Ep. 1408: James Dailey Interview with Michael Covel on Trend Following Radio

My guest today is James Dailey. He is Chief Executive Officer of DUNN and has responsibilities in the areas of strategic planning, business and product development, client relations and financial reporting. The topic is Dunn Capital's white paper High Vol Trend Following: Most Valuable Alternative Investment. In this episode of Trend Following Radio we discuss: Trend following as a true alternative investment Portfolio diversification and non-correlated returns Crisis alpha and equity market dislocations High-volatility trend following and positive skew AI, clean data, and systematic investment research Jump in! --- 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 https://twitter.com/covel Facebook: @trendfollowing https://www.facebook.com/trendfollowing/ LinkedIn: @covel https://linkedin.com/in/covel/ Instagram: @mikecovel https://www.instagram.com/mikecovel/ Hope you enjoy my never-ending podcast conversation!

• 0:00Speaker 00

  My guest today is James Daly. He is the CEO of Dunn Capital. Dunn Capital, one of the longest-running trend-following firms around. In fact, I think it's the longest, an over 50-year track record. Today, James and I get into a new Dunn Capital white paper that touches on many issues that are very interesting for the would-be trend-following trader, the would-be trend-following investor. Without any further delay, let's jump right into my conversation with James Daly of Dunn Capital.

• 0:46Speaker 00

  I always approach these things like everybody's a beginner and a novice and all that kind of stuff. But I think part of my thing today is to get us conversational. Like, have you bumped into some big attorney down in Miami or something who was raking into cash but had no clue about your style? So how do we walk that fine line of you not sounding like, oh, God, I've got to rehash everything? Because you never know who's listening and it's timeless, right? That's the thing.

• 1:14Speaker 01

  I was speaking at a conference last year. Somebody was at it about trend following in general. There were lots of different strategies represented there. And somebody asked me from the audience, what's the biggest challenge? And I said, educating people. It's so abstract for a lot of people and a lot of investors aren't aware of it, haven't researched it at all. I think that like you and Niels have done a great job of creating some education and being advocates in the industry. People like Cliff Asness has done a good job of putting out a lot of white papers. But still, in general, trend following hasn't promoted itself well. And the guy said, well, I'll tell you, you need a story. He said, everything you've been talking about today is math.

• 1:56Speaker 00

  Let me share something with you. This is really wild. I saw something on Instagram and it was just some random post. And I thought to myself, oh, that's trend following. So I took a screenshot of it. I cut it down to cut out any kind of copyright stuff that might be there. I don't think there's any copyright stuff. But anyways, I posted it on X just with my writing saying trend following, duh. What did it say? It was a screenshot and it reads this. I heard someone say, quote, "If you knew you were 100 rejections away from your dream, think how excited you'd be every time someone told you no," end quote. And that stuck with me. I saw that. I was like, oh, God, that's trend following. So I just posted it going to sleep or something and didn't think anything of it.

• 2:41Speaker 00

  I woke up the next day, 750,000 views.

• 2:46Speaker 01

  No way. Wow.

• 2:49Speaker 00

  Here we are talking about a story and there is something right there. That kind of phrasing or that thinking that just resonated with people. I've never posted anything that's got that kind of view in one day.

• 3:04Speaker 01

  Yeah.

• 3:05Speaker 00

  Never.

• 3:05Speaker 01

  How many followers do you have?

• 3:07Speaker 00

  Not that many, like 45,000 or something on X.

• 3:11Speaker 01

  Wow, and 750,000 views.

• 3:14Speaker 00

  That's insane.

• 3:15Speaker 01

  It's incredible.

• 3:16Speaker 00

  Somebody or several somebodies of size, I'll see if I can try to figure it out, obviously reposted it, you know? I don't know who, because like I said, I've never posted anything that, you know, like, okay, 50,000 views or something. The first thing I saw was the reposts and I thought it was saying five reposts, right? But it was saying 5.4,000 reposts. I was like, hold up, where, how am I getting 5,000 reposts in 24 hours?

• 3:43Speaker 01

  That's an incredible reach.

• 3:45Speaker 00

  Yeah, just to read it for you again. "If you knew you were 100 rejections away from your dream, think how excited you'd be every time someone told you no." And I just thought to myself, that's trend following. Because you just don't know. You don't know anything. And again, we were saying like, how do we make this into a story that's understandable? Look, I want to get into some of the details with you today on some of these phrases that take people and make them probably want to commit hairy carry, like positive skew. It's a very simple concept and we're going to get into it. But here's where I want to start. Alternative investments, what does it mean today?

