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Questa l’estrema sintesi della puntata di oggi con ospite Nicolas Mirjolet, CEO & Co-Head of Research at Quantica Capital, uno tra i maggiori esperti della strategia Portable Alpha.
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TL;DR
Punti fondamentali della puntata:
- Il costo opportunità della diversificazione tradizionale: Negli ultimi decenni l’azionario ha generato rendimenti eccezionali (es. l’S&P 500 ha registrato un +15% annualizzato). Nel modello tradizionale, per diversificare è necessario vendere una parte di queste azioni ad alto rendimento per comprare asset più sicuri, abbassando inevitabilmente i ritorni assoluti del portafoglio.
- La soluzione dell’Alpha Portabile (Stacking): Invece di sottrarre capitale all’azionario, l’approccio di Quantica Capital consiste nel sovrapporre (stacking) un diversificatore mantenendo intatta l’esposizione azionaria al 100%. Questo è reso possibile dall’uso di strumenti efficienti in termini di capitale, come i contratti futures, che richiedono solo una frazione del capitale come margine.
- Il ruolo cruciale della correlazione: La quantità di diversificatore che si può aggiungere senza aumentare il rischio complessivo del portafoglio dipende dalla sua correlazione con le azioni. Più un asset è decorrelato negativamente dall’azionario, maggiore è la quantità che può essere sovrapposta senza incrementare il rischio.
- Il Trend Following come diversificatore ideale: Le strategie sistematiche che seguono i trend si prestano perfettamente a questo scopo perché offrono storicamente un premio al rischio positivo (circa il 6% annuo) e, soprattutto, tendono a diventare più correlate negativamente alle azioni proprio durante i crolli di mercato.
- L’impatto degli shock di mercato: Eventi improvvisi o crisi geopolitical rovesciano le narrazioni macroeconomiche prevalenti, causando perdite fisiologiche a breve termine per i trend follower. Tuttavia, questi shock sono essenziali perché creano i presupposti per nuovi trend duraturi (es. il ciclo di rialzo dei tassi durato 18 mesi), offrendo enormi opportunità di profitto nel lungo periodo.
- L’adattabilità strategica: Il trend following è agnostico rispetto allo scenario economico (inflazione, recessione, stagflazione). Quando le opportunità di trend si esauriscono in una classe di investimento (come è successo per le obbligazioni dopo decenni di tassi in calo), storicamente si aprono in un’altra (come le materie prime negli ultimi anni).
Lezioni principali da trarne:
- Diversificare non deve significare sacrificare il rendimento: Utilizzando strumenti a leva in modo intelligente e controllato, è possibile costruire una “enhanced equity”, ovvero un’esposizione azionaria arricchita che genera rendimenti extra senza accrescere il livello di rischio originario.
- La correlazione ha un valore misurabile: Un errore comune è valutare gli strumenti finanziari solo in base al loro rendimento o alla volatilità isolata. Una strategia con parametri stand-alone apparentemente inferiori può rivelarsi estremamente preziosa se valutata per l’effetto stabilizzante e decorrelante che porta all’interno del portafoglio.
- Le crisi generano i nuovi equilibri: Non bisogna temere le turbolenze o i cambi di paradigma dei mercati. Ciò che disorienta i portafogli statici è spesso il carburante per le strategie dinamiche: ogni grave shock del mercato segna l’inizio di un nuovo equilibrio macroeconomico da cui è possibile estrarre valore.
Trascrizione
00:00:02,750 [Vittorio]
In questa puntata speciale, Nicola commenta l’ultimo paper di Quantica Capital insieme a chi l’ha scritto. Nicolas Murcholé, co-head of research della stessa Quantica. Il paper si intitola If you can’t beat it, stack it. E se il titolo non ti dice già tutto, te lo dirà lui. L’intervista è stata registrata nello studio di Mister Dip. Grazie a Giorgio per il prestito. Ti abbiamo nascosto qualche regalino in giro, ma non ti diremo mai dove. Ultima cosa, l’intervista è in inglese. Se l’ho montata io, puoi ascoltarla anche tu, quindi non avere paura. Se invece l’inglese ti mette ancora un po’ d’ansia, puoi rimediare con lo sponsor della puntata. Preply, il migliore modo per fare lezioni uno a uno con un insegnante madrelingua.
