Transcript
Tom Basso: Would I like the stock market to go up every year? Sure, absolutely because cheap capital feeds businesses, feeds jobs, it's so much better for the country. Do I think it's going to happen forever? No, I don't, so how do I deal with psychologically being able to react to that when times are not the way that I would prefer? I still want to try to be making money or protecting my assets at a minimum. I believe that by combining together lots of different markets like this, I think you give yourself a better opportunity to do so.
[opening title]
Tom: I'm answering questions from traders around the world asking me advice on how to get started, or they've got a problem with their strategy and might I give them some ideas. Lots of questions on position sizing and how leveraged people are, and I think most people are too leveraged and putting themselves in harm's way. I do a little day trading when I get a chance, I develop new strategies for myself.
Every now and again I give a seminar with a friend of mine Laurens Bensdorp over in Brazil, he comes in usually to Las Vegas when travel permits, and COVID is not keeping us grounded. Every now and again I'll do a webinar if it amuses me on a Saturday morning, sometimes my wife helps me with those. I love cooking, I love golf I work out, my day is pretty full.
[how did you two meet?]
Eric Crittenden: Somehow I stumbled upon Trendstat and looked at what they did and followed them for a year, year and a half, and I was living in Kansas at the time and the weather there is atrocious, people are great but the weather is just unlivable, for me anyways. I was looking to move on and I thought Trendstat sounded like an amazing place to work doing all kinds of stuff, trading futures and forwards and options all around the world, global macro style.
At the time I wasn't really familiar with systematic trend following and what Trendstat was doing, but just having the flexibility to do something different, to express your views in an unconstrained way was very appetizing to me. I reached out to them, I don't remember if it was via email or it was probably a letter, it was probably snail mail at the time.
Tom: It was a letter.
Eric: An interesting thing happened, I got two rejection letters from Trendstat. Remember this was I believe 1999 when I actually tried to-- I sent you guys a resume. One was from Tom and one was from Peter. These letters, when I got them, it was more than one page, a well thought out, flowed like a novelist wrote it and it just went through everything that Tom and or Peter, the letters were very similar, felt like someone needed to learn prior to entering this particular niche of the industry and being prepared.
It was a bunch of stuff that I had never considered before. It was about psychology, understanding yourself, understanding your cognitive weaknesses, your motivations for doing this in the first place. He brought up things like excitement, he brought up things like over caffeination, expressing or investigating your motives for getting into the business, and this all struck me as odd.
I was a very analytical almost robotic big ego guy who thought that it just boils down to the math. You're either better than your competitors or you're not, that's how I felt about it at the time and I had a chip on my shoulder. I thought I did good work and I know I out-hustled my peers and I thought well that's all it takes, absolutely dead wrong. At first, I resisted these concepts, but they floated around the back of my head which is I'm sure that was Tom's intention, and every single one of those points ended up being true.
I feel like they really expedited my personal learning experience and journey and helped me avoid the pitfalls that Tom knew that I and anyone else coming into the industry was probably headed for. He talked about all the magical indicators, curve fitting, indicator stacking, measuring the same thing in different ways, and thinking that they're independent, all of these things were foreign to me at first, but as my experience grew and I put some skin in the game and started making money and losing money, I was able to have these aha moments very quickly and say, "Oh, that's I think what he was talking about." Eternally grateful for that. I wasn't appreciative at first, it was just a rejection letter, but boy did it help and it helped me to learn vicariously through the experiences of others.
[what about from your perspective Tom?]
Tom: Eric sent a letter and I responded to it but some years later he shows up in Phoenix and says, "I'm in town, could I come see you?" I said, "Sure." He came over, we had a great conversation and we've been friends ever since. I've immediately became impressed with Eric's- I'd say street smart when it comes to dealing with investments and investment strategies and his analytical skills are second to none. I just felt this is my long-lost younger brother. We've known each other for a long time.
[why did you start Standpoint?]
Eric: I'm going to pursue something that I'm really passionate about, whether I get paid or not, that's just how I am. I don't apologize for it, it is what it is. I just love, love the all-weather approach, so that's what I'm going to do. Now, it also happens that most financial advisors in their moment of truth admit that they don't want to own bonds, they don't expect these things to work going forward and they really don't want to own stocks, well they want to own them, but they don't want to over own stocks and they expect returns to be below average.
What they wish they had is some an alternative investment they could plug in there that solves some of these new problems and it's like, if I could just have something that didn't get completely left behind in a bull market. Give me 70% or 80% upside capture to stocks, but don't bury me in a bear market. If the market's down 40, don't be down 40, don't be down 30, try to be maybe down 15 or something, help be like bonds in a sense.