• 4:17Speaker 01

  There's a lot of confusion and misunderstanding. I mean, especially when people couch it as hedge funds. Alternative investments are supposed to be investments, you know, the original idea where investments that the timing of the return streams from those investments were different than the timing of the return streams from traditional investments, stocks and bonds.

• 4:39Speaker 00

  Keep it there for a second, just for everyone following along. So if your stocks are making, I don't know, 20% in the first six months of the year, an alternative investment might not be making that money. It could, but it might not. And then alternatively, in situations where, let's say, equities were dropping, you could have a situation where this alternative investment is going up.

• 5:03Speaker 01

  Correct. Because the alternative is either short equities or it's making money in other sectors, the other asset classes that aren't equities. But that's what the original kind of design was. But there are so many quote-unquote "alternative investments" out there or hedge funds out there that behave very similarly to equities. So they might look different from an obvious way because they're using some derivatives or they're in an offshore fund. You have to use a swap to access them. They charge a performance fee. But when you boil it down, they're still very correlated to equities

• 5:45Speaker 01

  because they're profiting off of the growth of the US or the global economy.

• 5:51Speaker 00

  There's nothing wrong with that. It's just that it doesn't always go up.

• 5:55Speaker 01

  No, it's just that it's still kind of moving like equities. I would suggest that would be a good way to diversify your equities kind of bucket or sleeve in your portfolio. It's not really a true alternative if it's highly correlated with equities. If it's going to go down when equities go down, it's not working for you the way that maybe you envisioned an alternative would.

• 6:19Speaker 00

  Are we talking private equity, venture capital?

• 6:22Speaker 01

  Yeah, both.

• 6:23Speaker 00

  And just as a side tangent here, because there's probably lots of these, as you and I are talking about trend following as an alternative investment, often called managed futures. It's an investment or it's a strategy where you can see day-to-day what the positions are. And I'll let you go into this more, but for venture capital and private equity, that's like opaque. It's the middle name is opaque, right?

• 6:45Speaker 01

  Yeah, it's very gray area, the marks. Oftentimes, people's investors' money is locked up for five, 10 years. In managed futures, you have daily liquidity and all of the underlying investments, all the underlying futures contracts are mark-to-market every day. So there's no guesswork or assumptions involved in determining what the net asset value is and what the day's performance was.

• 7:11Speaker 00

  That's such a straightforward statement, but the scope and size of private equity and venture capital is off the hook. There's another side tangent here, too, is that how can something like what you just said, so reasonable, like, okay, it doesn't mean that all investments have to be marked to the market every day. It doesn't mean that. You're not saying that. But the size and scope of the money that goes into venture capital and private equity, this is not just all some rich dude sitting on a mountain giving his money over. These are investments being made on behalf of other people that might not know they're in these investments, correct?

• 7:48Speaker 01

  I think so. I think they've been approved now for 401K plans. And there are pension plans out there that have huge allocations to private equity. Pensions, endowments, yeah. Foundations, huge money.

• 8:00Speaker 00

  People might say, well, Mike and James are having this conversation about this kind of, you know, other alternatives. But hey, man, you know, US equities just go up forever.

• 8:09Speaker 01

  Until they don't, right? I mean, historically, there have been some pretty difficult times for US equities. I don't think I've seen any evidence to think, to prove to me that won't happen again going forward.

• 8:21Speaker 00

  The timing of it, though, you're not a prediction guy, so you're not telling anybody you know the timing of it.

• 8:25Speaker 01

  No, honestly, Michael, I have thought that US equities would have a massive correction several times in the past 10 years. I thought we were really close. That's why I am fully committed to following the data and being systematic. You know, as you know, trend following doesn't use any discretion in our investment decision-making. And I have felt so grateful for that so many times in the last 10 years, especially this year. There's been so much volatility, so much uncertainty from a geopolitical environment, environmental standpoint, that I am so glad that we aren't making discretionary decisions in determining our buys and sells and risk levels. All of that for us is 100% systematic.

• 9:09Speaker 00

  You could imagine yourself sitting back, you're an observant, smart guy. You look out there and you say, oh, my gosh, I'm using these AI products and these are just wonderful. I ask a question and it argues with me and it gives me propaganda and often errors in information that's not accurate. And I say to myself, this can only go to the moon. This has got to be the best investment ever. But now here's the funny thing is, my fundamental analysis doesn't mean S-H-I-T if the market's going up.