00:00:42,220 [Nicola]
So Nicolas, welcome to Too Big to Fail. So you recently wrote a super interesting paper on a topic that we try to introduce many times on this podcast, which is portable alpha. But before going there, can you introduce yourself to our audience? How did you come to specialize in systematic trend following and what drew you to Quantica Capital?
00:01:05,970 [Nicolas]
Yeah, thanks for having me on the podcast, Nicolas. Pleasure to be here with you.
00:01:10,980 [Nicolas]
Um, yeah, I’ve been at Quants for a bit more than 20 years now. I uh came here to Zurich um like yeah, a bit more than 20 years ago. Um did some student projects that touched a bit on finance, was interested, uh managed to get an internship and ended up at a family office. There I discovered quant finance, systematic investing and got the opportunity to launch uh a hedge fund. That is Club Arbitrage Equity Long Short Hedge Fund.
00:01:39,530 [Nicolas]
um, that was an incredible adventure, incredible learning for me, uh starting really from scratch, um and going out trying to raise money, delivering the performance uh that we believed would be able to deliver. Basically going through the whole experience of building a hedge fund. I did that for eight years until basically the learning curve was starting to flatten and we hit some glass ceiling, if I may say. And there I got the opportunity to join a bigger group and that led me eventually to join Quantica Capital in 2020 shortly before the pandemic. And I have been in this role of leading the research at Quantica now for the past six years. Now it’s on at the other end of the spectrum.
00:02:17,610 [Nicolas]
I started on the short-term conversion type of strategies, betting on on on single stock mean reversion in a way. Now I’m on the other side of the spectrum where we are basically trying to capitalize uh on the divergence of macro asset classes, long-term divergences. So it’s actually quite an interesting um evolution over 20 years from short-term mean reversion to long-term divergence strategies. But all systematic, always systematic.
00:02:43,140 [Nicola]
Now we are here because you wrote a paper that is titled “If you can’t beat it, stack it.” So what was the light bulb moment that made you want to write it?
00:02:52,490 [Nicolas]
it’s a it’s a long story. I mean, basically we run Quantica Capital is an independent business. Our clients are institutional allocators from the US to Japan and they have specific allocation requirements. That whole possible alpha topic came up is something that came up the last two years maybe I would say, originating from the US and spreading a bit across the regions and the and the type of allocators. So that’s what triggered the initial work that we did in this space and realizing that like thinking first what was driving this interest.
00:03:29,890 [Nicolas]
and number one is for sure the very strong equity performance that we have seen over the past decades. Actually, I was surprised myself. I mean, everyone knows that equities have been doing really well, but if you look at US equities, they have been annualizing at an incredible, I think S&P is around 15% annualized over 10 years. 15% annualized over 10 years. So it has been a pretty good strategy. Like just buy and hold equities, it’s difficult to beat. Uh if you take if you take tech equities, it’s even even even better. So that’s a reality and uh just generally global equities, I think are up 12% per annum and even in Switzerland. So in that environment, it’s very costly actually.
00:04:07,940 [Nicolas]
if you want to build a more resilient portfolio, if you want to just hedge your portfolio or find potential hedges for a crisis that may come up, what do you do? I mean, usually in the traditional sense, you would sell part of the equity exposure to fund your diversifier. And that today means opportunity cost. If we continue to analyze at that level, I mean, no one knows, right, but there is an element of that that has been leading to the question, how can I still add diversification without reducing my equity exposure? And then if you try to formulate that problem more mathematically, it basically means, okay, I don’t touch my equity exposure.
00:04:46,160 [Nicolas]
So the only way to add diversification is actually to layer it on top. So you stack it. But if you stack it on top, uh usually you would that implies that you increase your risk. Now in our our view, that’s easy. That’s basically leverage, right? But in our view, uh the interesting problem is if you uh add the constraint that your risk should stay equal. And then it becomes very interesting. It’s like the question is, how much of a diversifier can I lay on top my equity exposure without changing my risk profile? I want to keep my standalone equity risk profile.
