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Top Traders Round Table | Episode #18

“Markets are efficient most of the time. Every once in a while, human behavior

ultimately overwhelms the kind of rational deliberation that efficient markets are

based on, and we do see periods of fear and greed that ultimately take over. But

it's not one or the other, it's both."

~ Andrew Lo

The following eBook serves as a detailed transcript of Episode #18 of the Top Traders Round Table Podcast.

You can find show notes and more information on this episode right here: toptradersunplugged.com/rt18

I sincerely hope these interviews serve as a useful resource for you in your career and endeavors in the world

of trading. If you have indeed enjoyed these shows, please consider giving the podcast a rating and review

on iTunes. It would help spread this knowledge to traders everywhere.

As you read this transcript, remember to keep two things in mind: all the discussion that we’ll have about

investment performance is about the past, and PAST PERFORMANCE DOES NOT GUARANTEE OR EVEN INFER

ANYTHING ABOUT FUTURE PERFORMANCE. Also understand that there’s a significant risk of financial loss

with all investment strategies and you need to request and understand the specific risks, from the investment

manager, about their products before you make investment decisions.

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Top Traders Round Table | Episode #18

Niels: Welcome back to another edition of Top Traders Round Table, a podcast series on

managed futures. My name is Niels Kaastrup-Larsen and I’m delighted to welcome you to

today’s conversation with industry leaders and pioneers in managed futures brought to you by

CME Group.

Today I am very thrilled to be joined by Andrew Lo who is a professor at the MIT Sloan School

of Management and Director of MIT’s laboratory of financial engineering, as well as the

founder, and since 2018, the Chairman Emeritus at AlphaSimplex Group, and of course, the

most recent winner of the Managed Futures Pinnacle Awards. I’m also joined by another

veteran of this industry, namely Sol Waksman who is the founder and President of

Barclayhedge.

First of all, welcome, and thank you so much for taking time out of your busy schedule to join

to me to explore some of the things that go on behind the scenes in the managed futures

industry. Now, before we jump into today’s topics let’s start out by you sharing a little bit of a

short version of your background and how you got to where you are today. If I can kick off

with you, Andrew, tell us a little bit about your journey and how that’s lead you to combine

economic theory with practical applications within the investment management industry.

Andrew: Well, first of all, thanks very much for having me on the show. It’s a pleasure to be

here with you and with Sol. I got my start, really, through academia. I got my Ph.D. in

Economics and right from the very start I got really interested in financial economics: applying

mathematical concepts to making market predictions and trying to understand the risks

underlying the various different aspects of the financial system.

At some time, in the 1990’s, I began doing a bit of consulting and really started applying my

ideas to actual practical settings. In 1999 I thought, “Well gee, it really makes sense to take

some of these ideas and apply them in a much more direct way by starting up my own

company.” So, I founded the company AlphaSimplex Group with some of my former Ph.D.

students and consulting colleagues and have been applying these ideas ever since. So, that’s

really the background for how I got involved in this industry.

Niels: Yeah, that’s great. How about you, Sol? I’m curious what lead you to start your business

back in 1985 and what’s kept you going for all these years.

Sol: Well, first of all, Niels, thank you very much. Andrew, I am honored to be on a panel with

you. I’ve been a great admirer of your work for a long, long time.

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Top Traders Round Table | Episode #18

Andrew: Thank you!

Sol: The way that I started is that I used to trade my own futures account back in 1979. When

gold, sugar, copper and everything else was going to the moon, I started trading. My results

were very mixed, and then, at one point, I guess it was about the end of 1984, I was going

through those inevitable losing streaks, and I had a fundamental question. That question was,

“Does anyone make money trading the futures markets, or is it all a casino set up for the

benefits of the exchanges?" In other words, was it a sucker’s game? My self-image did not

allow for me to consider myself a sucker.

