve, there's this perpetual bid for equities. You get this suppressed volatility. All of these volatility contingent strategies increase their leverage, which increases their bid for equities. So you get this sort of procyclical grind up within

equity markets. And then when there's some sort of exogenous shock, they're all forced to unwind at the same time into a market that's already very fragile from a liquidity perspective, and so you get this very violent unwind that either sort of sees its way through, and I think we

saw that in March. Sort of by the end of March, most of these players had fully liquidated their equity exposure, or simultaneously you get a very heavy handed UH step in by central banks around the world to try to return liquidity back to normal and in many ways the whole cycle has started anew m. So is the upshot of this? You know, so many players around the world forced to increase risk, lots of leverage, lots of capacity to buy equities. Is the upshot essentially by the dip?

And I mean that sort of casually but also seriously, Like you know, people always tweet that there's like buying the dip, buying the dip. But in terms of like how one identifies alpha opportunities in a market with such a perpetual bid and such a sort of demand for assets, does that mean that like the sort of like biggest opportunity to exploit And obviously it worked out what it worked out, But in general that the players that provide liquidity when the entire system is demanding it are the

people who can reap access returns. I think what this thesis would argue is that price moves within the market are becoming an increasing function of flow and not fundamentals to your to your point Joe about uh mean version within the markets. It's a really interesting paper that was

published recently about the influence of target date funds. This is an industry that has silently grown from eight billion to two and a half trillion, And arguably this plays into the whole thesis of liquidity cascades as well, where the influence of central banks is forcing people up the risk curve. They can't hold money in savings accounts anymore, and so the market has become their vehicle of savings.

And what this paper found was that how much the market trends, So this this measure of auto correlation in the market, there's a really significant break post two thousand eight as these target date funds became larger and larger that before the influence of target date funds, which are systematic rebalancers, every time the market goes up, they're going to sell the market exposure to buy to rebalance down. Every time the market goes down, they're gonna buy to

increase their exposure. Prior to the real growth of target date funds, markets tended to trend more. After target date funds got really large, that seemed to disappear. Now that might just entirely be a coincidence, right, It's not to say it's causal um but I think what we're seeing is more and more circumstantial evidence like that that as in there's more of these sort of price and sensitive systematic strategies that are all existing in the market today,

they're having impacts that are no longer fundamentally related. They're purely flow related, and they're having knock on influence into how securities are being priced. So this is what I've called the flows before pros dynamic earlier, and I think it gets to some of what we were discussed. Yeah, I did, you can look for it on my Miscope, that's really good. I like that flows before pros, thank you.

But I think it actually gets to one of the reasons why a lot of professional investment managers seem to be so angry at the moment or disgruntled in some way. Up core, you are by no means disgruntled. You're very calm and explaining all of this in a very rational manner. But I think there is a lot of you know, you see a lot of commentary going, oh, the Fed's just inflating asset prices. It's creating this massive bubble. Uh, you can't generate alpha anymore. There's no point in making

rational investment decisions because everything is dictated by momentum. So I guess the big question is what does the dynamic that you just laid out actually mean for the relationship between the Federal Reserve and the market. Can the market stand on its own without a central bank back stop? Well, my my thesis would be that the central bank has put itself in a place where markets in the real economy have become more tightly lengked than ever before via

the wealth effect. That as investors are forced up the risk curve, as they're forced to put more and more in their of their savings into markets, that volatile markets have a very real knock on impact into the way consumers are going to spend. And so I think it's very hard for central banks to extract themselves for markets in a rapid fashion for that reason, because they can't just magically raise rates back to a reasonable level whereby investors could have a real rate of savings in a

bank savings account without causing huge disruption. And so I think this is going to have to be a very slow unwind for central banks. To your point, though, my view is, look, ultimately we're I can't control the field, I can't control the game I'm playing, and I just have to play the game. And so for us, it's not to be angry about what central banks are or are not doing. I think there's both plenty of qualitative and quantitative evidence that tail risk has increased over time.