00:05:19,890 [Nicolas]
that was the starting point of this paper and the paper basically is trying to provide a framework and an answer to this problem by making a few simplifying assumptions to actually come up with a clean solution and a clean representation of what is actually a good diversifier for my equity portfolio that doesn’t come with opportunity cost. And that’s a pretty powerful concept in today’s market because again, equity markets do really well.
00:05:44,690 [Nicola]
Yeah, because I read, I don’t know who said it, but like, the issue with diversification is that it’s a process of addition by subtraction. And so Portable Alpha is trying to solve this. In the paper, you argue that the cost of diversification is less a property of the diversifier itself and more about how it’s funded. So can you unpack this distinction?
00:06:11,630 [Nicolas]
So, basically, um when you, so the cost of that of diversification obviously increases in a way with how much returns you get from holding, what’s the risk premium you earn from holding equities, right? And at the moment as we have seen, like US equities, you get 15% per annum. There is no diversifier in this world, liquid diversifier that will give you 15% per annum risk premium. Like the trend-following risk premium, what we do, trend-following historically has generated between 4% on average for the industry. We have produced around 6% per annum over the last 20 years.
00:06:47,330 [Nicolas]
That’s pretty good actually in terms when you consider as well with what type of correlation to equity market that comes with it, right? Trend following performs in any type of market environment historically. There’s a good track record for that. So every time try to fund your diversification by selling equity, again, if you combine fifteen percent annualized source of return with a six percent annualized source of return and you do ninety ten eighty twenty whatever, it’s going to lower your return. It’s going to increase your risk-adjusted return. So the unit of return you extract per unit of invested risk is going to increase, but your absolute return is going to get lower and that’s a cost.
00:07:23,230 [Nicolas]
that’s an opportunity cost that you would not get if equities were returning zero. Then you don’t need possible alpha to improve your return. The main point is that of portable alpha is that why can you keep the risk constant when you combine equity with your diversified simply because it’s a function of correlation primarily. Using diversified is how they correlate with your with the equity portion that you want to diversify. And the the main result of the paper is very simple is that the more and it’s intuitive, right? The more negatively correlated the diversifier is to your equity exposure, the more risk capacity you will free up.
00:08:01,860 [Nicolas]
So if you combine a very negatively correlated asset with equities, you can layer a lot of it on top of equities without increasing your risk because it is diversifying by definition. The issue is that the more negatively correlated an asset is to equities, the more costly it tends to be. And the best example is long volatility. You can always buy volatility to hedge your equity exposure, but if you just buy, for instance, a VIX future, and you just buy 100% notionally of that, we know that in less than a year you have lost 100% of your investment.
00:08:37,780 [Nicola]
so it’s costly in terms of expected return
00:08:42,070 [Nicolas]
expected return exactly. So the diversifier will basically allow you if it’s lowly correlated or negatively correlated with equities to add a portion of it on top of your equity exposure without increasing the risk. Now, the key, and that’s what we are trying to highlight when it comes to, okay, what is a good diversifier? It’s actually the trade-off between the risk premium that that diversifier gives you, and that should be positive ideally, and how ideally negatively correlated it is to equity. And that’s kind of in a way you would think it’s incompatible.
00:09:21,550 [Nicolas]
like you get free diversification and you get compensated for that in a way. But that’s that’s why trend following is so interesting.
00:09:27,830 [Nicola]
maybe before going to transform transforming because I think that in the paper and I really wish that everyone goes and read it because there is a really elegant formula that you created to explain the capacity of this overlay that you put on. Do you think that there are other common mistakes that investors make when they think about how much of a diversifier they can own? I mean, you already mentioned like the correlation is the key, but
00:09:59,030 [Nicolas]
The correlation is the key and what we show in the paper is that we are trying to we tried to came up with an analytical solution to the problem of what is the maximum weight I can lay on to my equity exposure of a diversifier. And that’s a function we show it’s a function of correlation. The relationship tells you that the more correlated diversifier is to equities, the less you can stack it on top of your equity exposure because you don’t just free up enough capacity. So just to
00:10:25,690 [Nicolas]
very simple example, assuming you you have US equity as your benchmark and you add European equity that still will be correlated, let’s say to 0.9. So you expect those two markets to be very closely connected together. So so if you add it, your risk is going to automatically increase. That’s leverage. So there is no, it’s not a good diversifier, of course. Then if you take treasuries for instance, so treasuries historically have been the natural portfolio diversifier, 60-40 portfolio. Why? Because treasuries tend to be negatively correlated in risk-off environments. So it’s a very easy and natural hedge to use. Over the past 10 years has been less good because of high inflation, high inflation.