• 9:36Speaker 01

  You know what? What you just gave an example of is getting in your feelings and being emotional about investing. And I really look at a rules-based process like what we have in our fellow trend-following peers as being something that protects you from yourself. Because we all have these cognitive biases, whether we're aware of them or not. I think because I'm in this business, I happen to be hyper-aware of mine. That's why I said I'm grateful for being fully rules-based.

• 10:05Speaker 00

  You know, I just had on my podcast, David Booth, who founded Dimensional Fund Advisors, a long-only kind of mutual fund kind of thing. They maybe got some slightly different strategies these days. But I tried to get him to go into the conversation a little bit of, you know, Fama versus Condomen. He was like, oh, I'm on Fama's side. So I mean, you know, look, he's had a lot of success, you know, but it is an interesting conversation and he loved Kahneman's book, but he saw the practicality of something like Kahneman, that there wasn't a practical way to achieve it. Now, I might argue that a company like Dunn Capital actually has figured out a way to take something like Kahneman's book and reduce it to math.

• 10:45Speaker 01

  The way I describe it to people is that we don't have any control over returns and over markets. We really don't. What we're doing is our algos are out there trying to take advantage of the opportunities that markets give us. And really, we're just managing the risk in a systematic way. That's what we're doing.

• 11:07Speaker 00

  When you say opportunities, all you really are saying is the market moving up or down unexpectedly? And are we on board? That's what you mean by an opportunity?

• 11:16Speaker 01

  Yeah, the market moving up or down in a hopefully sustained way so that our models can adjust to what's happening and exploit the behavior in that market for profit.

• 11:28Speaker 00

  It is so simple, isn't it?

• 11:29Speaker 01

  Yeah.

• 11:30Speaker 00

  I've got a cool white paper in front of me. People can check it out. They can go find this online or reach out to you guys. From Dunn Capital, high vol trend following, most valuable alternative investment? Question mark. You know, it's not that long of a paper. It's a pretty quick read. I will say this, though, if somebody's not familiar with some of the jargon, it's a quick read, but it's dense. So you might be doing some homework to go through it, right? It's a little highbrow, right?

• 11:55Speaker 01

  A little bit. It's really designed to target our typical high net worth investor who takes an active role in managing his or her own investments and knows some jargon, but is not an expert.

• 12:09Speaker 00

  Let's break down some jargon that's always been, I don't know if it's near and dear to me, but I remember when I used to hear some of these things, I'd be like, I'd roll my eyes and go, oh, my God. Within the return stream of trend following, the way that it works, if we're in this typical 6040 world, stocks, bonds, and that's what most people listening, they probably have something like that. And so then the issue becomes, how do you add something else? Like trend following? And when you add something else like trend following, what are the benefits?

• 12:39Speaker 01

  I think the benefits are that trend following, as I mentioned earlier, the returns, the timing of the returns of trend following are different than that of the timing of returns from stocks or bonds. Trend following tends, has historically done very well when equities have done very poorly during equity market dislocations. So that's one of the big benefits is what some people will call crisis alpha. Now, the black swan, there's a difference between 10% correction or like a serious equity market dislocation.

• 13:16Speaker 00

  As you note, you say a sharp correction versus an extended drawdown.

• 13:19Speaker 01

  Yeah, so I'm talking about 20% or more. And if you look back over those periods over the last, since our track record started in 1984, I think there's been five.

• 13:28Speaker 00

  Hold on, your track record, I know there's different starting points, but technically it goes back a little bit farther than 84, correct?

• 13:36Speaker 01

  That's true. The composite track record for our firm, which has always been trend following, starts in 1974. But for our flagship product, that's an actual investable product, the Dunn WMA program, that starts in 1984. So if you go back to 84 to present, there have been five equity market dislocations that were equities down 20% or more. And WMA has performed very positively in all of those periods. And so has trend following in general, has performed very well in all of those periods. And that's because most of the time, when there's a significant equity market dislocation, they tend to take a while to play out. There's plenty of time for the models to adapt to what's happening

• 14:21Speaker 01

  and get on the right side of trades. And for lack of a better term, exploit what's happening in these different markets.

• 14:28Speaker 00

  You should also probably draw a distinction here because if we're talking about the typical, over here on one side, if we're talking about the typical equity bond portfolio 6040, yes, you're going to have interest rates and you're going to have equities in your portfolios that you trade, but you're also going to have other items.

