Eric Crittenden

-

In this episode, I talk with Eric Crittenden, Founder and Chief Investment Officer of Standpoint, an investment firm focused on bringing all-weather portfolio solutions to US investors. 

Eric plays an active role in the firms’ research, portfolio management, product innovation, business strategy, environments and client facing activities.

He believes using an all-wealth approach is the most effective way to prepare for a wide rage of market environments, while producing meaningful investment returns with limited downside risk.

Eric has over 20 years experience researching, designing, and managing alternative asset portfolios on behalf of families, individuals, financial advisors, and other institution investors. 

Eric and I talk about circuitous paths with multi-year dead end rabbit holes, simplicity can be the ultimate sophistication, what do clients want? What’s wrong with investing industry, strategy scaling?

For people who want to understand the capital efficiency argument, this is helpful: Backtest Portfolio Asset Allocation (portfoliovisualizer.com)

• Portfolio 1 = a blend of the more popular managed futures strategies
• Portfolio 2 =  100% Portfolio 1 + 50% global equities. Equities come at the expense of T-bills
• Portfolio 3 = standpoint 

 Towards the end, Eric was referencing a bond video. Here’s the link: https://www.standpointfunds.com/content/bond-return-simulator

I hope you enjoy this conversation with Eric as much as I did…

 

 

Listening options:

• Listen on Stitcher
• Listen on iTunes
• Listen on Spotify
• Listen on TuneIn
• Android users can grab our RSS feed here.

 

 

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 [email protected].

 

Sign up to stay up to date with the Mutiny Funds and receive our long volatility research and reading suggestions.

ENTER YOUR EMAIL TO STAY UP TO DATE:

[xyz-ips snippet=”Discuss-on-Twitter”]

Transcript for Episode 35:

Taylor Pearson:

Hello and welcome. This is the Mutiny Investing Podcast. This podcast features long-form conversations on topics relating to investing, markets, risk, volatility, and complex systems.

Disclaimer:

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 and do not necessarily reflect the opinions of 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 best or potential profits. 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 in making a decision on the appropriateness of such investments. Visit mutinyfund.com/disclaimer for more information.

Jason Buck:

So just two seconds ago, before we came on, I was confused because your partner Matt had told me you guys were on West Coast time like me, and I thought maybe you were taking a sabbatical in Southern California or something, so I asked you where you were, and you said you’re in your living room in Phoenix. And I’m afraid to admit that I didn’t know, apparently Phoenix does not switch with Daylight Savings time.

Eric Crittenden:

Yeah. Well, I didn’t know that when I first moved here. I also didn’t know that you don’t type one before the area code here in Phoenix. So it took me three days of not being able to use a phone when I first got here. Yeah. So we don’t switch on Daylight Savings Time, which means in the winter we’re on Mountain Time and in the summer we’re on California time like you. And as I mentioned earlier, parts of Arizona do switch, the Reservations, the Native American Reservations, they do choose to switch because they like to do the opposite of what the Arizona state government does. So it gets a little confusing where it’s an hour ahead two blocks away from you, so you just … you roll with it.

Jason Buck:

It reminds of that whole Chicago versus … I grew up in Southwest Michigan, and you’re so close to Chicago on Central Time, and then we’re actually on Eastern Time. We’re like the farthest west you can go and still be on Eastern Time. So it’s always confusing. And then I don’t know about you, but when I’m traveling a lot and trying to set these Zoom calendar invites on different time zones, and then you travel to a different time zone, I get so confused. So it must be even almost more confusing for you in Phoenix trying to adjust to everybody else’s time zone and whenever there is Daylight Savings Time.

Eric Crittenden:

So we’ve been doing it for a while now, so we’re super cautious about setting up our calls and meetings and making sure that people know. And also, I set most of my computers to New York Time just to avoid this entire mess, because it does become challenging when you spring forward or fall back.

Jason Buck:

Yeah, I think when I was talking to Matt about making the appointment and everything, we were actually recording this on Memorial Day, and he said what I love best. He’s like, “I’m not even sure Eric knows what month it is.” And I’m like, “I’m the same way, especially when I’m traveling a lot.” And so I would miss Daylight Savings Time. So yeah, I would have days to adjust. I’d be all discombobulated for days because I’ve missed Daylight Savings Times many times. Thank God for iPhones and computers that just automatically adjust us.

Eric Crittenden:

Yeah. My life changed dramatically when I started using Outlook 15 12 years ago or something. I stopped being late and stopped not showing up for my meetings. And I use it proactively to make sure that I adjust for Daylight Savings Time and all that stuff. But prior to having Outlook, I was a mess.

Eric Crittenden:

Let me get rid of some of this stuff here.

Jason Buck:

I was about to say, speaking of Outlook, you just got a ding from your computer.

Eric Crittenden:

Yeah. We’re going to shut all this stuff down. Should have read the instructions.

Jason Buck:

It’s quite all right. It happens. As you know, it happens every time.

Jason Buck:

I was thinking about all the different things we could talk about, and I was trying to think of where’s my wedge in, but one of the ones I was thinking about, and we’re obviously not going to talk about numbers on this podcast or anything as boring as that, but I was thinking about with trend following, CTA or commodity trend or whatever name people want to call it. I think you call it global macro. Is that right?

Eric Crittenden:

Yeah. I call it, depending upon the audience. Some people hate the phrase trend following. Some people hate managed futures. Some people hate systematic global macro. So I try to use whatever’s the least offensive to whoever I’m talking to.