If you simply plot a measure of tail risk in the SMP five hundred of weekly SMP five hundred returns, it has very steadily climbed over the last thirty years, UH, jumping in two thousand eight, but continuing to climb through the two tents. So I think there's an argument markets are moving further faster. Uh. They are. You're seeing more greater extremes with greater frequency. But that's the environment we're in.

So what we ultimately chose to do this year, Let's say, look, we we think the type of trend following approach that we were using may not work in this market regime, and so we need to introduce different features UM into the portfolio, not only diversify the way in which we're managing risk beyond just trend following, to include things like UM convexity on the downside with put options UH, stylistic tilts with inequities themselves, and overlay to bond futures to

try to capture that flight to safety premium but on the upside as well, we're just going to lean into the momentum in many ways, we're going to create some upside convexity using options to try to benefit from the same gamma that a lot of these retail option investors are benefiting from. If if that's what's going on in markets, then our job is to play the hand we're dealt.

Speaking of, um, the world getting tail riskier. One of the I like following Tracy on Twitter because she always informs us when events happen in the market that are only supposed to happen one every two million years, according to the math, happened multiple times in a cycle. You're you're always on top of that one, Tracy. I only do it so that people can have an opportunity to show that they've read to Leb's books. Everyone likes to do that, right, Well, according to black Swan, Yeah, you're

it's really a public service. Okay, Um, oh god, you're gonna want to get to live on, aren't you? I can tell all right. Um, here's my other question. So, if we think that the world is becoming more tail riskier, and if we think that market stresses are becoming more important, for the FED. Is there an opportunity in investing in identifying potential pressure points in the market and actually exploiting them on the assumption that if they blow up, the central bank is going to have to come in and

rescue the system. I mean this kind of goes back to Joe's point. Is the conclusion just by the dip, but in a slightly more I guess sophisticated way, is the conclusion, try to find the weak points in the financial system, arbitrage opportunities, free money basically, and get as much as you can out of it. I think the way we've tried to attack this problem is almost thinking

about it as a game of musical chairs. I certainly think that there are players out there who can survey the landscape and try to identify those fault lines and position themselves on it. I guess it's largely been my view that that is very, very difficult, because truly exogenous shock is going to be something that is going to be sort of unknown. I think, you know COVID nineteen. I think a lot of us were scratching our heads in February why it wasn't impacting markets more and maybe

this liquidity cascades. Answer is exactly why, because markets were being flow driven, not fundamental driven in February, uh, and then we saw the reverse in March. But ultimately, I think it's not so much a question of what's going to take the market down versus if we just know the market is going to move further faster, both on the melt up and the meltdown, how do you reposition a traditionally allocated portfolio for that? I would argue, if the game of musical chairs is playing, we need to

lean into the momentum. We need to lean into the upside convexity, but not leave ourselves naked on the downside. And I think that's the important point. It's trying to create this sort of asymmetric profile where we can harvest that edge and recognize that flows really are potentially changing markets.

I saw a wonderful little note this morning on Twitter where an analyst had demonstrated that YESG funds and green funds, which have had phenomen coominal performance year to date and we're only I don't know halfway through January, if you segmented them between funds that had just a few holdings versus more diversified funds, the performance was very, very different, and it seemed to be driven almost entirely by flows. That large flows into these highly concentrated funds were actually

driving up the prices of the underlying securities. And so if we think this is a flow driven market, if we think that there's an outsize influence of retail investors who are speculating using options with Robin Hood, I can either sit on the sidelines and and cross my arms and be upset about it, or I can take that into account, try to recognize where I think flow is potentially influencing prices, try to maximize our exposure to that momentum, and then again make sure that I'm I'm hedged on

the downside. Let me ask you, you know, uh trade As Tracy said, you know, some investors they do seem to get angry and they go on TV and wind about the fad. You don't do that at all. And that was one of the reasons I want to chat with you, just because of you know, how sort of like transparent open you are, and you're talking about lessons learned in UM. It's just like it's extremely refreshing. Uh, it's much more useful than uh and some of the