00:11:03,660 [Nicolas]
We know that in high inflation environments, equities and bonds tend to correlate positively. If it correlates positively, that’s more akin to again more leverage, so dangerous. The danger of of these kind of overlay solutions is obviously that you create overexposure. That is that you layer on top an asset that will go down at the same time as when equities go down. Where trend following is different is that we know historically that trend following tends to become more negatively correlated to equities in crises. In times of crises, it’s one of the few strategies that has this this nice behavior.
00:11:42,400 [Nicolas]
meaning that when the crisis hits, so when equity markets correct, we know that the longer the crisis goes, the more diversifying trend following becomes. That means that however you size your trend following exposure based on the long term, and that’s what we do in the paper, basically we assume we make a very simplifying assumption that correlations are long term constant, which is wrong obviously, but it’s just for purpose of coming up with a simplified model. And you can see that with trend following, you tend to actually underestimate the capacity you can lay on top because that capacity tends to grow in times of crisis.
00:12:15,110 [Nicolas]
So that’s a nice thing to do because, like back to your question, what is something that you can go wrong is obviously adding an asset that’s gonna correct that goes down at the same time, simultaneously than when your equities go down. You want to absolutely avoid that. You you can’t eliminate that risk. I mean, it’s part of every uh portfolio construction, but the the whole point is to choose an instrument that complements your equity exposure in a structurally robust way over the long term.
00:12:43,750 [Nicolas]
And that means understanding how correlation characteristics of that assets behave relatively to equities over the long term and trend following has luckily a more than forty-year track record of delivering pretty good uh returns in the worst crises like GFC, the GFC 2008 was the prime example.
00:13:03,110 [Nicola]
Yeah, because someone might say, you know, you run a trend following shop, so how would you respond if someone would raise the kind of conflict of interest in writing a paper in where trend following comes out so good?
00:13:20,270 [Nicolas]
I mean, of course, uh we are biased, right? I mean, we’re we are trend followers by conviction. We we have been a trend follower for 21 years. We truly believe in in trend following and uh we have always been high I would say a high conviction trend follower because we haven’t done anything else in 20 years and we have always been uh invested uh quite heavily in in uh in what we do. I mean, we started actually uh Quantica as an overlay solution. So it’s not something new to us. What is new is that investors are looking into this a lot more actively.
00:13:53,610 [Nicolas]
So, I would say in our case, the idea uh was to demystify in a way what it means and what is uh a good way to build a possible alpha solution that doesn’t go against you uh at the worst point in time. And so, I think trend following is certainly not the only solution, that’s what we actually uh showcase uh in the paper. There are other assets uh that fulfill uh those criteria of a good portable alpha candidate.
00:14:29,710 [Nicolas]
and we mentioned treasuries, we mentioned gold as examples and there are many others actually. They’re not so many actually, but there are a few. What is a good candidate? I I think ultimately what we want to show is like, okay, uh you want to build a portable alpha, so if you want to you you’re interested in this. What are the candidates? Let’s let’s ignore trend because yeah, you may argue if we are trend followers maybe we’re… That’s okay, but then consider fixed income or gold. What is the commonality between these assets? They are long-term uncorrelated to equities. Maybe not in the short term, like we mentioned fixed income has been more correlated and the higher the inflation the more correlated it is.
00:15:05,490 [Nicolas]
but long term, we see that the correlation is basically not not not very large. And when you have risk off events, fixed income still tends uh to be uh to be diverse. So that’s one one part the correlation structure. And the other part is the risk premium. So what is the risk premium that you earn from these diversifiers? And why is it positive? Do you understand why there is a positive risk premium? There’s two sides of trend following. I think the the correlation structure of trend following, you get it by construction. Unless you screw up the portfolio construction, if you design it properly, this is by design. The question that is open for debate and will remain a debate is why do you earn a positive risk premium?
