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Stocks on the Move book
Trading Evolved book
2018 CMT Symposium presentation on “The Trend Arms Race”
Tyler Wood 00:13
Welcome to Fill the Gap, the official podcast series of the CMT Association, hosted by David Lundgren and Tyler Wood. This monthly podcast will bring veterans, market analysts and money managers into conversations that will explore the interviewees’ investment philosophy, their process and decision making tools. By learning more about their key mentors, early influences, and their long careers in financial services, Fill the Gap will highlight lessons our guests have learned over many decades and multiple market cycles. Join us in conversation with the men and women of Wall Street, who discovered, engineered, and refined the discipline of Technical Market Analysis.
Tyler Wood 01:11
Fill the Gap is brought to you with support from Optuma, a professional charting and data analytics platform. Whether you are a professional analyst, portfolio manager or trader, Optuma provides advanced technical and quantitative software to help you discover financial opportunities. Candidates in the CMT program gain free access to these powerful tools during the course of their study. Learn more at optuma.com.
Tyler Wood 01:51
Hello, Dave, and welcome to Episode Seven of Fill the Gap with our special guest this month, Andreas Clenow, how are you doing today?
Dave Lundgren 02:01
I’m doing excellent Tyler. Nice to see you. As always.
Tyler Wood 02:04
It’s nice to see you as well. I can’t believe that we are already in the second half of 2021. A lot of folks doing a mid year update, a lot of market conversations about where we’re at. I really appreciated this episode. It was a focus on on process more than current market states, and really appreciated everything that Andreas had to share with us. For you, Dave, what were some of the surprising things about Andreas’ early beginning?
Dave Lundgren 02:28
He’s a noted expert in momentum and trend following with deep experience both as an investor as well as an allocator. So this guy knows what he’s talking about. What I really liked about learning about his background is in his early years, he went through the same process pretty much everybody went through; everybody was a bull market genius in the 90s. And he was riding that wave, and asking him, “you know what, what type of style of investing were you using back then?” was almost a joke, because I was experimenting with pretty much everything, just like so many of us, he went through that class as he had to learn that school of hard knocks, what doesn’t work, what does work and he finally, ultimately, as many of us do, to some extent, settled on a systematic process. And so he’s now since then, of course, fully embraced that. It’s really refreshing to see that early years’ experience leading up to this, the renowned trend following momentum investor.
Tyler Wood 03:19
Absolutely. Obviously, the path includes a ton of extreme dedication, a lot of hard work but Andreas pointed out to us both during this interview and and in other conversations that didn’t make the final cut just what role luck played in his life and that he’s very humble about having been in the right place at the right time. Great to hear him share that he got to meet John Bollinger in Stockholm – as university students that his Swedish university had a trading room, he got access to incredible technology and really started to understand the technical side of the markets. Andreas also mentioned that a college roommate pointed out to him that there was this group called the Market Technicians Association, they actually both pursued the CMT Association but they should, you know, dig into it and really take their studies seriously. Andreas, he’s a pretty honest guy; a lot of our listeners, they’re gonna hear the David/Tyler laugh track throughout most of this, feel free to rewind and catch the dry humor that Andreas has laid out in most of this interview. But it was great to hear from Andreas about that path. And he actually is quite an early adopter. Dave. He is charterholder number 494. We’ve delivered 1000s and 1000s of CMT charters around the globe. Andreas got in early but was officially awarded his CMT in 2004. So it’s great to learn a little bit of history about somebody who is clearly established themselves in the institutional systematic space. Dave, I wanted to ask you, as we always do, what was your favorite quote from this interview?
Dave Lundgren 04:43
Many gems of course, in this particular interview, as you can well imagine, either serious or humorous, but certainly many of them. One that really stuck out with me was one that I actually – in conversations I’ve had with Frank Teixeira at Wellington as we’re managing money together, we would say this often, unfortunately too often. But the way Andreas said it was, you can lose money in one of two ways, either following your rules or breaking your rules. And what that means is, is that you know, all systems don’t work all the time, all systems will lose money. And if you have to then turn around and explain to your clients in a given period of time, why you didn’t do well, you need to make sure that you’re explaining to them that you didn’t do well, because you were following your rules, not breaking your rules in the interview. Andreas makes a distinction between systematic and mechanical trading, but they all have elements of rules. And what’s critical is that come hell or high water, you need to follow your rules and see the process through the entire cycle. And that’s a critical point for all investors, regardless of how systematic or mechanical you are, or non discretionary as well. So the rules are there for a reason, and they’re critical. And when things are not going well, you need to stay on that horse and make it across to the other side.
Tyler Wood 05:52
Well said, Dave, I mean, after all, that is what the allocators are paying you to do as their money manager. You know, you mentioned the the difference between systematic and mechanical. In Andreas’ world for him, you know, the difference between something that is fully unsupervised, completely mechanical, versus a systematic strategy, just defining that as, as a rules based approach, a repeatable defined process, I thought was an important takeaway. I know I’ve talked to other asset managers and PMs and analysts who if they hear about, you know, systematic traders, systematic strategy, they sort of turn off; that if it’s algorithmically driven, then it’s a black box, and they lose interest. So for everyone listening to this interview, I think there’s a really important distinction to be made, and perhaps some myths to be busted around the systematic approach to managing large pools of capital, when he’s managing money, interestingly, has fully mechanical rules-based approach to all of his signal modeling. What struck me is that when it comes time to actually place the trade, he prefers that the execution be done by a human being, which – I thought that was an important distinction. And then of course, in the interview, we also talk a lot more about, you know, how he makes decisions about allocating to other managers, totally different process than allocating capital to individual securities. Really telling to me just in terms of, you know, a level of conviction in a process or a manager versus a level of conviction in the individual security. With that, we welcome you all to Episode Seven of Fill the Gap with Andreas Clenow, CMT.
Dave Lundgren 07:33
Welcome to Episode Seven of Fill the Gap, the official podcast of the CMT Association. This month, we welcome to the podcast Andreas Clenow, a noted expert in systematic investing with hand-on experience in portfolio management as well as allocating to external managers, hedge funds and the like. Of course, many of us know Andreas from his books, which are excellent. And I would recommend to anyone looking to learn more about systematic trend following and momentum investing. So with that, Andreas, welcome to the podcast.
Andreas Clenow 08:01
Thank you, Dave. Great to be here.
Dave Lundgren 08:02
So you’re involved in many things across the business, whether it’s, as I said, allocating or actually managing money, lots of presentations, you’ve written some fantastic books, why don’t you tell us a little bit about yourself, how you got into the business? And in particular, you know, you’ve settled obviously, firmly in the systematic camp. Why did you choose systematic over discretionary?
Andreas Clenow 08:21
Right, let me see, since you’re opening for such a broad question, you have yourself to blame. Let me see. I think I started trading somewhere in the early 90s, probably 95 or 94. I guess I joined University in 94. The first time I got exposure to the stock market, at least the proper tools, the Reuters Bloomberg terminals and stuff like that. I was an exceptionally good trader in the 90s. Me and everybody else who bought tech stocks in the market, of course.
Dave Lundgren 08:50
So was my mother.
Andreas Clenow 08:51
I consider myself very, very lucky because I started off during one easiest periods to make money in the markets. Yeah, that was the golden rule. Geniuses back then, we just bought Nokia and Ericsson back in Sweden on the way right where I grew up, where I went to university, in the trading trick, which worked for many years, was just buy Nokia and Ericsson, just report the report. Now you don’t know anything was in it, whatever the report, boss is going to go up, right? It wasn’t that impressed. I think I got interested because of that. Because for a while that is [unintelligible]. Like everybody else, I saw my share of losses once markets talked, but I got my start during these times.
Dave Lundgren 09:30
And I just – just to be clear, at this time, this was just discretionary investing. This is not systematic.