• 14:50Speaker 01

  Absolutely. So we're going to have currencies. We're going to have all the commodities as well. So energies, metals and all the agricultural products. And commodities make up a little over 40% of our portfolio. So it's a significant allocation.

• 15:08Speaker 00

  Does Dunn care how it gets paid? Meaning in terms of being paid from the market, from movements, from markets, there's no bias. Dunn doesn't care where the return streams come from and what markets, correct?

• 15:20Speaker 01

  No, absolutely not.

• 15:21Speaker 00

  When you're out and about milling around with all the interesting folks out there in the land outside of Asia, bring people into that, though. How can you feel like, okay, if this metal or this ag or this energy product moves up or down, that you don't care that if your money for that quarter or that year or whatever comes from that movement versus the movement coming from equities or bonds?

• 15:52Speaker 01

  What you described is a very typical trend following return profile. Oftentimes, the performance for a calendar year, say it's an arbitrary measurement, but for a calendar year, oftentimes, performance will come from a handful of markets that really just did incredibly well. And the rest of the markets were kind of up and down a little bit and basically washed each other out. The lots and lots of small gains and losses might be only five markets that really drove performance for that year. But that's very typical of trend following.

• 16:23Speaker 00

  When you get to the office every day, you have to go through all of the fundamental reports for the ags, whatever commodities, the energies. What's your favorite OPEC white paper that you read every month? There's got to be something, right? What is it? Come on.

• 16:36Speaker 01

  No, none of that stuff matters to us. You try to not sound flippant when you're talking to prospects or investors when they say, what do you think's going to happen this coming quarter or this coming year? And we say, we really don't care. We don't care. The models don't care. It's just data driven, 100% data driven. Now, I try to understand the bigger economic environment so I can help our investors put into context what happened, where our performance came from, why the models were on this side or that side of these various trades. But it's all just kind of looking back to help them put it in order in their minds in compared to the other things that they have in their portfolios. But the models don't care at all about any of that stuff.

• 17:18Speaker 00

  Some percentage of the folks that you talk to, some percentage of the audience, my audience too, is gonna think, no matter what you are or I am, passing the buck, as you said, being flippant. Maybe these people are not that bright. They don't appreciate that it's just an entirely different strategy on a different grouping of markets. Look, if you buy and hold the S and P, that's a strategy too. This is just a very different strategy.

• 17:44Speaker 01

  It is. You know, we'll have a lot of investors even say, well, I've got a lot of stocks and bonds. So can you give us a version of your program that just excludes those? You know, we always chuckle a little bit because you're not getting just a diversified group of markets when you invest in trend following. You're also getting a diversified approach, a diversified process. You probably already have stocks and bonds. We've been short fixed income for the vast majority of this year. I don't know any individuals that are shorting bonds.

• 18:14Speaker 00

  That also means that you're betting for rates to go up.

• 18:17Speaker 01

  We are.

• 18:18Speaker 00

  But I mean, your strategy is betting for rates to go up, but you're not betting for rates to go up. You don't know.

• 18:24Speaker 01

  We don't know. The models have determined that right now the rates have a higher propensity to go up than to go down. And so we're riding that trade until proven otherwise.

• 18:33Speaker 00

  Okay, so if we accept, and there's a bunch of data out there, if people are the uninitiated, there is a ton of trend following data. People want to prove to themselves that the strategy itself is valid. Let's assume it's valid. Now, back to the conversation with bringing people into, okay, here's this new return stream. You're going to add it to this 6040 return stream. There's a couple of different academic sounding issues that start to happen. One's correlation, so, right? So why don't you get into and walk people through one of the benefits of trend following managed futures from a non-correlated perspective?

• 19:11Speaker 01

  You know, trend following has a very low and in some cases negative correlation to traditional assets. Trend following can generate equity-like returns with zero to negative correlation to equities. The combination of adding trend following to your equity portfolio is hugely complementary, and it really improves the risk-adjusted return of the overall portfolio.

• 19:38Speaker 00

  And there are white papers out there upon white papers that go into extreme depth and math to explain why what you just said very simply is true.

• 19:48Speaker 01

  Just to let people know if they want to read this paper, there's no major math going on in here.

• 19:52Speaker 00

  Yeah, yours is conceptual, but generally there is here. I mean, to some degree, Mark Witz was bringing a lot of these things up back in the day.

• 19:59Speaker 01

  The paper's really focused on the complementary benefits that trend following brings to the table as compared to lots of other kind of quote-unquote popular alternative investment strategies.

