Pod Insights Michael Covel's Trend Following Ep. 1329: More Trend Following Masters with Michael Covel on Trend Following Radio About this episode Please enjoy my monologue More Trend Following Masters with Michael Covel on Trend Following Radio. This episode may also include great outside guests from my archive. --- I’m MICHAEL COVEL, the host of TREND FOLLOWING RADIO, and I’m proud to have delivered 10+ million podcast listens since 2012. Investments, economics, psychology, politics, decision-making, human behavior, entrepreneurship and trend following are all passionately explored and debated on my show. To start? I’d like to give you a great piece of advice you can use in your life and trading journey… cut your losses! You will find much more about that philosophy here: https://www.trendfollowing.com/trend/ You can watch a free video here: https://www.trendfollowing.com/video/ Can’t get enough of this episode? You can choose from my thousand plus episodes here: https://www.trendfollowing.com/podcast My social media platforms: Twitter: @covel Facebook: @trendfollowing LinkedIn: @covel Instagram: @mikecovel Hope you enjoy my never-ending podcast conversation!
Transcript 0:00 Speaker 00 As everyone sits around and looks at the same news, the same images, the same war, the same economy, and the same talking heads. Every day, the same people, the same whatever. How the hell does any of it help you? It doesn't. Of course, I'm guilty of occasionally checking out the news and knowing what's going on. But it doesn't help you for trading. The fundamentals, or as Ed Cakota calls them, the funny mentals, are not part of the game. If the game you want is winning.
0:45 Speaker 00 Today, following up on last week, let me give you part two from my book Trend Following Masters, the first volume. Because, because, because, because this kind of thinking from the guest that I'm going to play today, from my audiobook, can make you a million bucks or a billion bucks. It really just comes down to how much do you want it? Do you want to trade for yourself, or do you want to become a huge fund? It doesn't matter. Trend following can go either way. Without any further delay from me, let's jump right in. I hope you enjoy, and I'll see you again next week.
1:41 Speaker 01 Chapter 2, Harold de Boer, From Farm to Trend Following. Harold de Boer is the Managing Director of TransTrend and architect of the Diversified Trend Program, responsible for research and development, portfolio management, and trading. Harold was born and raised on a dairy farm in Trenta. From a young age, he has been intrigued by linking mathematics to the real world around us. In the final phase of his studies, while working on the project that would later become TransTrend, he became fascinated by the concept of leptocortosis, or fat tails, in probability distributions, a topic that has inspired him throughout his career.
2:26 Speaker 01 Michael Note I'm not sure why it took so long, but after years and years of waiting, Harold finally said yes to an interview. What an amazing story from the Netherlands.
2:39 Speaker 01 Michael Covel You have an interesting approach to the markets, best described as a combination of a farmer's common sense and mathematics, while at the same time never losing sight of the underlying fundamentals. People may be thinking, what kind of strategy is that? Guess what? It's trend following. You have a consistent track record every month back to the 1980s, and you're one of the legends of the industry. TransTrend is now at over $4 billion under management, and is absolutely one of the leaders in the trend-following world. I love the phrasing that you use to describe trend-following. Here's a quote. "Our investment strategies are guided by the footprints left by people running after ideas.
3:23 Speaker 01 That is, the prices they set in the market. It's all just an idea. It has no impact if nobody buys it, nobody uses it, nobody votes for it. But every time people do run after an idea, the world changes. Our world is shaped by people running after ideas." That's a great descriptor of trend-following. How did that idea come about?
3:48 Speaker 01 Harold de Boer I wrote that when I was asked to explain the idea behind trend-following. I like to explain in terms that are not too technical. The fundamental thing behind trend-following is there are a lot of people, including economists, who believe in a world reverting to equilibrium. So, prices can be temporarily high, but they will come down again. And prices can be temporarily low, but they will come up again. There is a reversal to a constant state. But if you look at the world, there has never been a constant state. It's constantly a temporary constant. Look at the big developments of the past. For example, in the Netherlands, until 100 years ago, people didn't travel by road, people traveled by water.