Andreas Clenow 09:35
This was all over the place. So how many people nowadays at University know what they’re doing in the stock market? I read –
Dave Lundgren 09:41
I don’t know, 30 years after university.
Andreas Clenow 09:43
So that was a short, you know, I mean, I read all the books what would you realize back then. It was, you had to read certain set of books and do the things that you just don’t question. They’re the gospel of trading basically, read the books, you pretended to understand. Understand, only pretending, but you do look for things. This works, but it wouldn’t. How much do you know when you’re 20? Something, right? So obviously, I read all of Jack Schwager’s books, the big ticket pitch from famous trading books written in the 80s or 90s. I probably read them. You don’t do anything other. What do I know? He was a mix of Bibles and the news. And the basic simplistic technical analysis. I was even doing a point and figure for a while. There. Yeah, I even built a sub base point. And figure plotter uses real time value in Excel to build the point and figure as it goes, how the story went very well. I was lucky. And I thought at the right time, basically, when money was fun, it was easy to take stock, I’m sure chances are, it’s gonna go up, right. We had excellent access to market data systems back in university. And this was a really good idea from Reuters, a company, I later spent some time working for Reuters. And sponsored by University with a trading room basically, with expensive terminals that not as good of course, for cost for 2000 bucks a month per terminal, and we had a whole bunch of them in the room. These things helped a lot. Why systematic? Well, long before this. Now we’re back to mid 80s. I’ve been programming using computers since since forever, that was part of the generation 64. The other guys who grew up with pirated copies of computer games in the mid 80s. I’m sure that’s past the statute of limitation.
Andreas Clenow 10:17
They can’t prosecute now, in the 2020s.
Andreas Clenow 11:28
Programming, I’ll take background and it just made sense to combine it a little bit. I think it took quite some time before I really got into anything serious and systematic, fine. But I started early. You know, back in the – back in the 90s, I built this trading systems, of course, projected that I’m going to have at least 500 millions within a couple of weeks or so like, I’m sure everybody’s been looking at this kind of ridiculous pay off things from back tests and not understanding how unrealistic it is. I’ve gone through all of this. So you know, whenever you hear me criticize and stuff, it’s because I consoled myself long time ago. But the short answer to your question is I was into trading for these reasons. And I had a tech background, it just made sense to combine this a systematic part.
Dave Lundgren 12:09
How would you define systematic investing? I mean, it’s it’s a term we use, often, how would you define it?
Andreas Clenow 12:16
Rules based, I mean, mechanical is something completely automated. And that’s not necessarily necessarily the case, there’s a subset I would say systematic is anything that’s kind of rule based.
Dave Lundgren 12:27
Interestingly, try the distinction between systematic and mechanical. So you can have systematic mechanical, and then you can have systematic discretionary. Either way, it’s rules based.
Andreas Clenow 12:36
I would say, the vast majority of systematic trading, that is some sort of discretionary element, whether you want to quit it or not, but you choose to realize that or not. But there’s usually some sort of discretion component, unless you really program your computers to do everything and you go fishing, very, very few people have something that’s completely unsupervised, just let it run, the more things you have some sort of discretionary element in it.
Dave Lundgren 12:59
Okay, so you define yourself as probably I’m assuming more systematic mechanical than systematic discretionary.
Andreas Clenow 13:06
Not necessarily, I like take, but I’m also paranoid enough not to let my own keys, my own personal code, send orders directly to exchanges, I prefer to have the computer tell me what to do. And me or somebody else executes and actually enters or exits the market, rather than sending in order to just route it over to the exchange. So I prefer to have an actual trader execute, it’s more of a personal preference. I’m not saying any either way is better or worse, can be errors in both ways. But that’s my preference.
Dave Lundgren 13:36
What I’m trying to get at is not necessarily the post signal implementation, whether that’s mechanical discretion or not, I mean, more the actual signal generation, and even like the position sizing and things like that this discretion reverses systematically, or using a phrase mechanical.
Andreas Clenow 13:54
Yeah, gotcha. I mean, on that part, yeah, on that point, I will be completely systematic. The all the time you override is when something happens that that your model is just not planned for, when a good example is what what are you doing, if you’ve been trading for 20 years, and suddenly 2008 comes along, and now you have behavior in the market, which just didn’t exist before. I mean, to simply let models be models and keep running during that is financial suicide, Russian Roulette, anything can happen. Either you make like a zillion bucks, or you lose everything. And that’s just not responsible trading, you have a fiduciary duty as well. If you manage other people’s money in such behavior, you need to take action.
Dave Lundgren 14:31
That’s a an interesting point, I think there’s two things that can change that would put a systematic approach to risk because it’s just simply not the data, the things you’ve back tested, one would be episodic or an event. And then the other would be regime. So in an episode, it would be like the pandemic or 2008, or something like that, where it’s just it’s not in the data, and you probably need to respond to that. But that’s obvious. I mean, it’s hit you in the face, it’s in the news, you know exactly what’s going on. So you need to know as a systematic investor that you probably need to consider changing your approach, at least until things normalize from a regime perspective, though, you know, when you think about what’s been happening with quantitative easing, I mean, that’s completely changed the way the markets behave, it has turned a lot of investment philosophies on their head just because it’s been a steamroller, just kind of pushing markets higher or lower, depending on what’s happening. And as a result of that has really caused a lot of the systematic approaches to really falter in, it’s not readily evident as to why because it’s a regime change, not an episode where you can see what you can actually understand what’s going on. How would you assess that?
Andreas Clenow 15:33
So different approaches to see the change in the markets over time with not just quantitative easing, but we look at what happened in the interest rate side, for instance, you guys only have half a percent over here, right? Um, you still have positive interest rates?
Dave Lundgren 15:47
And you are so lucky.
Andreas Clenow 15:49
Yeah, exactly. I mean, over here, once you start getting negative interest rates, you have all kinds of issues with your models [that you’re aware of]. Interestingly, I see that most models keep working fine. Anyway, obviously, profitability has come down on some trend following, for instance, which has been dependent on high interest level that slowly moved down over time. But that kind of stopped being the case, at least. The ideal scenario for trend following is very high interest levels that slowly slowly move down. That was a massive part of the success of the strategy, and we don’t have it anymore.
Dave Lundgren 16:23
And you’re saying that because that was, in particular, with futures, because most of your capital is kept in cash, and you’re earning six or 7% on T bills while the system is deployed into low margin exposure and futures? Is that what you’re showing?
Andreas Clenow 16:37
That this happened, this happened, that made a big difference. So if you can invest your free capital, you don’t actually need a good strategy. On the other side, I mean, for that part, you would just want to have – that’s the other thing, then what you want to have is very high interest rates that remain very high. Right? Yeah, we have very high interest rate too slowly moving down, which means we also had a lot of money and bulk of the money on trend following over the years was made on similar buying and holding bonds, Treasury and money market. Right. The trends were ridiculously consistent over decades, double whammy.
Tyler Wood 17:12
So that was that was brilliant. You were talking about having discretion over actually executing the trades. And the examples you gave Dave were longer term events, whether it’s great financial crisis, or even the COVID pandemic, what about something like the flash crash, something that is very short lived, but obviously spikes, the data coming into your system? At what point? Do you intervene as the human over machine? Or where do you have a certain threshold in mind before you take action?