So, I stopped trading, and I looked into it. I researched it a little bit. That’s when I first learned

about CTAs and disclosure documents and how you could see, by reading a disclosure

document, exactly how much money a CTA had made or lost. That’s when I decided to get into

the business.

Initially we were set up as a pool operator and then after I made a few mistakes on picking the

wrong managers for all of the wrong reasons, decided to get more on the database side, and

I’ve been there ever since we first started. How we continued to survive is really simple, I just

never gave up.

Niels: Yeah, absolutely. That’s a great story. Thanks for sharing that.

Now, our conversation today will focus on a number of different topics within the managed

futures industry, and, perhaps, a few that will fall a little bit outside of this. So, to kick things

off in a slightly different way, I want to come to you, Andrew, first, and ask what you think of

when I say Rabbi Mahony, Rabbi Mahony, Rabbi Mahony, and I hope you know what I’m

referring to so that our listeners don’t think that I’ve completely lost it at this stage.

Andrew: Well, thank you for bringing that up. That comes from one of my stories that I’ve

written about in my book, Adaptive Markets. It’s an idea about thinking about financial

markets more like a biological ecosystem rather than a physical system.

As you may know, most economists suffer from this disease that I call physics envy. We wish

that we had three laws that explained ninety-nine percent of all behavior, the way the

physicists do. In fact, we have ninety-nine laws that explain only three percent.

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Top Traders Round Table | Episode #18

So, the idea behind adaptive markets is that we really have to think about these financial

market dynamics as coming from human interactions, and trying to model those human

interactions is really critical. So, the Rabbi Mahony story really has to do with the fact that I

heard many years ago about a technique for getting parking in Harvard Square.

It’s a terrible, terrible challenge to drive a car into Harvard Square because there is never any

parking. So, for years I just decided not to do it. But, a friend of mine said that, if you used this

following algorithm: before you go to Harvard Square you utter the incantation, Rabbi

Mahony, Rabbi Mahony, Rabbi Mahony, at that point you should be able to go to Harvard

Square and get parking.

The amazing thing is this algorithm actually works. But, the more interesting reason is why it

works. It works because it changes the way we behave. It changes our expectation for getting

a space. Because now, once you utter the incantation, you must, somehow, in a part of your

brain, believe that you might be able to get a space and that changes the way you drive. It

changes how you look for parking, and, magically you actually increase the chances of getting

a space. So, it really says that human behavior can actually change our reality.

Sometimes things need to be believed in to be seen.

Niels: Yeah, absolutely. Just out of curiosity, do you think that belief always precedes action

and plausibility?

Andrew: I think it is something that happens simultaneously, in many cases. Our beliefs have

an impact on our behavior, but our behavior has an impact on reality, and that reality shapes

our beliefs. So, it’s kind of a feedback loop that is happening and updating all the time. Unless

we’re aware of that, it’s very easy for us to get mislead by various kinds of market events and

ultimately end up down a rabbit hole of behavioral biases that ultimately end up hurting us in

our investment strategies.

Niels: Yeah, well I look forward to finding out whether this little chant also works finding a

parking place here in Switzerland.

Andrew: You should try it.

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Top Traders Round Table | Episode #18

Niels: Yeah, exactly. I want to talk about the narrative of finance and investing because,

clearly, since the financial crisis, finance as an industry has received a very bad reputation in

most people’s minds. Often it’s criticized. I’m not suggesting that it’s not deserved, some of it,

but the industry that we all represent is also a place where a lot of good innovation takes

place.

So, I want to start by talking a little bit more about each of you and your experience through

your careers, and the narrative about finance and investing. Maybe I can come to you, Sol, a

little bit. You’ve been reporting on the managed futures industry and the hedge fund industry

for decades. How has your narrative changed over these years? Perhaps I can broaden the

question out and ask how you’ve seen other financial media change their reporting on the

alternative investment industry?

Sol: Well, I would say, in my mind, the biggest change has been the increase in understanding

on how to separate alpha from beta in an alternative universe. I don’t mean an alternative

universe like you would read about in Superman comic books but in the futures area and the

hedge fund area.

