Elevate Your Return Stacks with the Combined Power of Trend & Carry

The commonly well known trend following strategy and the slightly less well known in popular vernacular but Equally popular among systematic, uh, investors carry. And we're going to dive into what these strategies are, how to think about them, how they differ from one another, and maybe actually even share some similarities.

Both empirical and theoretical ideas for how they perform in different economic environments, and then how you can think about incorporating them into your portfolio, either as standalone components or in a return stacking framework. And some of both the return and behavioral Frictions that go along with those ideas. What's really important for this webinar is that you should feel free to ask questions at any time.

Uh, you can type in the chat box and I will be responding to questions either in real time or bringing them up to Rodrigo as we go along. I may hold them to the end depending on, on the nature of the question, but we want to make sure that this is engaging content for you here to hopefully educate and teach you something a little bit about these strategies, but want to make sure you feel comfortable. Uh, and answering and asking any questions you have.

with that, Rodrigo, I'm very excited to turn it over to you here to dive right in.

So just to kind of understand the similar areas and really intuit and really like get deep into what makes them different and what's, uh, what's the same, and then ultimately I want you to be as excited about that combo as I have been for a decade, and hopefully we can, uh, get that across to you and you're able to take something away from this presentation. So with that, let's start by actually trying to understand the basics of like the two components of price of an asset.

and so let's start by decomposing these, the two sources of return that I think we all understand and know for each asset class, the first source of return is the price appreciation of the underlying asset class through time. There's the capital appreciation when you buy a house, it's the, you know, the increase in land value. and the second one is the yield. Or carry of that asset class as it distributes a yield or a dividend or a carry over time.

So in a, in a house example, it would be if you're renting it out, what you rent minus your costs of, running that unit would be.

And so for all intents and purposes, when we talk about trend managers and carry managers, Trend managers and trend following managers tend to focus on the former, on the, the appreciation or depreciation of capital for each asset class, while carry strategies tend to focus on the latter, which is just simply focusing on what am I getting paid if I hold this and nothing changes.

And so both are actually using these markers as, the parameters to decide whether to go long or short, the different asset classes, right? So they're looking at price appreciation recently or the carry or the change in carry in order to, to try to estimate what's going to happen in the future and make predictions. But before we get into all of this, I do think it's useful and important to really try to understand how futures markets work and how specifically futures contract pricing works.

So what I'm showing you here on the screen is just a fictitious price term structure of a futures market.

A term structure of futures contracts if you've never heard of that term or don't haven't really understood it It really refers to the way that prices of futures contracts vary depending on expiration dates So think about it like looking at a calendar of prices contracts that expire sooner Might have a different price than those that expire later and you can see here in this chart that the, the idea here is that, when you look at, prices over time, December 24th maturity, this is a contract

that's going to deliver whatever, market that is at the end of December. This one at the end of January, all the way down to June. In this particular example, you can see that this is a calendar, uh, differences of return. Now the question is, Why is there a difference in prices over time? And this is depending on the contract has to do with a number of things. The first one is the cost of carrying a commodity, for example, right?

If you're going to have, you're going to store a commodity for delivery into the future, there are costs associated with that, right? There are expenses like storage, like insurance in that storage, financing costs of holding the underlying asset class. There's also supply and demand considerations that, that create these shifts. If there's short term scarcity.

For example, like we saw in COCO this year, because of a supply issue, the near term futures contracts might be more expensive, and that'll lead to kind of an inverted term structure. Uh, market expectations of, of future, prices. For example, if there's a geopolitical issue and geopolitical tensions might lead to longer dated oil futures, uh, having higher prices, and then there's also the, um, the idea of convenience yield.

So this is the concept of when an asset class is in short supply, generally speaking, the convenience of having immediate access can make the near term contracts much more valuable, creating a downward sloping term structure. Okay, so term structures can be normal, Upward sloping, or they can be, uh, where, where longer day contracts are more expensive, or they can be inverted and downward sloping when shorter day contracts are more expensive.

So that's kind of the, contango and backwardation that you've heard in the past, I'm sure. All right. So let's get back to the concept of like, what does this matter to trend managers? Now, the reality is that for trend managers, it's, um, it doesn't matter much, trend managers really tend to only focus on that front month contract. And they. They really care exclusively about how that, price has shifted recently in contrast to the recent past.

So when we talk about trend managers, they're looking back at 20, 30, 40, 120, 240 or more days and comparing today's price to the historical price. So they're really looking at a shift. In movement of the front month contract to make some decisions. If it's, if we see across all those look backs that the price has continuously shifted upward, then generally speaking, trend managers are likely to go long that asset.

If the price has shifted downwards, then they'd likely to go short that contract. So something that has recently moved is likely to continue to move as the concept. That's all the trend managers are looking at when they're looking at futures contracts. Okay, now moving on to the concept of carry. Okay, so in this chart here, carry managers actually care about the full term structure of the market that we're looking at.

And really the, what we care here about is the differentials across the whole term structure. Cause the idea behind carry is that what does one expect to receive when holding an asset class, if nothing changes. And in this case, from a visual perspective, what we want is that our assessment today, that the carry in this case from the back month or the front month of 3. 2, we want that to continue. We want this shape to stay the same. over the next six months as prices shift.

So in the case here, if I buy a June 25 contract, I hope that the shape of the curve stays identical so that the next month, you know, it appreciates and appreciate some more. And if I go along this asset and it keeps on appreciating until I receive my full yield, that is, that is the idea. That is the hope. you know, if you think about this, think about it from a perspective of a, somebody that owns a dividend paying equity, Let's assume, let's just make the math simple.

The equity pays 12 percent a year and it issues it monthly. What you would expect is that every month, you're going to get delivery of 1 percent of that expected 12 percent dividend yield. And if the price of that stock doesn't change over the next 12 months, my return is going to be that 12 percent dividend yield, right? Now, because really futures contracts do not pay a dividend. in fact, a lot of people ask the question, well, when I buy a futures contract, do I not receive a dividend?

