In this episode, we talk with Jeff Malec. Jeff is a principal at RCM Alternatives, a leading firm in the futures industry.
Jeff Malec began his career in the Chicago futures pits with burly traders spitting into their dip cups and has had a front-row seat to watching the futures industry develop rapidly over the past two decades.
We talk about the differences between the New York traditional equity-based markets and Chicago’s futures markets and the pros and cons for investors.
We look at why Chicago’s approach did much better in 2008 and what investors can learn from that to apply to their own portfolios as well as the cash efficiency of futures.
We dive into how investors should think about correlations, particularly when projecting into the future.
We also talk about the common traits of the most successful investors Jeff knows, particularly the engineering mindest and how other investors can apply that.
Finally, we dive into why low volatility often means hidden risk and how to spot it in your portfolio.
I hope you enjoyed this conversation as much as I did.
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Have comments about the show, or ideas for things you’d like Taylor and Jason to discuss in future episodes? We’d love to hear from you at info@mutinyfund.com.
Transcript for Episode 12:
Taylor Pearson:
Hello and welcome. I’m Taylor Pearson. And this is the Mutiny podcast. This podcast is an open-ended exploration of topics relating to growing and preserving your wealth, including investing markets, decision making under opacity, risk, volatility, and complexity.
Taylor Pearson:
This podcast is provided for informational purposes only and should not be relied upon as legal business investment or tax advice. All opinions expressed by podcast participants are solely their own opinions do not necessarily reflect the opinions of RCM Alternatives, Mutiny Fund, their affiliates or companies featured. Due to industry regulations. participants on this podcast are instructed to not make specific trade recommendations nor reference past or potential profits and listeners are reminded that managed futures, commodity trading, forex trading, and other alternative investments are complex and carry a risk of substantial losses. As such, they’re not suitable for all investors and you should not rely on any of the information as a substitute for the exercise of your own skill and judgment and making such a decision on the appropriateness of such investments. Visit www.rcmam.com/disclaimer for more information.
Taylor Pearson:
For more information about today’s episode, visit our website Mutinyfund.com and subscribe to our free email list. If you listen to this show on your Apple podcast app, remember you can give us a review. Each review helps more people find the show and join our amazing community. In this episode, we talk with Jeff Malec. Jeff’s a principal at RCM Alternatives, a leading firm in the futures industry. Jeff began his career in the Chicago futures pits, with burly traders spitting in their dip cups and has had a front row seat to watching the futures industry develop rapidly over the past two decades. We talked about the differences between the New York traditional equity based markets and Chicago’s futures markets and the pros and cons of each for investors. We look at why Chicago’s approach did much better in 2008, and what investors can learn from that and apply to their own portfolios. We dive into how investors should think about correlations, particularly when projecting into the future, as well as the common traits of the most successful investors Jeff knows, particularly the engineering mindset and how investors can apply that. Finally, we dive into why low volatility often actually means hidden risk and how to spot it in your portfolio. I hope you enjoyed this conversation as much as I did.
Taylor Pearson:
I’m Taylor Pearson. I’m here with Jason Buck and Jeff Malik. We’re gonna be talking with Jeff today about his background in the futures industry. I want to just kind of jump in. Jeff, how do you feel about Harley Davidson?
Jeff Malec:
I love Harley Davidson. I’m the great grandson of Walter S. Davidson, who is my mother’s grandfather. So we’re very proud of the heritage but I’ve never been a bike rider. My mom’s father worked in the factory. He died when he was 40. Something mostly of asbestos and lung cancer. But through their life, they never let the girls, he had three girls, and they were never allowed to ride bikes. So hey, I appreciate that. You called it Harley Davidson. Because we’re the Davidson sign. A lot of people just say, “Oh, your Harley.”
And then the Fletch II movie. Chevy Chase went into that one bar and said he was at Harley, the grandson of Harley Davidson. So sometimes I get that, but uh, yeah, we’re proud. I’m not talking to you from my private island. So it hasn’t been a financial windfall, but a lot of proud we go to the hundred year reunion or the every five years They have the hundred and 510 up in Milwaukee so we go to that and participate in activities.
Taylor Pearson:
My uncle’s a member of the iron butts club I don’t know if you’re familiar with the guy I don’t know that right 1000 miles in like three days or something.
Jeff Malec:
Yeah, it is cool when you go to those reunions they have the parade and there’s like the Brazilian hot hog is the big thing Harley owners group so there’s the like from any country any city you can imagine. And they ship their bikes over there and they’re coming through downtown Milwaukee. Proud as can be. It’s in some trouble these days with millennials don’t, aren’t buying into it but it’s always the millennials. Always.
Taylor Pearson:
You were a philosophy major in college. What was the thing you know, I guess while you’re a philosophy major first of all, and then what do you feel like had the biggest impact on you of what you read what you were studying?
Jeff Malec:
Well, the Why is a little bit embarrassing, but uh, the wasn’t very good at getting to you had to sign up for classes, which seemed weird, just let me sign up for whatever class I want. So you had to get there in time. And like basically put your names in to get to the classes. philosophy was not a big demand. So I’d missed the economics classes I wouldn’t get in time to sign up for a lot of this because I had a big theory of the first week and the last week of any school year kind of wasted. So I would show up a week late and leave a week early, like as soon as my tests were done, but it came to turn out that that impacted which classes I could take so long story short, the philosophy classes were the only ones left. And this was freshman, sophomore year, until I figured it out and got to take the classes I want it but by that time, I’d had all these philosophy credits built up. So I said, Hey, I like it. And it taught me how to write taught me how to think. So I don’t really view it as what was the second part of the question?
Taylor Pearson:
What was the thing you read that had the biggest impact on you?
Jeff Malec:
Yeah, I don’t think there was any like, big thing like that, to me, it was just more learning how to think. Yeah. And being challenged. I’d have to say if I had to pick one probably Thomas Hobbes, yeah, who’s the life is nasty, brutish, and short. I was my thesis was the irrationality of human cooperation. So kind of went into that’s our natural state. And then we naturally also figured out that we have to cooperate. Or else well, I’ll run each other over in the streets and whatnot. So I’d say that one, a bunch of other random weird stuff, Nietzsche, fun. But yeah, and I never really looked at it that way. They’re kind of like, old dead, mostly white guys.
Taylor Pearson:
Yeah, I feel like you’re sort of Gods too. But my theory is like, you either want to go like hard math and sciences or like history or philosophy. It’s like the social sciences in the middle where you think you’re doing science and you’re really just like making stuff up, really some philosophy or the history at least, you know, you’re making stuff thought like, exactly just like picking random data points and telling stories about him like, let’s let’s not like…
Jeff Malec:
And it’s actually interesting the far edge of philosophy and you get into logic and it gets very mathematical. So that was some of my favorite classes actually where the logic classes and some of these guys who were with words and whatnot proving some mathematical theories.
Jason Buck:
That’s gets in my buddy, the old Santiago George Saunders purse was the American philosopher that was like the founder of logic, saving money. So they say he’s kind of the inventor of binary digits, which lead to computers and everything because it comes from, you know, logic background. But I think the most interesting part that you said is like, it taught you how to think in the way like maybe origin or how to question your thinking, because like, everything in school is always additive here, memorize this, memorize this, and they’re teaching you something, we’re trying to pour information into your head, or then you get in philosophy class, and they’re like, wait, why do you think that was the definition of that word? Like, what’s your priors to that and so it forces you to be much more disciplined in a way.
Jeff Malec:
For sure. And if right, there’s probably a lot of banks that would have loved for their analysts and risk managers to have question bar and things like that of like, no, don’t just take this for, for what it’s worth. So.