00:15:43,930 [Nicolas]
And that if you don’t believe in it, you shouldn’t actually do trend following because then you will not generate any benefit. For treasuries, for gold it’s the same, but ultimately a good portable alpha candidate is one that has a structurally low correlation to equities over the long term and that has as well long term a positive expected risk premium. I think from from my perspective, the risk premium side, you can’t predict it. Today, over the next 10 years, we cannot say, I cannot say which one of those candidates will perform better. And actually, for trend following, fixed income, gold or any other candidate, we don’t know.
00:16:20,660 [Nicolas]
But what we know, I mean, we have more conviction in the correlation aspect. I think it’s more likely that these assets remain independent and we believe long-term that they will deliver that risk premium. So when you have that, I think the best is just to combine these instruments together, maybe equal risk, and that’s actually a quite attractive structure that we have done for some clients as well. So we do have as well, we have run, for instance, possible alpha on gold rather than equities. Why? Because gold trends and equities are materially independent over the long term. It’s all about that. Actually, investing doesn’t need to be too complicated in the end.
00:16:56,660 [Nicolas]
If you understand the correlation picture, if you understand what is the source of the inefficiency that you’re earning over the long term, and if you accept that you cannot predict the returns that one asset will deliver over, let’s say three to five years, then just mix them. If you have a strong hypothesis and if the correlation characteristics are robust, it will be a good portfolio.
00:17:20,050 [Nicola]
And then I guess like the third element that you didn’t mention is the volatility of the assets, but I guess that like the way that I explained to me is like, well, once I introduce leverage, I kind of can scale the volatility of each asset where I want to be because normally like the the issue with stocks and bonds is that the bonds have like really low volatility and if they if you take them unlevered, then the the combination is not good for the investors because it drags down the the expected return of the portfolio.
00:17:58,610 [Nicolas]
So one thing that we haven’t touched on is obviously to, so the classic way of diversifying to sell equity to fund your diversifier. That’s straightforward, but it comes with a downside if for instance you want to allocate to bonds which has much lower volatility, you are you need to sell even more equity in terms of your notion exposure to just build enough bond exposure. That’s the other benefit of these stacking structures. To implement it, you can’t buy cash securities, so you need to buy capital efficient instruments and that is now in in our case it’s futures.
00:18:33,670 [Nicolas]
futures is a very efficient instrument and that allows you basically because it’s a margin instrument, so to to build a hundred dollar risk exposure, you only need typically a fraction of of the capital. Which means that to build your hundred dollar equity exposure, you can either buy an ETF. You buy an ETF, you need hundred dollar, you consume them and that’s it and and and you have no capital left. In the case of Possible Alpha, you have to buy your equity exposure through a future or a swap for that purpose or any any equivalent structure.
00:19:07,730 [Nicolas]
And let’s say, uh, to buy a hundred, uh, dollar, uh, global equity exposure, you need, let’s simplify, you just need ten percent. So ten dollars. You’re left with ninety dollars that you can still invest. And that’s where we said before, taking trend following or any other diversifying asset.
00:19:25,260 [Nicolas]
But the interesting thing is, if we go back to what we said initially, if you invest the amount in your diversifier, that is that maximum scaling capacity that doesn’t increase your risk, then interestingly you can in some cases, and that’s that’s the kind of structure we have been interested in building, is like you you kind of can allocate another $100 exposure without without actually spending an additional uh dollar of capital, right? And and that’s the that’s kind of the beauty of it if it’s done well. Because again, the danger is if this additional $100 is leveraged.
00:20:04,920 [Nicolas]
That’s what you don’t want, right? You want a diversifier that reliably creates that additional risk capacity without increasing your initial equity exposure, right?
00:20:17,150 [Nicola]
So there is a point that we touched in our pre-call that I really want to ask you again because I think it’s it’s really interesting. Typically retail investors sees turbulent times as not great for trend following. But you said like that short-term crashes are like the tariff tantrum or the beginning of the war in Iran is what creates the opportunity for the long-term trends. So can you elaborate on this?