Is it just a stripped out, contract that only gives you price appreciation? The answer is no. It's embedded in, in that term structure as price goes up the curve, if you're going long or down the curve, if you're going short, then you are going to be receiving or getting that appreciation for that carry as time goes by, assuming nothing changes. Okay. But of course that doesn't always happen.

the, the idea that you're going to get a 12 percent return and that's it, is uh, you know, the same idea of a dividend stock, not changing in price. They do change in price. Sometimes it's, it's going to be in the direction of the yield that you're getting. Sometimes it's going to be in that 12 percent example, you're going to have years where that stock is down 12 percent and you made zero returns.

but that the idea here is that the concept of, of yield is that it's an indicator that if you, Choose high yielding things, or short, very low yielding things. Then you are likely to see that asset class appreciate more than others that have lower yields. Okay. So what's interesting here is this is the first time that I think everybody needs to focus and try to internalize the benefits of these two strategies on, on their own. Okay. the benefits here is.

In the case, in the case of the chart on the right, you saw that there is a price, a shift in the yield curve here that moves up the amount of carry available, right? So it really is looking at that yield and the expansion of yield. If in the second period, it increases. When trend managers go long their asset class, they really are looking at price appreciation. And, you know, I've been in situations where, we've had signals to go long gold on trend.

But because gold tends to have the opposite type of equity, uh, term structure is this, when you hold gold on average, you're going to lose, in carry. And there are times where you are right about the price appreciation of spot gold, but because the carry was so negative, you actually lost more in carry than the, um, than you made in the price appreciation by selecting it based on trend alone. Right?

So you can see that by having these two man, these two ideas and these two concepts in one spot, they kind of help fill each other's blind spots. So what are further similarities here between these two asset classes? Well, there's I've always said that managed futures, whatever type of managing of futures that we're doing, tend to have one thing in common is that they want to maximize diversity, they want to maximize breadth. And so both trend managers and equity managers.

Invest across dozens of global equity markets, global bond markets, global currencies, and commodities. All of these major asset classes react to different economic stimulus in different ways. and they offer different term structures and they offer different price appreciations at different times. So it creates, I would say that these strategies tend to be the most diversified thing that people have in their portfolios when they do allocate to them.

and so I think what's, uh, what's key here is the understanding of that. We're not, carry is often kind of, categorized as this, uh, widowmaker trade of, of a currency carry, specifically the yen carry trade. This idea that you can clip a coupon by getting paid more in a local currency and less in another currency over time. But then when economic, situations arise that you just lose all of those returns that you made, and it's, it coincides with an economic shock and negative economic shock.

Now that tends to be true for certain, currency pairs, but it's not necessarily true for, you know, If you're looking at carry across commodities, currency, other currencies, pairs, other bonds and equities, right? So having a diverse set, a wide variety of asset classes to invest in, much like trend managers do, is the key to all of this. All right, now getting down to, you know, I just told you about trend and I told you about carry. The question is, why do we think it exists?

Why do we think it'll continue to exist? And I think we can, you know, when it comes to, to trend following here, there's a risk based theory, a behavioral theory, and a structural theory that I think all have merit. the risk based theory is really the concept of you as a speculator that are looking for trends. you're providing liquidity.

You know, during periods of market stress or imbalance, trend followers offer liquidity by taking the opposite trade of those that need to buy or sell urgently, for whatever reason, whatever, uh, you know, active market participants, it could be a producer, it could be another manager that needs to hedge out certain risks. And so the idea of risk transfer here that other participants may be willing to, uh, Pay a premium to hedge in order to offload some risk.

Trend followers take the opposite side of that. They take the price variance in order to receive and get compensated for, in a form of higher expected returns in the future. So that's kind of risk based. I think that makes sense. Behavioral, I think this is the one that resonates most with people when they think about trend following, right? This idea of herding behavior. A lot of this has come from the, uh, the works of Danny Kahneman, Amos Traversky, behavioral finance.

and there's a wide kind of variety of, of, ideas here, anchoring and adjusting the idea that when you get information, Uh, you know, you, you anchor to the recent past and you adjust a little bit, but not fully, the idea of sequential decision making or information cascades where information goes from the back of the newspaper all the way to the front. It takes time to disseminate and that's why if you get on the trend early, you're able to ride it up or down.

depending on whether you're shorting. And then structural inefficiencies is an interesting one that I've always found, um, valuable. And this is just, again, intuitive, right? If you're an advisor that's ever had to deal with a large order, you're not putting it in at market and hoping for the best, you're actually working that order over time, and if it's a big order and you're buying, you're going to over time bid up that price on average, right? So, uh, this idea of order execution delays.

creating the trend is, is very, um, uh, intuitive. The other one is queuing dynamics. If you look at, at the idea of, how information theory works and the idea of, you got the same amount of information across, let's say three different tellers trying to get through, a, uh, um, to pay for, for anything in the grocery shop.

Then what will happen is if everything, if every one of these individuals goes in the line at the same time, in the same sequence with the exact same delays and everything clears. But if the moment that any one of these people go to different lines and they create more delays or the queue moves faster or slower, you're going to create imbalances that need to clear out over time.

Okay. So delays in sequencing is another one that I like in order to understand why trend is likely to work in the future. Now let's get to yield. how do we actually measure futures yield first of all? And then why do we think that there is, this is likely to continue? And I think for us, this is really a risk based approach to carry. let's, let's go through it one by one. So for equities, we talked about it a little bit already. It's the dividend yield. That is the carry of equities.

We believe that. Ultimately, this is a measure or a proxy for fundamental risk. So for example, when there's economic stress, like in 2008, what will happen is you will, you'll bring a higher future yield, right? As prices go down, the yield of that expected dividend is going to be higher. And that higher dividend yield is a sign that you will be bearing excess risk in order to ultimately get compensated for that risk and get rewarded for that.