Taylor Pearson:
What is explained var for the listeners?
Jeff Malec:
Var is value at risk. It’s a standard deviation based risk measure of you’ll never lose more than 1% 99% of the time. So it’s kind of based on the normal bell curve. But as we know, we don’t live in normal bell curve land. So.
Taylor Pearson:
Right was the anchorman, quote works 80% of the time, every time?
Jeff Malec:
Yeah, or my favorite is 96% of statistics are misleading. Right?
Taylor Pearson:
And then how did you end up in the bond futures pitch? How did you sort of end up in finance and the Chicago School and all that?
Jeff Malec:
Well as a philosophy major I went to live in Aspen, Colorado for a year and a half after school top destination for philosophy majors. Was slapping chili on the mountain there and you know, living the dream. But you’re looking across the place of the people you’re serving the chill. You’re like I maybe I want to be that guy. He seems to have it pretty good. So move back to Chicago. I was born in Chicago, raised down in Vero Beach, Florida, but a move back to Chicago where my dad was his wife at the time, which is a whole nother podcast, but his wife at the time put made a connection with a guy she knew on the trading floor. So it started there as a clerk. didn’t last terribly long down there. It didn’t fit with my personality. It was kind of loud, crazy. And I was always asking like, you know, and I was in the bond pit at the time, which was they just built the new room at the border trade. I think you could fit a 747 plane inside the room. There were multiple pets that 30 year bond pet was the largest pet and You know, I would rally. I think that was the time the Asian bond crisis like 99 ish? And would be, you know, millions of dollars changing and I’m like, Why? Why did we rally What’s going on? And they’d be like because Billy’s buying.
Taylor Pearson:
So for someone that’s like never seen what he says set the stage what is like a typical day What was it typical day and in the bond pit? Like what was the big rooms a big open room, you could park a 747 in there. A bunch of dudes holding up pieces of paper yelling at each other.
Jeff Malec:
Yeah, so it’s very three dimensional too. So the pits are all raised. There’s, you know, it’s kind of a ring and octagon. The middle I don’t even remember what the middle is for. There’s no one really in the middle and then there’s the first during the second ring. The best guys have either the third or fourth step up so they can see over and do everything. And then they’re all everyone looking into the pen is trading with each other. And it was all go watch Ferris Bueller’s Day Off that scene. Were there. Looking through the thing, and Cameron’s doing all the hand signals pretending to do them, that was the, that was called RB. So, you know, fate if your hand palms facing out you’re selling, if your palms facing in you’re buying and it was 12345 normally, then you turn your hand sideways 6789, then a finger on your head 1020 3040 fingers on your arm, hundred 200 300 400 I don’t remember what thousands are, but it was at Whole code. And so they’re screaming at each other because you can’t hear there’s thousands of people in this huge room. There’s probably 200 people in the bond pit itself. And they’re trading with each other and then they just have a little sheet of paper. So they look over you Taylor 200 200 and you say 200 sold, and then my badge would be j e f and yours would be ta y and they just scribble in the most unintelligible way possible. Try to 128 40 whatever the price was, and then rip that off and they had a hard card that they’d put in their pocket, rip off the carbon copy, hand it to the clerk. The clerk at the end of the day would go find your clerk. And they’d match up the trade. So in today’s world of globex, and, you know, digital automatic trade matching, that’s crazy, right?
Taylor Pearson:
Right. But wasn’t that like 20 years ago? I mean, it wasn’t that long ago.
Jeff Malec:
Yeah, yeah. And so then my job was I’ve the brokers are all looking inside trading amongst each other, then I would be back to back with him looking into the option bond option pit. So the option guys are doing their options and then they need to delta hedge so as the markets moving they’re in real time looking at me saying buy 200 bucks, and I turn around and tell my guys to buy and then they do the trade with the other guys. So the just the sheer amount of paper is would be blow your mind. Like there’s no way I could exist today just from the you know environmentalists would be like this paper is gonna go. Like there’d be literally an inch to two inches of paper on the floor at the end of every day.
Jason Buck:
Can you explain Delta hedging real quick for the audience?
Jeff Malec:
Yeah, so if you have an option position, as the position gets closer to the strike price, so in the bond, say I was short of 106 call or something, as the end, the prices are at 102. The Delta of that 106 call is the amount that option moves in relation to the underlying market move. So as prices get closer to that strike price of the option, you know, if it goes in the money, the deltas one it’s basically just becomes the underlying that. So these guys would have all these complex option positions on and in those days, they had another piece of paper in their pocket and they’ve constantly be looking down at the sheet to see okay, if we move this much My Delta has changed by this much. And I need to add features, because they’re
Taylor Pearson:
They’re market making. So they’re just trying to stay Delta neutral. So they don’t, they don’t care which direction the market moves.
Jeff Malec:
They’re probably not market making most were trading their own money or whatnot, but they wanted to be delta neutral. So they’re just trying to scalp the volatility of the option or have some other concept in set of options of what they wanted to do. But yeah, they didn’t want to be directional. So they’re selling, you know, they think they get a good price on the option, they sell it, they want to hedge out the directional movement as quickly as possible.
Jason Buck:
And then do you think it’s a bygone era? Like you said, these guys are a lot more trading their own money. And it was a unique era in Chicago times where like, these guys would go down the pit, they’d trade for those few hours in the day, you know, and they and they’d walk away and they were buying houses cash or whatever, they, you know, their p&l would you know, fluctuate tremendously throughout the year but it was all eat what you kill and we don’t really have that physical sense of eat what you kill in the markets.
Jeff Malec:
Yeah, I’d say the closest thing these days is probably the crypto space of people who could just get in for next to nothing and made millions of dollars like, and it was a huge in Chicago is proud of that because it was very differentiated from New York where you had to go to the right schools and get the right internship and get onto the trading floors. Chicago was like, if you were an aggressive guy, and, you know, push your way onto the floor, you could you could make a killer and a lot of guys did without any education without anything. So for sure, it’s a bygone era of nowadays that’s all computers talking to each other. And when you said the bond, it wasn’t for you is that because you’re a philosophy major and you’re not an enormous dude. I mean, maybe you played football and everything but like typical bond pet guys were like, big dudes, and they’re spitting on you elbowing you is like it’s a very physical job in a way. Oh my god. Yeah. So two things. One, there were a lot of guys who there they’re all big guns. There were fistfights. You know, once a week, probably two, they all had some sort of advice. At least one vise. So a lot of them to keep going during the day would dip, you know, have chewing tobacco. And so where are they going to spin it so they have their dip cup that they’re spinning in inside their jacket. And so to complete the picture everyone has you The rules are you had to have a sport coat, essentially. So that became super loose and they’re all like mesh custom. And then you want to it’s like being a peacock, you got to stand out. So if everyone’s trying to sell you 500 you want to be the guy in the big loud coat that the eye catches. So like our uniforms, were these red and white candy striper kind of codes other guys had purple or yellow or, or whatever color but uh yeah, many times I’m in the in the thick of it there and a guy gets bumped in his dip cup gets pushed out of the jacket onto my arm or leg or whatever. Yeah, that’s someone that was like what am I doing? But for me, it was it was less than physical side was more of the mathematical like no one could tell me why bonds are rallying and they’re finally they’re like, oh, cuz Goldman came in they’re buying them from upstairs I’m like well I need to find out what’s upstairs. And so that started my progression of like I’m getting off the floor. I’m going to see what’s going on upstairs and upstairs was managed money and big firms hedging and things like that.