00:20:45,940 [Nicolas]
the positioning of a trend follower always reflects the prevailing macro-narrative. Because you follow trends. And so for trend following to make money, you need a stable macro-narrative. If it’s changing all the time, there is no trend to build on. Now the more stable that macro-narrative is, the more you expose yourself to shocks. The biggest risk when you run trend following is that something hits the markets that no one expects. And markets are always pricing some form of macro equilibrium. There’s always a narrative priced in the markets. And trend following thrive when that narrative is just the strongest and the most stable.
00:21:21,590 [Nicolas]
Now Liberation Day, so the unexpected terrorist announcement or oil price shock of March this year, they are the prime definition of shocks. If you understand how trend following is built, by definition, the one day after this shock happens, usually it’s negative for a trend follower because all the markets will reverse. And the macro narrative valid a day ago is completely off. So that’s only natural. Actually, that’s one way to explain the risk premium that you earn with trend following. Why is it that trend following produces huge long-term uncorrelated return to equities, to fixed income, to actually any traditional portfolio risk factor?
00:22:00,580 [Nicolas]
and on top of that, you annualize that four, five, six percent per annum. That shouldn’t be.
00:22:04,610 [Nicolas]
you shouldn’t be able to get protection and not pay for it. And you’re actually being rewarded. Why? Because you’re actually taking a significant risk is that as soon as you detect trends, you build up positions and you will build up risk proportionally to the strength of those trends. And it’s intuitive as well to think that the stronger these trends are, the longer they last, the more likely there will be some reversal. And usually we know the more stretched markets are in one direction, the more abrupt and shocking the reversal is, right? So this is what Liberation Day was. It was pretty insane actually the moves that we witnessed. Yet, uh, the negative returns of trend following were actually not really surprising. And then there are two scenarios from there.
00:22:43,760 [Nicolas]
Either that reversal creates a new type of crisis that is entrenched, and then trend following will adjust because you follow the trends, and a shock like that, the one thing that it does, it triggers a transition to something new. Usually you don’t go back to the the macro narrative that was valid before the crisis. And that is where the opportunity usually is for trend, because the bigger the shock, the bigger the likelihood that we will gonna move to some sort of new macro narrative, new new market equilibrium if you want, or cost asset picture that will be radically different. And then the second part of this is that it takes time to figure it out. Markets don’t reprice that overnight.
00:23:23,770 [Nicolas]
It can take a long time. And we have seen that in 2021 with the inflation shock, it took the market 18 months actually to correctly price in the terminal rates, like US rates went from zero to five percent, at least for the 10-year. It took almost two years. And that’s a fantastic opportunity for trend following because trend following is actually striving on capturing that opportunity, that that mispricing of markets for a prolonged period of time. That’s why Liberation Day may have seemed
00:23:54,760 [Nicolas]
like the end of trend following and that’s what we heard here and there is like, well, in a world where the guy in charge is changing his mind every week. Yes. It cannot be a great environment for trend. So trend is definitely not a strategy you want to be exposed. History tells you exactly the opposite. If you go back in time and and we published actually in the weeks following liberation day a research paper titled From Tariffs to Trends. We just wanted to pass on the message, those shocks, historically, they produce the biggest opportunities.
00:24:25,450 [Nicolas]
and fast forward to today, actually the second half of uh 2025 was one of the strongest half-year records for the strategy in over three decades. Who would have seen this coming? Well, actually trend followers would have seen this coming because history repeats. And just one thing that we can say about Iran War, so it was less extreme in terms of market reaction because trend followers were already positioned on the long side. I mean, basically the being long energy helped tremendously diversifying uh the the maybe some of the losses that were experienced on the on the equity side.
00:24:59,480 [Nicolas]
uh but here again, we go again like, uh, this oil shock is gonna create, uh, some new cost asset picture that we probably don’t even know for sure what it’s, how it’s gonna look like. We see interest rates, uh, have two big impacts actually of this oil shock so far is that we have seen rates really going up again in a way we haven’t seen, uh, since that, uh, 2022. We see obviously the role of commodities continuing to be absolutely critical. Um, there have been a lot of opportunities in, in, in commodities for trend, uh, over the past six years actually since Covid basically. And that continues to be the case this year. Uh, so we’ll see.