Andreas Clenow 17:41
I think a lot of these things depend on who’s monitoring your trading, and what are they expecting, it is your own money, you can act in a very different way. But if you have 100 million bucks in somebody else’s money, now you have a whole different fiduciary responsibility, you don’t – you can’t just take whatever action you think might be right. You have to take whatever action you promise people to be taken. and kept justice. I used to say that there are there are, there are two ways of losing money. And one is worse than the other. I mean, you can lose money by following the rules. So you can lose money by breaking the rules, and one is easier to explain than the other. So yeah, you have to consider more factors. If you’re trading other people’s money, your flash crash, that’s not easy to respond to; flash crash will probably hurt you a lot if you’re working with actual stops and owners in the market. And many people do. I have a strong opinion either way, I prefer not to but that’s again, personal opinion as to which is best by having a strong view on. But if you had stopped orders in the market, for instance, you probably had a pretty bad day. If you did not, probably things worked out. Let me see, there was about four and a half years ago. Don’t worry here, the European is not getting into American politics. But markets had some interesting moods that particular day. I was in Singapore when the results were coming in when the result of the presidential election in 2016 materialized. Being in Singapore that day was interesting, because the really scary action was when I was out. Otherwise I’d be asleep. It was Europe. That was scary. I followed the rules and came out okay. But on paper, there were some pretty big losses for a couple of hours to remember the market was saying that the results of elections are coming out and the market absolutely tanked. It looks like an excellent market disaster. You guys a lot. You didn’t probably sleep as well. And it’s probably during American sleeping hours as well. Now you’re up and watching.
Dave Lundgren 19:35
I was awakened. I actually, I actually wrote a note to the firm that night. Yeah, one in the morning. Yeah, buy with both hands, right? They did. It’s actually what I wrote.
Tyler Wood 19:44
Andreas, keep in mind. Brexit had happened. The cubs had already won the World Series. So I mean, in terms of random things happening that year, we were already two for two. Of course it comes with all baseball players. Let’s get right and first guess. Well done. Right, and the numbers are coming in.
Andreas Clenow 20:07
And no, I think my point, my point was, if you had stop losses in the markets, and what I’m seeing was that if I was to time, you will probably have lost a lot of money that day, I did not have stock markets in the market. Most of our problems were based on not acting on intraday signals like that. But it’s still not very fun experience when you have significant money in play, and you have such big moves. I mean, the market came back, I was fine at the end of the course, another time, maybe the market would actually tank and that you wish you had that stop loss. So, you know, don’t quote me now and say that you shouldn’t have stop losses in the market. This particular time, it turned out that my decision not to stop in the market was correct. But who knows about next time.
Dave Lundgren 20:45
I didn’t want to just ask you a question that was more bigger picture as it relates to quant investing. And just what is it about quant investing that causes that approach to, you know, every five to 10 years? Basically blow up? What causes that to happen?
Andreas Clenow 21:01
I have no idea whatsoever. I don’t know if I knew that. I know.
Dave Lundgren 21:07
Andreas Clenow 21:08
Yeah, making money off either writing a book about it. I mean, you know, some approaches work for a long, long time, you know, you see bad years and good years. And if you find something that works all the time every year, then sure, I’ll call that out, you can find things that on average were great over decades, but you’re gonna have your bad years.
Dave Lundgren 21:28
But I don’t mean bad years. I mean, like they either blow up in a systemic way that almost causes the system to implode, or they just have massive, massive drawdowns that are just not in the backtested expectation.
Andreas Clenow 21:42
I’m not sure I agree that all systemic strategies have such disastrous effects on them. But okay, why does it, why do things happen? We should not have the data? Well, I mean, that’s to be expected. Frankly, you haven’t tested for every scenario, right? You optimize something for, for the poor, observable, observable universe for what you can, but something’s going to happen. We all know it sooner or later, a particular with a high steam strategies, say mean reversion type of things. It’s not – a different type of strategies, where simple example is this, your proverbial next in front of the steamroller? There’s a lot of trading strategies like that. You’re winning almost all the time, you have an embarrassingly high hit ratio. Yeah, it could be here up to here, you win almost every month, it looks brilliant. But we all know that such strategies sooner or later, the guy take a big hit, if you’re aware of it, as a trader, as a manager, as an investor, if everybody involved is aware of it, and maybe it’s fine. But if you see a strategy that kind of looks like made up strike record, then sooner or later, something’s gonna happen.
Dave Lundgren 22:44
As an expert in both trend following in momentum investing, I mean, they’re they are different. So how would you define the two? What distinguishes one from the other? And which do you prefer?
Andreas Clenow 22:54
Definitely different to my view, I mean, I, I tried to make a difference in terminology was to make the point that are different they are, the biggest thing for me is when you talk momentum, you’re talking primarily stock strategy, stock picking, portfolio construction type of services. And when you do that, say like my second book, to plug that one, I talk smooth, that was about a portfolio construction methodology we pick, basically, the stock that stocks have performed well, in the recent past, and even if you construct a great portfolio of long stocks is still a portfolio of long stocks. But it still had a method beater component. Right? Sure. I mean, you know, somebody says, Why don’t you hedge it out? Right? Why don’t you leverage up and take a futures position against it and hedge it out? You get tired of assault. It’s no longer interesting, though. Unless you’re a, I don’t know, a 5 billion family office and you’re happy with two 3% return per year, write novels guys as well. But for most people, it’s just not interesting anymore if your job to be done. So momentum is primarily about taking on long data, you just got to be smart and how you take all along beat on target catches an elephant. Yeah, but it’s on the beat they’re talking about, you’re not getting anything uncorrelated. You can have all kinds of downside protection search things built in, but you’re still primarily working with data. That’s the main thing. And trend following now, you can define employing a systematic trend following on futures in a way, you have a completely different animal. You have all this assets, which can move in completely different ways. You have other phenomenons to trade, uncorrelated phenomena, uncorrelated to each other. But don’t forget that a large part of what you’re trading is something like that is actually term structure. You’re trading the the implied yield all of the markets. There’s a large product, some of these underlying markets, they’re just not trending at all or they’re trending differently. That wouldn’t be profitable, but you can trade and I know a lot of people miss this, that for most futures markets, you can’t actually trade the underlying stocks impossible. You can’t even trade the s&p 500. A lot of people are missing the yellow lines for trades. You got to trade some sort of market based on – in the case of the s&p 500. The underlying is very, very similar to the futures, right, nobody can trade. Because it’s just a calculation, right? It’s just meanings, it’s not tradable. The futures is very similar but you don’t take something extreme like the VIX, the VIX index is simply not trading what you can trade anything similar to the VIX, because the VIX future behaves in a totally different way than than the VIX index, they’re not similar in any way except in the very short term. So when trend following. Keep in mind, you treat your trading so many factors, many asset classes completely unrelated to each other. And you trade the cost of carrying all this of these markets.
Dave Lundgren 25:30
So when I think about the two processes, one is basically ranking historical performance, and then just buying the top, whatever it is, whatever your preferences, decile, quintile, whatever it is, and then stopping yourself out when it falls out of that decile. That is your stop. So though momentum investors formally use a stop their actual stop is when the stock or the underlying falls out of the top decile, that’s when you get out. And then trend following is more, you know, you don’t have to look at charts necessarily to do it. But it’s looking at higher highs and higher lows or moving average configurations and things like that. So would you say that either of those two strategies one is better suited to certain asset classes versus another asset class?
Andreas Clenow 26:07
I’m going to be the difficult one here. I’ll say that I don’t believe that such a thing is better. It all depends on what you want to do. Let me know my thing is I look at this, I look at all the strategies from a business point of view more than a trading point of view. And this is, Would you rather rather manage Ferrari or Fiat, same company these days, or Kia, a Korean car, family car? Would you rather be in charge of that? Or a Bravo, Ferrari? It all depends, right? Clearly, one is more fun to drive. But isn’t the better business? Yeah, that’s what the customers want, right? And if you look at these kind of strategies, better, I mean, it’s better to want better or better not to want below, please do more work. Who you are, what’s your background, if if your net wealth is 50,000 bucks, and you want to get rich quick, you probably have a very different mindset and very different view on on what to trade and save than if you’re a family office of 500 million, and you just want to have this nice and slow retirement and you want to have an explainable return to your principle, you want to have something that follows the economy as long, as long investors. I don’t think anyone is better. Sorry for the long answer about that.