4:34 Speaker 01 What if investors had said, "Roads are coming, and people are using horses more and more, and carriages, and later on cars, or even trains? But it'll come back to the equilibrium of people mostly using boats." Of course, that's wrong. It was a normal development. These developments, big developments, are happening constantly. That is the main driver behind trends in markets. In the last few years, there has been a big move from people driving cars powered by gasoline toward electric cars. In an electric car, there is three times as much copper as in a regular car. So this has a big impact on the market.
5:18 Speaker 01 It means that there's more demand for copper than there was before, and there's more demand for all kinds of other metals. This is not something that will revert. It's a new development. Maybe in fifty years' time, people will not be driving electric cars anymore, but driving something completely different. But there's no way that it will turn back to the cars we had twenty years ago. It's a constant development. Michael, I like that you describe your work in a hands-on way, so that the average person can approach it. Other people in the industry talk about the statistics behind something, the academic aspects of it. Now, don't get me wrong, you guys have your academic and statistical chops as well.
6:02 Speaker 01 You have sophisticated, statistically-based strategies. But philosophically, you're clearly comfortable explaining things in everyday terms. Harold, for that, I have to thank the professor who guided me through my degree in mathematics with his specialization in statistics. He was an old-school professor whose background was in industry. His experience in industry taught him to see a problem, something that had to be solved, and then identify what kind of statistic would solve it.
6:33 Speaker 01 If that statistic didn't exist already, he would create it. Based on that practical experience, he became what we call in the Netherlands, a doctor of statistics, and then he became a professor.
6:47 Speaker 01 My philosophy is, first look at the real world, then choose the techniques and then apply them. What often happens is that people start with the techniques instead of the real world situation. There are not many markets where it is reasonable to assume a linear relationship. If you start your research by looking for correlations, you've made a mistake already. You can keep on doing calculations, but the problem is that using a linear correlation measurement, such as Pearson's, which is the most commonly used one, already assumes that any relationship will be linear, when there's absolutely no reason to assume that. Those fundamental choices are important.
7:31 Speaker 01 We often have discussions about whether what we're doing is technical analysis or fundamental analysis. It starts with fundamental analysis. Search, decide which techniques can be used, and only then does it become purely technical. This is somewhat opposite to what other people do. The more traditional financial approach is to start with the technical element and then make the fundamental case.
8:00 Speaker 01 Michael, you mentioned the statistics professor. Let me take you back in time before that to your early life on the dairy farm. What's the connective tissue between where you are today and growing up on a dairy farm? How did that shape you in terms of your current world? Harold, there's a lot of connective tissue, because there are many developments going on in the dairy industry too. For example, the Netherlands was a global leader in dairy cows for many years. During the 1950s and 1960s, other countries, including the United States, began importing cows and calves from the Netherlands and breeding from them. The Dutch kept on thinking that their cows were the best in the world,
8:45 Speaker 01 so they were only concerned with the appearance of their animals and other non-relevant issues. While in the United States and some other countries, the stock was being bred for more efficient production and less disease. Then, in the nineteen seventies and nineteen eighties, Dutch farmers began to realize, hey, we've made a mistake here. My father was among those farmers who started to use the sperm from US bulls to improve their own herds again. That was a development that required a fresh look at genetics and the statistics behind them. My background in statistics started with looking at how we could justify making changes in cow breeding.
9:27 Speaker 01 Michael, the real-world application of your math background is taking place right there on the family farm? Harold, I learned statistics from how it applied to cows and calves and colors and all the genes. Then later on, at school, I learned from the statistics books and they fitted. But that's the way I learned it first. Michael, you're saying to the younger generation coming up, hey, hold on. You might not get exactly the education you need to compete with me at the academic universities. You might need to go to the farm? Harold, not only the farm, it doesn't matter where it is. Look around the world. I grew up on a farm surrounded by cows.
10:10 Speaker 01 But you could just as easily get the similar experience in, let's say, a railroad company. Start with looking at the world, see what's happening and what structures are there and what developments are going on. We have an item on our website that says if you take a picture from fifty years ago, you will recognize it's a picture from fifty years ago. There will never come a time that this picture could be taken again, except for in Hollywood and other places where they can remake history. But aside from that, the world is continuously changing. Michael, according to the scenario you've described,
10:51 Speaker 01 your math background gave you a real world view and your farming background introduced you to commodities. When did the transition first happen? We're talking about the nineteen eighties. What was the moment you said to yourself, okay, I'm going to go into trading? There must have been a lightbulb moment when you said, okay, there's this trending behavior that's interesting to me. Explain that story to me. Harold. My professor said that to finish my degree, it was best to find a real-life problem. This was pre-internet and email, so I had to write letters to all kinds of firms and ask them if they might have some problem which it would be interesting for someone with a mathematics background to study. I got two appealing possibilities.