• 20:12Speaker 00

  And then back to the black swan issue that if you do get one of these extended drawdowns in equities, having something that's not correlated, producing returns at a time where your equities are not producing returns, this is one part of the, I'm going to let you explain this, but one part of the smoothing that trend following brings to the world of 60-40.

• 20:34Speaker 01

  That's right. So it brings a lot of smoothing because the thing that we just talked about, correlation, trend following over long periods of time has virtually zero correlation to equities, but there's also this conditional correlation that it brings, which is that it does particularly well when equities are doing particularly poorly. It offsets equity losses during those big dislocations like the global financial crisis in 2008, like the dot-com bubble in the early 2000s, like 2022, for a recent example, when inflation was going crazy and there were numerous rate hikes and equities went down 20% over a nine-month period.

• 21:19Speaker 00

  I don't know if there's any research about this, but when we do get these dislocations in equities, people just think about it conceptually. There's very large funds out there that have got equity positions. If the shit starts hitting the fan, they start exiting. And if they start exiting, they start putting those funds somewhere. And putting those funds somewhere where a firm like yours might already have positions is a side benefit here, right? When the equity dislocations unfold, if your strategy is predicated on being ready or perhaps already taking positions, because sometimes that market is like clairvoyant. It tells things that are happening before, right? Before we really know what's happening.

• 22:03Speaker 01

  There's usually some indications in other sectors before equities go through a period like that. So it might be in gold, or it might be in fixed income or something like that. So oftentimes, at the beginning of an equity market dislocation, we will be losing in equities as well, because there was probably a lot of momentum there before it turned. You know, we're following momentum and we're positioned long there in equities. But a lot of times, there are these precursors in other sectors where other sectors have started to already react to whatever's going to eventually kick off in equities, and we're positioned well there.

• 22:44Speaker 01

  And that happens oftentimes in gold, or in fixed income, or in oil. And so that kind of offsets for us the losses that we take in equities as we get repositioned there, as we get short in equities. And then, as you say, when the shit hits the fan and people are really starting to, you know, panic sell, and oftentimes already positioned short there because we've adapted to what's happening in those equities, and it's just creating more of that momentum now going down.

• 23:15Speaker 00

  If we just isolate there on equities for a moment from a trend following perspective, as you point out, hey, we very well could have been long, and then things start to go down, we're long, we got to get out, that's not necessarily positive for us, but there's going to be some point in time, your model's going to flip. And if things stay extended on the downside, all of a sudden, people are saying, hold on, those guys are brilliant, they caught the whole downside move. It's a very deep philosophical system rooted back in Bill Dunn's work over 50 years ago that sets the foundation for this. You know, it's really cool, honestly.

• 23:52Speaker 01

  Oh, yeah. I love it. There's so many moving parts and everything that we have done to improve the program over the last about 15 years, we put a lot of time and effort into a lot of research and development on improving trend following. Just because it's been around for 50 years doesn't mean you can't get better at it. We're really determined to improve the way we practice it. And everything we've done has been to make the program more systematically adaptive to what's happening from all levels. Okay, so from all three phases of the investment process, the trade entry, so the trend identification, to managing the risk, managing the size of the trade throughout the life of it, to the

• 24:37Speaker 01

  trade exit. We've made all three of those phases more adaptive.

• 24:42Speaker 00

  Some people might hear that, the way you phrase it, and they might think, well, hold on, it's an entirely new trend following, it's something brand new. Look, everyone's got their own version of their own proprietary version of how they do things, how they improve things, but there is going to be, at the end of the day, if markets play out in some of the hypotheticals that you and I are talking about, your strategy is going to work very similarly to how it's worked for 50-plus years.

• 25:08Speaker 01

  Yeah. If we hadn't made those improvements, the correlation of our current version of our program to the old version would still be very high.

• 25:16Speaker 00

  But that's life, right? Everybody wants to improve on things. Hey, let me bring it to something too, that's a little academic, but I think is a really important concept. And this is right back to the classic, let your winners run and cut your losers short. In academic parlance, that's got phrased often as positive skew. I think all positive skew really means is, hey, you've got more big positive outliers for your returns and much smaller negative outliers because you're cutting your losses short. Fair description?

• 25:50Speaker 01

  Yeah, that's true. There are times when trend following has large negative outliers as well, but the number of large positive outliers far outweigh the number of large negative outliers.

• 26:00Speaker 00

  What keeps you engaged? What makes you love this? You've been at it for a while. What makes you love being part of Dunn Capital?