So it's a good signal telling you that it's a good time to buy, the, uh, dividend yield. And so the other one for bond is the coupon yield plus the roll down yield. And so here again, intuitively we would demand higher yields and a steeper yield curve as compensation for things like country credit risk, illiquidity risk, monetary policy risk, and inflation risk, right? So all of that kind of makes sense.

And the further out you go in terms of duration, you're also expecting to get higher yields on that. On the commodity side, um, we talked a little bit about the convenience yield here.

So if you think about it from the perspective of being a producer of a commodity, if you're a producer of a commodity and you're running a business on, you know, gold or, or corn, you really, you're going to ask yourself, do you want your company to Success to be defined by the vagaries of the price movement of your underlying Commodity or do you want to have more control of that and really be about are you a good operating company? You know, do you keep costs low?

Are you efficient with uh with your assets? And I think everybody would agree that the latter is more approachable and uh and acceptable by market participants. So what tends to happen is People want to hedge out those risks. Uh, there's a convenience that you're willing to pay to hedge those future price fluctuations. And the moment you stabilize and you sell forward your commodity and you have some certainty, you can then go back to the banks and get better financing.

You can go back to the capital markets and get better pricing and a better valuation for your company. So by, by paying on hedges, you actually increase your market value and your ability to participate in capital markets much, in much more, in an easier way. So I think the convenience yield year makes a lot of sense. and on the currency side, we're effectively capturing the spread in interest rates between the different countries.

but you know, it captures things like, funding liquidity, like consumption growth, growth risk, and a number of other smaller associated risks. But again, all of the risks, uh, we're ultimately, we're ultimately bearing, and that's why we really think it's a true measure of risk premium. And this tie between carry measures and risk provides a very strong intuition as to why we think that carry is likely to inform us about future total return of any asset in the future.

and also gives us a confidence as to why we think this sort of strategy isn't really going to be arbitraged away. There's always going to be players willing to compensate speculators for their, for this type of service over time. And so unlike trend and many other strategies, the, that depend on the misbehavior of investors, to, to provide that premium, we actually believe that this is largely compensation for bearing risk and a risk premium based strategy.

so, that's, uh, obviously why I think it's worked so well in the past. And when we look at the CTA space and the managed future space and the different strategies available in trading futures contracts, what we actually find is that the two most used are trend.

So this graph, what we just did is we just went through the current managers, that exist in this auction trend index or this auction CTA index, uh, went through the brochures, fact sheets and websites, um, and in order to find out what they kind of use the most. And we can see that, you know, trend is first, very intuitive, very easy to articulate carry second. Part of us having this conversation today is, It's a little less intuitive than just following a trend. The trend is your friend.

There's not a lot of things that rhyme with carry. and so it's, it's likely the reason why it's, uh, it's a second. And a lot of, things that have been miscommunicated when it comes to the risk of running a carry strategy. All right. So now we're going to get into some analysis. the, but maybe Corey, before I do get into this, are there any questions that I think that, that we should cover before I move on to the, to the analysis of the strategies?

But sadly, there aren't any clear indices like there are for, for trend following. we've, scoured the universe. We always find that they are very, uh, you know, they're only commodities or only currencies. And they're only doing, you know, relative value or cross sectional. Like they're, they're not cohesive. They're not well diversified.

And so what we had to do is we actually used the index that was provided in the, in the Resolve Asset Management, paper called Managed Futures Carry A Practitioner's Guide. The link is in there. We'll share the presentation if you guys want to take a look at that paper, and, and I'll just kind of provide some key highlights as to what really differentiates this carry approach to many others that we've seen in the past. I think the, the first one is the idea that it is cross sectional.

and so when you think about. If anybody that has really looked at the risk premium strategies or think about momentum and trend, right? Momentum managers versus trend managers, especially like market neutral managers. momentum is just kind of grabbing the top decile, grabbing the bottom decile, making sure that you have equal risk across them and go along the top decile, short the bottom decile. And you get kind of like a, a market neutral approach or a sector neutral approach.

And then the time series is more like trend following, which is just ranking from best to worst, all these asset classes based on their trend momentum and allocating long to the things that are going long. And then allocating short to the things that are kind of having a negative trend. When it comes to carry a lot of these, indices that we've seen in the past, really just focus on sector neutral, um, you know, cross sectional. What we.

think is more valuable as a diversifier to equities and bonds and trend is to really focus on using carry from a time series perspective where we, you know, we can be in theory, net long, all asset classes, net short, all asset classes are somewhere in between. Generally you're somewhere in between, but we are not forcing a market neutrality here.

the other thing that is I think different and we don't see any really indices use this is The readings for carry that we just talked about, you know, the differential between the back month and front month, that type of like absolute carry number is very, uh, normal in order to, um, to assess what type of, what the carry measures are. What we've also added to the mix is the concept of, Hey, how is the carry of this asset class? Let's say gold compared to its own history.

Is it really above average? Is it really below? And what we tend to see is that. The more, the further away it is to its own historical norms, the more likely it is to appreciate, if it's a positive carry and depreciate if it's a negative carry. And again, that's a key differentiator, differentiation here. the other things are that we, this series targets a 10 percent volatility target. the index, the paper was written in January, mid January.

So for the purposes of this paper, for this, of this presentation, we end the analysis in December, And this is all net of trading costs and expect a transaction slippage. All right. Let's talk about why they work together. I mean, the obvious one, if we take the 10, 000 foot view here is that they're non correlated to traditional assets and to themselves, right? So you can see that carry has a low correlation to trend and basically no correlation to us bonds and us equities.

Again, this is a view, from a 10, 000 foot view, this idea of, you know, on average, the correlations are really low. But in reality. Do we always want to have zero correlation to bonds or zero correlation to equities? If at that time, bonds are providing positive returns because the carry is positive or equities are providing positive returns because the equities are positive, right?