11:37 Speaker 01 One was with a dairy factory and the other was with a company that traded agricultural commodities. Because of my background, I was thinking, "When I grow up, I'll be working in the dairy factory. So for now, I'll have a look at this trading firm, because this is something I don't know anything about and it'll be good experience." That's why I chose the trading firm. The company was a traditional commodity trader that used the commodity futures markets. They had begun to notice that more and more so-called firms were active there. To their astonishment, those firms never took delivery and never did anything in the market, but still made money.
12:19 Speaker 01 They said, "If these people are able to make money in our markets, then we should be able to do that ourselves too on a more technical level." That's where the project started. I came to the project to finish my studies and it proved to be interesting. We did all kinds of different things. My first research task was looking at the relationship between meats, cattle and ox, or feed cattle as they were known in those days, and grains and feeds, soybean milk, corn, and so on. There are all kinds of interesting relationships between those markets. From there, we looked at carrying out some kind of arbitrage study.
13:01 Speaker 01 But on further consideration, we realized it could be interesting to do that on a more fundamental, semi-fundamental or semi-technical basis. But it's a big risk, because if you are wrong, it can be a costly error. This is, of course, a big disadvantage of arbitrage strategies in general. In the meantime, we were doing all kinds of other analyses, testing strategies that had been written about, as well as traditional technical methods such as trend lines and so on. Our research revealed that trend-following-type strategies were interesting. One of the reasons being that many different markets can be traded at the same time, enabling a large diversification.
13:44 Speaker 01 In the case of arbitrage, if you are wrong, the only thing you can do is hang fire, because you think the markets will come together. With trend-following, it's the opposite way around. If you are wrong, then you get out of your position or go your own way. Trend-following is also a much better fit with the idea that relationships between markets can fundamentally change, something that is much harder to account for with arbitrage. We saw this issue with the trader in Norway that lost a lot of money in a spread between German power and Norwegian power at a time of significant change in the price of emission rights in Europe.
14:24 Speaker 01 Issues such as climate change can seriously undermine an arbitrage strategy, while in trend-following, it's no problem at all. It's interesting that emission rights are currently, 2018, one of the best trends in the markets. By studying these different philosophies and different ways of treating markets, we found out that trend-following is good. The main benefit is that trend-following is so great to use in a diversified way. However, we had to solve one issue, because the company we worked within had chosen to only trade commodity markets. You have to realize this idea started just after 1987, which had not been a good year for investing in stocks.
15:09 Speaker 01 They decided, whatever we're going to do, we never want to be in financial markets. We said, with trend-following, you can also trade in all these financial markets if you can support diversification certification.
15:23 Speaker 01 We had to explain to them why this made us different from many traditional hedge funds, which typically have a financial background, and sometimes fail to see how the same strategies can be applied to commodities. Our experience in commodity trading gave us a completely different view about how markets function. Things such as time structure and old crop, new crop are relevant for commodity markets. Michael, let me keep you on that point for a moment. Given that you started in commodity-only markets, when did it occur to you that trend following could apply to other markets? Or did you always know that these techniques could work in the full global suite of markets?
16:05 Speaker 01 Harold, we didn't realize this could be done for all markets at that time, because there are more markets now than there were then. Let's say stock indices were pretty new. The stock index futures started in 1982. I think S and P 500 was the first one. There were not that many stock market futures, and of course, sector indices and single-stock futures didn't exist at all. But currencies and bond markets were being traded, and those were ideally suited for these techniques. Later on, we realized that you could do the same thing, not only with stock indices and single-stock futures,
16:47 Speaker 01 but also with emission rights and those kinds of new markets that didn't exist before. It's relevant to keep active in new markets. I remember, around 1998, we decided that we wanted to trade the NASDAQ futures, and our largest client at that time said, "Why would you want to trade such a small market?" We said, "It may be small at this moment, but maybe it'll grow." No one nowadays would call the NASDAQ futures a small market, but at that time, it was something new, so was it going to last? Well, it has. Michael. Rolling forward from events in the 1980s and early 1990s,
17:30 Speaker 01 here we are in 2018 and I gather you now trade for 500-plus markets? Harold. Yes, but that's not relevant because although there are 500-plus markets, the actual number of different trends is smaller than that. Right now, you have an energy trend and you can say, "We trade heating oil and we trade gasoline and we trade oil." But on a day like yesterday, for example, all these markets came down. We used to say the more markets, the better, and it's true, you still need diversification. But you also have to realize that real diversification is not measured by the number of markets, but by the number of different underlying trends we can be positioned in.