Early on, what everyone used to regress performance against was the stock index. I don’t

know the reason why that is. Maybe they looked at the S&P 500 as an alternative investment,

or what have you, but a stock index, as we know, has no relevance to the performance of a

CTA, maybe a little relevance, a little more relevance on the hedge fund side.

If you calculate alpha by regressing against the stock index, you have a number that is

absolutely meaningless. Over time, and we’re seeing it more and more now in terms of smart

beta strategies, investors and students of the market have come up with, I think, much better

ways to approximate the underlying (for want of a better term) alternative betas that are used

by managers within their trading methodologies to earn return. The obvious fallout from this

is that the amount of return that’s attributed to alpha has decreased over the years and you

have more and more people, I believe, competing on the beta side, which makes the

environment a whole lot more competitive.

I would say that that’s probably the biggest change that I’ve seen over time. That’s what I see.

Niels: Sure, sure. I would love to hear your thoughts on this, Andrew, as well.

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Andrew: Well, you know, I couldn’t agree more with Sol that the idea of separating alpha

from beta has been really revolutionary. In fact, I would go so far as to say that that has had a

major impact in the entire financial industry, not just in managed futures.

Part of that is really the democratization of finance that was really begun by academics like

Harry Markowitz and Bill Sharpe and others showing that you can create these relatively

passive investment vehicles that actually earn reasonable rates of return for investors. That

began in the 1950s and 1960s, and we’re still seeing that kind of a trend towards this type of

passive management going on.

What I see, though, is a little bit of a slightly different perspective than Sol. That is certainly a

phenomenon that he and I both observed, but my interpretation of it really comes from this

notion of adaptive markets. In other words, I see these markets as various different species

interacting with each other, and the species that Sol is referring to is this notion of passive

investment vehicles. The creation of ETFs and futures and various different passive investment

portfolios, that’s actually changed the dynamics in relation to other species like active

managers.

So, the whole process by which these markets have evolved is really fascinating, and it really

has changed the way that we interact with each other. Managers that don’t really understand

this kind of interaction are really at risk of becoming extinct. So, it’s become a much more

complex and competitive environment than ever before.

Niels: Yeah, yeah.

Staying with you, Andrew, just a little bit longer. I’ve heard you talk about the importance of

language and the environment when it comes to creating new behaviors. I think we can all

agree that the environment, in the financial markets, has changed dramatically in the past few

years. Here, particularly thinking of the level of volatility we’ve seen in markets, and perhaps,

first and foremost, the lack of volatility in the U.S. stock markets, at least until quite recently,

so share with us why is it so important, and what are the risks that you see from a change in

market environment like that?

Andrew: Well, in fact, you bring up a very important point. The volatility of financial markets

has become much less predictable than before. So, you’re right that volatility is quite low

relative to historic levels. But I would argue that the volatility of volatility is actually quite high.

That really suggests that we need to look at another dimension of risk, and that is something

that very few of us are prepared to do.

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Top Traders Round Table | Episode #18

Part of the reason why volatility of volatility is high is because we now see geopolitical events

playing a much more important role in financial markets, really ever since the financial crisis.

Prior to the crisis, it was rare that you got major central banks involved in the kinds of

interventions that we see today. But, since the financial crisis, it has actually become expected

for central banks and governments to start intervening in financial markets directly.

So, you now have very large players that feel no hesitation to engage in the kinds of activities

that have a direct impact on market dynamics and, therefore, volatility can be actually

affected to a great degree. It’s just over the last few months, in terms of current events, when

there are concerns about trade wars or threats with various different geopolitical entities

because of disagreements and concerns regarding policy. All of those issues, now, factor into

markets in a much more direct way than over the previous ten years

Niels: I completely agree with both of you about this alpha, beta, and so on and so forth. But

in terms of bigger themes, I’m just curious. Have any of you started seeing what the next big

narrative could be going forward so to speak? Are there any new things on the horizon that

might become the next big talking point?