Jason Buck:

I’m thinking about with, obviously, I don’t think … without talking returns, I think most people know that the second half of last year and then end of this year until probably last month, an amazing return driver has been commodity trend following or systematic global macro. We run one of these funds, but I’m curious, our phone is definitely not ringing off the hook. So I’m just curious what your response has been just from ballasting a portfolio from the trend side. It seems like people are either praying that 60/40 comes back or that inflation goes away. That’s at least my take. I’m wondering what your take is.

Eric Crittenden:

Kind of the same in the sense that we’ve had a lot of interest in what we do, but we don’t hold ourselves out as CTAs or trend followers or any of that stuff, because it’s not what we’re doing. That’s an element of what we’re doing, but there’s a hefty global macro, macro trend. Let’s just stick with macro trend. I’m going to go with macro trend.

Jason Buck:

Okay. Macro trend, got it.

Eric Crittenden:

There’s a healthy macro trend component to what we’re doing, but it looks and feels a lot differently than what people are used to when they would dabble in managed futures, the asset class specifically. So the way we talk to people is about all-weather investing, having true broad global diversification all pulled into one program, and it looks and feels a lot different than pure managed futures. So any tailwind that managed futures is getting right now really isn’t affecting our business model.

Eric Crittenden:

And candidly, I think people gave up on managed futures as an asset class a long time ago. And I don’t think what we’ve seen recently is … I was just looking at the AUM levels of some pure managed futures programs, and they’re so unbelievably low now, 90% declines in AUM from where they were just five or six years ago. I think that tells you what you need to know, that the marketplace simply has voted and it just doesn’t want pure managed futures.

Jason Buck:

Do you think … I think you and I both hate the term they tried coming out of the global financial crisis of calling managed futures crisis alpha, because we know it’s not crisis alpha, right? It’s uncorrelated in a way. But macro trend has ballasted a long S&P 500 only portfolio over the last, let’s say, nine to 12 months. Do you think that’s kind of like almost just luck because it’s been like an organized sell-off and just because we’ve had a boom on the commodity side at the same time, or how do you think about the correlation over a shorter term period like that?

Eric Crittenden:

That’s a tough question to answer, is it luck? There’s a degree of randomness to everything that we’re doing. So some people are going to associate that with luck, but I would say that long vol, long convexity trend-oriented strategies deployed on a global basis, meaning you’re really diversified: grains, energy, currencies, bonds, livestock, stuff like that, has been the best diversifier to an equity portfolio for all the decades that I’ve looked at it. My research typically goes back to 1970, and it’s always been the best balanced. It’s been a better diversifier. By my metrics, it’s been a better diversifier than bonds for 50 years. So I’m not surprised. I don’t know if you were getting at a causal relationship there, meaning the stock market and the bond market are struggling because commodities are going up. That’s kind of a chicken versus the egg. You don’t know what caused what.

Jason Buck:

Yeah. Well, part of that, I wasn’t even necessarily hinting at that, because I’m probably on the same page with you, but part of it though is, historically, pundits have talked about the price of oil and how that affects the stock market. I’m more curious how you think about that causality. We need an oil sell-off for S&P 500 to have a rip higher, although, I guess, it’s been going higher the last week or so, but I’m wondering if you think about any of those causal relationships of the price of commodities versus 60/40 portfolios.

Eric Crittenden:

I used to. I used to think about that a lot, but what I’ve observed over the years is that it’s a problem that doesn’t have a solution. You can never really figure it out, and you end up spending so much time trying to chase that ghost that you lose sight of running your business and just putting one foot in front of the other and doing the right thing, because it’s always different each time. I’ll give you a couple of examples. I had clients back in 2016, I think, maybe 2015, ask me about interest rates. And during the conversation, it came up that I felt interest rates could one day go negative. And I lost business because of that. I had people tell me, “Well, that’s completely insane. That can’t happen. That’s ridiculous.” And then a few years later, it happened.

Eric Crittenden:

Also, on a couple podcasts in 2019, the price of oil came up, and somebody asked me, “Could the price of oil technically go negative?” And I said, “Yeah, if the cost of storage exceeds the salvage value.” And I got a bunch of hate mail from that too. And it cost me business. So it’s one of those things where you overthink this stuff until it happens. You can’t afford to be on the wrong side of the narrative with people. You lose credibility, and it doesn’t come back after. They don’t call you up a year later and say, “Yeah, interest rates went negative and crude oil went negative. I didn’t realize that could happen.” They moved on to the next thing. So my philosophy is stay disciplined, stick to what you’re doing, rely on your research, and don’t overthink things, and don’t try to out-guess the market. The market’s a discounting mechanism, and I’m not going to do a better job than the market.

Jason Buck:

Well, like you said, you don’t have to be overly prescient to talk about negative oil or negative interest rates. What I’ve always loved about macro trend is that you just follow price, right? And so if price goes negative, you just keep following it negative if that’s the direction of the trend. You don’t have to have any global macro narrative. And that’s the point, is you’re just offsetting narratives and people love narratives, so they didn’t like the idea that you said it could potentially go negative. You weren’t calling for it. You’re like it’s just within the realm of possibility. And I wonder, do you think that following trends for so long just opens up your mind that anything’s possible?

Eric Crittenden:

I think doing the research around it and seeing what actually happened. I mean, you can see with your own eyes what happened historically, like the sugar trade in the 1980s, where the price was below the cost of production. And the price didn’t actually go any lower, but you made a boatload of money being short because of the Contango and the futures curve. Right? So today, you fast forward to today, and I talk to emerging CTAs or people that want to start trading their own account, they’ll do the same thing over and over. It’s always the same thing. They come up with all these filters to filter out trades and they say, “Well, if the price is too low, it won’t go short. If the price is too high, it won’t go long.” Well, okay, so one of these days you’re going to experience this phenomenon, and the greatest trade of the decade will be the one that your filter filters out.