Taylor Pearson:
So let’s get into that what you mentioned like the New York for Chicago School what how do you like explain that difference? Like what? How they distance?
Jeff Malec:
Well my favorite thing to say in that regard is New York doesn’t have alleys. So they they pile up all those trash bags outside their $30 million condos and Chicago has alleys so we’re much better in that much cleaner. But uh, well, the the main thing right is New York has stocks New York Stock Exchange, Chicago futures. So Chicago, grew up on the agriculture futures Chicago Board of Trade, 100 and whatever years old
Taylor Pearson:
Chicago was sort of like the center of like agricultural trade. It was like in the middle of the country and where the railroads came in. And so you were like, farmers were shipping in soybeans or whatever. And they were doing trading futures on them.
Jeff Malec:
Exactly. And I always tell people new to futures, like, It’s not what you think the price is going to be in the future. It’s agreeing on a price today for future delivery.
Taylor Pearson:
Right. So I’m going back and forth. And like I want to hedge out, you know, right now, the price of corn is $18 a bushel, but like, it could go to 25. Or it could go to 12. And so, Okay, I’m gonna sell some today at 18. And luckily,
Jeff Malec:
If corn prices are at $18 a bushel, you’d have billionaire farmers, I was like, $4 Yeah, there you go. But yeah, so a farmer be like, Okay, I’m going to come to Chicago and someone’s going to agree to buy my corn that I haven’t even planted yet. For $4 a bushel, and so you’re like, great, I know. I can plant it, harvest it, get it all out of the ground for 360 So I can immediately lock in that 40 cents profit.
Taylor Pearson:
Right. And walk us through. How did you get how did Chicago sort of how did that grow into, you know what, what it is today? What is sort of, you know, I’ve heard it sometimes CTAs managed futures, futures. How did that what does that sort of industry How do you think about that?
Jeff Malec:
So there was the agriculture futures, corn we all that stuff grown in the ground commodities. And then the that was all Chicago Board of Trade then Chicago Mercantile Exchange launched in the 70s something and came up with the idea of we’re gonna trade currency futures, Swiss franc yen, things like that, which exploded, and then they started adding stock index and a lot of other stuff and then you had, you know, New York barter trade, cotton sugar, all these things. So, managed futures CTAs john Henry was actually one of the first ones who’s the Boston Red Sox. sooner so he was out of Boston, but essentially was trading all those different futures markets. The classic example is trend following or the classic approach to that was trend following. And this ties back to turtle traders to which some people have heard of so in the Merc pet. Sometime in the 80s, Bill Eckhart and William Dennis, William Eckert, and Bill Dennis had a bet, like straight out of Trading Places like I bet they were arguing, I think you could teach people to be great traders, you have to give them these rules. And those rules were essentially kind of a trend following approach only risk a set amount per trade. And they taught many people, some of which are CTAs today that have continued on and been very successful. So the Manage feature space was born out of these out of this futures trading, which was highly right the futures contracts are internally leveraged. So the back to the corn contract, I can call it $25,000 worth of corn for putting $800 margin in my account. So, right, that’s inherently risky. And people were trying to do that on their own, whether in the pet or calling a broker or whatnot and losing a lot of money. So manage features came along and said, Hey, we’re gonna put some rules around this. I’m not gonna, you know, I’m not gonna play. I’m not going to only put in $800 to control that corner, maybe I put in $50,000 to control $25,000 worth of coins, so kind of institutionalized it, controlled it, put a model around it, and started to become a big asset class.
Taylor Pearson:
It was like a regulatory framework that was just investors started to say, like, I’m not going to do this highly leveraged thing.
Jeff Malec:
Yeah, I think it ties back with the turtle trader kind of concept of just, you know, yeah, people are like, there’s a lot of money being made there. I don’t need 80% volatility, like can we get 10% volatility and make 20 percent that’d be great. I don’t need to be impacted Jason’s things. People are buying houses in cash. And I have friends whose parents were traders back in those days and they’d be like, we had a new car. The car got taken away. We had a piano, the piano got taken away. So there was constantly like, all this volatility, not just in their p&l, but in their lives. Right, we got a new vacation out to Michigan, and we’re back to Indiana. So it was just controlling that volatility and and attracting outside investor capital.
Taylor Pearson:
And so the CCT is commodity trading advisor and so what’s happening is that you have the corn the cotton or whatever futures in there and these guys are coming in and they’re setting up these trend following rules trend following where you explain like trend following and in general, and then like how it applies to CTAs. Like what Well, what’s an example of like a trend following CTA strategy?
Jeff Malec:
Sure. And I you know, they’re known for they did great in 2008 made like 18%, while stocks were down everything was down. And I’d say it’s not magic, they didn’t predict the crash, they didn’t do anything. They’re participating, you know, imagine a band of, you know, one standard deviation above one standard deviation below prices on any chart, they’re just putting that on a chart. When prices break above the upper band, they’re going to buy, hoping it’s a breakout, and it’s going to continue for weeks or months or when prices break below that band, they’re gonna sell and hope that it keeps selling off for. So there’s no magic there. They’re just doing that every time it breaks above or below those bands. And it’s not a very efficient trade, but they’re doing that every time to ensure that when it is the big move, that they catch it, and then they control their risk by saying I’m only going to risk one half of 1% of my equity or 1% of my equity on each of those trades, knowing they’re probably only going to be 30 40% profitable On the on the ones that do hit though they’re huge outliers.
Taylor Pearson:
And they’re capping the downside because if it wants to drops below one standard deviation or whatever they’re using, they’re, they’re out of the market in there.
Jeff Malec:
Right and it’s like a you know, it’s kind of synthetic put buying. So you’re, you’re controlling what how much you risk, you’re kind of buying or not put buying buy option, but so you’re controlling your risk, you’re only spending a little bit of money of your capital to participate in all those moves, hoping that the final outlier move happens.
Jason Buck:
And they, you know, it’s counterintuitive to most people, but they tend to, they joke about they buy high and sell even higher, or they buy there, they sell low until even lower whether it’s the opposite of most people want to do, especially when they think about like value investing. They’re trying to buy low and sell high. They that’s why it’s called trend because they they believe that humans are very emotional and rational and we tend to herd so if prices spike higher, they’re trying to get in thinking that that’s going to run along or if spike prices crash down. They want to ride those trends. As we get emotional and overshoot the target, so to speak.
Jeff Malec:
For sure. And it was it was one of the first quadrant models, right? It was one of the first people to use computers to trade markets. And it’s essentially a strategy where you’re plotting all the and some of these early guys were doing this by hand of taking in the data every day, putting it on charts, actually drawing charts and saying, okay, we’ve broken above the one standard deviation of average prices. Now I’m going to buy in today, right? That can all be done in two seconds on any number of platforms, but was one of the first to put an automated systematic model onto the onto market.
Taylor Pearson:
And then what like talk through you could get exposure to the s&p index through an ETF or you could do it to the futures industry. You could trade options on s&p futures like what what are the pertinent differences between like, why would an investor choose to use futures as opposed to equities or equities as opposed to futures like what are the or Have the trade offs in differences.