Dave Lundgren 27:15
No, no, it’s great. It’s a great speech. So that’s really an interesting response. Because of your perspective, your perspective is not just an investor who’s passionate about this particular topic, but you’re also running a business. And so that’s a an important implication for you when you’re making decisions is what’s the actual better business decision?
Andreas Clenow 27:31
Yeah, I mean, the formal answer says that the guy running the business is peddling whatever he can. Not really about that either. Because different organizations, different investors need different things, you can never really say that one strategies, but you can probably pick some strategies that are that are pretty horrible that you shouldn’t sell to anybody or should recommend to anybody. But there’s quite a large universe, all perfectly valid investment approaches and trading approaches. And it’s very, very difficult to say that one is really objective better than another for everybody. It doesn’t work that way, in my view.
Dave Lundgren 27:59
Yeah, that makes sense. Over the years, you’ve written some pretty interesting, we’ll say, papers and interviews on this particular topic that really, in many ways brought into question some of the foundational principles that everybody accepts to be the truth of momentum investing that you would obviously take the counter argument to, and one of which I really resonates with me is is a study that you did, where you basically shed light on the falsity of the notion that your actual signals are what matter; when to buy when to sell position sizing, how many stocks to own in a portfolio and basically, you basically took a I think it was the s&p 500 universe, and you randomly pick stocks, you randomly position sized, you randomly determined how many stocks to own in that study, again, having no oversight or anything like that, other than running the models, those various iterations of those combinations of three things beat the market. So that obviously, back into the question, why do we spend so much time on those things, when in fact, they don’t seem to matter? If they don’t matter? What does matter?
Andreas Clenow 28:58
If I remember correctly was a long time ago, I wrote that one. If I recall, I think in that article, I presented the clinical strategy, where I buy all the stocks to start with CL, E, N, or W. And then we’ve got to find some truth in that; I believe that I think there’s some credit to that research. Now, my point, again, if I remember correct was not actually that random stock picking is a great idea, but even the so called cloud strategy, but rather that following an index, which is massively concentrated, and a few enormous companies might not be a great idea. You could also do an equal weighted version of the index and you still get better results right at the time. The problem is look at something like the s&p 500. Now, if you were a competitive this particular question, I would have pulled stats because I don’t know in my head at the moment, but the top like five components, well, they say that 87% of all statistics or statistics is made up on the spot, right? So why stop now is probably equal to the bottom 100 something like that. The bottom 50 or 100, stocks of the s&p 500. Probably the bottom 200 stocks, they don’t really matter. They’re a rounding error. Why pretend that this is some sort of diversified index fund, it’s really just driven by the top stocks. Because the way the weighting system works here. So the way these particular stocks have grown, we have a few stocks that are so enormous, they will drive the entire performance of the index. Right? And while I mean, obviously, the stock got there by performing incredibly well, some like Apple or Facebook is the only reason that in the index is because it performed incredibly well in the past. But once you’re the largest company in the wall, how many times you’re going to double? So does it make sense that your largest weight in the company, which arguably performed excellently, but it’s one of the largest companies in the world, it’s not possible for it to keep on doubling?
Dave Lundgren 30:48
If I can summarize what you’re saying is that the s&p 500 is basically a momentum strategy that does not use stops on stocks that have worked in the past. Because if Apple becomes the largest company in the index, that’s great. And it got there because it did really well and benefited shareholders while they were in it. But if it then goes on to become the smallest company in the index, there is no stop for that in that particular momentum strategy. Yeah, clearly, you read my article more recently than I did. Yes. That’s my point. Yeah. So I actually did forget that your conclusion there was that it was more about there being an issue with how the index is constructed. But if we accept that, and I think that’s there’s been a lot of papers and whatnot written on that. And there’s an entire industry based on alternative weighting structures for indexes and whatnot. But put that aside, and let’s look at the actual results of the study you did, which was random stock selection, random position sizing, and random number of stocks in the index. And all of those iterations did well, that to me, if we can we just forget about the other part of what you were trying to get to let’s, let’s focus on that. Does that not mean that the buy decision, the sell decision, the risk, not the risk management, but the weighting scheme, and the number of stocks you want? i.e. diversification does not matter?
Andreas Clenow 31:57
I think, I believe when I think back, I think it was not a conclusion I had that when you – once you build your trading model, you might want to compare it to the expected return on models and the models, because you can get improved value just by doing this random stuff, right? So maybe it won’t, maybe your rules matter. But maybe they don’t create this great stock picking more beats index, right. But to beat the index might not be terribly difficult if you have free hands. In all fairness, a lot to pick on the mutual fund business. But in all fairness, these guys had no choice. It’s not like mutual fund managers are stupid, it does not beat the index, he’s not allowed to. It’s just how the rules work for mutual funds, right? It’s not possible that those rules for tracking errors and stuff pointing what you think is your great rules. If it doesn’t really significantly beat the expected return of the random models, then in that case, yes, your rules didn’t really matter. You could have have random rules, you can have the clever monkey throwing darts, you probably have been fine with that. And, of course, if you have significantly better returns, you can just say the rules don’t matter. I’ve seen some brilliant rules out there or the results of them. results that I couldn’t couldn’t explain myself, but I know are real because I’ve vetted them, managers diversity. And then clearly these guys build rules that that matter.
Dave Lundgren 33:14
You know, I remember a couple of years ago, you did a presentation at the CMT Association, where you – and again, being the controversial self that you are, you came to a technical community and basically presented on this idea of taking the other side of the trade of a trend follower. So I’m not sure if in that moment you had completed the work or you had done any work on that since then, I think that’s fascinating as well, it doesn’t deter me from wanting to be a trend follower, because I know trend following works. I think one of the conclusions you came up with was that they both work. In fact, they’re uncorrelated because they’re both doing the exact opposite thing. But over time, they both work. What can we learn from that? And have you done any more work on it?
Andreas Clenow 33:46
Sure. I mean, this I published quite a bit on that, I believe, over the years. The point is, is that can be exploited, who understand the strategy, even a successful strategy, even a great strategy, like trend following can be exploited. It doesn’t mean there’s something wrong with the strategy, but it could be some angle of it, you can take advantage of what I did in this case was, this was a strategy originally born out of my own frustration, as a trend follower, you very often stop out to random, we all had our little cute little solutions to this. And we all realize that none of that really work, move the stop loss away, and all of the usual things, right. But what happens with trend following a lot is price moves down hits, your stock moves right back up again. And it happens often. It’s my view that this is the cost of doing business and trend following. That’s how the game is played. It’s still frustrating. So what I did was I built a model that identifies where trend followers tend to stop out. Now if you want a theory about why it works. I usually don’t care too much about this. But if you want to think about why it works, here’s a good one. It could be that trend followers have grown so large, it’s no longer like a small friendship strategy. It’s multi billion dollar business, half a trillion something like that. So when trend follower stop to stop out, they’re treating each other stop losses, one by one by one. They fall in the prices falling down a bit and everybody’s long to begin with, they push it down further and further until it’s like a vacuum where trend followers are already out, that’s when the price goes snaps up. So I constructed a model which works on much shorter timeframe than trend followers. It enters on a dip created by well, possibly created by transformers, and right back up again with an exit. And yes, I also tried, of course, it does work well also that to enter in these dips, and then switch camps have this position, you just enter the date, we call it transform a position, slap a stop loss or underwritten and trail it and then move on also works. But my personal preference is to just start out soon again, take your profits test, what you see if you get you also get pretty good results. And you can run it together with a trend following approach to help smooth the returns over time.