• 26:06Speaker 01

  Well, first of all, we have a great group of people here. We have about 25 employees, the vast majority of which have been here for a long time. I've been here since 2003, and there are at least five people that have been here longer than me. So that tells you what a good place it is to work. It's kind of a hybrid feel with a foot in each camp. There's this family feel to the office and to kind of like relationships here, but then I also think everybody takes a lot of pride in being professional. I think we provide that blend of a boutique family office vibe with the professional

• 26:47Speaker 01

  corporate type approach to practicing trend following and servicing our investors.

• 26:55Speaker 00

  50 years helps.

• 26:56Speaker 01

  50 years helps. We had our 50-year anniversary a couple of years ago. A lot of fun and a lot to celebrate.

• 27:01Speaker 00

  I assume this is part of Bill's plan back in the day to keep everything going. I'm sure you can only say so much, but obviously, he had done very well, set aside significant capital of his own, and clearly wanted this to go on as long as it can, I guess, right?

• 27:19Speaker 01

  He did care about his legacy. He wanted to kind of keep it quote-unquote "in the family." You know, Marty Bergen, who was Bill's protege, Marty's been here at the firm since 97. He became partial owner in 2010, and Bill passed along the, fully, the reins in 2015. So Marty's been the full owner, president, leader of the firm since over 10 years now.

• 27:43Speaker 00

  Stop me if I'm going into details that can't be broached, but did Bill set things up where he imagined 100 years out and stuff like that?

• 27:52Speaker 01

  Well, he definitely imagined next generation. We are one of the few of kind of the original old-school trend following firms who has successfully transitioned to a 2.0. And now I think Marty, who's the leader of 2.0, is, you know, thinking about 3.0, and certainly wants to keep it going for generations to come.

• 28:13Speaker 00

  Yeah, it's very cool.

• 28:14Speaker 01

  It is.

• 28:15Speaker 00

  Back to your fundamental predictions that you were making earlier, I guess as unrelated to trend following, but I was making fun of AI earlier. I got to tell you, at first, I thought there are some interesting aspects to this. Maybe I'll be surprised, but I find myself being less and less surprised these days. I'm starting to feel like I'm dealing with a toy. I can't make any fundamental predictions to save my soul, but it does feel like, my gosh, we're all using these things, and how much did they cost? Who paid for it?

• 28:44Speaker 01

  Uh huh. And are you getting any real productive results out of it?

• 28:49Speaker 00

  Is there any aspect of these large language models that you really see as a benefit? I mean, look, I'm talking to a gentleman yourself. I remember being in your office for the first time in 96 and seeing a computer sitting over in the corner. I think it was running Fortran perhaps. So you guys have been tech for a long time before tech was cool. What is your perspective on these tools?

• 29:10Speaker 01

  It's a tool, what you just said. Our research group gets very geeked out about tech. Their approach is to use AI as a tool for things like more of what I would say, the operational aspect of research. So coding, how to take a piece of code that they wrote into and make it more efficient, streamlined, how to take something that they coded in one language and have AI convert it to a different language because we use one language for research and a different language for operational programming.

• 29:41Speaker 00

  Doesn't that still leave you having to check all the code though, too, again?

• 29:45Speaker 01

  Yeah, yeah. We have to run a lot of checks. We don't use AI for any creative part of the process. All of the actual research and development is done by human beings and our simulation environment and AI is just used to make that easier or more efficient.

• 30:04Speaker 00

  Look at all the care that you have to use, and this would probably be a very long conversation, on something like data. Now imagine, there's a ton of people out there right now that have gone to some of these LLMs and they type in a few words and they say, do a back test for me. And it's like, hold on, where's the data coming from? How do you know it's even valid? Most of these AIs lie to me every day. What's your warning to the budding trend follower out there that wants to not understand his code, not understand where his data is coming from, and then trust that Sam Altman is going to deliver gold to him via a couple prompts?

• 30:39Speaker 01

  I would say, keep it simple, focus on fundamentals. The blocking and tackling of research is clean data that you trust and that you've gone through and cleaned yourself. Absolutely, you have to understand what your code is doing. Otherwise, you're getting into a scary realm.

• 30:58Speaker 00

  This is independent of trusting the new AI model. I mean, like, you know, hey, look, I just heard a China model came out and it's free. I no longer have to pay clause so I can use the Chinese model to back test my trend following system. Does that sound like James Plan down there at Dawn?