It doesn't matter who I'm talking to, it's essentially the same story. Give me enough upside so that I'm not under constant pressure from my own clients but help me mitigate the downside and don't kill me with fees and don't hit me with an enormous tax bill every year. You'll recall back in the research days before we actually launched Standpoint, 90% of the time we got some version or some variant of that explanation.
This all-weather thing that I happen to be perpetually married to, if you just strip away the labels and you look at it, you say, well that's pretty darn close to what advisors are describing to us as the ideal alternative investment, it's not exactly but it's so close that I'm like, "Wait a minute are we idiots or are we missing this great opportunity?" Maybe that is actually what people want, they don't want pure alternatives, they want something like this. Why would they care what's inside of it if it actually delivers what they say they want and need.
Now, I'm not saying they shouldn't care, I care what's inside of it but for the first time in my experience and I'm a database guy I look at all the different asset classes. I've got databases that have 70,000 indexes in there, 50,000 global mutual funds, hedge funds, SMEs and whatnot, it's very, very rare to find something that's scalable and has AUM that actually adds value to a 60, 40 portfolio, it's very rare. Most things are completely redundant with either stocks or bonds and in some cases both. Whereas this all-weather approach that I personally like, adds a lot of value, at least historically.
That's the bet we're making, it's the overlap between those two things, I believe in it, I'm willing to eat my own cooking, I will do this for the next 30 years with my own money. I also think that it is the ideal alt that people are looking for, so why not make a go of it.
[why haven’t more people adopted an all-weather approach?]
Tom: People were just not motivated to get over the learning hurdle, to get over the check it out with their lawyers hurdle, or approach their clients with the concept. The clients might have been open but if they never hear about it, they'll never ever do it. You now can get it almost directly from the firm rather than having to go through multiple layers of distribution like hiring a fund-a-fund manager and the fund-a-fund manager hires us, and there's layers and costs and it gets expensive to the client and makes it harder for the client to actually produce a return.
I think what's happened now is the world has moved over the 17 years I've been retired finally to the common sense that I was trying to put in place 17 years ago and really 18 or 19, because I was starting to do it before I retired. It's a type of thing where I believe Standpoint has nailed it and which is one of the reasons why I wanted to become involved. I think to me it's what Trendstat might have tried to do if we were smart as Eric is way back 17 years ago.
[what makes you optimistic about all-weather now?]
Eric: An educated guess about the risk/reward with respect to stocks and bonds. It's prudent to conclude that being along stocks and bonds, particularly bonds going forward is a bad business decision. Doesn't mean that it won't work, it's just that the risk/reward is the most negatively skewed that I've seen in my career, then if I look at the data going back to say 1860, it's the worst on record, in my opinion, when you consider valuations and the mathematics of bonds right now.
I'm comfortable telling people that given the information we have right now, that is probably a bad bet. I'm very confident that it's a bad bet, but it's a personal decision and that all weather is a superior choice going forward. I'm not guaranteeing it's going to work out and I'm not saying interest rates can't go lower and that a 60/40 portfolio can't be up 20% next year but given what we know right now, that's a bad bet.
[why are you so confident bonds are a bad bet?]
Eric: Because for bonds, you actually can predict with a high degree of accuracy, what your compounded return is going to be going forward because it's basically the yield plus or minus whatever the capital gains are. Historically speaking, if you just use the starting yield, that's about 90% to 92% accurate in predicting what your future compounded return is. That's what I meant earlier when I said bond mathematics are pretty unforgiving.
You can't really do meaningfully better than what the yield is. You can if interest rates go down, but from the current levels, they have to go to like negative 6 on the 10-year for bond investors to get the returns that they're used to. Now, if you think we're going to negative 6 on the 10-year, it's time to take up organic farming and weapon design and all kinds-- I'm moving up to Payson and we're going to build the compound.
Tom: Yes, I would even add one little other layer on top of Eric's beautiful explanation of the bad deal with bonds right now and that's that people have a tendency to look at their monthly statements and open them up and look at those things. They'll never stick around to maturity when they see what the shredding that their bond portfolio's going to get through. To get that lousy return that Eric is predicting, you would have to stay with it all the way to maturity so that the math worked out.
It'll be far worse over the short run, and you will see a whole lot of people not having the temperament to stay with it and looking for other alternatives. The psychology of investing will come into play and make it even worse.