What we see when we look at not the average, but the movements over time, is that this concept of conditional correlations. Here I've just given I'm showing you the 252 day rolling correlation of carry and trend, against the S& P 500. And what we see here is that this idea of time series momentum and time series carry allows the system to breathe a little bit, allows.

The system to kind of be on the same side momentarily, if need be, of certain asset classes that are working rather than, than taking out all of the beta. So surfing some of those waves, but they do it at different times and they do it for different reasons that we've already covered. and so the, I don't want people to take away that, carry and trend always have very like zero correlation equity bonds.

So what I want them to take away is that we will be sometimes negatively correlated, which is sometimes great. And sometimes possibly correlated, which is sometimes great. Not always, right? On an average, it's better. the other interesting thing to note is that, you know, trend is correlated. quite known for its quick shifts in their longs and shorts over time. Whereas you'll note that carry in black here tends to maintain its correlation over time.

Uh, you know, it doesn't, it's not as quick to change and there's a bit less whipsaw there. Okay. Now let's get to the, the returns on a calendar year basis of these strategies. This is the history from 2000 to 2023. And the one thing I want people to take away from this is on average, we see that they both provide positive outcomes on calendar years. They're not the same outcomes.

They're, they're very different every year, but on average, they both provide positive outcomes along with, the, uh, we're looking at the, the blue one here is the combo. So you can kind of see over time how well it does. Now, the second thing I want people to notice is that on average, when one has a bad year. The other one has a good year.

Again, this concept of filling in each other's blind spots, based on, you know, whether trend is aware that it has a negative carry while going long an asset or not, it clearly works to have two different points of view for the same asset class there, you know, in reality, people think that a lot of people think that investing is about hitting it on the bulls eye 90 percent of the time. The truth is that.

In any one of these quantitative strategies, you're hitting it, you know, 52 to 54 percent of the time, correct. And so what you want is when you're hitting it right and carry, you know, the other 48 percent of the time or 46 percent of the time where trend might not be hitting it right, you, you have at least a chance to offset some of that. And we can see that from the calendar year basis that it is, they, they clearly work well together.

And that blue line tends to be much more stable than if it was just the green or the black. The other thing I wanted to point out. Uh, that I think is useful to understand about, uh, carry and, and some of the carry indices that you've seen in the past is that there's a, you know, from January, 2000 to 2023, you can see the carry has, If a phenomenal, return profile, right? We're looking at a sharp ratio of 1. 15, which is a very, very tough thing to get.

And where as trend is looking at 0. 42, which is about right. This is kind of what we expect, maybe, you know, depending on, on the rolling periods, higher or lower. The reality is that there's a kink in that return stream on, in, um, 2013. And the reason we think that there's a kink there is because, you know, carry was relatively unknown.

Very few people were using it, but in 2013, there was a paper by AQR, uh, written by Khoijin that really described a way of looking at carry across all these multi assets and how it would be useful for portfolios. And from 2013 on, we saw that kind of a bit of a reduction return.

Again, we expect this, This risk premium to be in reality in the future, much more similar to what we saw from 2013 to now, and it's similar to that of trend again, both for, you know, on the trend side for behavioral and economic reasons and carry for the economic reasons that we described, is it going to be the heyday of, you know, a sharp ratio of 1. 15 unlikely, is it going to be more like trend probably.

Is it is the fact that it's not correlated and that it provides an upper sloping equity line over time over a portfolio, a good thing. Absolutely. Right. So I just wanted to make sure that everybody, kind of understood that and it's something that comes up quite a bit. The other thing, we're going to really talk about the, um, I really want to focus on how Carry really does in economic downturns.

Uh, and we all kind of know, and we've seen all the literature about how trend following has a great reputation of being crisis alpha, of providing positive outcomes when there's big negative economic shocks. and I want to show how Carry does during those periods. actually, before I get into the slide, we do have a poll that I'm interested in running. and, Ani, could you run the poll, with regard to, Carry and, what people expect during downturns for us?

So the question is, how do you think carry strategies tend to respond during economic downturns? Do you expect negative returns, positive returns, or an equal chance of a positive or negative return for carry? All right. This is actually quite interesting. So expect it to have negative returns. 11%. We have a very educated audience here. That's fantastic. Expect it to have positive returns.

We're looking at 25 percent of people expect a positive return outcome and an equal chance of positive or negative returns, is about, uh, 63%, which is, which is an interesting point of discussion. So let's get into that. Let's, let's talk about what is the likely case here. So again, before I get into that, I just wanted to, address one thing when it comes to comparing apples to apples, uh, when I'm comparing carry and trend, we really want to make sure we're comparing apples to apples.

And the problem with doing that, just as a, you know, blank slate, or just as a comparing that stock to trend index with a 10 percent volatility targeted, carry equity line is that The CTA universe and its volatility profile has really evolved over time. There was apparently in the beginning of, uh, CTA trend followers, a lot more appetite for risk, in the late nineties and early two thousands than there were in the mid nots than there were, uh, in the last, decade.

What I'm showing you here is that, you know, in the first few years of the two thousands, the average, CTA manager. It was running at an 18. 4 percent average, annualized standard deviation. So quite, quite hotter, right? And what does that mean? It means that if trend does well and equities are doing poorly, then the, the, return that you're likely to achieve with a higher volatility strategy is going to be much higher. IE is going to provide much more protection on a higher level of risk.

And in the mid noughts, that protection number would have gone down. And then in the last 10, 10 years, given that the variance in volatility is, has kind of like settled in at around 11%, we would expect the kind of crisis alpha. When it works to be lower than if we were running an 80 percent volatility strategy.

So what we've done for this analysis is went for those periods of market and economic downturns, we've just matched the volatility of the carry strategy to that of the CTA, index in order to get a good sense as to what carry would have done at the same level of risk. And what's interesting is. So let's just start. This is in chronological order. So we got the 2000 to 2002. this is the tech crisis.