18:16 Speaker 01 Michael. Talking about trends, there's another great line that I've seen come from your world. "Price trends are as inherent to markets as the wind is to the atmosphere." I love the way it gets people thinking about trends and movements. I'm going to ask your opinion about factors. The academic world is trying to make a breakthrough here, but again, strays philosophically from what you've grown up on. What you have done with your firm is to stay grounded and say, "Hey, these big trends exist. They come from sound reasons. We can look at why these things start to happen." But they're unexpected. What is your view of factors? Bearing in mind that academics have claimed that there's a factor for momentum and there's a factor for value,
19:01 Speaker 01 and you can just isolate it and find it in a back test and apply a hundred billion dollars to it? Harold. There are factors, but those ones you mentioned are not relevant. Relevant factors are if OPEC is doing something that has an impact on the oil price or on the price of stocks for oil firms or on the value of the Norwegian kroner, that kind of thing. OPEC is a factor. A central bank policy is a factor. Environmental pollution by governments is a relevant factor. Those are real-world factors as opposed to academic ones. When you talk about investing, you should explain, "We are buying copper now for this and this reason,
19:45 Speaker 01 not because of momentum or because of value or whatever." Of course, when many investors are following those factors, it produces a short-term impact. However, that will generate a price movement that does not fit with the underlying markets. Because when investors are buying more and more copper for some kind of academic reason, instead of a real-life reason, it doesn't mean that consumers will use more copper, or that there will be less copper produced. Ultimately, it's all about the real-life markets and not about these future switches. When that doesn't work, then those factors are not relevant. The relevant factors are what's happening.
20:28 Speaker 01 Michael, does it make you smile, as a man who's been in the markets trading for thirty-plus years, when you see some of this new branding coming along? Where everyone all of a sudden is talking about factors? Harold: Yeah, but don't forget branding can become a factor in its own right, which can impact markets. Especially nowadays, you have to understand that markets are being driven in the short-term by factors that should not drive them. Prices can go away with a serious force because of investment flows, rather than being driven by what's happening in the underlying markets. People often think that an active investment style, or even a fundamental style,
21:12 Speaker 01 should be able to make more money nowadays because of the large number of passive investors. But that's not true. Because the power of all these passive flows is so strong, then an active fundamental investor has to be able to withstand that force, which can drive the market in the wrong direction. Sooner or later, it will go in the right direction, but it makes it harder for active investors. This is a problem, because if active traders cannot have a big impact on the market, it's not healthy for the economy as a whole.
21:46 Speaker 01 Michael, you've explained why many fundamental factors are useful, but do you have moments when your own decision-making is driven by the simple heuristic of price action? Harold, we have to, because we are not a fundamental trial. It's not that we say, "From a fundamental point of view, the price of cocoa is too low at the moment, so we will buy." No, we will buy if there's an uptrend. But we do realize that there can be a significant uptrend when the market has been too low for a long time, which happened, for instance, in 2018 in the cocoa market. This all has to do with to what extent does the market as a whole still function?
22:31 Speaker 01 Market participants play an important role in that. If more and more market participants start to behave in a way that does not match with the underlying markets, they do have big impact. For example, from a fundamental point of view, you could ask why Tesla's stock has been rising so much while the company never made a profit for many years. Well, it's because investors are buying it. Then they buy more, then it becomes a bigger index and passive investors have to buy even more. Ultimately, it's hard to stop such a thing. Finally, Tesla did make a profit, but this is immaterial. The most important driving factor is getting more and more in indices,
23:16 Speaker 01 and as a result, the stock will keep on growing. You cannot go short on a company or any other markets as long as there's so much power driving it, even if you fundamentally believe it's being driven the wrong way. Take Brexit, for instance. It doesn't matter whether we think it's a good idea or a bad idea. It's happening, so it will impact markets. We have to take into account that these markets are driven by people who support that idea. If people vote for something because they believe in it, whether it's the president or whether it's a movement like Brexit, it doesn't matter if what they say is true. It's all about whether people are getting behind it.