00:25:34,410 [Nicola]
So I have a personal question, not because the paper is is focusing, I think, on 21 years. So, do you think that is enough data to provide a reliable test?
00:25:45,900 [Nicolas]
Well, it’s a very good question. Um, you never have enough data. Yeah. So, you know, when we write the papers, the idea is to illustrate concepts. The way we write these papers, the topics always come out of client conversations. We have been writing one paper every three months for the past six years. We always think about it from our side, how we how can we make a quantitative piece, so we just not just talk high level, but make it quantitative, so you substantiate actually your views by proper analysis. Now, in terms of the look back, there is a trade-off here. If we just talk about the last three years, you can arguably criticize us of just cherry-picking the period.
00:26:23,450 [Nicolas]
uh if we go beyond 21, actually I didn’t remember it was 21 years, but um usually we don’t go back further than the year 2000, simply because uh what we tend to see is that if you go back to the 90s, and we have data set going back to the 1960s. Because when you look at futures markets, they emerged in the 1960s, like in the US you had agricultural futures. But the what you always see is that the results just get better and better and better. What you can then easily be accused of is just to make your your results look better. Because the markets were in a way less efficient, maybe as well.
00:27:01,910 [Nicolas]
Yes, we know that trend following worked phenomenally well in the 80s for those who had access to the market. I mean, the data back then wasn’t that easily accessible. So that’s the reason why we tend to not do it and as well the universe was smaller as you deal with other problems is that, you know, you would have to select a smaller subset of markets and so on. So technically speaking, not easy. That said, you know, there’s a lot of parallels actually between today and the 1970s, like in terms of the inflationary environment.
00:27:33,320 [Nicolas]
we believe actually that the results being able to analyze the behavior, the cross-asset behavior in the 1970s is actually interesting in terms of evaluating the potential scenarios that you may face as well in the future today. And one thing that we said after COVID, we used 40 years of data actually for that paper to make that case. What you see over those 40 years that every time the opportunity set in one asset class shrinks for trend following, the opportunity set in the other asset classes expands. And that’s the beauty of it. And we wrote we wrote it back in in 2020 because we came out of a decade of declining interest rates.
00:28:12,390 [Nicolas]
and back then, the main question mark that investors had is, look, we know how you make money. You make money on declining rates. But what will happen when rates increase? That’s another criticism, was another criticism of of trend following actually. is like, it’s great just because you have been just riding the the declining yield trend, the QE in the QE environment of the 90s, of the the 2010 decade, right?
00:28:37,700 [Nicola]
which actually was really bad because like if you think about that that strategy is an overlay on the cash rate. The more the cash rate was going down, the less absolute return you had and
00:28:49,180 [Nicolas]
true
00:28:50,180 [Nicola]
and so like
00:28:51,150 [Nicolas]
But that’s true.
00:28:52,130 [Nicola]
Salaam alaikum
00:28:52,710 [Nicolas]
That’s true.
00:28:53,450 [Nicolas]
So it obviously it it it it was not an easy environ- it was actually the most challenging environment for for trend following if you take the period 2015 to 2018. It was pretty tough. But if you look at the decade, the post-GFC decade until COVID, a big chunk of the returns, it’s true, were were by fixed income. And so investors naturally get worried if, let’s say, like 80% of your returns are driven just by one trade. With trend following, that’s always the case actually. There’s always just a few trades that drive your P&L. Now, fast forward to today and that’s really fascinating and we are just about to that next paper will be exactly about starting on that observation.
00:29:28,730 [Nicolas]
If you look at the return attribution since the start of 2020 for the current decade, you can actually explain almost the entirety of trend following returns through commodity contribution. In the previous decade, that was negative. Commodities had a zero to negative contribution over 10 years. It reflects just one of the fundamental principles that you should follow when running trend following and when investing in trend following as well, is that you cannot a priori know where the trend opportunities will happen tomorrow, but what you know is that if you are diversified enough, there’s always something going on somewhere. And when the asset class has been or when the sector that has been
00:30:08,660 [Nicolas]
your biggest performer in the recent past when that opportunity shrinks, right? Somewhere else, where new opportunities arrive and it’s interesting to see that history repeat over and over again. But it’s a hard sell, right? To tell like in 2020, say, yeah, we believe that if interest rates rise, maybe the opportunity is going to show up in commodities. And funny enough, we have seen exactly that over the last six six years so.