Jeff Malec:
Sure. I’ll back up a second say part of that managed futures classic portfolio also is broad global exposure so I’m going to have about a quarter of my risk in fixed income futures which is 30 year us 30 year bonds German boons Japanese bonds then I’m going to have about a quarter in currencies again franc British Pound Aussie dollar. Then I’m going to have a quarter in row crops are grown in the ground commodities. So corn, wheat, gold crude oil, I guess I don’t know if we’d say crude oil is grown in the ground but comes out of the ground. And I’m I pulled a rick perry there. I can’t remember my fourth one. But uh, what do we go through? The end? Sorry, equities. Thank you. Yeah. And then equity indices, and global. So SMP Hang saying Aussie German DAX. So at any one time, and you’re not trying to catch any specific trend, you’re just trying to spread it across, wherever the whole model is markets cluster. And then they break out or break down to new highs are two new lows, they phase shift to these new things. So the whole concept of I just did that on the SMP. I could go years and years and years waiting for that phase shift. If I’m on five different global equity indices, there’s a better chance that one of them is going to break out if I’m on five different market sectors now, energies, currencies, interest rates, even better chance if each inside each of those buckets, I have 50 different things. So the whole concept is I want as much exposure as possible. I’m going to be playing 600 hands at the blackjack table, and I know risking only a little amount and knowing that at any one time I’m going to go on a big run on one of those hands.
Jason Buck:
So Going back almost to the start of Taylor’s question when he was actually, you know, asking about in a way is like, you know, he brings up futures managed futures CTAs now at RCM, you guys are calling them alternative investments. This is a marketing problem that I know makes you want to rip your hair out. But it’s like, now everybody gets told by their ra that they need to have a global portfolio and they’re trying to implement a three ETFs. But the guys that were trend following CTAs have been doing this for decades and the most global portfolio you could possibly imagine that you just laid out like literally everything in the world, they’re trading yet almost nobody knows about it. So how do you like, I don’t know if you if you could be a billionaire, but how do you overcome that marketing problem with futures options? And
Jeff Malec:
Yeah, and it’s compounded by the the thing we’re talking about one slice this trend following that we’ve been covering, but then there’s discretionary ag traders, there’s professional energy traders that are doing different things. So you and that all comes down to this manage features. umbrella so you I don’t have a good answer for this.
Taylor Pearson:
Here’s the way I minders because you think about futures and equities like there’s, there’s different like, you know, one things we’ve talked about is like counterparty risk, right. So if you’re doing a big options trade that’s over the counter in the equities market with Goldman Sachs, Goldman is your counterparty and if they blow up or whatever, you know, you have that counterparty risk. Yeah. So it was more like Mark to markets cash base, you don’t have the same counterparty risk, which I like other other sort of, like pertinent differences like that, that you think like investors should be aware of?
Jeff Malec:
Yeah, so the classic ones are, excuse me, the futures get 6040 tax treatment, which actually comes back to there was no difference in tax treatment in a bunch of the Chicago traders would at the end of every year, basically buy new stuff to they did like a tax spread on the calendar. And the feds came in and they were gonna like, take all these guys down and they somehow lobbied and got this thing put in for 6040 tax stream. And so no matter if you trade every second of every day 60% of your gains get treated as long term capital gains. 40% is short term. So that’s a huge, huge benefit, especially the more active you are as a trader. The other thing, as you mentioned, there’s no counterparty risk. So the exchange backs every trade, which is how the whole futures market work. If you had to worry about you know, I buy this corn future, I have no idea if the guy who sold it to me is going to be able to deliver, the whole thing would fall apart pretty quickly. It’s sort of an issue in the crypto space is there isn’t a centralized thing by design, but right people have a problem trusting that who’s on the other side. So the futures markets fix that by each exchange, which was CME. CBOT, NYMEX has a guarantee fund. So, in the case that the counterparty if you are JP Morgan, I’m Wells Fargo, whatever We do the trade, say one of those banks goes bust the CME will step in with their guarantee fund and say I’ll make you good on that trade. So you got the tax difference, the whatever I just said difference, counterparty risk Counterparty difference, and then the leverage difference. So as we talked about before, the leverage is built into a futures contract. If I want to buy, so I can control you know, $150,000 worth of s&p by buying money many and putting up $6,000 worth of margin or whatever, I don’t know what an E Mini is.
Jason Buck:
E mini s&p is the electronic small version of the s&p futures which gives exposure to the s&p 500. So it’s a easy way to get trade the SMP a little cheaper and then they actually came out with micro minis, which you’d allows you to do it for even cheaper and less money. But so that leverage is built in if I want that same money. exposure in stocks without putting up as much capital in a stock account I have to post, they’re gonna charge me 50% margin, they’re actually going to charge me for borrowing money from the bank to buy that full nominal amount. Whereas in futures, it’s embedded in the, in the, in the contract. I think this is a good place to point out that typically when people hear leverage, and especially leverage in futures and options market that usually scares people away right away, understandably so sure, because you’ll be afraid of leverage and leverage is that you had a beast that cuts both ways. So going back to what you pointed out earlier, if going into futures, I can trade 60 global markets and I can have on hundreds of bets at the same time, well, then using that cash efficiency of that margin and leverage now makes me much safer. So not only can you know, leverage be used to hurt you, it can be used to help you and that’s the kind of the beauty of the futures market that most people don’t understand is it allows me to put on a broader diversification of bets across global markets, which makes a more robust, safer portfolio than I could ever possibly attain with equities because I have the cash efficiencies of being able to cross margin those different markets.
Jeff Malec:
Yeah, for sure. And that’s, I agree 100% of that it’s, it’s got a bad connotation of leverage. Where in the futures markets, anyone who’s knows what they’re doing, it’s like, that’s the main main reason they use features versus an equity component cuz they, they don’t have to put up all the cash. Right? So if I have to put up 100 grand to control 100 grand, that’s gone. If I have to put up 10 grand to control 100, guess what, I can do something else with my 90, which in a in a, anyone’s features count, you can buy t bills that count as collateral. So right there, you can get an extra whatever, 2% a year to just do what you were going to be doing anyway. But then the more sophisticated and as Jason saying, Okay, I’m going to take that 90. Now I’m going to buy a few more things, which if you’re doing that poorly could be over levering if you’re doing it into non correlated things. It’s it’s additive and can, can grow. And also add. So people like our clients that RCM who trade multiple professional managers, multiple CTAs. They prefer futures and managed accounts, because they can put up a million dollars and have it traded as $5 million. How, because of this embedded leverage, so each manager might say they’re meant their minimum investment is $1 million. And that gives you this, you know, fake numbers here that gives you a 15% return with 12% volatility. Okay, I find willing to have a 20% volatility, I can put in a little less cash and they still trade it as a million dollars, which is notional funding. We’re getting a little off the rails here, but the whole concept is they can trade all five of those managers with just the one investment which you can’t do anywhere else besides features accounts without borrowing actual money and paying a yield. To borrow that money.
Taylor Pearson:
Yeah, the key thing As I understand it right as the yeah you get paid, you get paid to take leverage as opposed to paying to take leverage. So that’s nice and then what the CTA is trying to do is like well if you’re using that leverage to buy things that are diversified you know if you have two assets and you know when one goes up or down when the other goes up the other is gonna go down and they’re offsetting each other you can use that leverage safely right because any and that’s what that that’s what the CTAs were kind of trying to replicate with their global trend following right is that yeah no diversified basket.
Jeff Malec:
I’d be careful saying safely but because people can for sure do it right.
Taylor Pearson:
And we don’t know if coalitions are gonna hold into the future.
Jeff Malec:
Yeah, exactly. So I think it’s, it’s less about that and more about so if a trend following CTA has a $1 million minimum, they only actually need to put their strategy on their average margin equity, what they actually have to have in the account per the exchange and in the rules is probably on average $120,000 so 12% So why then don’t they say their minimum is 120,000? Because a, their volatility would be like 50%. And no investors would sign up. So one, it’s just a bit of window dressing of, Hey, I can’t put it at the minimum I need because it looks too volatile. So I’m going to say I need a little bit more. And that’s back to what we said a little earlier of like, instead of trading 25,000 worth of corn for $800. I’m going to trade $25,000 of corn for $50,000. So one, it’s a bit of window dressing.