Sol: I don’t have an answer to that question.

Niels: Sure, sure.

Sol: But, Andrew, if I may, I have a question for you on what you had just said with regards to

the increase in the volatility of volatility based on geopolitical events. Do you feel that this is...

and you were talking about the last few months, but I remember going back for the last

several years, while the U.S. still had a policy of keeping interest rates low, we saw that

managed futures did not do well. A lot of what I would hear was that, although you have all

these markets that are different from one another, the correlations came together because, in

effect, there were just two trades: risk on, risk off. And in that context things would get very

volatile. Do you see that in the same way as what we are seeing now, or do you think that was

something different?.

Andrew: Well, you know someone once said that history may not repeat itself, but it sure

does rhyme. I actually think that there’s a lot of rhyming going on right now. In other words, I

do think that we live in a unique economic environment and so there are things going on

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today that really didn’t exist ten or fifteen years ago. But, the mechanisms by which those

various different, unique challenges have emerged, they have very much the same impact on

financial markets.

So, one example is this notion of a trade war. We’ve actually enjoyed a rather long period,

prior to the most recent time, where we’ve engaged in open trade with various partners

around the world. One of the reasons that mega economies like China and India have

emerged as real forces in the twentieth and now the twenty-first century is because of

international trade. So, this idea of a trade war, that’s actually pretty new. Obviously, there

have been trade wars many, many times in the history of the world.

But the difference is today, because of the nature of the way we interact with various

different economies. The fact that we’re engaged in trade at the speed of light, if you will,

because of the internet and all the kinds of connectivity we enjoy across these various trading

regions. The threat of a trade war, the mere threat of a trade war is enough to actually cause

businesses to pull back and to change the way that they invest in their infrastructure.

So, we now have technology enabling all of these various businesses to react much more

quickly. I think that’s what we need to worry about. That’s the new kind of perspective on how

these old themes are emerging

Niels: Yeah, you both talk about, I think it was you, Sol who brought it up about the low-

interest rate environment and how that has certainly created some challenges for many

investment styles including managed futures in the broader scheme of things. I was just

wondering, from your point of view, Sol, what have you seen, or have you noticed anything:

style drift, or anything else that is going on among managers to compensate for the lack of

opportunities that we’ve seen in some of these strategies partly because of low volatility, but

also partly, maybe, because of low interest rates?

Sol: The one thing that I’ve seen that, at the time, looked the most optimistic was the

willingness of firms, primarily the larger firms that were able to do research, was the

willingness to get into more exotic futures markets where there were regulatory issues,

financial issues, liquidity issues. What they were finding was that because these markets were

thinly traded and they weren’t widely participated in by their competitors, that these markets

still reacted to more or less traditional trend following methodologies. I assume that, over

time, these advantages would be arbitraged away. I haven’t been following it that closely to

really know any longer. But, that was one of the things that I saw.

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I think that when you look at different approaches to trading if a market is going up everybody

is long. When that market turns, as it certainly does, people are going to get hurt. I think that’s

a lot of what we’ve been seeing, as well, that’s been taking away from performance.

Niels: Yeah, sure.

Andrew: You know, there’s one aspect, that Sol mentioned, that is worth observing about

today’s markets which is that the rise of passive investing and all of the various different index

products. What that means is that when markets go down, we now have a much larger shared

experience of loss because now more and more people aren’t invested in the same thing.

So, that’s sort of the downside of the move towards passive investments. It has brought some

great benefits to many people and allowed us to invest in a much broader way across these

larger asset classes. But, at the same time, when there is a market downturn, it means that

we’re going to be crowding for the exits all at the same time now.

Niels: What about demographics, Andrew? The markets have gone up, there’s been massive

inflows in these passive products, not least because there has been a lot of people just putting

money in, but as baby boomers start to retire in bigger force, the next four or five years, I

think there are other issues with having so much money in passive investing or in mutual

funds that I can see as a concern. But just the demographic, is that something that you’ve

spent any time on?