Eric Crittenden:

So you try to share with people these observations. I try to learn just vicariously through the experiences of others rather than do it with my current client’s money. So that, I would say, from the research, you can learn a lot if you’re open-minded and you just relentlessly ask questions and look at things from many different perspectives.

Jason Buck:

One of the things you brought up about right now what’s going on, and you said long volatility positioning or whatever, which a lot of people would say a macro trend is a long vol position. And I just bring it up, talking in my own book, is that, in this, we’ve had an orderly sell-off in the stock market or 60/40 portfolios. So we haven’t seen a pop in pure long volatility and tail risk and option pricing. But do you view then though macro trend as a sort of long vol? I mean, I’ve had this argument many times online with a lot of people that are traditional CTA trend followers about is their positioning long vol or long gamma? They’d have to add to the positions if it was long gamma, and I don’t think anybody’s really added to positions since the ’70s. But I’m just curious your take, because you brought up long vol, and you always have different views. So do you think that macro trend is a long vol strategy, and do you need volatility to actually harvest profits from that kind of strategy?

Eric Crittenden:

We could talk for a couple weeks on that particular topic. I’ll take a step back and say we actually do add to positions in a sense.

Jason Buck:

Okay.

Eric Crittenden:

We’re using three different lookback periods to measure trend. So short-term, medium-term and long-term. And I did that because I don’t want the dispersion risk. Sometimes short-term trend followers knock it out of the park and everyone else sucks. Sometimes long-term trend followers are in first place. I want something that’s more consistent and durable. And this can go on. I mean, short-term trend followers can help outperform dramatically for four or five years in a row. So you want to diversify. So in a sense, we could get a buy signal in something like soybeans on a short-term frequency and then a few weeks later get another buy signal on a medium-term. And then a few weeks later, or months later, whatever, get a buy signal on the long-term. Then you would have approximately triple the position size on.

Eric Crittenden:

And then, if that market becomes more liquid, meaning the open interest is increasing in that market, more hedgers are pouring in, then our position size will increase also because of that, at least relative to the other positions in the portfolio. That’s not exactly what you were saying, no one is … I think you’re talking about pyramiding, like the old turtle style pyramiding from the ’80s.

Jason Buck:

Yeah. I was referencing both. But I think you made an excellent nuanced point, is that’s the whole point to multiple lookback periods. And as you know, I’m a huge fan of that, and I wish, hopefully, you push back on me more than you used to with other people. But the idea is, I always think about, when we have, even in our trend portfolio, we’re tranching lookback periods, short, medium, long-term. Same as you are. But I’m curious your take though, if somebody studied these markets and these trading strategies for as long as you have, obviously you can come up with a panoply of solutions and use all the different ways that people incorporate macro trend in their portfolios. But to me, I always thought I’m taking idiosyncratic risk if I’m just betting on you to come up with that versus using multi managers and multi lookbacks.

Jason Buck:

And I’m curious what your pushback would be on using multiple managers that have different idiosyncratic risk to one manager who could maybe try to incorporate the full umbrella of strategies over multiple time cycles.

Eric Crittenden:

That’s a great topic. I talk with clients about that from time to time, because I feel like when I explain to them the diversification across different trend lengths, they feel like, “Well, that’s great, because now I can just put more money with you. I got rid of the multi … solved the multi-manager issue.” And I said, “Well, maybe it solved 60 or 70% of it statistically, but the other 20, 30, 40% is more about the business risk.” Is the person crazy? Do their systems go down? Are they taking cybersecurity seriously? So there’s more to it than just … I’ve done what I can on my end, but I’m in a capsule. I can’t diversify. I can’t start another company and hire another CIO and have them be independent from me. I guess I could, but I’m not going to. So I’m solving as much as I can, and I feel like that’s 60 or 70% of the risk, but it’s still up to … the client still has to be cognizant of the balance there.

Jason Buck:

I think you are solving most of the risk, even from the separate lookback periods, but I’m also curious, have you thought, and I know you have thought about it, is the different even trading strategies, whether people are using [inaudible 00:16:06] curves, moving averages, breakouts. Do you also try to overlay all the different historic macro trends, strategies along with the time tranching, or how do you think about that?

Eric Crittenden:

I’ve thought about doing that. I looked at many, many different ways to measure and identify a developing trend, and what I found, and you know this, is that they all basically pick up on the same thing. They’re just different ways of measuring the same thing. It’s like if there’s a wave coming in and you’re in Santa Barbara and you’ve got a guy from Hawaii and a guy from Oregon and a guy from California, and one guy says it’s four and a half feet, the other one says it’s five feet, and the other one says it’s four, they’re all measuring the same thing, they’re just doing it the Hawaiian style or the Oregon style or whatever.

Eric Crittenden:

So there’s not a lot of benefit from diversifying your entry/exit style, moving average crossover, breakout. There’s a whole bunch of different styles. That being said, you could develop a strategy that uses a moving average crossover that doesn’t have a lot of … in other words, they’re not all created equal. I like breakouts. So I’m kind of in the minority there. I like breakouts because they’re pure trigonometry. They’re just triangles, essentially. And you know the price that would force you to get in, and then your stop-loss is some other price, and you know what that is. And you know what both of those prices are every single day. And that means you can calibrate your risk. You can lean on that. We call that the risk range. So I know approximately how much risk I’m taking to market because I know what both of those prices are.