Dave Lundgren 35:53
As a trend follower one way to passively continue to respect your process, which, i.e. stop out when you’re supposed to stop out but also potentially capture that short term mean reversion that you’re selling into is to maybe respect your stop by calls or respect to stop. But sell puts over some combination of some options overlay around your exit.
Andreas Clenow 36:12
You can do both. And so as looking at it, you could build your trampoline model more complex. By having additional rules around this, I don’t like that way because you only have too much complexity, too difficult to build attribution analysis of what created returns last and so on and refer to a separate model. So you have one trend following model multiple if you like. And then you have a mean reversion model or multiple if you’re like you have different parameters or whatever else, everyone has separately, so that they cannot vote, if you don’t get your portfolio, your aggregated portfolio, all the models, the models will evolve they want as long as you wanted. One is short, but you have not incisional. But they’re both trading independent of each other. I also just record what you said, if you’re a trend follower, I personally try to avoid calling myself anything like that. Because once you make a statement like I’m a follower or a momentum trader or something, now you’re locking your mindset of it. I have no ideology on this, I have no religious devotion to any sort of trading model or asset class or anything else. Whatever works in my philosophy, like trend following stops working tomorrow, which I don’t believe will happen. I’m perfectly fine, dominant, do something else. I think it’s just very dangerous to classify yourself as I’m the strategy.
Dave Lundgren 37:22
But it’s you know, a lot of people ask Tyler and I when we’re with the CMT Association, we’re doing presentations and whatnot we’ll often get the question, you know, if momentum works, or if trend following works, why isn’t everybody doing it? If and when that should happen? Isn’t there this risk that it will stop working?
Andreas Clenow 37:37
Right? I mean, we always have to catch, right. And this is a general thing. But technical analysis I’ve heard since since the 90s. Half the people who don’t like it say that it only works because everybody’s doing and the other half says that it will stop working if enough people are doing it. I mean, you know, if you’re looking to me for some sort of answer to this, it should get known or whatever. All I know is I mentioned what I believe works or not, and adapt to that.
Tyler Wood 38:02
The CMT Association, I think has made leaps and bounds in terms of the acceptance of technical analysis by the wider financial community, the asset management industry, in part because we’ve done a much better job identifying and defining the tools that we include in our body of knowledge for the CMT program, and, and even what we showcase within events, and publications, and all that all of it, if you’re gonna just distill down to what we have found works, it’s that price is the overwhelmingly most important signal and everything that we do. And I think the fact that that most investors nowadays are much less dogmatic than perhaps they were, you know, 20 30 40 years ago, but you’ve done some work that centers around the fact that price is not the only signal in your book trading have evolved, you talked a lot about term structure based trading that may be specific to the futures industry. But I was wondering if you could talk some more about what have you removed price and time series data? Would you still be able to develop a trading system in a model that works?
Andreas Clenow 39:05
I don’t remove price history from this. So what I wanted to talk about was a way of expanding the toolkit for for technical analysis. By doing things that do not involve history at all. I believe it still fits in the realm of technical analysis. I mean, if people can throw in moon phases that I think I can throw in this one. Sorry, no problem. This particular thing was always only applicable to futures. So futures you have all kinds of deliverables trading at the same time, you don’t just trade oil, you trade the September 2021 oil price to play a specific delivery. And if you just look at the chain the bid meaning the chain is just a list of concentrated futures contract for for particular market. Do you see the prices slightly different? I’m sure I’m talking about things that are obvious to most people who are listening it should be anyway, the difference in these prices reflects a whole bunch of things. But what they do not reflect this most common misunderstanding is that this is the market view of traders, that if you see a higher price in December than you see in June, that means a trader thinks that the price is going up, not necessarily, it reflects so called cost of carry, there are all kinds of components in there. But the good news is for us who work with the numbers for lending, it doesn’t particularly matter. It could be due to seasonality or somebody sitting but it could also be cost of storage, expected supply issues, demand issues, or all kinds of other things coming in cost of financing the position of borrowing the money and so on, basically, is the cost of hedging the position. But anyway, the difference in this prices don’t really matter for our conversation here. What I did this as a presentation I was gonna do here deliver this presentation, actually in Singapore year half ago, I built a trading model for demonstration purposes that only looks at snapshot once we look at a snapshot of current less known prices for futures contracts, and not just the most liquid one but across the chain. And then we calculate the implied yield based on this curve, we can get an implied yield across a curve. Basically, we’re looking at the price difference between two deliverables say June and December, for instance, we’re looking at not just the percentage change between them. But given the number of days between the deliverables we calculate what does it mean on a implied annualized yield equivalence based on this and nothing else about the trading, there’s no stop losses, there’s no profit targets. And it’s not even a position sizing logic because we take an equal side of everything. Regardless, I kept it super simple to make a point, I showed many different variations, but they all boil down to one thing. We go long markets that are in backwardation, we go short markets that are in contango, and we don’t care about price trends or anything else and more stops, no targets no nothing. That simple more or completely rule based with equal weights across a whole bunch of futures markets actually works quite well. If you’re totally wrong, the parameters are not selected point out, if you want to understand the model, the inputs, the inputs, and the parameters shouldn’t matter that much. I told them around a lot on how we do it, and it still performs quite well. So think about how you can build a completely uncorrelated model, long futures contracts in backwardation short futures contracts in contango.
Tyler Wood 42:19
Forget about the price history altogether.
Andreas Clenow 42:21
No price history whatsoever needed.
Dave Lundgren 42:23
Did you find that that back test worked better in different futures markets? Like I’m picking commodities versus financials?
Andreas Clenow 42:30
Sure. So two asset classes were works best. You’d be surprised, you guys, you know, the futures markets. They work best in commodity markets and interest rate markets. They’re also obviously the biggest market. But what are these markets have in common? Well, they actually have in terms of the care about if you look at something like the s&p 500 futures, the circle curve is pretty much flat. There’s no big difference there. So even if you if you construct rules to say that take a position, whatever, whatever the steepness of the curve is a certain a certain percent, or take the steepest, you’ll never get a position in something like the s&p 500. It just won’t happen to put it out into the universe, the factors, but you’ll never get a signal. You get a signal into commodities, maybe the interest rates, not the normal financials.
Tyler Wood 43:13
Well, I’m looking forward to the next CMT symposium when we can have you back out to actually see the full model and the full presentation.
Andreas Clenow 43:20
Yeah, absolutely. Yeah. Yeah, this is just my way of making sure you get me out.
Tyler Wood 43:28
That’s right. If we put a plug in now that it’s much more likely to happen later, you know, the fact that you are doing this work suggests that perhaps you spend all day every day just focused on model building, systematic investing, but I know that’s not the case. And just in preparing for this interview, you mentioned that trend following really isn’t that exciting anymore? From a business standpoint? Maybe it is, you know, in terms of the academic pursuit, can you unpack that a little bit more for us in terms of what you’re seeing now in 2021? Or what you anticipate for the years ahead in terms of the business of trend following?