Andrew: I’ve certainly looked at that and I’m quite concerned about it. You and Sol both

talked about the low-interest rate environment that we’ve been in. Well, think about what

that means in a situation where you’ve got the baby boomer generation that retired and is

really thinking about their fixed-income assets supporting their retirement years.

In a low-interest rate environment it becomes much harder for that to happen and it creates

all sorts of pressures on the economy and on the consumers that are trying to deal with these

issues. So, demographics play a huge role. Compared to the United States, China and India

have a very different workforce that is in the process of emerging into the middle class so that

the rise of the middle class in China and India have also had a huge impact on labor markets

and on the international competition.

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Niels: Yeah, well, certainly these points we talked about in low-interest rates and low

volatility, they certainly must have had an impact on some of the economic theories that

you’ve spent a good part of your life studying and teaching, namely the efficient market and

the adaptive market hypothesis.

Perhaps you need to take us back, a little bit, to your school days and explain the basics and

the differences behind these very important financial frameworks. I want to jump to a

question that I also think a lot about as I meet with institutional investors around the world,

and it’s just the question of what do investors really want? So, if you can combine some of

your thoughts on these two topics.

Andrew: Sure, I’d be happy to. There’s a really interesting dynamic between academic

theories and market practice. For a very long time, financial market practitioners have been,

obviously, managing investor money and have done quite well in many cases. But there has

always been this skepticism on the part of academics that the kinds of fees that are being

charged by professional money managers really may not justify the performance that they are

providing to their investors.

So, in the 1950s and 1960s, a number of academics started looking at this. Eugene Fama,

University of Chicago professor and Nobel Prize winner was one of the earliest to really take a

hard look at the data to try to understand what it is that professional money managers are

providing to their clients. A combination of Fama and some of his students and colleagues as

well as Paul Samuelson, at MIT, formulated this notion that markets are pretty efficient in the

sense that it’s hard to make money and information that is out there and relevant for financial

markets gets incorporated into prices very, very quickly. In which case, there’s not a lot of

value added by professional money managers because, if the value could be easily gotten it

would have already been incorporated into market prices.

So, this notion that prices fully reflect all available information, this notion of markets being

efficient, that really came out of the academic literature and Fama was awarded the Nobel

Prize for it and justly so. It’s a really important idea. For quite a few decades it actually was the

way of thinking among academics, and, eventually, a number of market practitioners realized

the wisdom of that approach and then adopted it and created the whole passive investment

vehicles that we now see as a multi-trillion dollar industry.

The work that I’ve been doing, recently, is to try to understand how efficient markets relate to

all of the behavioral anomalies that the psychologists and experimental economists have

come up with. They argue, of course, that markets are driven not by logical deliberation, but

by fear and greed - the kind of animal spirits that John Maynard Keynes wrote about decades

ago.

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So, if you believe that markets are driven by these kinds of irrational behaviors, then all of

these kinds of efficient market arguments go out the window. What I’ve been trying to do is to

demonstrate that there is actually an important middle ground. Markets are efficient most of

the time. Every once in a while human behavior ultimately overwhelms the kinds of rational

deliberation that efficient markets are based on, and we do see periods of fear and greed that

ultimately take over. But, it’s not one or the other, it’s really both. We have both phenomena

going on at the same time.

So, the question we should be asking is not so much, are markets efficient or are they not? But

rather [we should be asking] what is the degree of efficiency at a point in time, and what are

the different species in the market place that are working against each other to try and rule

the roost? At which point do we see market efficiency overtaking the forces of fear and greed,

or the forces or fear and greed overwhelming the kinds of efficient deliberations that give us

rational market prices?.

Niels: Now, I was just saying beforehand that one of the questions that I’m trying to come to

terms with on my journey meeting these investors, is what do they really want? I’m going to

come back to you, Andrew on this, because I know you have an interesting thing that you do

when you talk to people. But, I want to go to you first, Sol.