Jason Buck:
Yeah, so basically, you can leverage B or D leverage is what you’re saying too.
Jeff Malec:
Yeah. So essentially, the CTAs build their model, see what it is and then they D leverage it by and make it look okay, what kind of return stream would attract investors. And then in the first days, like john Henry, when he launched he was doing 4050 60% with 30% volatility and people were into that these days. You go much over 1012 15% you’re gonna spook a lot of people. So I lost my train of thought. But you have the million dollar guy, all he needs is 120 he’s gonna window dress it up. But the investor still only needs that hundred and 20. So instead of putting up all the million dollars, they can only put up and there’s rules around it. Usually most CPAs don’t want to put in the bare minimum because if there’s one week of losses, then they need to ask you a send it more money. So typically, they only allow two to one or three to one.
Jason Buck:
And then you pointed out three of the biggest benefits to futures markets. And a fourth that I always loved is that depending on the manager you invest in and depending on what you structure negotiate with them, you can have what we call SMS or separately managed accounts. And what I love about that is it almost eliminates the possibility of like a Bernie Madoff scenario of him like falsifying trades, because on a daily basis, you get almost a window into what your manager is trading. And you know, given the cash settled markets, that’s the the other, I guess benefit A and B to this idea is that it’s cash liquid market. So no You’re able to kind of see the trades to make sure they’re not going off off the rails or using excessive leverage or anything. But you can also go to cash on a daily, weekly or monthly basis. So you can, you know, there’s no lock ups like you would see in like a hedge fund space where they, you know, they’re down 10%, they lock up your money for two years. Now, these things are capital markets, we can go to cash right away, we can also see what our managers are trading so that way, you know, they’re, they’re sticking to their knitting, so to speak. And these are things that I think that are not talked about enough is the benefits of how do we mitigate any sort of even like Bernie Madoff risk with an individual manager, this can take care of 99% of that risk.
Jeff Malec:
Yeah, that’s a great point. So in practice, how it works. So you’re gonna sign up with CTA superduper CTA one, you’ve been tracking you like all the performance, so she’s gonna send you an advisory agreement. You’re gonna open a futures account with someone great like RCM. They’re going to put it at a FCM to EMS, but that’s just the firm that The exchange membership and you do your trades and clear your trades through that, that firm. So it’s called a clearing firm. So you open an account there. It’s your account, it’s in your name, you can call it tomorrow and say, send me my money. Then you give our superduper XYZ CTA power of attorney to place trades in that account. But also they have to follow a disclosure document and have to follow the rules. They have guidelines, so they can’t just willy nilly do whatever they want. So they have to do their program in your account. So they’re placing the trades with that account number. And then there’s several additional layers of risk there as well. So say they mess up hit, you know, by 1000 instead of by 100. That’ll go through that clearing firm to the exchange. There might be gates there of Hey, this CTA for that account, don’t allow any orders that are more than 10 contracts. So there are some like fat finger protection. But also they can’t, the manager can’t call and say send me $100,000 out of that account. So the money in that account can only go back to the person who funded the account. Where right versus a fun are made off. You were sending the money and it was all commingled. And he had control and he could, you know, write himself checks or do whatever you wanted with that.
Taylor Pearson:
You mentioned RCM which you work with. Tell us a little bit about about RCM and like how y’all fit into the futures? CTA space?
Jeff Malec:
Sure, so backup so after the training floor, I came upstairs I bounced around a few different brokerages. One had an owner that drove a Lamborghini and more leather pants. So that almost freaked me out of the business. But I left there ended up starting my own firm in 2000. To obtain Capital Management. We launched our own CTA In 2004, ran that up to about 75 million bucks. Had a few industry issues MF Global went bankrupt pf g guy stole some money. We’re had exposure to both those so eventually shut down the CTA took a bit of a hit in our business, built it back up. That was 2012 built back up through 2015. In the industry was consolidating regulation was getting more expensive. You had to have tech, you had to have websites, so merged in with RCM in 2015. And our both of our models were complimentary, but you know, the essential thing we do is is help investors find and access these professional managers. So we have a database of thousands of managers. I came up with a proprietary ranking methodology, where we rank those managers across several different metrics. And then also not just these different metrics but across timeframes. So my and seeing all these Things you always had a, there was an old trader called Rosetta capital who made like 80% in their first year. And then like 5%, every year after that, or something, and but their compound rate of return was off the charts. But I kept looking at I’m like, Well, nobody wants that, though, that’s not so we came up with this model that time weighted the returns across 135 10 and all time, and kind of averages those and then gives a score to each one. And, and, and that happens across all the metrics too. So it’s a way to, you know, compare apples to oranges, and compare across all these different metrics that are important to people. So we have that database, you can build portfolios, you can blend different managers, you can see all the statistics there and then we’re doing the actual physical face to face due diligence on these managers also an understanding what they do, and my personal feeling is you can run all the math you want but If you end up with some guys that on paper are non correlated, but they’re all doing a similar type of trade, at some point in the future, they’re going to be very correlated, and it’s going to hurt your portfolio. So, kind of RPMs mo in my personal mo is you gotta put managers that are fundamentally non correlated together as well. And by that I mean doing different things and having different return drivers.
Taylor Pearson:
And what do you mean by fundamentally non what is it what is a non fundamental correlation as opposed to a fundamental correlation?
Jeff Malec:
Well, so I could just in the database be playing around all day and come up with this great portfolio and all the managers have 0.04 correlation with one another. But if I dig deeper, I see that manager one is doing volatility breakout on a daily barns and manager two is doing it on 15 minute bars. So maybe statistically, they’ve been uncorrelated but they’re sort of doing the same thing. They need volatility. They need breakouts to new Highs. So it’s just a little bit of me personally not trusting the math or Jason probably has some fancy word for it, but I’m like that it won’t. It just hasn’t happened yet. So in my view, if they’re doing something similar, they’re gonna be correlated. It just hasn’t happened yet. And it’s not showing up in the math. So I have a distress of the math based on that what fundamental non equation I want. If I’ve got that guy doing this volatility breakout, I want to discretionary ag trader who trades hogs based on calling around, you know, 500, pig farms and seeing what demand and supply so they’re just fundamentally different in what they’re doing.
Jason Buck:
And another way to look at it to almost simplify is like, statistical versus fundamental correlation is the science versus the art or the math versus the art. So you guys have the ability and that you guys are pretty much the only one in this game that has amazing platform where all the math is there for you to look up. But then you have all of the personal experience and the art from that 30,000 foot view. To say, you know, decades ago this happened. And these things were fundamentally correlated versus uncorrelated, or you go, look, I’ve been in the game for a year, a year, you know, decades. I know that hogs are actually correlated with the Swiss franc. Whether people were there statistical correlation has not been there for a few years. Over the long run, these things are fundamentally uncorrelated. So it’s this combination of math and art that is very rare to find in any financial space. And that’s what you personally embody. And that’s what you guys are trying to do at RCM.