• 31:13Speaker 01

  No way. Backtesting itself, you could get into lots of debates on what's the most robust way to do that. I certainly wouldn't just instruct an AI model to back test.

• 31:24Speaker 00

  So that's your diplomatic way of saying, please, people, trust but verify. Back to Reagan and Gorbachev.

• 31:28Speaker 01

  Yeah, there you go. Ron Reagan, trust but verify. Use it to automate operational processes. I think that's great. But research and development, I would keep pure. And can I just encapsulate the one kind of what I think is the most important message of this white paper that we've talked about a bit today? I would say that if you look at the white paper, what it does is, as I mentioned before, it compares and contrasts trend following as represented in the paper by both the index and our program, which is the high vol version of trend following. And it compares it to all these other hedge fund or alternative strategies. So early in the paper, that from a standalone basis, trend following doesn't

• 32:13Speaker 01

  look like the best alternative. It actually has the lowest Sharpe ratio.

• 32:17Speaker 00

  It's side tangent here. Sharpe ratio. Why am I judging a trend following with a Sharpe ratio?

• 32:21Speaker 01

  Okay, perfect. So we make this point in here. Sharpe ratio should be used to measure a total portfolio of all your assets before and after different things are added.

• 32:32Speaker 00

  Sorry to interrupt the encapsulation.

• 32:34Speaker 01

  No, I'm glad you made that point. But we have to present Sharpe ratio because so many people ask us for it.

• 32:40Speaker 00

  It's so pretty. It's so elegant.

• 32:42Speaker 01

  It's misused, but if we didn't present it and spend all our time explaining why, it would seem like we were trying to be evasive or ducking something. But anyway, from a standalone basis, trend following doesn't look like the best alternative. But from a complementary basis and what it does to add it to a 60/40, it creates the best improvement of all these other alternatives. That's the bottom line.

• 33:09Speaker 00

  Because taking a non-correlated to the 60/40 equity bond split, taking a non-correlated trend following stream, adding it to that, returns coming at different times, mashing it together. I once saw, it wasn't a meme, but it was somebody giving an explanation, something like, you know, your risk drops by putting one leg outside the plane window or something, something to this effect, right? But it's true. It's something that looks like, hold on, why am I bringing something in that's perhaps looks volatile as a standalone? And how does that kind of add together with what I've got over here and create something entirely different?

• 33:47Speaker 01

  The most difficult thing for investors is holding trend following, especially when you see it as a separate line item. Because when stocks and bonds are working, a lot of investors are saying, what is this thing again? And why do I have it? It seems to be underperforming stocks. Remind me why I have this in my portfolio. It's not generally discussed on Bloomberg or on CNBC. It's not generally accepted in the financial media. But certainly, it's appreciated by some of the world's biggest investors, sovereign wealth funds, pensions, endowments. And I think now advisors and high net worth individuals are really starting to appreciate what it can do.

• 34:29Speaker 00

  You know, one thing that we didn't talk about, the way that some trend following firms, and everyone's got their reasons for why they do things, but that some trend following firms have reduced their volatility, reduced the return, perhaps they had mandates or reasons they had to do this because they all know what you and I are talking about, too. They're not stupid. But this puts them in a situation where the returns drop. And so that diversifier element of trend following, if your trend following investment has been whacked in half, you know, have we necessarily lived through one of those dislocations where trend following at reduced enhancement or whatever you want to say, whether it's going

• 35:13Speaker 00

  to work out for people that have bought it in the last 20 years? If they bought something that was kind of a little watered down, is that a fair way to say it?

• 35:22Speaker 01

  The watered down version is easier to hold and to explain to your investment committee. Doesn't look like it's lagging equities as much in some of those periods where trend following doesn't work as well. But when you really need it, you're not going to have enough of it. Or you're going to need to allocate a bigger chunk of your portfolio to it to be able to really have to offset the losses from equities during a dislocation. That's why we've always remained high vol. It's very important. We do a lot of education to help people manage their expectations. People are willing to live through the difficult periods because in the good periods, they're getting much more efficient use of their

• 36:03Speaker 01

  capital at investing in a high vol version of trend following. When I say high vol, our annualized volatility is in the low 20s, 22, 23%. And that's almost 2X the typical big trend follower out there that most people have heard of, the brand name, trend followers.