Since you track all these investment strategies, so you probably have somewhat of a good

bird’s eye view of the various strategies that appeal to investors and how this shifts over time.

Perhaps you have some kind of an opinion about why we see these shifts and maybe where

are investors looking at the moment in terms of alternative strategies when they don’t put all

their money into the passive products we just talked about?

Sol: Well, at the risk of everyone finding out how unsophisticated a thinker I really am, I think

that, for the most part, investors misrepresent what they want. That, in spite of all of the

verbiage that talks about the importance of diversification within a portfolio, about all of the

discussions back and forth between managers and large investors how the majority of large

investors do not believe in trend following, that there’s no real strong academic case to be

made for that type of approach.

I think investors, as a rule, based on their nature, are trend following. By that, I mean that

what they are looking at, or what they favor once they look at everything are the strategies

that have been profitable most recently and that the idea that non-correlation or

diversification helps. It helps when they make more money, and when it doesn’t I think you

start seeing a lack of interest in that particular category.

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Niels: Yeah, sure.

Andrew, you do, as far as I’m aware, a little experiment, a kind of a survey among the

audiences you speak to where you ask them to choose between four different investments.

Can you, and I know it’s maybe hard to do on an audio only, but can you explain this

experiment and what your findings are and how this fits into the theories and the practical

implementation that we see from investors?

Andrew: Sure, yeah, that’s a fun experiment because it really shows exactly what it is that

investors are looking for and it actually goes to Sol’s point about trend following and why

there is a very strong human element to that particular kind of investment approach.

So, the chart that I show my introductory MBA class every year is a chart that shows the

growth of a dollar invested in four different financial assets. I don’t tell them what the assets

are or even over what time period they span, I just show them this graph of these four curves

that have very different properties.

One of them is a line that is almost flat. It really just is very, very smooth, but it doesn’t go up

very much, so you’re not earning a very good return on that one dollar investment. The

second line is way more volatile. It’s got lots of ups and downs, but at the end of the graph, it

goes much higher than the first line. The third line is even more volatile, lots more ups and

downs, but it’s even more rewarding. The fourth line, curiously, lies somewhere in between

but it’s much, much smoother. It’s pretty much almost a straight line up. It’s more steeply

sloped than the first line, but its endpoint is somewhere in between the other investments.

When I ask my students to pick which investment they would choose for their retirement

money or their kid's college education fund, or their grandparent's savings, without exception

the vast majority of them will pick that fourth line, that straight line up. In a way, that’s a kind

of a trend. It’s a trend following type of a strategy.

Now, I then reveal to them what these four different investments are just so they understand

what their risk preferences look like. The first line is U.S. Treasury bills. They don’t have a

particular reward that is very exciting, but they’re certainly very safe. So, most of the students

don’t pick that. The second line is the S&P 500 which is way more rewarding but also is way

more risky. A few students pick that, but most don’t choose that either. The third line is a

single investment in the pharmaceutical company Pfizer, way, way more volatile, but more

rewarding. Again, a few more hands that go up, but, as I said, the majority picked that fourth

line which turns out to be the returns for an investment in Bernie Madoff ponzi scheme.

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They all feel very embarrassed and disappointed that they picked that one. I tell them that the

reason that ponzi scheme grew so large is because of human behavior. It’s because all of us

are seeking that high return, low volatility or high sharp ratio, as we call it in the industry, that

high sharp ratio investment. It’s human nature.

So, part of the role of trend following is to capture that element of human nature. That human

nature is also supported by a lot of institutional restrictions that, essentially, create trends. For

example, when the Fed tries to manage a smooth landing by changing interest rates so as to

allow the economy to grow in a way that doesn’t cause massive inflation, or allows the

economy to cool down in a way that doesn’t cause a recession, the actions of the Fed to

create these smooth landings are actually creating trends in various different market prices.