24:00 Speaker 01 Then it will create trends in markets, which will have an impact on growth as a whole. Michael. To follow up on your point about Brexit, yes, you can have a personal opinion, but that opinion is not factored into your decision-making for the funds you are trading. Harold. No, but it does have a role. We can look at what kind of effect this might have and how our systems work. Are there elements that will not be taken into account by a correlation message or whatever? Is there any place and the event that the way we work is not right for? It can be something simple, like, are we trading the right markets?
24:42 Speaker 01 We have to realize that certain events or situations can create trends. We also need to evaluate whether what we have observed fits with the underlying idea. The Brexit referendum was a case in point. In many respects, what we did was exactly what we expected to do and how our system would respond to such a thing. But there were also a few surprises in there, and some elements we could have handled better.
25:12 Speaker 01 Based on this experience, we did make some changes to the way we execute business in volatile environments. We profited from that following the outcome of the US election when Trump was chosen, because again, that night, there were some erratic moves in all kinds of markets, which we could better profit from because of changes we made after evaluating what happened after Brexit. Michael. Before we leave the subject of trends, I want to quote from your world. This is a great short paragraph. I'm going to let you explain it and we can break it apart. Trends in particular, those that are most profitable for trend-following systems, like those in DTP, a trans-trend program,
25:57 Speaker 01 are comparable in a number of ways to burning haystacks. Once such a fire has broken out, it's often hard to extinguish. The same applies to price trends. But equally important, a haystack normally does not start to burn all of a sudden. The fire is typically preceded by so-called self-heating, a fermentation process whereby the temperature gradually rises, starting at the core of the haystack, eventually leading to spontaneous combustion.
26:26 Speaker 01 I wish I'd written that in one of my books. I wish I could steal it from you, but I can't because everyone knows it came from you. Harold. Yes, that's something we worked on when we saw what was happening in the second quarter of 2012, a period in which normally you would expect a trend-following strategy to work well. There was a sell-off, especially in emerging market equities, that then also went over to other markets. This was the kind of movement where you would typically think a trend-following strategy should be doing well. We made some money there, but we realized, this is not enough. We should have been doing better in this environment.
27:08 Speaker 01 We tried to figure out what made this period different from previous ones. We traced the story back to the Russian situation in the late 1990s. The oil price had been going down for a long time, for obvious reasons to do with the oil industry globally. But for Russia, this was a big problem because its economy was dependent on oil. Until then, most investors in Europe, the US, and further afield, were not watching what was happening in Russia. But all of a sudden, this Russian crisis impacted all the markets at once. When there is a fire and it is combusting, it's impacting many, many other markets, even markets that should not be affected.
27:52 Speaker 01 These kinds of movements can create big reverses in some trends. The US stock market could also come down as a result of the crisis in Russia. We would normally not profit from being short the US stock market in that situation, because it was not happening there. Where you can profit is being at the source of the event. To make money, you have to be positioned at the base where the thing is happening. For instance, at the start of 2018, the Turkish lira had been declining for a long time. This was just a local Turkish issue that had nothing to do with what was happening elsewhere.
28:33 Speaker 01 All of a sudden, one morning, The Financial Times published an article about European banks that would have problems because of the situation in Turkey. This sparked a sell-off of stock markets worldwide, and of emerging market currencies above all, for instance, in South America. The Turkish issue was far from new, but this one story triggered the spread of this fire to all kinds of other markets. At that moment, we held positions in the South African rand, and were losing on them because the rand was coming down as a result of Turkey. But to profit from such a situation, we had to be short of Turkey, since we had large-short positions in Turkish lira.
29:18 Speaker 01 That's where the fire started and was still going on. That fundamental awareness has been the basis for many changes we've been making to ensure the choice of programs optimizes the chances of high profit. It is likely that we hold sizable positions in any haystack that could become the next big fire. You have to be in that haystack, and not in one that is being impacted, because if the latter, you're probably on the wrong side.