Jeff Malec:
Yeah, I would call it math and philosophy. They full circle full circle, right. But yeah, and so then RCM. So we’re helping investors in that manner. We’re building these portfolios and then we help the as we said, you open an account the manager advises manages that account. So we actually clear like 13 different clearing firms from small Chicago based guys up to you know, JPMorgan and Wells Fargo and whatnot. So depending on what What kind of client you are, if you’re a high net worth guy with $500,000, we’ll get you to this clearing firm that will accept individuals if you’re a $50 million family office and have to build a fund to one and do all this, you know, sophisticated stuff, you’re going to probably go to a bank FCM. So, in addition to building the portfolios were given, introducing accounts to all those fcms. Then on the manager side, we help managers by matchmaking with the other side with the investor clients, and helping them structure funds, helping them with their clearing with their execution. Then we also have a algorithmic execution division, which is super complicated and kind of cutting edge stuff. But essentially, there’s as everything that’s gone digital, there’s bad actors out there prop firms who are trying to scalp and take advantage of people naively buying and crossing the spread these execution algorithms computerize Have anti gaming theory all sorts of things that kind of help you not cross the spread and not get preyed on by those high frequency guys on the other side. And then lastly, we’re doing some interesting stuff in China now, where we’ve set up a Chinese Wi Fi, they call it wholly foreign owned enterprise and bringing signals bringing Western CTA signals through our Chinese partners there to trade Chinese money on Chinese futures markets. So Western people aren’t allowed to put their own money into trade Chinese futures markets, but they’re highly volatile. They’re kind of like the markets, Western markets in the 80s. highly volatile directional volatility. So some of these classic trend following and classic models are working really well there. But you can’t get Western money in there yet. But the Chinese money has a big desire to have a trading. So we’re working on facilitating some of that.
Jason Buck:
Just what you said about you know, directional volatility. In China being like 70s and 80s in our markets and obviously the next question for our audience is how do you view even like the cryptocurrency markets using like classical trend following?
Jeff Malec:
Yeah just was here down at a conference talking about that with someone of why don’t more managers have it in their portfolios? Because it’s Yeah, it’s the same thing like hey, why go through all that trouble to get into China do that you have it right there and you know, there’s only one futures market right now Bitcoin futures but for sure, that’s, that’s the same. That’s the kind of volatility that people like and there are managers who have outright crypto, Bitcoin futures programs managing and kind of probably more volatility breakout shorter term and classic trend following. But yeah, to me, every CTA should have Bitcoin as one of the markets they’re tracking and trying to catch those trends. The issues are there the clearing firms were spooked from the beginning. So our corn example you know, have put up $800 to control 25 grand in corn mostly Sam’s are saying Bitcoin you have to put up $25,000 to control 25,000 worth of corn. So it kind of removes a lot of the benefits we were talking about earlier with all that embedded leverage. But still, if it’s going to be one market out of your 85, I think it should be added.
Taylor Pearson:
So we kind of started working together, because as you said, you’ll have this big database managers, and we were trying to do the due diligence, and you’re managing billions of dollars across all these CPAs and have the infrastructure and stuff set up to do that. But I’m curious, like in terms of, you know, you work with a fairly sophisticated investor base, like if you were sort of like looking at, you know, the median retail investor that’s got a job running a business and like managing their own account in the background versus the people you’re working with, like, what are the what are the big differences? Like what, what what do you feel like the lessons are that you’ve taken from that, that investor is.
Jeff Malec:
To tell you the truth. I don’t think there’s that much of a sophistication gap. It’s kind of crazy like the. And I hope not to offend any of our clients who are listening to this, but some, I’ll say in the far past, I’ve run across clients who you’re like, you must have found your money in a bag and anally, because there’s there’s no sophistication there. So a big part. I don’t know if there’s that big of a sophistication gap. The performance, they chase performance, just like retail, yeah, they panic and get out at the wrong times, just like smaller guns. Yeah, I think the the biggest differences the smaller investor can only you know, it’s a minimum game. So the larger investor can see a lot more things, things that have 510 million dollar minimums. But there’s also a flipside, I’d rather be the smaller guy and be more nimble because these sophisticated institutional investors, they end up only being able to invest in this super small sliver of managers because they have their checkboxes. Okay? You have to have such and such business structure, you have to have all this cybersecurity stuff, you have to have this, this and as you go down and have to check all those boxes, you might end up with, you know, six managers across the world that qualify. I know ipers I was pension, like four years ago put out a RFP, basically saying we’re gonna put 100 million to work in the CTA space requests, you know, submit your things, and I should have at the time, but I was gonna write a blog post, I was just like, Hey, I better save your time. Here’s the six managers you’re gonna end up with. Like, don’t go through this whole stupid process and interview all these thousands of managers when there’s only six that check your boxes.
Jason Buck:
And this might be to Taylor’s point, and this might be just subjective to me, but I always had the gut feeling or inclination that the future traders, like you’re saying in the bond pits are those pit traders were very entrepreneurial, they’re trading their own money. A lot of times the people that are going to invest in are high net worth individuals that actually are the first generation? Well, they’re theirs doesn’t make it they’re an entrepreneur. So it seems to me It always felt a barely alignment as an entrepreneur, dealing with Chicago guys that are entrepreneurs and then creating trading systems or trading global markets in a very statistical entrepreneurial way. It just seemed like alignment of entrepreneurial upon you know, it just it’s a almost a perfect alignment. Do you see that a lot with your clients, a lot of entrepreneurs first time
Jeff Malec:
Definitely. And a big
common denominator across our clients, we tend to have these engineering type, whether outright engineers or just that kind of a mindset. And that entrepreneurial mindset, I’d say is, a lot of them are engineering type. There’s a problem, I’m going to figure out a way to fix that problem. You know, even if it’s not, I’m not saying like mechanical engineering, but just the process of like I need I need to have a process. I’m going to go through that process and get to the result. So you definitely have a lot of clients to have that mindset of not just blind trust of like no, I want to understand how this guy is applying. A model to a market. And the better I understand that I’m more willing to invest instead of right of 80% of the rest of the world. It’s just like well, I golf with Jim and he says, this is a good thing. I’m going to invest in it.
Taylor Pearson:
I’ve been interested like, the people that I’ve found that have known the most of the CTA space in like my circle has been poker players and I guess you know, something about like, the way they they obviously they understand risk and like a more sophisticated way than, than most people but like that the global asset allocation trend following that, that seems more intuitive to to that crowd, like every kind of poker player I’ve hung out with has always been like CTA.
Jeff Malec:
For sure, and get super deep in the weeds here, but it’s all probability based, right? The best poker players are saying, Okay, I’ve got I think there’s a 20% chance Jason’s on a flush draw. I’ve got a straight already like in there just doing the math and then Okay, there’s that much in the pot. If I risk x, I know I’m gonna get why. So they’re doing that math in real time in there. Which is impressive. But that’s essentially what the advanced CPAs are doing. Right? Okay, here’s the market setup. The pie is I think it could move this much. I’m going to risk x, you know. So it’s, it’s a similar mindset for sure of, Okay, I’ve got probabilities, and I’m going to risk certain amounts based on those probabilities with an expected return. And by the way, I can back test on that and see how it would have done in the past across many different markets.
Jason Buck:
And before I mean, I’ll try to keep it short without going on a rant that’ll start a whole nother podcast. But as we know, the My favorite part about the CTA and future space, is we talk about your return to draw down is your risk, you know, where a lot of other spaces now are talking about, you know, volatility as a measure, measure risk. And you know, you know, I love that line, Nick, why did we let a 22 year old Liberty University Chicago define what risk is where for entrepreneurs, it’s about Did you lose my money or not? That’s your drawdown. Not it? how volatile are the cross asset correlations it’s like, what is my return? And what is my drawdown at the end of the year? Did I make money or lose money? And the Manage feature space has been pounding the table about return versus drawdown since the start. So they always understood that from the entrepreneurs perspective, it’s like about what I can eat at the end of the day and I can either Sharpe ratio or my volatility. I can eat returns and I can not eat what drawdowns
Taylor Pearson:
Explain what you mean by who’s the 22 year old that we’re talking about. And then give the unpack the Sharpe ratio return to drawdown.