00:30:35,160 [Nicolas]
We’ll see if it’s twenty if if this decade will remain the decade of commodities, but um like uh last year and again this year, commodities are central piece to trend following and it’s actually if you think going forward, what are the risks to traditional portfolios? I mean, you hear about stagflation risks, right? You hear about the potential comeback of inflation, potential recession down the line. You know, the good thing about trend following is that you don’t really care about what scenario is gonna… The one thing we don’t need to worry about is actually which scenario is going to happen.
00:31:08,570 [Nicolas]
because we know, and that’s really based on how the strategy is built and just the track record, the long-term track record, that whatever is going to happen, the strategy is going to adjust the positioning to that macro environment because it’s agnostic to the correlation structure of the market. That’s its strength. So, and trend following becomes all the more valuable that the positioning is not a strategic portfolio positioning that you would be able to take, like being long commodity. Like being long strategic long energy over the long term is probably not that a good trade. But tactically, when inflation comes back, you want to be long. How do you get in and out?
00:31:46,800 [Nicolas]
Trend following is is a great strategy for that.
00:31:48,960 [Nicola]
But then what’s the one thing that you wish retail investor would take away from the paper that you suspect they will miss the most?
00:31:58,100 [Nicolas]
The motivation to write this paper was not necessarily just the portable alpha subject. For a long time, I was thinking, how do you show the value, quantify the value of correlations? Everyone can quantify the value of returns, right? Easy. Everyone looks at returns, but correlations? Yes, you’re uncorrelated.
00:32:15,400 [Nicolas]
great, but what does it mean for my portfolio? That’s where portable alpha is actually a nice tool. Because if you basically you just transfer your standalone, uh, view on on on trend following into your portfolio context. And there suddenly trend following shines relative to other strategies. Suddenly, the strategy that has three times lower Sharpe ratio than the than for instance an equity long short strategy, suddenly looks as good as equity long short because you take into account the correlation effect. So that’s one thing is that one thing is not stopping at just the standalone metrics and look at what’s in it for me in my portfolio.
00:32:53,970 [Nicolas]
and trend looks always better and has a great track record actually improving the portfolio characteristics. The second thing, and I think that is valuable for any type of portfolio is that it’s a great complement to your equity holding. Look at portable alpha, well-constructed portable alpha. Again, I would be extremely careful about understanding what is being done. Like always investing in what you understand and and why it will deliver what it is supposed to deliver. And again, that’s why trend following is a very reliable building block in combination with equities.
00:33:31,580 [Nicolas]
and then it’s a great, it’s just a better way to build your long equity exposure. You can buy an MSCI World ETF. Great. You do nothing wrong by doing that. And or you can buy like what we call, we call it enhanced equity because it is enhanced equity. Because if you do that well, combining 100% equity exposure with an exposure to trend gives you an additional excess return which is equal to the risk premium you earn through trend following without increasing the risk. Without increasing the risk, that means that you have a beta one allocation. And you may have an allocation to MSCI World, you may buy into active equity managers.
00:34:11,500 [Nicolas]
you may do different, you may implement your equity exposures in different ways. But this is nothing else than just an equity building block, which we believe and we invest as well personally that way. It’s just one piece of your equity allocation. It’s a great piece and and it’s something that uh the the enhanced the enhanced return they are generated through that systematic in a way through a systematic macro overlay which is trend following.
00:34:38,960 [Nicola]
Manicula, thank you so much. This is a
00:34:41,990 [Nicola]
a message that we are really passionate about and I was really glad that you were able, uh, you accepted to come here to talk about it because, uh, yeah, one thing is to hearing from me, one thing is to hearing from someone that does it and lives it and breathes it. So, thank you, thank you so much for the time.
00:35:00,670 [Nicolas]
Thank you, Nicolas. It was a great pleasure speaking to you today and uh, yeah. Thank you.