Eric: The other thing I will share with you is that bonds, both corporate and government in the US lost money in real terms from 1940 to 1980. That's 40 years of going backwards in real terms. Anybody who says bonds can't go down, bonds always belong in the portfolio, bonds are a source of return, you wouldn't in saying that in 1980. You're saying it today because it's worked for 40 years, but in 1980, it had done the opposite for 40 years. Let's at least be honest about that. Who knows what the next 40 years are going to provide. The volatility and the drawdowns and the losses are going to shake most people out of those bond positions.
They won't stick around to get that low yield anyways if there's any downside volatility and that'll catch everyone off guard. I've had advisors tell me that like, "Look, Eric, I understand, I look at the math and you're right. I think bonds are going to have a negative real rate of return going forward, but they're up this year. How am I going to get investors to be comfortable selling something that's up for the year as when they were up during COVID?" It's like, "You see, you can't do the right thing for the long term because of this feature that whatever's worked this year must be good."
Tom: What about peeling off some of those profits and take the profits and put them in an all-weather approach that might be able to buffer the other direction.
Eric: Yes. I think that that is a viable strategy going forward.
Tom: Like position sizing. If bonds have been doing really well, they're getting to be a little bit bigger part of the portfolio. If you're doing a 60/40 you'd be required to peel back to what? 40, I guess. How about if you go a little farther and peel back to 35 or a 30, retain some, but peel off some of those profits and put it in something that might have a shot at holding up in the future.
[why are you confident an all-weather strategy can handle difficult market environments?]
Tom: You could go long or short anything and we were trading at the peak at Trendstat 80 different futures markets, and some of them were pretty obscure like I don't know, rubber in Tokyo. There were some markets we traded back then that don't exist today. Eric might not have been around in the '60s, but I was. When I look at where that ended up attracting a lot of assets for Trendstat and then moving into the FX trading that we did that incorporated a lot of the 600 million eventually that we ended up peaking at under management, I was able to go in two directions that gives you the ability to deal with a bear market or hyperinflation or deflation or political crisis or wars breaking out or whatever.
I think that to me psychologically, I'll speak to that this way, that if I know that I've got a strategy that can deal in an all-weather manner with no matter what the world throws at me, for the most part, I don't know if I figured it all out. Eric probably would say the same thing that he doesn't know if he has a lock on everything, but to know what you've done can react up or down gives you so much more peace of mind to me. As a human being, as a citizen of the United States, I can predict what I would prefer to happen to our future.
Both as a country, both as markets. Sure, would I like the stock market to go up every year?
Sure, absolutely because cheap capital feeds businesses, feeds jobs. It's so much better for the country. Do I think it's going to happen forever? No, I don't. How do I deal with psychologically being able to react to that when times are not the way that I would prefer, I still want to try to be making money or protecting my assets at a minimum. I believe that by combining together lots of different markets like this, I think you give yourself a better opportunity to do so.
[why can’t I just manage an all-weather strategy myself?]
Tom: He's put it together so that say a client or an advisor doesn't need to worry about all that detail. Trying to pull together everything that Eric has pulled together would take a tremendous amount of effort and work to do. In my case, I had a couple million dollar pension plan, bunch of physicists out in just South of LA. I managed their pension plan. I convinced them, and they were really fans of it to hedge their stock portfolio, I managed on the one side, with a futures hedge. We used an S&P contract, and we had two separate accounts because one had to be a futures account. One had to be a stock account and different laws are involved in both of those. The US government has never seen fit to blend those together in any consistent way and we went through the crash of '87 and I still remember the numbers vividly.
We ended up making something like 0.2% more return on our future's hedge through the day of the crash than we lost over in the stock portfolio. We actually made money the day of the crash with a long strategy that was hedged. I go out there for my next meeting, feeling like, wow, they're going to be really happy with me. I'm out in LA and we bop down there and we go in front of the whole board and I present the stocks and I present the futures and you would never guess what they wanted me to do. Just trade futures. They wanted to fire me as a stock manager and just do the futures hedging.
I said, "Guys, that doesn't exist by itself. This doesn't exist by itself. Marrying them together is the important thing. We ended up making them money, but we preserved your assets. It's a retirement account." No, they wanted to now make 20% on the short sale of the futures contract and not have the drag of this boring old stock portfolio. These guys were physicists. These were brilliant people in terms of their knowledge of guidance systems and things in planes, they blew me away.
It speaks to what Eric talks about is if I could have somehow married those together and say, "This is an all-weather approach. Don't look at the details." Let me worry about that, but we're looking at the total. We were up a fraction of a percent on the day, one of the worst days, single days in the market, up to that point. We made it through, we're alive, and we go forward.