other stuff out there. What is the conversation like with clients in terms of how you're sort of explaining how you're incorporating these new ideas, and also, you know you're you're sort of point your point about how a true systemic strategy is selling something of a call option. You're diminishing some of that optionality for the purpose of sort of taking human human emotion out of it. How are

you thinking about that going forward? Because may not be the last time where you sort of identify that certain rules aren't working in real time as much as you expected they would. So how are you thinking and sort of the long term strategy and your long term career approach about the role of flexibility and maintaining that. I'll start by saying, I appreciate the kind words my wife will tell you. I wine plenty, so's I'm just taking

it out in a different avenue. So as it relates to client conversations, I do think it really all is going to depend upon your relationship with your clients. I think we have great relationships with our clients. We work very hard at that. We worked very hard at constant communication, and so for us. The process of transition this year

was not I won't say it wasn't unexpected. We were in contact with our clients and stakeholders the entire process of the research we were doing and sharing with them what we were finding and the questions we were asking. And it's hard to be that transparent it right, this is an industry where confidence really does sell. Hubris Cells, Um, you're the only one on Twitter that didn't gain a

last year. Well that's true, that is true. But if if Hubris Cells, I would hope that humility ultimately survives. And so my view is that if we can have that conversation, that hard but transparent conversation with our clients, they're either going to say, look, I bought you for a particular position in my portfolio. I wanted you to fill that position. You're changing and therefore I I no longer want to allocate to you, which I think is

totally fine. Right. If they wanted an intermediate term trend follower and we're not going to do that anymore, then I think from their portfolio composition, they do need to find another manager. But for other clients who are saying, look, I was really just trying to allocate to you for

resilient equity exposure. If you think market structure has changed and you need a to change your process to increase the amount of diversifiers are holding in your portfolio to adapt to this new market environment, well that's what we ultimately are hiring you to do. So please give yourself the flexibility, Please come back to us when you think

you have the solution. And so it really I think if you have a good relationship with your clients, this is something that you can make that transition over time. As it relates to the role of discretion I think this is a really interesting one. I will say the market trend within investing over the last decade has been towards greater and greater, greater and greater pushed towards systematic strategies.

We've seen it through the adoption of smart Beta. We've seen it as people move away from traditional discretionary, especially within equities, and so I continue to get pushed back both among prospects as well as clients of US adopting any discretionary To be honest that the question is how are you going to make this systematic? I think what is interesting is I think there's certain areas where I

will continue to be systematic. I think within our stylistic tilts of equities, um, momentum exposure, defensive styles that we implement UM. So whether that's quality tilts or UH statistical measures a risk like low ball or low bait up, those will continue I think to be systematic because I haven't seen a lot of evidence that we can add

a lot of value. On the discretionary side, where I think it's harder to be systematic, where we've given ourselves more flexibility and being discretionary is in those types of positions that are going to have a very strong path dependency. So, for example, are options that we hold a ladder of, say out of the money call options and out of

the money put options. When you want to monetize those positions is going to be very very path dependent on the nature of the type of draw down that you're seeing.

And so you can try to enumerate all the rules in a systematic manner, but I think ultimately at the end of the day, you just end up with this sort of infinite long list versus having some sort of ad hoc you know, or maybe some rules of thumb about when you might want to monetize, but recognizing you're gonna need a little bit more discretion in those types of market environments because those situations can change rapidly. Liquidity

can change rapidly. You don't want to just lock yourself into making a decision beforehand without giving yourself a little bit of flexibility to recognize how how environments are changing. Corey, that was great. You do such a good clear job of explaining this, and I really appreciate you coming up well. Thank you so much for having me, and you didn't whine about the FED at all. I can if you want me to next next when we do the follow up, when they change the rules again next year, then we'll