29:48 Speaker 01 Michael, I like how you describe a gradual start of a price increase or decrease as "self-heating," the well-informed insider is making moves. When the average person sees a little bit of up-or-down movement, they're not necessarily drawing much conclusion from that. But a price-based approach, such as you employ, does lead to a conclusion. Harold, we have to make sure we do, because that's relevant. If we don't, we're on the wrong foot. And when we're on the wrong foot, we're losing money. It has to do with the broader change in the world. Let's say until fifteen or so years ago, oil traders didn't know everything about oil, but they read everything that was relevant to oil.
30:31 Speaker 01 People trading Canadian bonds were well-informed about Canada, Canadian politics, Canadian monetary policy. People trading soybeans, such as our former parent company, know everything about soybeans, but were not interested in Canadian monetary policy and the like. There were a lot of specialized people and information was held within particular groups. This was the status quo up to the credit crisis, which started in 2007 in the interest rate markets and infected the stock markets the following year. Now, information was being spread in fear via the internet and social networks,
31:12 Speaker 01 resulting in much more information becoming available to many more people at the same time. You would think, if people have more information, they can make better decisions. But what happened in practice was that everyone was being exposed to the same information at the same time. For a few days at the start of 2018, many people were only looking at Turkey. The following week, they were looking at something else and forgot about the previous issue. People trading oil maybe should not look too much at Turkey and just keep focusing on what's happening in the oil markets, because that will be more relevant to their business. If everyone is looking at the same thing at the same time,
31:54 Speaker 01 local self-heeding will be less visible because people who should be focused on trading corn are going to be distracted by other factors, while the more relevant factors for the corn trade are not coming into the markets until they become a problem. This is what happened in 2012. All of a sudden, there was a drought, but a drought doesn't start overnight. It's something that develops slowly. In well-functioning markets, there are enough informed people who understand the drought is ongoing, and as a consequence, the price of corn will rise. If that doesn't happen because people are too preoccupied with storylines that are running in the media at that moment, then the corn market is not developing well.
32:40 Speaker 01 It's hard to recognize trends. This is one of the things that has made trend following more difficult over the last few years. You have to make all kinds of amendments to make it better again. Michael, I'm getting the impression you don't work under benchmark pressure. How has that unfolded? Listening to you, I can see there's a sound philosophy from the ground up. But investors are often irrational. I'm assuming you've trained your investors well. You've had performance for a long time, which helps a lot. But how have you allowed yourself and your firm to steer clear of benchmarks? Because benchmarks can cause psychological harm, can't they? Harold.
33:21 Speaker 01 As CTAs, we have far fewer problems with benchmark stock investors who are trying to stay close to a benchmark. I wouldn't go as far as to say that benchmarking has had a negative impact. But back in the 1980s, even some of the most successful US CTAs were not recognized by the broader investment community institutions. So they would not invest at the CTAs. Coming into the 1990s, and especially the early 2000s, when we had some stock market sell-offs, institutional investors realized that trend-following strategies could be okay. What happened next is that trend-following started to be seen as an investment style,
34:04 Speaker 01 as opposed to many different traders doing similar things and all doing well. Rather than going with a name such as John W. Henry or Temple, for example, investors decided to invest in trend-following, and then had to choose which name to invest in. That didn't ultimately make things any better, because there are essential differences between investment managers, and it's important that investors realize the differences. Trend-following became successful in the 1980s and 1990s because all these investment managers were doing maybe similar things, but also a lot of different things. Their variation made them strong together, which is generally true in nature.
34:48 Speaker 01 If you have, let's say, dogs that resemble each other too closely, it isn't healthy for the breed. The same thing happened in the CTA industry, in which it became important to be aware that you constantly had to make the best decision from your point of view, instead of being influenced by an investor demand to follow the trend. We were successful, not because we did what we were expected to do, but because we did what we thought was right. If I go way back in history, when we did the first studies on trend following, we found an article that stated there were three important factors in trend following. One, you should always be in the market.