I think it's important. Psychologically, it's hard for people when they look at all the details, even future traders. I traded 80 futures markets back in the day at Trendstat. People would say, "Oh, that palladium contracts really slaying it. Can we get more of that in the portfolio or whatever?" No, you can't. That's just one of 80 things. It's palladium today, six months from now, it's soybeans. Who knows? You got to trade everything, you got to figure that all the odds are going to come together to have your all-weather plan come together. I think that's so important to realize globally. Let a guy like Eric or me take care of those details because we're used to doing it, we understand what we're doing.
You get to the point where if people are looking at each individual thing with a monthly statement, that's probably this thick sometimes. It just drives them nuts and they just psychologically are not prepared to handle it.
[aren’t futures risky, why do you use them in the portfolio?]
Eric: Futures contracts, they're just a vehicle. They're a tool like a knife. You can use it to cut a lemon, or you can stab yourself in the thigh. It's up to you. You use them intelligently. They're a way to provide liquidity to very important sections of the economy and collect a risk premium the same way. I look at stocks and say, "Those are far more dangerous than these futures I'm participating in." I look at treasury bonds and say, "Those are far more dangerous than the currencies I'm participating in." I think I'm right. I'm sure I'm right. Well, dangerous is a subjective word, but in terms of risk, I see these things as risk mitigation agents.
By bringing in these different asset classes, I'm able to triple and quadruple the amount of diversification and put us in a position to potentially make good returns during hostile environments like the 1970s or the crash of '87 or the SNL crisis, or 2008 or 2002. Can't guarantee it, but it certainly gives you a shot, which I think is worth taking. That's the way I look at it. I look at it and say a multi-asset, multi-strat manager needs to be comfortable with this multi-asset global portfolio and that's what we are. I would be far less comfortable if I was concentrated in just stocks and bonds, at least at this point in time.
[what are your thoughts on short volatility and long volatility strategies?]
Eric: Here's the thing. I'm interested in collecting risk premiums that are sustainable and accretive to society, and that means participating in some short vol approaches, but it also means that participating in long vol approaches and thankfully those two, when they get married solves a lot of problems.
Tom: It does.
Eric: A lot of problems that you can't wait until after they start to solve. Long vol is not very popular. Short vol is popular because for whatever reason, psychologically, human beings will choose to have a 90% win rate, be right 90% of the time and then just lose a boatload of money 10% of the time. They like that better than the opposite, where you're wrong, 90% of the time, but you have really tiny losses and then the 10% of the time you're right. You have that almost lottery-like payoff.
Now, if you just show it to them, that's not true, but when they have to live through it month after month, quarter after quarter, year after year, they naturally gravitate towards the left-skewed, short vol, win most of the time style. That's your experience too, Tom?
Tom: Yes. I have a great example of that. Comes from my Trendstat days were, of course, long vol trend followers, long volatility. We're looking for those big moves where two or three of our markets are paying the way for the year. We're doing all right, and we've got a pretty reasonably smooth track record and an okay return. There's another firm out there that was always number one on return to risk ratios. I won't mention the name of the firm. We were trading currencies going long or short and being long volatility oriented. They were buying high-yielding currencies and selling at the same time low-yielding currencies and picking up the float of the different and leveraging it.
I knew that and I would be out there competing and I'd even see some of their salespeople or somebody repping the firm in some due diligence thing like I'm coming out of my grilling and he's going in or vice versa.
It got to the point where we'd be sitting around looking at the monthly track records and after about two or three years of competing and watching all of the assets being given to this other firm, it was like Butch Cassidy and the Sundance Kid and they're getting chased by the Marshalls back there and they turn around and look and they say, "Who are those guys?" That's the way we felt. Who are these guys? How do they do this? They make money every month, month after month. We can't keep up with this. It was very frustrating for a while. Then, of course, the Irish punt hit the skids and was devalued overnight and the firm was out of business.
[how does an all-weather approach combine investments?]
Eric: A real good all-weather portfolio should combine any and all sustainable risk premiums together and some of those are going to be left-skewed. I'm not afraid to be invested in the stock market for the long-term as long as I've got the right-skewed positive risk premium assets on the other side of the portfolio.
[when should you invest in an all-weather approach?]
Tom: Anytime is a good time. Particularly, if things are good, you're helping to protect and soften the next blow to the downside and yet, if it keeps going for the next two, three years, you still participate in it. That makes a lot of sense to me.
[if any time is a good time what would prompt an investor to make a change now?]
Tom: If things are going really well now, what's next on the cycle? Things don't go well. You got to buy these things before they don't go well, not after.
[music]
[00:28:09] [END OF AUDIO]