have you back for that. But no, that was really great. It's so so clear and helpful, and I learned a lot. Good luck. Thanks, Cory. That was really good. Corey is great. It is super clear. You know, like one thing I kept thinking back to. It's like when we first you know, when I was thinking about this episode, I was thinking about it, Okay, this is gonna be talking about quantitative stuff,

of the challenge of quantum investing, and it is. But it's interesting how many conversations come back to this point about the degree to which the FED is sort of in this corner where they're the only player in the game and everyone has to buy assets, and how linked

the real economy is to financial markets. It's such a recurring theme of so many of the guests we talked to from all all different perspective, right, this idea that you have the central bank suppressing volatility, which then leads to risk taking, which leads to further suppression of volatility until something kind of um gets knocked out of whack in the system, and then you get stresses, and then

they kind of cascade in the opposite direction. You get sell off, you get a big burst of volatility, and then the central bank comes in, pours cold water on whatever fire has set the whole thing off, and then the cycle begins again. I think that's definitely a theme

that's come up in a bunch of our conversations. But I'm thinking of a couple right now, Chris Cole and Ben Effort, which of course Corey mentioned as an inspiration for his Liquidity Cascades paper, but also, yeah, I mean all of those, and then also I'm thinking like uh, stream of us to Vedanta and Paul McCulley and like, how much of this situation where the FED is the only game in town is downstream from the fact that economic policies deprive the private sector of the income it

needs to have a sustainable economy, and so therefore you end up with this situation where so many people's fortunes are not really linked to GDP per se, but to asset markets specifically. So it's like, there is like this weird There are tons of guests that we talked to last year that all sort of like talked about this same phenomenon. I don't know what he's going with that. It's just it always seems to come back to this phenomenon, regardless of the sort of perspective that the person is

coming from. Now, I think that's a big deal for the way the world act. That's another one who's sort of in that. Yeah, yeah, I mean it's a big deal. And but I I think one of the reasons it's important is because, well, first of all, it deals with the gap between the reality of the economy and what's happening in markets, which we've seen a lot of people

complain about last year. But it also explains why there's the sense of um again, dissatisfaction both among financial professionals, but also between people who are set out of the stock market rally versus people who are included in it. Or you know, this idea of the K shaped recovery in I think that disconnects, you know, Yeah, go ahead, No, I was just gonna say, it's interesting, there's something I

meant to bring up with Corey. But you know, it's their signals were obviously for a long time after March, obviously not telling them to get back into the markets aggressively. But I think if you looked at a lot of

like non systemic investors, you have the same thing. I remember talking to a someone at a broker dealer this summer whose clients were mostly high net worth and family offices, and he's like, everything, this is probably May or June, and he's like, every single person I know is missing the rally to some extent, Like everyone is under invested here. And remember, there was just this general disbelief that amid such an economic downturn, the market could be railing this much.

And so whether it's like people on a purely systemic basis or just people going with their gut or whatever. Lots of people had some sort of mitigating thing keeping

them out of the big rally. Well, so this gets back to the flows versus prose phenomenon, which is that if the entire market is moving based on momentum and inflows, then the retail trader, you know, the guy sitting in his basement who's reading the Reddit forums and looking at a bunch of meme stocks, he might have a better sense of those inflows and momentum than a lot of professional investors do. Wow. As a very very provocative statement to end, I don't know what to say, but let's

leave it there. Okay, it's late at night, maybe we should end it. Okay, very provocative. Yeah, all right. This has been another episode of the Odd Lots Podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy Alloway. And I'm Joe Wisenthal. You can follow me on Twitter at the Stalwart. And you should definitely follow our guests on Twitter. Corey Hofstein he's at Sea Hofstein Fountain Insights. You heard just now extremely clear. Also check out all

of his research at I Think Newfound. Very provocative stuff. Follow our producer Laura Carlson. She's at Laura M. Carlson. Follow the Bloomberg head of podcast Francesco Levi at Francesca Today, and check out all of our podcasts at Bloomberg under the handle at podcasts. Thanks for listening.