I think as we have, ourselves in a resolve kind of landscape, I had gotten a sense of that landscape, even talking with Cliff Assets at AQR, the reality is that there's no appetite or there's very little appetite for high volatility managers and, um, The way to think about this is what are the repercussions of having a 20 vol manager where a 20 vol manager, assuming like you have a normal distribution and a sharp ratio of one would mean that your drawdown is going, that your three standard

deviation drawdown is 20 minus 20 is zero minus 20 is negative 20 minus 20 is negative 40. Sometimes a four standard deviation event, probably not, but if it's normally distributed, you're looking at negative 60 percent drawdowns, right? So those drawdowns. Are going to happen in alternative strategies, not at the same time when everybody else is getting hurt, right? It's going to happen at a different time and people are going to give up on it. Not based on, they don't care about volatility.

They care about like, look at those returns are down 60%. What's going on? And so I think the, it's very painful to, for any allocator, whether it's professional pensions or individuals to really go high ball, we know a few, right, but it is an acquired taste. And I just think the industry has recognized that a 10 percent volatility is just right below that of a balanced portfolio. equities run between 15 and 20. You know, nobody really has a hundred percent equity portfolio.

Um, you know, they generally have a 60, 40. You still want the drawdowns to be slightly lower than that of 60, 40. So I think everybody's kind of settled in an eight to 10 percent volatility. That is an active decision by managers trying to be as commercial as possible in my point of view, Corey, what do you think?

even in high vol events, they're selling their positions down. and then when you blend 10, 15 vol managers together in an index, you get a vol around 10, uh, because of correlation differences. So I think part of it is how managers have evolved their portfolio construction over time.

And I think as the quant started taking over this concept of a correlation matrix and, you know, the impact of, uh, volatility sizing becomes more and more prominent and you do get a, uh, much more focus on not only, you know, return profiles, but also the diversity and, and, uh, balance within the portfolio. So that's a good point, Corey. All right, let's continue on this uh, review of drawdowns. Um, you've all had a bit of time to take a look at these bars.

Just quickly, black is U. S. equities, uh, green is trend, and blue is carry. and what we notice is that It turns out that Carry seems to do a pretty good job during the most abrupt bear markets here, right? In the 2000s, 2008, the credit crisis did a pretty good job.

And then during the Ukraine war, we saw a similar outcome, which is kind of interesting because I think most people would consider Carry to be disastrous and, um, and pro cyclical, much like, you know, again, the yen carry trade can be. And when it comes, because we call it a risk premium, I think a lot of people equate that to the equity risk premium, which we know, you know, hurts a lot when there's an economic downturn.

And so they think, okay, well, if equities are down and that's a premium, then carry a risk premium is also going to be hurt. But the reality is that the ability to short. The ability to be directional and the ability, to move quickly because these systems update every day, allow for as much, opportunity to transition to things that are working away from things that are not just like trend does in its own way.

And if you think about the concept of an absolute return strategy, and you think about the concept of the length of a bear market in equities, for example, it really shouldn't care too much about what's happening to a single asset class. If it's a strategy that's just trying to harness some sort of premium, whether it's the trend premium or the carry premium, you just need to give it time to manifest, right? So in one of the, I think the question that was answered the most was a 50 50 chance.

You know, that is very true any single day, any single day, there's roughly a 50 50 chance of carry being positive or being negative. Now. Because we have a positive expectancy and we assume 52, 54 percent hit rate, then we're actually going to be slightly positive. So we have a, in both carry and trend, we have, a weighted coin that's in our favor. And so.

Overtime that price movement in any given day is roughly 50, 50, but actually more than 50%, likely to be positive and the longer the bear market to any single asset class, whether it's corn or the S& P 500, the longer an absolute return strategy is going to, you know, migrate around its long term expected positive return. And so you can see that over a three year period.

There's likely a much higher chance for carry to provide positive returns, like in the tech crisis, then it would over smaller kind of drawdowns, like in 2010, 2011, 2015, where if you really kind of squint here, you'll see that what actually, you know, carry had a negative period during 2020, but provided positive returns. But you know, not big enough to really provide any, concrete conclusions as to whether carry is better than trend.

And certainly we only have eight observations here for economic downturns and what it does. So I think I want to take it back to the concept of, Hey, if we expect this to provide a positive sloping equity line, positive return over time, every day, there's roughly a positive coin flip to the upside, the more days that go by, the more likely we are to have a positive return, regardless of what's happening to any single market. I hope that makes sense to everybody.

speaking of other markets that people care about, I just found the two periods where the aggregate bond index had lost more than 10%, and again, similar outcomes, right? Um, this period here from September 10th to October 12th of 2008, very short period. Trend, you know, eked out a slightly positive return. Carry did nothing.

You know, not enough days to really manifest its upward slope in equity line period from August 11th, 2020 to October 24th, 2022, lots of opportunity to continue to, you know, aggregate that expected positive equity line. And we're looking at compound total returns of just under 60%. Right.

So I, I hope that this really helps, in, in, in really dispelling the myth that carry is, good, but you know, you want to be careful because it might be pro cyclical and might hurt my portfolio more guaranteed when things go wrong, depends on the duration, depends on whether you get lucky. you know, I think broadly speaking, we can expect to be similar to trend.

Uh, maybe there's some slight convexity and trend in shorter periods because of the concentration that it can have, but you know, it is a pretty good, protector. It's a pretty good crisis alpha strategy. It turns out if you're diversified enough and you apply it the right way. Any questions, there, Corey, before I move on to the next section?

Buying long, only equities and long only bonds understand the return drivers and they really compare themselves against those two markets. And what we're asking them to do using all the math and all the financial theory as to, as to why it's valuable to use non correlated alternatives in a portfolio is we're asking them to sell their favorite toys and add this obscure one, this thing that kind of makes some sense, but I don't really understand it. Right.

Is this idea of addition by a subtraction. And if that 20 percent allocation that you gave to the alternatives happens to outperform the 30 and the 50 here, then you're great. It's it works out fantastic, but because of the nature of it being non correlated by definition, it'll have periods where it does worse than the equities and the bonds combined.