Eric Crittenden:

When it comes to a moving average crossover, I don’t know what price is going to force those two moving averages to crossover without doing some really advanced, or not advanced but tedious math to come up with a bunch of different scenarios about how they might crossover in the future. So because they all basically pick up on the same thing, but the breakout approach is very clean from a risk management perspective, I gravitate towards that, and I didn’t see a lot of benefit from diversifying meaningfully beyond what I’m already doing when it comes to entries.

Jason Buck:

Do you think the breakout’s also just cleaner from a discretion? I mean, you would think it’s all model-driven and you have to stick to your systems, but there’s a lot of discretion I feel like with a lot of … especially like moving average, and you’re like it’s getting closer to what lookback period I’m using. There’s a little bit of fudge factor there, I think, that people have a little conundrum on their hands when it’s getting really close to their inflection point, where breakout’s just a clear thing so you can’t really deviate from breakout as much.

Eric Crittenden:

I never really thought about that. I don’t use discretion. The only discretion I’ll use is regulatory, meaning like what happened in the nickel market a couple months ago.

Jason Buck:

Yeah.

Eric Crittenden:

When it comes to taking trades, I’ve never skipped a trade in 24 years, or a stop-loss. So I’m not in there agonizing and saying, “I think we’re going to get long [inaudible 00:18:54], so I’ll just go ahead and get long right now.” So I’ve never really been motivated to probe that particular question.

Jason Buck:

You also opened up the question, and I hope we talked about this when we did a Masterclass on Real Vision, I’m sure we did, but maybe hopefully I can ask it in a different way. It’s always fascinating to me that macro trend or CTAs, they have a lot of study on where they’re going to open a position, but it seems like maybe 1/10th as much as taking profits. And so one of the most controversial things in your world and my world is the idea of vol targeting in open position. And I’m just curious to your take on that.

Eric Crittenden:

Well, you have to control your risk somehow, especially with all the new rules coming from the SEC. They’re going to be applied to anybody that uses derivatives that’s managing a registered investment company. So you have to control your risk somehow. Now, we do it by measuring the distance to the stop-loss for every position in the portfolio at all times and multiplying by the contract multiplier, and then dividing by the FX rate, and you get an aggregate number and you divide that by the total value of the fund. You’re going to get a number. For us, that limit is 10%. So that means if we have a 0% success rate, a 100% failure rate in every position, all 60 positions, go against you by five or six or seven standard deviations, the estimate is that you’re going to lose, right now it’s 9.3%, but the limit is 10.

Eric Crittenden:

So vol targeting, well, so if we’ve got a whole plethora of new trades come into the portfolio, I’m going to take them, but I still have to honor that 10% risk budget limit. So algebraically, the only way to do that would be to scale down existing older trades in order to free up the risk to honor these new trades that are coming into the portfolio. And that’s how most CTAs do it, roughly. So is that vol targeting? For us, it’s kind of risk targeting, but it’s a close cousin, I guess, for vol targeting. But then again, when someone says we’re doing vol targeting, if you get 10 different CTAs to say they’re doing vol targeting, you’ll get 10 potentially very different methodologies.

Jason Buck:

So if you weren’t opening up a new trade, then you wouldn’t be attenuating contract size down on any of those positions if you didn’t have any new trades, or you need to open up space for that aggregate max drawdown?

Eric Crittenden:

Can you say it a different way?

Jason Buck:

Yeah. Like you were just saying, if you have an aggregate max drawdown of 10%, and you have a bunch of positions on, and vol is picking up, volatility across all the assets are picking up but you didn’t have any signals to put on any new trades, would you take down the sizing of those, the current positions?

Eric Crittenden:

Yes.

Jason Buck:

Yeah. Because the max drawdown, right? If you felt the max drawdown was going up from stop distance, that’s what you would attenuate the portfolio with?

Eric Crittenden:

Yes, but we’re pretty flexible and liberal. We’re not in there trading every single day. It has to move. It has to be somewhat meaningful before we’ll bother doing anything about it. Otherwise, you just churn the portfolio and have lots of turnover and transaction costs. But yeah, I mean, it actually happened recently when vol really picked up. One day, I ran the operations, and I’m like, “What are these trades for?” Oh yeah, the risk went up enough, such that it’s telling me to scale down every position in the portfolio, or almost every position by a very small amount.

Jason Buck:

I’m curious then what, because I’m sure you looked into it, with having that max drawdown to 10%, how does vol, the actual volatility of the portfolio change over time? I assume it stays in relatively tight bands. Even though you’re attenuating the portfolio to max drawdown, you’re not necessarily targeting volatility. I would assume volatility stays pretty narrow tight bands on that.

Eric Crittenden:

Yeah, it does have the effect of muting volatility when volatility’s spiking and actually increasing it when volatility is really low. But we’re directly targeting what matters to us. Volatility is not risk. Volatility is a symptom of risk. We’re targeting the risk itself. I’ve never understood this complete obsession with standard deviation and volatility. It’s just one way to estimate risk. And you know the markets are fractal and have fat tails and whatnot, so it’s actually not a great way. It works. But depending upon what you’re doing, how much convexity, whether you’re on the right side or the wrong side of convexity, volatility is potentially a very dangerous way to measure risk.

Eric Crittenden:

We’re targeting risk directly, exactly like a cash accounting, like this is how much I expect to lose if this goes off the rails in this market, and I’m going to be pretty accurate to that number, and we’re going to manage that number.