• 36:22Speaker 00

  And look, I would make an argument, too, without knowing all the data off the top of my head, but having been in this world for a little while, and I'm not trying to say this in a mean way, this is all comes down to math and choices and everyone does what they got to do. But I would hazard a guess that most of the quote watered down versions of trend following, they didn't start watered down. They started at scale and the watered down came later. I would hazard a guess, too, that some of them, maybe not for investors, still have that full program rolling behind the scenes somewhere for someone's capital.

• 36:58Speaker 01

  For their internal money.

• 37:00Speaker 00

  It still exists. I'm not going to buy into the idea that it's all dead. There's a lot of very successful people out there that came to the game. I can't prove that, but just instinct says.

• 37:10Speaker 01

  I'll give you a quick example that illustrates what we're talking about. And this was given to me by one of our peers in the space, Standpoint, who, you know, is run by Eric Crittenden, and they are providing an already done blend for you of stocks, trend following, and cash. And he did a little study, which put us in a great light. And our industry is very collegial. And he sent it over to me and said, you know, feel free to use this with some of your prospects. We have a mutual fund for which we are the sub-advisor called Arrow Managed Future Strategy, which is MFTNX. He took all of the 7,400 mutual funds out there. He took the Vanguard Balance 60/40.

• 37:54Speaker 01

  As 90% of his portfolio and looked at what adding the other 10% of his portfolio to all 7,400 of the remaining mutual funds out there. And then after that first cut, he determined which funds both increased overall returns and decreased drawdowns. And there were about 1,000 funds that did that. And then he ranked them by return to drawdown ratio. And our strategy was number two out of 7,400 funds. And a lot of the reason for that is because it's the higher vol version. So you're getting that efficient use of your capital. You're getting more bang for your buck. And the number one was like one basis point away from us.

• 38:39Speaker 01

  It was almost a tie at number one, was also a high vol version of trend following.

• 38:43Speaker 00

  You would think in this modern world where everybody loves to be online and compare notes and talk about the scientific method and believing the numbers and believing the data. And then the decisions for why what you just described might not be accepted by significant portions of the population have absolutely nothing to do with the scientific method or data, right?

• 39:10Speaker 01

  Yeah. A lot of times it's, oh, you're too volatile.

• 39:13Speaker 00

  You're talking about somebody who could very well graduated at the highest of their class at Wharton, who supposedly took all the classes that you're supposed to take. And they look at you with a straight face. Look, they're smart.

• 39:27Speaker 01

  Oh, yeah, they do.

• 39:28Speaker 00

  They know what's up. That kicks the can down the road to who? The ultimate investor.

• 39:32Speaker 01

  Oh, we have lots of Wall Street guys who have their personal money with us that they just can't put institutional money with us. That happens all the time. What it comes down to is what I said, I shouldn't be talking too much about in the beginning of this conversation. I should focus more on storytelling, but it comes down to math. It's just math. It's very easy. You just do a little study like Eric did, you back into the best, the best, most impactful investment. It's not that hard, especially when you're talking about a repeatable process that has a 50 year track record.

• 40:01Speaker 00

  One thing we haven't talked about though, too, is that one of the reasons back to why somebody might say they don't want trend following because it's too volatile, that human thinking is actually, you could argue, is part of the reason that trend following works. The irrationality creates the irrationality.

• 40:22Speaker 01

  That's true. People say, oh, well, there's a lot of crowding out there. Aren't you afraid of that? And I kind of think crowded trades are what's driving momentum. That's making money for us. We're not afraid of crowding.

• 40:34Speaker 00

  Crowding is a good place to leave it. James, if they want to find you, you're easy to find. I think everyone's easy to find today. Look, if somebody opens their mouth and says, my name is such and such, I work at such and such. If somebody can't find you, then you know, you probably don't want to talk to them. It's a good filtering mechanism, right? It's if they can't find you, it's kind of like, hold on, there might be some kind of IQ issue here or something's wrong or is it imbalanced, right?

• 41:02Speaker 01

  Yes, an imbalance.

• 41:03Speaker 00

  If they can't figure out a way to reach you, maybe this is the filtering system that, you know, okay, then you probably weren't meant to reach James.

• 41:10Speaker 01

  Fair enough. I mean, we're a quick Google search, but dunncapital.com and reach us at [email protected].

• 41:18Speaker 00

  James, cool stuff. I appreciate it.

• 41:20Speaker 01

  Thanks for having me on, Michael.

• 41:27Speaker 00

  I see a time when those awake will understand how to make money in up, down, and surprise markets. Whether a 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. But if you want to buy and hold, trust the government and trust Wall Street, this is absolutely not for you.