And if we look at going back to the charts here, what I'm, what I'm going to show you now, the black bars here represent a U. S. balance fund is a Vanguard fund here. And the green bars represent an equal weight portfolio. of equity and trend. Okay. And so I've just kind of really walked you through and got everybody really excited about the benefits and how amazing these two things are. But when we actually live it, it just kind of changes it all, right?

It has made it so that it's Most people don't own trend and certainly very, very few people that own carry within a, um, an ETF or mutual fund today. And I'm going to highlight the periods of pain, right? We have 2000, 2013, where the underperformance was double digits. And then, you know, if two years, wasn't enough, From 2016 all the way to 2021, out of all these years, there was only one year where the combination did better than, than 60 40. And that was in 2018.

The other years was drastic outperformance by a very simple portfolio, even though volatility was reduced on the portfolio level. And the, um, the return of the green line through that period was a positive one. It just wasn't as positive as people want it to be. Right. 2022, obviously a very different outcome, but that, Doesn't matter when you go through this, you don't want to go through it again, right?

It's this idea when you think about the relative returns here of a 50 percent equity, 30 percent bond, 20 percent alternative versus a 60 40, you know, when they're working, you love alternatives. When they're not working, hate alternatives. And this is what, um, the major issue is and why the adoption has been very, very low. and it's why we are talking about return stacking today, right?

This idea of yes, and-ing the problem is, I think, going to be a revolutionary concept that If people here haven't really absorbed it yet, it really can change dynamics of how you look at your own portfolio or your clients look at your portfolio by not taking away those asset classes that people truly understand that 60 40, and rather stacking the return profile on top, you really are giving yourself a behavioral leg up where you can provide the return of the 60 40.

And. If we assume everything that we just talked about is correct and that we do expect a positive returns on these strategies, we do expect to be positive most years, not all years, then it will add value most of the time. Uh, the question is how do you do it? how do we stack 20 percent on top? And the answer here is, you know, you would The easy answer is you borrow some money and you invest in the security.

It's, it's like, it's like when, you know, the vast majority of people don't own their home outright. vast majority of people, I know what vast majority of clients that I've had in the past have had a house with a mortgage. And an investment account, right? They, they, they aren't selling down their investment accounts fully to pay for their mortgage most of the time they're diversifying risk away. And so they're borrowing money from the bank to buy a home and buy an investment portfolio.

They're really stacking that investment portfolio return on top. and the return they're going to get on that portfolio is the return of the portfolio minus the cost of the mortgage, right? It's the same idea here, but we can do it in a much more efficient manner using derivatives, using futures contracts, and, uh, and it's specifically for carry and trend strategies, you know, there's many ways of doing this, there's many ways of creating capital efficiency and return stacking.

but if you are already using strategies that, that are capital efficient, that invest just in futures contracts, It's even easier, right? So the way that this is done from a technical basis is this is one way, right? You have your 60 percent equities. You don't sell out of your equities. you keep 15 percent of your, of your traditional bonds and you have a margin, in cash buffer of the amount of cashier that represents, 25%. Right.

So with this, a portion of it will be used as margin for the futures commodity merchant, dealers to provide you with. an extra 25 percent of a U. S. treasury index future, right? So we, I can put a little bit of money in those FCMs to get a full 25 percent exposure of treasuries. And that's how I top up my 40 percent book. With the rest of the margin, I will invest in my futures contracts.

Same thing, the commodity merchants will provide me, Exposure to these asset classes, long and short with just a little bit of margin. So the portfolio really looks like 60 percent equities, 15 percent bonds, a bunch of cash. Some of it's for margin requirements and some of it's just safety buffer in case margin goes up in a period of economic duress. We have a little bit of buffer there to, um, to help us out. And so what does this look like at the end?

You know, you got your 60, you got your 40 and you got your 50 percent in a managed future strategy. In this case, we're showing trend and carry. That's, that's the magic of like being able to deal in these markets in the future space. And so why is this useful from a behavioral perspective? Because returns stacking is a yes and solution, right?

All of a sudden, when I highlight those periods of pain before that 20 2012, 2013, the 2016, all the way to 2021 period, all of a sudden we go from a mountain of pain to, for most people, pretty happy. Right. Even during these periods where there's a slight underperformance, I don't know if that gap in returns between a traditional 60, 40 and the 60, 40 plus 50 is enough to really sway them to quit.

and I think this is why, you know, pension plans like the Delta pension plan and many others that we describe on our website have really adopted this. You can't do this in size. So it's kind of pension plans that are 20 billion. Um, Really have been adopting this and using it to their advantage because there's not a lot of pain in providing diversifiers as a stack. And when it does work, it's beautiful, right?

You're not going to be forced to sell out of your main, you know, let's say you have that 15 percent of us bonds is tied up in private credit, or, you know, longer dated duration that got hit more. you don't want to be forced to sell these. And you certainly don't want to be forced to sell your equities.

Now we could, and people have done this and they continue to do a combination of some bonds and some equities, but again, if you, if you were just to sell your equities to get exposure to SPY, which you can through the e mini contracts. You are going to be required to, to provide higher margin requirements.

You are going to, you're going to see blowouts in volatility, and you're likely to see more opportunity to get margin calls and be forced out of the equities that you, that you, that aren't based on S& P 500 futures contracts. Again, private equity could be part of the U S allocation, and then you've got to be forced to sell that. Can't get out of your private equity for six months. All of a sudden you're forced to sell out of your alpha that's providing you all that protection, right?

So I don't want to be prescriptive here. You're right. You could use us equities, but there's, you know, pros and cons to all of Can

And typically the funding rate in equities is much higher than the funding rate implied in treasury futures for a variety of reasons. Today, for example, the funding rate in equities in S& P futures is about SOFR plus 100 basis points. Whereas the implied funding rate in treasury futures is less than SOFR.