So, once we understand that this kind of nature of investing automatically generates these

types of patterns, it actually makes sense for investors to take advantage of them in some

way.

Niels: Yeah, that’s a great way of visualizing these things. To me, when I hear that, one thing

that springs to mind. I wanted your thoughts on that. We all crave this sort of trending

behavior, but also crave this smooth trend to participate in. But, of course, trend following (as

a strategy) is probably the least smooth investment strategy that you can find among the

bigger ones, at least most of the time. How do we relate these to things?

How can we better explain to people that volatility and risk are not really the same thing?

Some people would certainly argue that the more volatile strategies can often turn out to be

the more robust strategies because we’re not trying to, as the Fed is doing, we’re not trying to

make this smooth curve and then suddenly end up with a huge problem later on in life.

Andrew: I think Sol can speak to this even better than I can, having been in the trenches, but

let me start by pointing out that trend following offers a unique set of exposures to investors.

That is very difficult to get anywhere else. Those exposures really show that they are

uncorrelated, and, in some cases, negatively correlated with traditional equity investments.

That’s a very important point because the one lesson that we learn from academics

throughout the whole process of passive investing is that diversification is really key.

Diversification means that you want to hold investments that are not highly related to other

investments. You want to be able to spread your risk across lots of different holdings. We

know that nowadays the factors that are generating returns are becoming fewer and farther

between. In other words, we see that there is a big equity factor, even in foreign currency

markets, which traditionally had very little to do with equities.

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Now there’s very strong coupling between foreign exchange and stock markets. So, trend

following and managed futures, for many, many decades have provided investors with an

alternative source of expected return. But, there’s a big but to that and that is they also offer

some very important risks that investors may not be equipped to address. So, that’s one of the

reasons why managed futures, for many years, was really a niche investment that institutional

investors were focused on; sophisticated investors: family offices, high net worth individuals,

people that understood that they were getting something very different.

This notion of crisis alpha that my former student and portfolio manager in her own right, Katy

Kaminski has written about, I think that really highlights the unique aspects that managed

futures brings to investors. What has happened in the last ten years, though, is the

"retailization" of managed futures. That’s a very important trend.

It allows individual investors to be able to get access to this, but, at the same time, it’s also

brought with it the kinds of risks that managed futures have and that not all retail investors

are equipped to deal with. This means that, when you’re using managed futures in a retail

environment, you need to be much more focused on risk management. You have to approach

risk management in a way that you might not have had you been focusing just on institutional

investors.

Niels: Yeah, I definitely want to hear your view as well, Sol. There are a lot of people out there

saying that, yeah, we know that diversification is meant to be the right thing, and it works in

theory but maybe not so much in practice. Maybe 2018 was one example where we could say

that diversification is working eventually because there are big parts of the year where maybe

it didn’t work. But, do we need to remind investors that the point of diversification is not

about converting a negative return into a positive return but rather it’s about reducing the

variability of the risk associated with returns in general. Therefore investors might confuse risk

with familiarity, meaning that if they’re not that familiar with managed futures, they

automatically think it’s more risky.

Andrew: Without a doubt, that’s a great point. I think that’s one of the reasons why managed

futures association and the podcast that you’re creating is so important. It really allows

investors to develop a deeper understanding of this relatively unknown and complex

investment style.

I say relative unknown because, of course, over the last ten years we’ve had a lot more money

coming into this space. So, it’s no longer the niche investment that it used to be. You’re right,

that investor education plays a really important role.

15

Top Traders Round Table | Episode #18

One of my former colleagues at AlphaSimplex Group, Pete Martin, a great marketing

professional, he once said that if you’re earning positive returns in all of your investments, you

are not diversified. Most investors would love to be able to earn money in all of their

investments at the same time, but the whole point of diversification is that what you’re

looking for is a good average return across your investments over an extended period of time.

That means that, at any one point in time, you’re going to have certain underperforming

investments. That’s just the nature of diversification.

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