35:31 Speaker 01 Two, you should always trade the same size. Three, you should always use stocks. When we did our own research, however, we discovered the reverse. You should not always be in the market, you should not always trade the same size, and you should never use stocks. We accepted everything about trend following except for the three factors being recognized as the basis.
35:59 Speaker 01 Once, I was with one of my colleagues at a conference in Italy. As we were walking to lunch, we overheard the conversation of some potential investors walking in front of us. One said, "Those people behind, they are from trans-trend and they're good." "Yes," the other one agreed, "they are good." But then the first one replied, "They don't use stocks, though. That's bad." "Yes, that's bad."
36:26 Speaker 01 Those investors decided not to invest in us because we didn't use stocks. In recent years, there's been a lot of stories about what trend followers are supposed to do and what they're not supposed to do. You see this with independent advisors who resort to box ticking. "Are you doing this? Are you doing this? Are you doing this?" It drives investment managers to take decisions that are not necessarily for the best. Being selected based on a box ticking exercise that says a trend-following CTA has to use stocks, and if they don't, you won't invest with them, is unhealthy for the industry as a whole. Over the last few years, I've seen some developments in making CTAs more diverse.
37:12 Speaker 01 I think that's important. CTAs should be studying the market and doing their best to make money, but there's no rule they should be using stocks or crossover strategy or momentum, where they should be using a value-at-risk measure that is defined in such and such a way. Absolutely not.
37:32 Speaker 01 Michael, have you always been systematic going back to the late 1980s? Harold: Yeah, in the research project we carried out, some things were based on more fundamental strategies. So the first trades we did in the markets were sizable, but nowadays we would call them marketable trades in commodity markets. My first research was about developing hogs and the impact of the 1998 drought on the number of pigs and the amount of corn. What kind of price move can you expect then? We decided to take a long position on core hogs and made one million dollars. From that start, we financed our long-term research.
38:14 Speaker 01 We ended up doing everything systematically, but always keeping in mind the underlying market. Michael, I'd like to make a point to buttress everything you've said. You lay this foundation of knowing how things work, then use those real-life factors to apply a trend-following approach. But some people might not know that you're systematic, which throws another wrinkle into it. You can have strong opinions, but at the end of the day, your system is written down, it's coded, and you're executing in a systematic fashion. Harold: Indeed, I want to make it clear that our process is not to read about some rules and then apply them.
38:54 Speaker 01 We studied the markets and, based on that, we choose techniques and we systematically apply them. That's different from starting with techniques. Michael, I guess there's been some change in the last handful of years, but for a long time academic papers and Nobel Prize winners were telling you, "Harold, markets are efficient and you can't be doing what you're doing. It doesn't work." And here you are for thirty-plus years, scratching your head. I seriously doubt you're scratching your head. You're happy with the direction you've taken, but it must have been interesting to watch this community of folks across academia and Wall Street talking about efficient markets over the course of your career. Harold
39:38 Speaker 01 I have turned in a completely different direction to academics. I wouldn't even call many of them academics anymore. Look at the number of articles being published that contain nothing more than theoretical results. If you wanted to publish something like that, say, twenty years ago, the discussion would be about whether you had to take into account one percent or one point five percent price impact. The outcome always was, "It may seem like you can make money, but if you take into account the cost and the market impact, there will be no result in practice." Nowadays, you read more and more articles that argue that while markets are efficient, liquidity is large, and therefore, we don't have to take into account any market impact.
40:23 Speaker 01 I don't understand the academic reasoning behind that. Because how do markets move and how do prices move if not due to the impact of people trading these markets? The role of investors is to be aware that they have market impact, but they're not the ones that make profit out of the markets, and the markets themselves will automatically go in a certain direction. All the participants make the market, and all movement creates market impact. The academic argument that market impact happens automatically doesn't work because it denies the fact that markets are being moved by what people are doing in them. Take a stock like Apple.
41:05 Speaker 01 People may think that the price of Apple stock rises when many people are buying iPhones, but that's not what happens. They can sell lots and lots of iPhones, but if no one buys the stock, it will not rise. The stock only rises because people are buying it and are willing to pay more for the stock than they were previously. We all hope this is because they expect Apple will sell more iPhones. But if they forget that element, then the price will not move at all, or it will move in another direction. Market impact is the only thing that moves markets, and as an investment community, we have to take that into account. We have to be aware that we should never neglect underlying markets.