So in terms of being thoughtful about how much you're paying for leverage, historically and today, treasury futures have afforded a lot of benefits, both from a net of tax perspective, as well as the implied funding rate that you're paying.

So that's a very good point, Corey. Thank you. All right. So just to finish off on this slide, the, let's, let's look at the statistics here. If you just own the U. S. balance fund over this period, this whole period, you've annualized at 6%, which is kind of surprising, right?

You invest, uh, for the long term, Everybody's been telling us that it's a eight to 10%, but in reality, when you include a couple of bear markets, maybe three bear markets, you end up with a 6 percent annualized return volatility profile of around 12%. So it's 11. 64. This number is going to be important. Oh my, I'm going to run out of time here. So we may not even cover that part. we, uh, sharp ratio of 0. 53 and a max route out of 36. When you include that 25 percent carry 25% Stacks on top.

What we find is that the return differential is 3. 87%. So you increase your returns by almost 4%. Your volatility increases, but it doesn't increase by 50%. Right? Which is interesting. It only increases by 1. 29 percent. Your Sharpe ratio, improves. actually that Sharpe ratio is incorrect. Oh, the difference in Sharpe ratio. The difference in Sharpe ratio is an improvement of 0. 24. And the, uh, maximum drawdown is an improvement of seven. Okay?

So the, let's, let's address, very quickly why We were able to stack four percentage points of return on, averaging up. And while we were only, increasing volatility by one point. 1. 29, because I think a lot of people tend to just do general arithmetic, right? If you added 50 percent of risk and that risk for the trend and carry portfolios is, you know, 9%, it's only 50 percent of that. So you're, you should be adding four plus the 11.

64, the balance fund, that's 60. And that's where your volatility should be. That's really not how the math works because, the reason we got to 12. 93 percent on the portfolio is because The portfolio volatility is the weighted average volatility of the two asset classes. divided by the diversification ratio. So weighted average of the S& P in this case is 100 percent times its volatility. The other one is 50 percent times its volatility.

And then you divide, divided by the diversification ratio. I won't get into how to calculate that. It's, uh, you can, you can look it up, but the more diversified the assets, the higher the diversification ratio, the lower your portfolio volatility.

So when you are looking at ETFs, When people talk about leverage, the first thing that comes to mind is double bull, triple bull ETFs, and the carnage that comes with levering into the same risk, most blow ups that I know of in the financial markets happen to be a levering of the same risk. What you want to use leverage for is for defensive measures, right?

You want to have diversified asset classes stacked on top so that you can have a high diversification ratio and keep your portfolio volatility low. Okay. So. With this discussion of, you know, increasing or stacking returns or versus stacking risk. There's always a discussion of the, um, the variance track. I'm sure a lot of people have heard about variance track.

And so just broadly speaking, the actual money in your pocket, your portfolio compound annual rate of return is the simple arithmetic return minus half of the variance. Right? So if you add up all those bars on a yearly basis, you get a number. Then you have to subtract the cost of the volatility, which is half the variance. And that's why the arithmetic return is higher than the portfolio compound return.

If we think about the a hundred percent us balance portfolio, and we multiply its standard deviation by itself, we get a variance of 1. 35. If we were simply to lever up the us balance portfolio by 50%, the variance actually goes up by half. Significantly, it's, uh, it's over two times, right? The, the variance that just went up by levering the same risk.

In contrast, when we add the 50 percent trend carry that are non correlated, that diversification ratio being higher has meant that the, the, uh, variance has gone from 1. 35 to 1. 67. Ultimately the diversification benefits of the stack portfolio lead to a variance increase of only 0. 25 versus a 2. 25. For the increase in the balance fund. Right.

So that's, we get asked a lot, you know, variance drag, you know, what this really means at the end of the day is you're going to get an 80 basis point drag from levering your us balance portfolio by 50%, and you're only going to get a 16 percent basis point drag on your arithmetic return by using a 50 percent stack in a diversified strategy like this. Okay. I hope that makes sense. you know what I think. We are going to leave it at that as we're at the top of the hour, Corey.

just, I'm going to kind of wrap it up, this real concept, return stacking, you know, we've known about portable alpha forever. It's a very complicated, has many facets to it. I think we've really zeroed in on return stacking being using, instruments that give you 1 dollar of something diversified on top of something else and using that as tools in your portfolio in order to create the stacks that make the most sense to you and the, the, the amount of stacking that, uh, that you want to have.

You know, we talked about 50 percent stacking. Some people are using a hundred percent stack. Some people are using 20 percent stacks. you can do that now in a way that wasn't really available in a couple of years ago. And so the way to practically implement this, if you have a 50, 50 stock bond portfolio, and let's say that there's a fund out there that has a hundred percent of something and a hundred percent of something else.

Let's say it's a hundred percent of bonds and a hundred percent of, managed futures. Well, what you could do is you could sell. You know, 20 percent of your bonds and buy this hundred, hundred fund. And what you would see, what your clients would see is three line items here in the most simple way. But if they put their x ray goggles on, what they're actually getting is a prepackaged solution that provides them that stacking of the alternative on top.

so. Let's just key takeaways that I want everybody here to, I want everybody to be roughly on time. The key takeaways here is clearly carry and trend offer diversification benefits, both to each other and to traditional asset classes. And it's my two favorite premiums since the beginning of my career. And contrary to the popular belief, the idea of cross sectional carry that we discussed has actual strong potential, of protection during economic duress.

So I want to put that one to bed, take that away, you know, think it through and assess whether it makes sense for you. And regardless of the behavioral barriers that make it difficult to hold these in isolation, I think return stacking can help. And, um, And by stacking these diversified returns on top, my last point is that yes, we are stacking, we're using leverage. That's okay. We're using leverage or stacking returns by leverage, but the leverage we're using is a defensive leverage.

Is it we're stacking things that are non correlated so that that increase in stack return shouldn't, have a commensurate increase in portfolio volatility and with that, um, if anybody's still sticking around, we can open up for questions.