Andreas Clenow 44:00
Sure. I tried calling, actually a trading strategy you’re gonna you’re gonna see from two perspectives. One is, Does it make sense to trade? Can it show interesting results, but the other if you’re running a business is is an interesting product to sell? If you raise money for it, can you can you build a business rather than trend following? Well is a trend strategy as part of generating results? I haven’t thought it’s going to continue to work all the problems, we’re not going to see the spectacular returns that we saw in the 80s or 90s anymore, or 2008. It was exceptional times but he’s got to hold his own. It’s got to be completely valid. The asset class by itself, in my view, but as far as running a business, the CPA spacer is, the administrator space in general, has consolidated dramatically in the past 10 to 15 years, and particularly last 10 years. It’s become a very much brand oriented business. This is what happens when a business mature, right? Most businesses it consolidates, it becomes but it becomes an issue of brand management. So I’m not sure if I would want to be the guy who goes out to try to raise money for a new trend following startup, it’s a tough tough sell today. Now when I got into trend following, it was still kind of a new cool, exciting thing and you can explain to people that were doing this cool uncorrelated strategy never heard about and look at this returns and how different they are not just high return or how different they are uncorrelated, you could explain this new concept to people and you know, the the question you got back then was why should I invest in your trend following strategy and not in say, mutual commerce and the 500? Which is a great question to get. You go out now to the same people and you’re going to say, Why should I invest in your portfolio strategy and not to, say David Harding’s Winton fund with what it’s like 40 billion something right? It’s a little bit on what we’re doing slightly here but it’s a little bit like like creating a toothpaste thought up and you got to go compete with Colgate even get a better toothpaste, you come up with something revolutionary is the best toothpaste ever. Now what you got to talk to the supermarkets, get shelf space, your messaging marketing campaign and how many tens or hundreds of millions so you got to spend before you get any sort of consumer traction. That’s a little bit of the uphill battle you’re facing now with that if the people listening are managing if you’re building bucks and have the marketing dollars, all of that then perfectly fine. I’m guessing most people do not.
Tyler Wood 46:22
Yeah, what a helpful perspective. And most of our listeners, obviously, a lot of the content we want to talk about is ingredients to the model itself. But thinking about raising assets and the institutional space really important for those thinking about running the business. Obviously, you found some success with the Tom’s of Maine variety of trend following investment strategies and yourself some space on the shelves. So –
Dave Lundgren 46:45
He won’t get that analogy.
Tyler Wood 46:47
Oh, no, we haven’t started exporting to Europe yet.
Dave Lundgren 46:51
Yeah, that’s successful. Can I make a controversial statement? I’d like to share with you, Andreas and get your thoughts on it. You may have said this yourself. And I apologize if you have but I the way I’d love to get your your thoughts on it. So I’ve been thinking more and more about this notion that momentum as a factor. And as a signal doesn’t actually work. But knowing that anybody that deploys momentum in a strategy makes money. So why is that? So? The reason I would say that it doesn’t work is because if you qualify signal as to whether or not it works versus it doesn’t it’s – it would be the hit rate, does it actually generate positive signals? And I think the turnover on most momentum strategies indicates that the signal doesn’t actually work. But the strategy works. And the reason it works is because momentum as a factor does find those right tail events, by definition, it can’t avoid them, it absolutely must find those right tail events. In other words, the stocks that double and triple because its momentum, and it’s going to find them. And the reason it does, it avoids the left tail events or the stocks that do really poorly is because as I mentioned earlier, momentum gets out of stock when it falls out of the top decile. So it has that sort of stop mechanism that prevents the left tail event from happening. So when you think about that, the reason why momentum actually works is because of the the age old, let your profits run and cut your losses short. That’s why momentum works. It’s not because momentum is a good signal. Any thoughts on that?
Andreas Clenow 48:14
I’m gonna be the difficult one to say that doesn’t matter. I mean, you know, if the strategy works does matter if it’s the entry signals, right?
Dave Lundgren 48:22
So that’s what I’m saying. That’s the point I’m trying to get. And I’m not talking about the strategy. Yeah, right. The strategy is to is to own things that do well and sell things that do poorly, but I’m trying to assess the quality of the signal and maybe to the point that you may be making is is the quality of the signal, even what matters, is it just the – What really matters is how do you identify winners and stay with them as long as you should? And how do you identify something that you thought would be a winner that is no longer and it doesn’t actually matter if you’re doing momentum, trend, following value, investing systematic quant doesn’t matter just as long as you have a way to identify winners and stick with them, and losers and exit them.
Andreas Clenow 48:56
The difference to me is, in my view, it all depends on how you classify momentum. But for me, the way I look at it is a portfolio construction methodology. And as such, I’m not too bothered with the entry signal, oh, prominently made use of terminology. For me, it’s a way of constructing a portfolio ,not picking an entry point. Now, when I say before the construction method, I also I also mean that it is is a relative strike, it’s not an absolute strategy. In my view, you can make some adjustment to to improve the absolute return over time, but we’re still looking at relative strategy. That’s a huge difference compared to an absolute return strategy, but absolute returns translate things like like signals matter much more. Whereas if you if your goal is not to make money, but to beat the market, and let’s face it, that’s actually the majority of investment strategies out there. Maybe most people miss or many people are missing that especially if you don’t work in the business, but most people are working in finance to manage money, they want relative strategies. Their job is to follow hopefully beat some sort of index. And as such, the cost of signal is too important to me. It’s a matter of public construction. Or you’re not accepted when you enter them, I don’t know, your question. But that’s just my view.
Dave Lundgren 50:05
I mean, I mean, would you would you agree that at the end of the day again, if whether you’re Warren Buffett, or David Harding, or Andreas Clenow, it doesn’t matter. At the end of the day, what matters most is it the stocks that are winning, you hold them, and the stocks that are losing you cut your losses short. So when you look at Warren Buffett’s returns over time, we all know him as being one of the great and he truly is one of the Great Investors of our generation. And I think he’s even said this himself. So I’m not I’m not speaking out of school here. And the idea that if you strip out his two or three biggest winners, he just basically then a market performer. The idea being that even Warren Buffett, the reason he did so well is because it’s the whole expectancy formula, right? How often are you right? times how much you make when you are right, times a plus, how often are you on times how much you lose when you’re wrong, put those two things together. And that tells you if you have an edge, Warren Buffett’s edge was the fact that he held on to three or four stocks forever. So it that’s value investing. So it doesn’t matter what the style is. It’s about identifying, knowing when you’re right, and sticking with it and knowing when you’re wrong and exiting, and just let that play out.
Andreas Clenow 51:04
Sure, I mean, I completely agree. And since you mentioned Buffet, well there’s another important point, I think most people need to be aware of that you look at someone like that. And clearly, clearly he’s done amazingly well over his career. Yeah. And most people would assume the problem is he not only compounded at around 500% a year right? Last I saw, I haven’t seen an updated number in a while. I think he’s about 21, maybe of the fees of the costs total, annualized compounded return. And then you see all these people tried to mimic his success. But instead of aiming for something reasonable, they’re aiming for 100% a year. And that’s when you take insane risks. And that’s why you do things that’s going to lead to blowing up major recently, Warren Buffett made us along this because he needed to take insane risks. He never aimed for ridiculous yield returns, he very much realized that the big money in this business is not in compounding your own money at the highest possible rate. It’s in managing other people’s money. And that I guess I just said did you turn on you hear about your back to the whole business perspective we talked about before, but that in my view is how the game is played. The interesting thing with trading and finance and managed money is family managing other people’s money.
Dave Lundgren 52:16
When you bridge that gap and you’ve managed other people’s money becomes a completely different animal on many levels, not just the business level, but also on a psychology level, etc. You know, I wonder if you can comment on the role of luck in investing.
Andreas Clenow 52:28
There’s an old probably overused cliche, I like the story. I heard it attributed to all kinds of famous investors. I think last I heard was was George Soros, but I had no idea where it comes from. Are you familiar with the the coin flipping game but experiment? The idea being that say you have a nationwide competition in the US? Everybody has $1 coin? You just have dollar coins, don’t you?
Dave Lundgren 52:49
This is Warren Buffett, Warren Buffett, this is something Warren Buffett did.