Jason Buck:

Yeah. We’ve talked many times about the terrible naming conventions that are within our industry, right, if it’s managed future, crisis alpha, CTAs, trend following, et cetera. But one of the ones that has surprised me the most is like you’re saying, this cash accounting of like what can I eat at the end of the day? What are my max loss on a cash-weighted basis? Why do you think that hasn’t picked up across other asset classes and asset managers? That would be the number one thing, is CTAs have always been pointing out, or macro trend special …

Jason Buck:

Is like CTAs have always been pointing out, or macro trends specialists, have always pointed out that this is what actually matters is your aggregate drawdown risk, not your volatility metric. But that just doesn’t seem to translate well to everybody else, and everybody still seems to care most about sharp ratios versus max drawdown.

Eric Crittenden:

I think in the securities world, stocks, bonds, mutual funds, it’s historically been a relative game rather than an absolute game. In a relative game, anytime you sell, you’re putting yourself into a position to get left behind. If you get left behind, it’s game over for you, everyone loses confidence in you. Futures guys, derivatives guys, live in a very different world or grew up in a very different world where it’s all about survival. Some of these guys are using leverage and quite a bit of it, so it really was essential that they control the amount of risk they’re taking. So, and when CTAs is drone on, and on, and on about risk management, it drives advisors crazy, because they don’t even really know what you mean when you say that.

Eric Crittenden:

It’s not that important in their world, because a balanced portfolio of stocks and bonds, it’s more important to not manage risk, because you don’t want the taxes, you don’t want the turnover, and you don’t want to get left behind. You can look at these psychological studies, and I’ve had people tell me it’s okay to be down 50% once every 10 years, as long as the market’s down 45, or 50, or 55%, I won’t lose my clients. But if I manage my risk along the way, the way you guys do, and I’m up 20 when the market’s up 25, and then the next year I’m up six when the market’s up 11, it’s game over for me. That’s unfortunate, but that’s how it is in the securities industry. So, but when you’re looking at alternatives, and in particular all-weather investments, frame the right way, that all goes away.

Jason Buck:

It seems like there’s a certain pragmatism to it that, to me as an anathema, how it doesn’t translate across. I mean, I understand what you’re saying with a relative value CYA of financial advisors, but it’s just one of those things that I don’t think I’m ever going to quite understand why that pragmatism doesn’t transfer over. Other than everybody’s incented to just keep up with the Joneses, and their neighbors, and if they have the similar draw downs, then they’re okay with that, but it’s kind of shocking to me. The other thing you said again, that I’m always curious, you said, “All-weather type portfolios,” there’s got to be a part of you that wants to get away from that phrase, all-weather, or do you just go with the pragmatism, but that’s what people call it, so that’s what I’ll call it?

Eric Crittenden:

No, I chose it. I went into that with my eyes wide open and embraced it, and feel like the portfolio mix that we pursue is as all-weather as I can make it, based upon research going back to the seventies, and my obsessive look at every asset class, every SMA, hedge fund, mutual fund, ETF index, it’s as all-weather as I can make it. All-weather, to me, means something specific, it means doing everything we can to be prepared to survive and thrive in all plausible market environments going forward. That doesn’t mean that we will succeed in every market environment going forward, but we’re doing everything we can to not put you in a crappy situation, like a 60, 40 portfolio, or an all stock portfolio, lost decades, a great depression, 1970s style inflation, that kind of stuff, so I feel like it is all-weather.

Jason Buck:

Dalio coined that term or made it popular and he sometimes will say, “You need upwards of 16 uncorrelated return streams,” do you think that’s even possible?

Eric Crittenden:

No, it’s not, and I like Dalio, I like his writings, I modeled a lot of what we do off of what their firm did in the ’80s. So, I have a lot of respect for what he achieved, and how he did it, the how is very important. That being said, anyone with a plain vanilla copy of Excel can use a random number generator and realize that three uncorrelated variables are pretty much all you need to be the best money manager out there. So, I don’t know where the 21’s coming from. I’ll tell you hit on something though that there’s only one thing in this world that actually that I’m jealous of right now. That is there’s one risk premia out there that I can’t source, but it would be so valuable if I could.

Eric Crittenden:

So, I’m really just getting three, and I feel like that’s all we need, it’s the best I can do. I think it solves a lot of problems for people, but there’s one more out there that I think is big and sustainable, but you can’t get it from Phoenix, Arizona, and that is the market making style risk premia. Where you need economies to scale, you need poll position, co-locate your servers, you got to be big, and have a solid network. You got to be basically like Amazon or Costco, where you can just muscle your competitors out of the way. You’re like, “Nope, get out of here, this is my real estate, and I’m doing…” It would be so valuable, but there’s just no way we could pull it off, it’s as the guy said, [inaudible 00:29:10], they’re going to get it.

Jason Buck:

Yeah, you’d probably need a hundred million dollars a year tech budget to keep on top of it, like to keep up the Red Queen principle, and then the firms that do do it, they’re not looking for URI investors, so that’s always the hard part. I always think about though market making has this unbelievably uncorrelated return stream, but my always question is it short ball or long ball? It depends on your capital base, and your access to liquidity, right?

Eric Crittenden:

Yes.

Jason Buck:

As markets blow out, it becomes much more a target rich environment, but you have to survive that blowout, and then you’ll be able to come back in. So, you have to really assess what is their dry powder, and or what’s their access to loans, capital, et cetera, from that bank, and is that bank solvent? Am I looking at that fairly?

Eric Crittenden:

Absolutely. Yeah, that’s the economies that scale I was talking about and the network.