41:50 Speaker 01 Michael, given the longevity that you've enjoyed in the trend-following space, it must be some comfort to have a real-world record that people can look to. Of course, the past is the past, and we don't know what's going to happen, but we can draw a little bit of inference from a long-track record. It's got to be interesting to some degree to see so many academic folks going straight into fund management with all of these papers and raising a lot of assets on techniques that might not be the best thing in the future. Harold, I recently gave a presentation about responsible investing in commodities. A lot of investment benefits are derived from long-only positions in commodity futures. Some people present semi-academic arguments
42:34 Speaker 01 why being long in a commodity future would give you some kind of risk premium. These arguments are completely wrong. From day to day, there's a risk premium normally being paid by the ones that are long and not by the ones that are short. There's a fundamental reason for that. So, all these semi-academic stories that say, "Well, you can invest long-only commodities, and you can do it like this, and you'll get the risk premium," often they refer to claims. There's one basic rule for anyone who wants to invest in commodities. If some investor tells you why his strategy works, and he refers to claims, you can be sure that he did not read claims,
43:19 Speaker 01 and if he did read claims, he did not understand it. Such an investor will surely not make any money on the strategy. The best way to recognize a bad investment manager in commodity markets is someone who refers to claims. I once came across an investment manager who described claims as "a cost-of-carry model." This is based on the idea that you can store a commodity and then sell it at a later date. The price between the futures now and the futures in the future is the cost of carry. In other words, the cost to store that commodity. The investment manager illustrated it with reference to feeding cattle. While feeding, the cow has to be, for argument's sake,
44:04 Speaker 01 between three and six months in age. There's no way you can store the costs of this cow for a year, and in a year's time, it's still between three and six months in age. There are some people who would like to believe they could live one year without getting older, but it's completely impossible. Using these kinds of theories and applying them to things that are absolutely not connected is a bad use of academic theory. Michael, have you perceived any advantage over the course of your career from being based in Rotterdam or from being Dutch? Harold: Yes and no. For potential investors, the distance can be a deterrent. What often happens is that potential investors will arrange a trip to London,
44:49 Speaker 01 where they can meet many different investment managers over a couple of days. They will not visit us in the Netherlands or our colleagues in Sweden or Paris, because we're farther away. However, the ones who make the effort to visit are more motivated, which means we waste less time talking with potential investors who are not serious. It can be an advantage or a disadvantage, depending on how you look at it.
45:16 Speaker 01 Another difference is with the staff we have. We're not competing for people who can choose to work for another firm around the corner. These people have chosen to work with us, and if they wanted to do something completely different, most of them would not even be working in the financial sector. For students from this region, and the Netherlands generally, who want to work for a CTA or a hedge fund, there's not that much choice, and that's an advantage. Something else that helps is because we are different from other CTAs, we're also better at having our own ideas. In London, a lot of people have been working for one CTA and then another and then another, so you find similar ideas within different CTAs.
46:00 Speaker 01 We are a little bit like an isolated desert island where people live completely in their own way. Michael, you don't want to be tainted by all kinds of bad influences. Harold, it's not even that we don't want to. It's about being different, and another place helps you to be yourself. Michael, I've had a chance to speak to so many of your peers. Probably we have mutual friends that we don't know about. One day I'm going to make it to Rotterdam. We'll have to do lunch. It's been a long time since I've even been in Amsterdam. Harold, beware, Amsterdam and Rotterdam are not friends. Michael, they're not friends? Harold, no. Michael, you want nothing to do with them? You've drawn the line at Rotterdam?
46:45 Speaker 01 They're not allowed over? Harold, in football competitions when Amsterdam plays Rotterdam, the fans from Amsterdam are not even allowed to visit Rotterdam.
47:01 Speaker 02 I see a time when those awake will understand how to make money in up, down, and surprise markets.
47:10 Speaker 02 Whether new trader or experienced, college student or financial advisor, protecting against a crash or just trying to make a lot of money, trend following offers everyone an answer in uncertain times. To get started immediately, send me an email, [email protected] . I will send you the right trend following steps to take, along with my free video.
47:37 Speaker 02 But if you want to buy and hold, trust the government and trust Wall Street, this is absolutely not for you.
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