Andreas Clenow 52:52
Right. Yeah. I mean, it was good chocolate for the readers, the ideas, and everybody competes pair up to or to flip the coin, whoever wins, gets the coin and get to go to the next round loses out of the game. Oh, by the very definition of such a game, but by pure mathematical certainty. After a while there will be people who won hundreds of times, right? They’re going to see themselves as having amazing skills, and other people who see them as having amazing skills. Because if flipped 100 times and they won 100 times, they got to write books about it, they’ve got to be on talk shows on TV, you know, they’re gonna have their own talk show. They’re gonna run for president. They’ve got to do all kinds of silly things, right? We all want to see the message conflicting God’s, okay. It’s a little bit pushing it to say that this is trading. But clearly, there’s some truth in this. Luck is a major factor. Even if you have amazing skills, you have luck. And when you got in, I’m the first to admit that I had tremendous luck in my career. I started with multiple times, I started trading strategies, I started building some business at the right time. Yeah, I made the other two years earlier, two years later, that probably would have gone pretty poorly, I would have stopped them. I don’t come back to my day job. Lack is a big factor in trading. Even if your skill level you need you’ll need some skill to stay in the long run. But skill enough might not be enough skill, and luck is probably what you want.
Dave Lundgren 54:14
That’s a good combination. How about the importance of being able to define the regime that you’re in, in knowing when your strategy performs well, under certain regimes? Is that something that’s necessary? Or do you feel you just need to kind of live and die by the sword of whatever gets delivered to you and your strategy year to year and just pay no mind to what regime you may or may not be in.
Andreas Clenow 54:31
If you’re managing larger piles of money, larger mandate, say somebody that all the money for somebody or somebody’s family, something like that, they need to do very well. That matters a lot on how you allocate what you invest in and so on. Right? Yeah. So if you’re a trend follower, if you’re running a trend following shop, you have all these investors on board and they bought you as a trend following guide your trend following fund. That might be, it’s not your job to see that trend. Following is not the best strategy next year. I’m going to do mean reversion unallocated, I will be pretty angry over that one. I will say the case; I will say even though you have your gifts, but you know what, that’s not your job. That’s my job. You’re a building block, you teach me trend following I bought you because you’re transforming whatever you think is right, you do trend following that I decide how much I want to invest in you. And I want to take up money and put somewhere else, I default the business perspective of everything. But if you’re managing your own money, it’s a whole different thing. You have all kinds of flexibility, you’re high risk trading, you want to have high returns fast and so on different perspective, I tend to see this on the professional side, the allocator side, that case, I will say managers are primarily building blocks, and they should remain building blocks, what you want to see his manager should be predictable. If he told me he’s got to do I don’t know long, short macro, I expect that performance to be long, short macro, I would expect the outcome one day and say that, guess what crypto work better next month we switch strategy, then managers not going to keep my money? That’s for sure. Right? Right.
Dave Lundgren 55:53
How about for, because a lot of our investors or listeners are also individual investors as well. And I’m not necessarily talking about switching strategy as much as knowing what regime you’re in. And therefore knowing that your strategy is either likely to excel if it’s a headwind or a tailwind, and so make adjustments accordingly.
Andreas Clenow 56:11
It’s just part of the strategy. But then default up front, I say, don’t wait until the machine goes against you. And then you say, Well, it seems like this particular market is not great, let’s do something else, you have to default up front the market, you have to think through the possible regimes. Again, you can’t plan for everything, there will always be some exception. But you should try and wait. You can’t do a say, momentum strategy which just go along with that and stocks and then be surprised over the bear market, and not know what to do and what the changes are, etc. prepared for it, you don’t get to prepare for it, you probably haven’t had an issue when we’re not done as far as classic things. Unless you see momentum as a purely purely relative strategy view. You need to have some sort of machine logic in there.
Dave Lundgren 56:51
Exactly. Yeah. And so I think when I think about your books, particularly in Stocks on the Run, well you introduce an absolute stop on the strategy to have them really, actually really interesting, where if I recall correctly, if a stock goes below the 100 day moving average, you exit, and then if the market itself goes below its 200 day average, you keep what you have. But if you get stopped out at something, you don’t replace it. So that’s sort of taking a momentum strategy in putting an absolute sort of barrier beneath it to make sure that if, indeed, the regime does change to a bear market, you cash as opposed to ride it all the way down. As you would in a rollover model.
Andreas Clenow 57:26
Yep. Yeah, exactly. So many ways you can implement such things, of course, but you got to be careful with machine filters is the lack of data to test with, with a simple machine filter you can think of? And I probably did that in something I wrote as well. So feel free to dig through myself and send me an angry email about what something like, let’s say you put a 200 day moving average on the s&p 500. And now you just take the risk off the board. Sounds great, right? How many signals that you have in the last 40 years? Is it statistically significant? Or are we just deliberately cutting out some specific bear markets that we already knew about and therefore optimizing to what we knew about the market? We’re curve fitting? I mean, maybe it was quite forward, who knows. But there’s certainly no statistical significance in any, any, any other logic. So you got to be careful how you do it. I mean, you can build in many ways you can look at volatility levels in the market or something like that, based on that, just check how many signals you got.
Dave Lundgren 58:22
Right, I want to spend a little bit of time speaking about your books only because they were, they were foundational to how I have come to think about trend following momentum investing. And then I would just highly recommend them to anybody who’s listening that they pick up and read these books, and not only just read them once, but multiple times. And to me the greatest takeaway. And it turns out that most people have said the same, is the fact that you took a portion of your books, and you dedicated it to sort of doing a walkthrough analysis of the year by year performance of the strategies to get a sense for what it was actually like to experience that equity curve over time. Because it’s one thing to put the chart up on the wall and say, Hey, this is what this strategy does over time. But it’s another thing to actually walk through it month by month, and get a sense for what it feels like when the strategy draws down 10 or 15%, and experienced volatility, the markets going up and you’re not and all these other things. I know that’s not what you intended readers to take away from that part of the book. So maybe talk a little bit about that. And then what were you surprised by when you added those to your books?
Andreas Clenow 59:20
Well, the thing is surprised me the most is that nobody wrote me an email saying that okay, book, but you know, you could have written it in 20 pages and removed the page for a little while, you know, 100 pages of year by year. Yeah, nobody, which surprised me, that was my main concern that somebody is going to say that this year by year stuff is just to kill pages. And I’ve come to realize actually why people liked it. When I wrote that particular part. I was in a bad state. I was in the drawdown, I was having a bad year. I was not the most optimistic guy around at that time, not during writing the whole book, but during writing during the time I was writing this year by year stuff. I was like, I had some issues back then with TradeStation use, I was in the hole I had drawdowns on other things right probably helped me to put it in a critical perspective to explain that the difficulties what happens really, when you get a drawdown is not as easy to say it’s this little, tiny thing in the chart, you’ll see on the 30 year equity curve, right looks like nothing right? That could have killed you, you don’t know if your message is gonna stay with that you don’t know how close you’re going to get, can you deal with this, because you’re getting the pressure of getting to chase strategy to do that something, it’s not that easy. And I think going through much of that was writing is probably helped me put a perspective in that.
Dave Lundgren 1:00:35
I’ve always said that there are five things you need to be able to have a process for in order to have a successful strategy or successful outcome, I do believe one is a regime definition, two is when to buy, three is when to sell, four is how much, you know, position sizing. And then five is mindset management. And I didn’t list them in any particular order of importance. But if I were to do that, I actually do think that number one would be mindset two, would be regime, you know, tell me what the market’s going to do. I’ll tell you what, what to do in it. And then probably position sizing and when to sell and then when to buy those, that would be the order I put them in. But what I got from just from my own experience, having managed money institutionally dealing with clients, as well as dealing with myself, my own mindset when managing a portfolio is the value of watching you walk through year by year what it’s actually like. And so I think that the sort of the holy grail for this industry, if we can figure it out is what are the tools that you can use in deploy, to not just help yourself execute, from a mindset perspective, but to help your clients? And I think, although it’s a bit of a laborious exercise to do it, I think what you have done is, I think can largely solve that problem, not just for the person deploying the strategy, but for the investor. So in other words, if you think you’re going to raise assets as a trend follower, or value manager doesn’t really matter. And you’re going out and showing this equity curve, part of your presentation should be a walkthrough so that that prospective clients can come to appreciate what it’s actually like to experience and obtain that equity curve over time and how difficult it is in the short term as an investor in the strategy, let alone the investor itself.