Jason Buck:
So, Jeff, actually probably knows the history better than I do. But the the idea of Bill Sharpe coming up with the Sharpe ratio is that it’s based on volatility and volatility is based on a look back and and look back as your standard deviation over time. So, you know, based on you know, your Gaussian curve once mgh and Tuesday, no deviations, it’s basically you know, how far Towards this asset over time, but as you would assume you’re saying over what look back period. So if I look back over a week, I’ll have a certain volatility, I look back a year certain volatility, 10 years volatility, you know, it changes over time. So when people are talking about the Sharpe ratio, they’re taking their return divided by the volatility over the timeframe that we’re looking at. And that’s how that’s what we call the efficient frontier portfolio construction. And that’s what everybody uses to kind of match up their portfolio based on volatility. Now, volatility doesn’t necessarily correlate to your drawdown. And so you can have a low volatility but a high drawdown means from peak to trough if I’m you know, I’m at $100. If I if I go down to $70, that’s a drawdown of $30. So I’ve lost $30. And my volatility might not have changed very much over that timeframe. So this goes back to the actually the idea of math in order math and philosophy is you can work out the math of your returned volatility and you can line up your portfolio to be very be efficient to have the best return to the volatility, but you could still have your drawdown could be massive. And so I don’t
Taylor Pearson:
Mortgage backed securities is the example right low volatility of mortgage backed securities in like early 2007 was like extremely low right? So that guy using Sharpe ratio and like the historical volatility is a measure of risk. It’s like oh, this is an extremely safe investment, which is what everyone was doing and I you know, that’s how the whole thing blew up.
Jason Buck:
And that’s why you know, everybody’s actually searching for you know, high Sharpe ratio, which means low Vol. And think that’s what you should be searching for. But almost to Taylor’s point you should be looking for the opposite. If somebody has low vol and a high Sharpe ratio, you should be looking for how do I lose all my money because that’s most likely what’s going to happen is because they have a barrier point risk, there’s an embedded risk that you’re not seeing, and you’re going to lose everything.
Jeff Malec:
And that’s why you know, everybody’s actually searching for you know, high Sharpe ratio, which means low Vol. And think that’s what you should be searching for. But almost to Taylor’s point you should be looking for the opposite. If somebody has low vol and a high Sharpe ratio, you should be looking for how do I lose all my money because that’s most likely what’s going to happen is because they have a barrier point risk, there’s an embedded risk that you’re not seeing, and you’re going to lose everything.
Jason Buck:
It makes me think like you were talking about earlier your proprietary metrics that you developed at RCM, which I always liked about them, is you risk weight based on per unit of risk, what’s your return per unit of risk? And you’re using like drawdown for per unit of risk? That’s very unique instead of using volatility.
Jeff Malec:
Yeah. And so it to me, it’s all like you’re saying the I need to see the investment through the biggest thing to write if it’s, if I, if I’m down 10% and then back up the next day, that’s volatile. But I’m fine, right? Like if I didn’t feel it, if I’m down for 23 months in a row, and sitting down negative 22%. That’s a big problem. You’re going to somewhere along the line, you’re going to be like this isn’t working, I’m going to get out and invariably you’ll get out right before it goes on to make new highs. So it’s, it’s two parts of driving one is the magnitude and the other is the duration which is part of our risk metrics as well. So right you can have something have super low drawdown but if the duration is three years like you’re never gonna stick with that?
Jason Buck:
Yeah, like that you always had that as like, yeah. If I’m in drawdown for three years, there’s no like, I’m not I’m not getting back to even so what does it matter? Like it doesn’t matter at all. And then the other thing we didn’t point out about Sharpe is that the volatility is standardized both up and down. And so what do we really care about upside volatility? No, we care about downside volatility. And Sharpe doesn’t take that into account. So you could have a manager that they have extreme volatility to the upside. So they’re making huge gains or small gains huge gains or small gains, but then their volatility on a sharper they’re gonna look terrible based on a Sharpe ratio, but it’s not accounting for that volatility is only to the upside and they’re mitigating the volatility to the downside.
Jeff Malec:
For sure, and that was the birth of the sortino ratio, which is returns over downside deviation, not just upside deviation. The proponents of the Sharpe would say hey, but large upside volatility portends large downside volatility just haven’t seen it yet. They’re saying there’s no free lunch. You can’t get that large upside volatility without risking low downside volatility, which I’d say is patently false. Right? You can set up asymmetric return profiles and say, No, I’m risking very little and waiting are in for the outlier move. And that’s how I get the high volatility. I’m not getting the high upside volatility by risking a lot. I’m getting it by structuring the trade in a proper way.
Jason Buck:
Would this be oversimplification? If you can think about Chicago versus New York is like future commodities versus stocks is CTAs commodities will take a lot of small losses and take large asymmetric gains, where New York and stocks will take a lot of small gains and large asymmetric losses. Is that too much more sympathy?
Jeff Malec:
No, that’s I love that. That’s perfect. I wanted to start a Twitter account. There’s like five years ago and when I can’t remember someone New York was talking smack about Chicago and like you are the second city. And so I just have a Twitter account that every day was like we have Bally’s, you have trash. Okay, that was as far as I came. I had to come up with 300 more stuff there. But yeah, and then, as as, right, we have futures, you have stuff.
Jason Buck:
Yeah. As we talked about a million times, and what always boggles my mind is like, so if you take those two dichotomies of like Chicago versus New York, commodities versus stocks, is if they have these two different return profiles. It’s like, why would you combine both of them, and if you combine both of them, they might offset each other and you might end up with with a better portfolio overall. And that’s what we’re always working towards is like, if you combine, you know, these short volatility and long volatility assets you up, you upgrade to a better holistic portfolio that you can hold for a lifetime.
Jeff Malec:
Yeah, and that was 2008. Right? The and people get confused, I think with diversification, oh, I wouldn’t have lost money. No, you had if you had managed futures, and you had a significant, not significant, maybe at 10% 50% allocator to manage futures, the your drawdown was less, because it was making money the long ball was making money as the short ball stocks was losing money, and your duration was much less. So it’s back to that concept of Okay, I’m adding this to make my worst period less painful and less long, which drastically, you know, non symmetrically increases your odds of sticking with the investment. And that’s the biggest thing to me. Like if you once you get out, you’re done. So it’s like, how can I structure things to make sure I don’t get out of equities? I’m saying like, and how many people you know, they say this is the most hated rally of all time, because people just got totally spooked and move to the sidelines and oh, nine and 10 when if you’d had something that kept you in the game, there you were, you’re gonna be way better off.
Jason Buck:
And just to keep reiterating what you said, because you’re one of the people I hear speak about it the most. And it’s such a rare thing about the duration of the draw down. You would love to harp on that. And I appreciate how much you harp on that because, for example, in equities, you can go an entire decade without getting back to even.
Jeff Malec:
Yeah or let’s look at the Nikkei in Japan they went I think 30 years until there was a new high. So yeah, that’s that’s the whole game. That’s the painful part of it. Can I make it to new highs? Yeah, it’s all I gotta say about that.
Taylor Pearson:
Jason was telling me earlier that gold once took your mother out to a nice seafood dinner and never called her again. I want to see is that is that correct?
Jeff Malec:
Leave my mother out of it. But um
Taylor Pearson:
How do you, how do you feel about gold? What? Tell us about your thoughts on gold as an asset.