Jason Buck:

Yeah, it’ll be interesting to see which one of those firms will blow up in a dislocated market and which ones will survive, and the ones that do survive are going to have unbelievable returns after that dislocation. You said three return sources, so eliminate the three return sources that you believe you have?

Eric Crittenden:

So, I feel like there’s capital formation markets, like stocks and bonds, which are kind of a one-way street, the risk premia is kind of a one-way street. I mean, the bulk of the risk premia is your long stocks, the futures, whether it’s metals, grains, livestock, energy, these are risk transfer markets and risk transfer markets are different than capital formation markets. I feel like risk transfer markets, you need to be symmetrical, you need to be willing to go long or short, because they’re a zero-sum game. They have term structures, so they’re factoring expectations, storage costs, cost of carry, all that stuff.

Eric Crittenden:

So, and then there’s the risk-free rate of return, which used to be a great way to kind of recapture inflation, it’s not so much anymore. We can get into that later on, it’s a fascinating time to be managing money, because there’s a huge gap between inflation and risk-free. But, historically speaking, those are the three that I think makes sense, especially in the context of an all-weather portfolio that uses futures to get its commodity and derivative exposure, because it leaves a lot of cash lying around. So, to go source that risk-free rate of return costs you nothing, there’s no opportunity cost, because you were going to be sitting on that cash anyways.

Eric Crittenden:

So, when I look at all the different risk premium on this computer or the one behind me, historically, I see those three blending together more beautifully, and there’s other ones out there, they just don’t move the needle for me. Things that are related to real estate, credit, they just all have that same trap door risk that the equity market has when the equity market’s going down. So, and then the rest of the time they’re expensive, they’re tax inefficient, they’re illiquid, and then they disappear on… Sometimes they get crowded, I mean, they just cause more problems than they solve. That’s how I feel about corporate bonds, credit, all that stuff. I mean, I wish there was something there, I know other people strongly feel that there is, but I’ve looked at the data until my eyes are blurry, for decades, and I don’t see it.

Jason Buck:

Yeah the way I always think about it’s like there’s only two ways of making money in the long-term is stocks and bonds are basically credit and debt, and they’re intertwined with each other. So, they’re very intertwined, obviously, on risk on, risk off, and then like you’re saying, all those other forms of sourcing are just leverage versions of credit or debt. So, that’s why we say correlations go to one in a sell-off, because they’re all the same thing. Now, during a risk on cycle, they might be fairly uncorrelated, you just don’t know. It depends on if there’s a mark to market or mark to model, but you threw those in the same bucket too, as stocks and bonds. So, I’m curious, how do you think about that? That’s overall a risk kind of on trade, is stocks and bonds, or why do you think about them in a similar vein?

Eric Crittenden:

Well, I was associating them with capital formation markets, rather than risk transfer markets. So, this is an important concept to me, because it goes to the point of why I do what I do, or why I think that macro trend oriented approaches expect a positive return over time, because the futures markets are a zero-sum game or actually, a negative-sum game after you pay the brokers, and the NFA fees, and all that stuff. So, in a negative-sum game, you better have a reason for participating. For you to expect to make money, you better be adding something to that ecosystem that someone else is willing to pay for, because somebody else has to mathematically lose money in order for you to make money. So, in studying the futures markets, and I’ve been on both sides, I’ve been on the corporate hedging side, I’ve been on the professional futures trader side.

Eric Crittenden:

I believe I understand who that somebody is, that has deep pockets, and they’re both willing and able to lose money on their future’s position. A trend oriented philosophy that’s liquidity weighted is going to be trading opposite those people on a dollar-weighted basis through time. It does make sense that they would lose money on their hedge positions, I mean, in what world would it make sense for people who hedge, which is the same thing as buying insurance, to make money from that? It makes no sense, that would be an inverted, illogical world. So, anyone who’s providing liquidity to them should expect some form of a risk premia to flow to them. It’s just up to you to manage your risk, to survive the path traveled, and that’s what trend following is. I don’t know why that is so controversial, and more people don’t talk about it, because I couldn’t sleep at night if I didn’t truly believe that what we’re doing deserves the returns that we’re getting.

Jason Buck:

No, you’ve stated this many times, and just for those that aren’t maybe deep in the space as we are, is [inaudible 00:34:51] will have CTA trend followers, or whatever, just they don’t really know how they make money. They’re like, “It’s trending, it’s behavioral, it’s clustering, it’s herd mentality, and that’s how we make money.” You’ve accurately portrayed it as these are risk-transfer services, speculators make money off of corporate hedgers. But the only thing I would push back, and I’m curious your take on this, is like you said, zero-sum game or negative-sum at the individual trade level.

Jason Buck:

But when we look more holistically, those corporate hedgers are hedging their position for a reason, and it’s likely lowering their cost of capital for one of the exogenous effects. So, my question always is, is it really zero-sum or negative-sum, or is it positive-sum kind of all the way around? In a sense that the speculator can make money offering these risk transfer services that the hedgers are looking for that liquidity, and then the hedgers are also… If we look at the rest of their business, they’re hedging out a lot of their risks, which can actually improve their business over time, whether that’s cost of capital, structure, or other exogenous effects.

Eric Crittenden:

Absolutely, I wish I had… You did record this, so I’m going to steal everything you just said. In the future’s market, it’s negative-sum.

Jason Buck:

Yeah, right.