How do portfolio characteristics change? Are there reasons to tilt towards trend versus carry or reasons to tilt towards carry versus trend for certain investor profiles? And is it anything we've written on this topic that we could share?

Really what I think everybody needs to think about when it comes to allocating to anything, to asset classes or strategies is the idea of being broadly correct. Cause you don't want to be specifically wrong. And I think way too many people want the data, want the minutiae, want to see what happened in these two periods or eight periods, and based on that data, then decide to overweight or underweight one or the other.

The way we see it is that it's so difficult to assess that if the characteristics in terms of sharp ratio or Certino ratio are fairly similar. Right. And I think I made a case for why they're like the sharp ratios are likely to be very similar going forward at the same level that that means that at the same level of risk, I can't tell you which one's going to be better. I can tell you from a fundamental perspective, why they're likely to be different in any given day.

I cannot tell you with any certainty, which one of them is likely to outperform. And in the absence of that knowledge, the do no harm approach is the thing that you could take, which is just equal weighted. And that's at this point, but this type of kind of meta allocation, I think a prudent approach.

And so every fund that runs, managed futures has to have a Cayman fund for 25 percent as a Cayman blocker that basically allows you to trade commodities and transform that into, ordinary income. And so depending on whether Carry made all of its money on commodities this year and trend made all of its money on financials this year, you will have different outcomes in terms of tax treatment, right? So in every year, it's going to be different. And it's really tough to tell who's going to win.

Again, it's kind of like answering the same questions before over time, they should be fairly similar. Any given year, they could be wildly different.

If it has a positive Sharpe ratio, it means that you should expect it to do better than the, than the rate of, of the cash shield and in futures is actually quite interesting because you don't really trade these managers when they looked at their performance, remember what they're trading, they're trading the excess return lines of each one of the securities.

So if you were to put a S& P 500 mini futures contract, stitch together returns versus the S and like the iShares S& P 500, return total return profile, you will see that the, the returns of just owning the futures contract is going to be lower than that of owning the actual total return ETF, because it, it includes the cost of financing already. So what managed futures managers. What they're trading is already the excess returns.

And what they're trying to assess is does carry or trend allow me to pick these excess return lines in a way that over time I'm going to make an, a return above excess cash. And that's exactly what you get when you, When you look at managers and when you assess managers on both types, anything on the managed future side, you're really just assessing the excess returns. and, and really that's the, the cost of financing doesn't really matter at all to an excess return manager.

We don't see a correlation between periods where the cost of borrow is really high and the excess return profile of a trend or managed future or a carry manager. Uh, whether it's been in the mid noughts where rates were five or now with rates are low, roughly speaking, the excess returns are fairly similar. I don't know if you have anything to add to that. I know that there's another question there, Corey.

Again, it's already, you're already, priced into the futures, it's in the return of the futures themselves. And if the hurdle rate is high enough, such as it drags down the return of the futures contract, great. We can short it and earn that financing rate. Um, so it's actually something we can take advantage of if it is high enough, it's already baked into the return of those futures. another question here for you, Rod, trend and carry both incorporate bonds.

Can we aggressively eliminate bond allocations and simply rely on an allocation distract to, to, to these stack strategies?

They're going to be, I think we should expect, in any bond portfolio that has any duration at all over time for that risk of buying something in the future, or that's that, you know, loaning money for the future, you should expect a higher return than cash. you want to capture that term premium. Right? It's a different premium than carry and trend. And the problem with assuming that, okay, well, I got trend and carry together. They have a bunch of bonds.

Forget about my traditional bonds is that you then will go through periods like 2016 and 2021, where bonds did well, 2020, uh, one, uh, where bonds did really well. And carry and trend as a combo didn't do so well. And then your clients are asking, I thought we had a 60, 40 portfolio. Right. So I think, I mean, this is portfolio construction 101.

The magic here is finding as many, in my opinion, liquid, asset classes as possible that are, that you can expect a unique return that is not correlated to the other things that you own and do it at a, at a level of risk, volatility that you can handle so that you can also achieve as much return per unit of that risk that you're taking. So I definitely, um, espouse more diversity rather than less.

The beautiful thing was that we had dozens of other, trades on at the same time that more than offset the loss for the end carry trade. Right. So again, this is about the key thing here. When we say carry is really moving past the very concentrated definition of carry of a single trade or a just currency carry, and really understanding that we have a wide variety of assets that we can capture carry from. That all respond differently to the same economic impact.

And so that positioning creates a breadth and diversity that tends to have a very, you know, robust equity line, uh, over time. I don't know if you want to add anything to that, Corey, because I know you did some analysis there.

And if you go to the return stack ETF website, you can actually go to the carry ETFs and you'll see on any given day, there's a wonderful graph that says how we're allocated. On a risk basis. And you can see there's considerable diversification in what we're allocated to far beyond just sort of a single currency pair.

So historically, yes, the yen dollar, or you really yen anything has been the quintessential example of a carry trade, but we think carry commodity, carry bond, carry currency, carry, and even equity carry, will, will continue far beyond no matter what happens with the yen specifically.

And as we like to, uh, to do, when we start talking about trend, you and me, Corey, we immediately, not trend, when we start talking about any strategy, we immediately find that, uh, it has a drawdown for a period that is uncomfortable. so. You know, that the reality is that the last six months for Carry has not been great.

It has, it has probably been one of the worst strategies to, uh, invest in, in kind of the, uh, the number of strategies that we run, but in the context of the last five years, it is just a correction of a phenomenal run. so I just want people as they examine Carry and kind of get to know it and, and see it that they don't feel like. You know, there's something wrong with it now, that we've started talking about it. it is a fairly normal correction.

It just happens to be highlighted by the fact that we are paying attention to it at the wrong time, as, as we like to do, Corey.

Uh, the vast majority of you are here 20 minutes after this webinar was supposed to be over. So we, we really sincerely appreciate your time. I'm