Jeff Malec:
was golfing once at a band and dunes the lovely Oregon resort. This was back at gold it made some moves higher in the caddy at it. He’s like, what do you do? And I was like, I’m kind of hedge funds, commodities things. He’s like, what do you think about gold? He’s like my mom on some bars as like the total magazine indicator. I’m like, Alright, a cat is telling me his mom. Gold’s gold bars. I think I’m going to sell tomorrow. But I told him I’d say, you know, I’m in Warren Buffett’s camp, which is rare. But and this one thing like he says, if aliens were watching, and we dig up gold out of the ground, we try and buy and sell to someone else. And then whoever buys it, sticks it back in the ground with a guard. Like they think we are insane, right? Like what are we doing? So just and it has limited, economical use, right, maybe on some stereo equipment or why not? jewelry? Okay. But so to me, I just don’t see the economic purpose of it, which you could argue same with Bitcoin or anything like it’s just valuable because people think it’s valuable. But more importantly for me is you have right we have an infographic we’ll put it in the show notes of five different crisis periods, which was like long term capital management meltdown, surprised fed rate hike in 91 911. The Internet bubble burst financial crisis. Oh 809. So five big market moving crisis periods in stocks. Gold averaged a gain of less than 1% across those five crisis periods. So, right it’s it’s not doing it for me as a diversifier in a crisis period there, then people will say, No, well, you need it as an inflation hedge. And I looked up some stats here from 1980 to 2000. It lost 80% on inflation adjusted basis. So, since then, it’s done pretty well, since 2000, whatever, but I don’t know. I just don’t understand the I understand why people like it. I just personally don’t like it as either a diversifier or an inflation hedge.
Jason Buck:
Well, that’s Artemis would argue that even since like 2000, like you pointed out, it’s actually gold has done better on a purchase power parity than even the stock market since 2000. Yeah, it’s like, and to your point to back up what you’re saying is like, we think about purchase power parity, but people go with the 5000 year history is like over are large spans of time you get that purchase power parity but is it is it really going to keep up with inflation when you needed to or is it going to be during a risk off event? Is it going to provide you with those returns? It’s hard to really know then you’re so I you know, it depends but also like, as you know, like it this is a hotly debated issue. And after like 20 years of studying gold I still uncertain. I just, I just don’t know, like you say, Is it is it a barbarous relic? Or is it currency?
Jeff Malec:
Well, that’s Artemis would argue that even since like 2000, like you pointed out, it’s actually gold has done better on a purchase power parity than even the stock market since 2000. Yeah, it’s like, and to your point to back up what you’re saying is like, we think about purchase power parity, but people go with the 5000 year history is like over are large spans of time you get that purchase power parity but is it is it really going to keep up with inflation when you needed to or is it going to be during a risk off event? Is it going to provide you with those returns? It’s hard to really know then you’re so I you know, it depends but also like, as you know, like it this is a hotly debated issue. And after like 20 years of studying gold I still uncertain. I just, I just don’t know, like you say, Is it is it a barbarous relic? Or is it currency?
Jason Buck:
And that’s why I think what’s great about portfolio construction is we can debate The fundamental merits of gold all day, but who really cares if it helps our portfolio? Just put it in there and we trade it.
Jeff Malec:
Yeah. And back to my other thing, right? If the if the math works out, which from a non correlated standpoint, it pretty much does. And the fundamental reasons workout sort of, right. Yeah, in both those things, I can put it in a portfolio because it checks both those boxes, even if I don’t wholly believe that it’s, it’s the end all and i’m, i’m curious whether, you know, Taylor could speak better to this but if Bitcoin kind of surpasses gold as the which they would love and that’s part of their theory right of the holders, but that it would surpass gold as the de facto like, this is what you want to own in case global currency, government controlled currencies. Go bananas.
Taylor Pearson:
It’s my working thesis is it’s a it’s a bad inflation hedge, but probably a good hyperinflation hedge right like in China. Know why Mr. Chairman, he picks some snare, you know, one and 100 scenario, when the hundred year scenario of hyperinflation, an echo no gold or either necessary or both right, which is, the stock to flow ratio is low, you can’t, you know, you can only dig up so much more graph gold out of the ground every year, she can only make circuits like 1.7% more a year over the last 100 years. So you can only you can only inflate it, you know, call it 2% a year.
Jeff Malec:
But there’s that tweet that circles around like every six months of that asteroid that has all the gold and if we could just capture it, and I was on my strew I’m like, then gold prices will go to zero. Like if there’s 50 times the amount of gold ever put on the earth is now we just grabbed it off this asteroid.
Jason Buck:
But to your point, though, if you have trend following you would ride that down to zero and you’d make money shorting gold. Yes, right. Yeah. And so that’s that’s kind of the the point that we’re all that I’ve always I’ve always felt an affinity for trend following CTAs is a comment from the perspective of like, your fundamental narrative arguments. Don’t matter. Yeah, I’m going to be invested in 60 markets both long and short. And I’m just going to follow my probabilistic trend strategy. And I don’t have a view on markets, my view is only going to hurt me. So like, for example, let’s take fixed income as you know, bonds are going zero to negative two year in Europe. Everybody that has a fundamental perspective is screaming their heads off like this is irrational. They’re there. They’re killing the economy. Like they have all these reasons why this cannot happen. negative interest rates. Meanwhile, the CTA trend followers are just riding the trend.
Jeff Malec:
Yeah, and they actually did that was their best market last year. Right. And they actually bought German bonds, boons, right. And you buy bonds and bonds, prices go up rates go down. So they’re actually buying bonds, whereas they’re negative. So they were implicitly betting on rates going more negative, which you’re at any other economists like, are you crazy, like this is unsustainable, and they don’t Yeah, it’s pure. Math, they could, they don’t care one way or the other what the narrative is, it’s just this is, and that’s the all time example of like, why you’re going to buy high and sell higher, or this is you’re buying negative yields and selling more negative yields, which is insane to anyone who studies that kind of stuff.
Jason Buck:
And that’s why their discipline is impressive, because, you know, personally, they might have a personal opinion that this is insane. But their their formulas and their math are telling them that you need to be in this trade, and they just get in the trade and they don’t let their personal opinion override direction.
Jeff Malec:
I think back to something you said, whatever, 20 minutes ago, like why can’t people wrap their heads around all this man’s future? CTAs and stuff is because of that the narrative is hard to explain. You know, if you’re just saying, I know you heard 23 hours of junk on TV about why negative rates are bad or whatever. And I just say, well, we just bought it because that’s what the model didn’t. Like it doesn’t sit well with a lot of investors. They need a narrative built around the trade. And by definition, you know, most managed futures CTA Don’t have a narrative. Like they can try and make one up, which is what other people are doing. But it’s just it’s just making it up around what the math told them to do.
Taylor Pearson:
On that note, wrap it up or if people want to get in touch with you, what’s the best way to do that?
Jeff Malec:
You can follow us on Twitter at RCM maltz Check out our blog, our Sam oats.com slash blog. Maybe we’ll put it in the show notes. And then we’re launching our own podcast the derivative hosted by yours truly. So check out that as well on all your favorite podcast places. The most underrated blogger in finance Jeff Malik.
Jason Buck:
Yes, thank you.
Thanks for listening. If you’d like more information about Mutiny Fund, you can go to Mutinyfund.com or better yet dop us a message at Taylor@mutinyfund.com and Jason is Jason@mutinyfund.com and we’ll get back to you. You can find us on Twitter at Mutinyfund and I am @TaylorPearsonMe