Eric Crittenden:

But if you include the 50% of participants that are commercial hedgers, it’s no longer zero-sum. But most CTAs, and futures traders, and futures investors don’t even concern themselves with what’s going on outside the futures market. So, but if you pull that in and look at it, you can see, or at least it’s clear to me, we’re providing liquidity to these hedgers. They’re losing some money to us, and the more money they lose to us, the better off their business is doing, for a variety of reasons. Tighter cash flows, more predictable cash flows results in a higher stock price, typically. But you brought one up that almost no one ever talks about, and that is if they’re hedged, their cost of capital, the interest rate that they have to pay investors on their bonds is considerably lower.

Eric Crittenden:

Oftentimes, they end up saving more money on their financing than they lose on their hedging, and they protect the business, and they make Wall Street happy at the same time, so who’s really the premium payer in that, it’s their lenders? So, by being a macro trend follower in the future space, the actual source of your profits is some bank that’s lending money to corporations that are hedging these futures. So, it’s the third and fourth order of thinking, and you can never prove any of this, which is great, because if you could prove it, then everyone would do it, and then the margins would get squeezed.

Jason Buck:

Exactly, it’s like you said, a lot of people just don’t look outside of their concentric… Their circles just keep going out, and out, and out, and we have to figure out who’s making money here, and follow the money. Like you’re saying, a lot of traders just look at the actual individual trade, they don’t think of how the money’s getting made. Do you also think that… I always think of, and correct me if I’m wrong, options traders a lot of times are just risk transfer services as well. Especially if you’re a long option outlet or long volatility, I’m just building an inventory of risk transfer services when people actually want cash. So, please push back if you think that’s a misnomer, the way I’m looking at it.

Eric Crittenden:

I’d have to think about that a little bit more, but off hand, I would say yeah, I think that’s reasoned. But I haven’t put a lot of thought into that before, so you’re putting me on the spot, but my instinct is yeah, that makes sense to me right now.

Jason Buck:

Well, and I’m obviously being very generous to my own book as well, as far as we inventory liquidity with buying optionality, is the way I look at it. But also, so speaking about liquidity, you touched on something that I think is very unique to the way you look at markets is you talked about liquidity waiting. So, that’s very different, I think, than a lot of people look at their positioning, so tell me a little bit about that? Especially if you’re offering risk transfer services to corporate hedgers, it’s really incumbent on liquidity. Because also, as we went out and looked at their cost of capital, their cost of capital is also dependent on liquidity or people’s perception of liquidity. So, liquidity is the number one factor to the way you position, and I think that’s pretty unique compared to most people, is it not?

Eric Crittenden:

I think it is. Yeah, and it wasn’t my first choice. Let me tell you the story, I’ll try to do the two minute version. So, after I left my previous firm, I had a two year non-compete, so I had to sit on my hands for two years. So, I took that time to basically redo all of the research, and rethink every assumption that I’ve come up with. I’ll tell you a little bit about my biases, and my weaknesses, and how they affected the direction I went. So, I have what I call a very strong small cap bias, which is probably surprising, meaning that the way my brain works is I think if something scarce and hard to do, it must be more valuable than what’s laying around and freely available. That is a primal thing that is generally true in life, if it’s just laying around and available, like rocks or dirt, it’s not going to have a lot of value.

Eric Crittenden:

If it’s a diamond, or it’s platinum, or whatever, it’s going to be valuable. So, but that bias has followed me my whole life in my trading, and so I always have been a small cap guy. You have to get in there and trade small markets, you’ve got to do three-way spreads, you got to do stuff that other people don’t want to do. If it’s harder and more time consuming, the risk premium will be higher, and therefore, it’s worth it to pursue all of these esoteric type trades, and whatnot. That was my bias, so my other bias was strict control over risk, and absolute balance at all times.

Eric Crittenden:

Meaning, you get to look at the covariance, and you have to treat natural gas as if it’s special, because it’s uncorrelated with the other energies. Treat [inaudible 00:40:30] they’re special, because they’re correlated with every market, and then kind of dampen things like 10-year T-notes, because they’re the most redundant with all the other markets. So, because on paper, and in an optimizer, in a spreadsheet, it makes perfect sense, I know the math behind it. So, it turns out though that neither of those things are particularly true, if you’re looking at impact, actual impact to what matters to you. So, you build a utility function, and my utility function is the geometric return divided by the risk taken, not the draw down, but the risk you’re actually taking.

Jason Buck:

Define that? What do you mean by the risk you’re actually taking and not draw down?

Eric Crittenden:

So, it would be how much could you lose? How bad could the draw down get? Which requires some assumptions, but we know it’s at least the total open risk that you’re taking, plus the number of times that you have a draw down before making a new high. So, it’s kind of my own version of risk of ruin, that’s my own personal utility function. So, think of it like this, calculate your max draw down historically, multiply that by 1.5, and that’s your downside risk. Then take your geometric or compounded return and divided by that, and then there’s a little bit of [inaudible 00:41:53], too. It’s like, “Well, how consistent is that?” Is it all from one decade and the rest of the time you sucked, or was it reasonably consistent through decades? Not perfect, I’m not talking about that perfect equity curve, anyways-

Jason Buck:

Then sorry to interrupt, just a very specific issue, because I always think about these [inaudible 00:42:09] a lot of times. I assume that’s on your monthly when you’d multiply by 1.5, and then sometimes on your daily you need to hire multiple, or how do you think about that?

Eric Crittenden:

Everything I do is using daily data.

Jason Buck:

Daily, so you feel 1.5 times your max is good on a daily?

Eric Crittenden:

Yes, but I wouldn’t feel that way if I had a more fragile set of rules. So, that’s only fair if you really believe what you’re doing is durable, it isn’t lying to you, basically. All right, so let me rewind here, what were we talking about? I lost my train of thought.

Jason Buck:

You were talking about the diversification effects on whether that’s true or not on a sector basis, and then-

Eric Crittenden:

So, I took two years off, and I built the most elegant thing that I could possibly build, is this super CTA, at least in my mind. It was doing everything that I wanted, it had the most complex value at risk, it was the different versions of modern portfolio theory. Just essentially, normalizing every position, so I did it many different ways, where it was beta neutral, where everything had the same risk contribution. So, I ran it every way I possibly could, it took forever to build it all out in Python, and it looked good. But when I was done, when I was finally done, I looked at it and I asked myself, “Would I put my mom’s money into this?” The answer was just immediately, “No way,” and would I put my own money into it? I thought, I’m not sure about that.

Eric Crittenden:

What’s my problem here? So, I started working backwards and I just realized that it’s just got way too many features, way too many moving parts, and I’m not comfortable or I’m not super confident that all of these moving parts are worth it. So, I did something interesting, I sorted all the features from most important to least important, and then inverted it, and I just started removing them one by one, the least important ones. Then each time I would remove it, I would rerun and look at the impact, and I was just really surprised at how little impact that these features that sound so important makes no difference to the long-term. They don’t increase the return, they don’t reduce the risk. Then if you focus on turnover and the consequences of turnover, the operational heartache, the potential for trade errors, the taxes and stuff like that, it really starts to become apparent to you that I need to be getting rid of a lot of these features, because they’re not moving the needle or making a difference.

Eric Crittenden:

So, I started off with 18 features, I was able to remove 15 before I saw anything that bothered me, 15 out of 18. In that 15 are the things that CTAs and other people feel are so critically important. Now, remember this is a 50-year simulation using all the futures markets that existed during that period of time. So, a lot of different markets, many of which are gone today. So, Eric, you knew this, you knew this intuitively really, and you’re just trying to provide liquidity to hedgers and collect that risk premia in a durable way. You don’t need 50 features, you don’t need 18, there’s really probably only three, maybe four. So, I bit the bullet and said, “You know what? I’m getting rid of all that stuff, and I’m just going with a really simple, durable approach.” It’s got a little bit higher volatility, slightly lower returns, but I can sleep at night, because I really do believe this thing’s durable and it’s going to be around in 30 years.

Jason Buck:

Do you think this is an example of the opposite of curve fitting? Because, basically, everybody builds out more and more features to curve fit more and more. You started with all those features, then just kept reducing, so this was kind of a perfect example of the opposite of curve fitting.

Eric Crittenden:

Yeah, which you could only learn, I think, by doing it, by suffering the consequences of having-

Jason Buck:

Of doing too much, yeah.

Eric Crittenden:

Yeah, but it also revealed to me some of my own blind spots, that small cap bias, I still have it, but I know better. I know better, and I can put policies in place [inaudible 00:46:13]. I know not to trust it, that weird voice in the back of my head that thinks that trading palladium’s important, it’s just not, lumber’s not important-

Jason Buck:

Well, see that begs two questions though, to me, it’s like that’s what we had especially last year, everybody kept coding the lumber market and everything. I kept asking like, “Who actually trades lumber though?” It’s such a small and capacity constrained market, so that’s kind of one of my questions for you is how do you think about that? Whether it’s lumber, lithium, et cetera, or carbon credits, these are very small markets. I know you try to make sure you don’t have too big a AUM, and I think a lot of the classical macro trend or CTA trend followers, their AUM is such a large size that they’re not trading a lot of what we call smaller caps in this space. So, you don’t think there’s advantage there, but I’m just curious, in these markets like this one, we primarily saw just… Whether it’s lithium or lumber, these just crazy markets, but also, that makes it even harder to trade even with the system, because your open trade profit can get smoked and you can blow through your stops on the other side.

Eric Crittenden:

I feel the same way about it that the equity guys feel about micro-cap penny stocks. Yeah, they’re amazing, some are up a thousand percent this year, what differences it make? It’s not real, it’s not real to me and my asset base. So, if it’s not real, I’m not going to worry about it. So, lumber, it’s not going to move the needle in a fund that is making a difference out there for people. [Inaudible 00:47:35] you got to have a couple billion dollars to be making a difference for people, meaningfully, and Lumber’s just not going to fit into that portfolio. The carbon emission credits do, it’s like the 18th most liquid features market in the world. Look, if there’s no liquidity, there’s no hedging that’s available to us to transfer the risk, so where’s the risk premia? It’s not there.

Jason Buck:

But to your point earlier, I think that’s when people are running back tested, don’t have a lot of marketing experience, you tend to run with-

 

Jason Buck:

… when people are running back tested, don’t have a lot of marketing experience, you tend to run with those smaller caps and it looks great on paper until you find out in real life, all of your commission slippage, blowing through your stops, getting limit down, all of those things, they’re not really factoring into their back test. Is that fair?

Eric Crittenden:

I think it’s fair. But if you liquidity weigh all of your rules, your positions and your back test, that phenomenon won’t come back to haunt you.

Jason Buck:

There’s something-

Eric Crittenden:

I run-

Jason Buck:

Go ahead.

Eric Crittenden:

I run my system right now like it’s got $12 billion in it. The model believes it has $12 billion, and then we just ratio down to our current asset base. So that’s important because I don’t want to have the conversation with my clients, say three years from now, that they say, “Oh, I love this thing and I want to buy, tell me how it’s changed.” And it doesn’t even resemble what I was doing in the beginning. That means I can’t trust it. It needs to be fungible from one period to the next. So I run it like it’s got $12 billion in it right now. That way, if I’m fortunate enough to be successful three, four years fr