Andreas Clenow 1:02:05
So thought provoking thing that you remember who wrote it, I will credit him interesting report from some of the things. So you have an analysis saying that net net, people have lost money on hedge funds since hedge funds were created. Here’s an interesting point, you will think that there must be nonsense, look at the enormous hedge funds, great returns, right? It’s not possible. No, he had done some serious math on inflows and outflows. You see where I’m headed with this right? As a hedge fund manager, I think we all see it. See, I have two brilliant years returns like no one, you had a brilliant year returns a way over expectation, what happens now you’re getting close. Customers call your money just flows in anonymously, there’s just money just flows in, you don’t even know where it came from. It’s just great, how it was growing before anybody is worried. Of course, KYC diligence, all of these things is done by banks for forms, we never get to see who’s behind it. Unless, of course, you can also in Switzerland fall under money laundring rules these days. Anyway. Before my time in Switzerland, things were different. Money just flows in from from nowhere. Now, what happens after that, say you have a bad year, or hasn’t been two bad years, now money flows out, people taking the money out, you have another good year, then they put the money. It’s just investor behavior is the money comes in after good periods. It goes out on the bad period. So the question is net net such investors, do they actually make money on hedge funds or any investments?
Dave Lundgren 1:03:31
Well, yeah, I know. Morningstar did a study on this where they actually showed the investor gapping, is what they call it. But it’s a difference between the stage of return on the mutual fund and the actual return experienced by the average investor based on flows. But I think the report yours referring to as it relates to hedge funds that might have been Tom Basso, that did a study. Yeah, the idea is, and again, I just I have a very visceral experience with this myself, you know, being an institutional investor and in seeing money come into the strategy when we did well and go out when we did poorly. And I never blame that on a client, I always blamed it on on our community inability to properly communicate with clients, in terms of what it takes to stay with this strategy. It’s one thing to put in a pitch book and show the returns over time. I always say that’s, you know, everybody wants uncorrelated strategies until they’re uncorrelated, and then it looks like there’s something wrong, but in actuality, it’s doing what they’re doing. And you should be actually perhaps adding on that drawdown so leads me to my next question. So an allocators perspective, what’s the right way to determine when to invest in a strategy versus not you’ve already determined the strategy works over time, when should you allocate when should you take some out?
Andreas Clenow 1:04:36
Also difficult one, but okay, I should generalize a little bit. I prefer to invest in strategies I believe in when the strategies as such are struggling. Yeah, to see if I’m struggling, but is it the founder or the entire industry around that fund? I mean, you can you see times where I don’t know long short, delta neutral funds are struggling or macro funds are struggling. You see, you often see this pattern but if it’s the entire industry, that’s a good time to enter. If I believe in the industry, I think this is a good manager in the industry and he just had a bad year. I know some trend following managers as well. I like to invest in and also some of the crisis side. But I mean, in a good way, I know some trend following funds with an insane volatility. I would – volatility levels, I wouldn’t, they’re wrong, but they’ve been doing it great to do so well, for many years. But those guys would like to time, you know, I believe in them. But I don’t want to hold such volatility for the long term. But if I see that they had three horrible months, they just lost 40 50% of the fund. And we’re talking a bunch of 100 million for this kind of guys. And they just lost like half of it. Yeah, mine. After they double the money one year, I don’t know, I might go out.
Dave Lundgren 1:05:48
Is it intuition? Or do you actually have hard set rules as to how to determine systematically determine whether something’s in an expected drawdown versus something’s wrong with the strategy or the strategy is fine, but the pm is mis-executing, is there a way to clear this out in between?
Andreas Clenow 1:06:03
Now, when it comes to allocating it’s largely a discretionary thing, I’d like to know the manager, I probably would like to meet the manager either come here to my office in Surrey, I go visit them wherever they are, I get to know the manager, I trust the manager, I get to know the strategy and the details of the strategy. I mean, any cars these days, any talks about black box, and that’s proprietary information, and so on that that gets you off the list pretty fast, because that’s not how the game is played then. You know, if they’re so scared of talking about the third hit, and you know, find it or something is wrong, or it’s not about probably not conversation, you want to continue too long. Now, as long as you diligence and then experience really well, when it comes to allocate to automatic, but manager having a bad year, as long as the salary of that sale happens, everybody, you know, everybody loses money once in a while. But it’s a great manager is a horrible gear on the clock.
Dave Lundgren 1:06:52
By good I mean, if you want to outperform a strategy, you actually want to buy the drawdowns and sell the the the runs of performance, right.
Andreas Clenow 1:07:00
I don’t particularly care about performance. But because it’s because I don’t have, I don’t really have much of a relative mindset. I mean, when it comes to allocating, I’m looking to make money period, not just making more or less money than somebody else.
Dave Lundgren 1:07:13
And I don’t mean, I mean outperform the strategy itself, not outperform a benchmark. But if you have a strategy that has an equity line, and if you actually, were thoughtful about it, and you bought the drawdowns, and then had a big three year run on you, and then you allocate it away, that that would actually have the potential to actually result in in your in a personal Equity Line that’s better than the equity line of the strategy itself. It takes confidence it takes as you said, conversations with the pm to get to really know them, make sure they’re not doing anything wrong. But that truly is the way to allocate, isn’t it?
Andreas Clenow 1:07:40
Yeah, but then again, that is manageable. And I know for regulatory reasons, I’m not mentioning any manager here, but this a great manager I’ve been looking at for about half a year now are really what I’ve allocated these guys. And last year, they had an amazing year, there were about 70% last year, so I don’t want to clean up to that they had really tremendous run with 70% and see what this ridiculous, but they didn’t have it.
Tyler Wood 1:08:03
So where the teenagers have been on Tiktok, Andreas.
Andreas Clenow 1:08:06
Okay. All right, fine. Thank you to that. No, I mean, this the I’ve just been waiting for that to happen bad month for probably a couple of horrible this bloody years. Well, they’re up like 40%, I’m not getting my entry. So yeah, you can get, you can get both ways on this, right. I’m looking at doing the articles often this wrong to it, I’m not chasing it. But I love the manager. Whenever they call I say, Hey, guys, but you’re coming in, lose some money first, then we’ll talk.
Tyler Wood 1:08:37
Trying to reconcile the two pieces, both of you were discussing the ability to cut your losses short, let your winners run when you’re talking about an individual trading strategy versus allocating, you know, a fund of funds and basically taking a contrarian approach. And there was a story relayed to me from a great trader in Chicago, who had a client at this broker dealer and they actually made a desk for the client. He was such, you know, such a big customer that they said, Now, why don’t you come down to the office, downtown Chicago, and you trade with us, you trade right here with our traders. Now, this is not a story at the expense of somebody with mental health issues. But dude would come into the office and had tinfoil hat and he had a coke bottle with a straw in it. And he would listen to the straw. And he would say, Zoltar 29, Zoltar 29 says we got to buy soybeans, Zoltar 29. He’s telling me soybeans, and everybody in the room would take a look at the chart. And when the trade was working with this guy, they would all keep their mouth shut and trade right alongside him. And when when it wasn’t running, they’d say Oh, buddy, it looks like Zoltar is front running today, you know, and they would just abuse him and make fun of him until he would close his position. Right? So this guy had zero trading strategy except to listen to the ridicule around him and that, in essence created his risk management to let his winners run and cut his losers short. So what you guys are talking about in terms of allocating to the managers is, you know, a direct contrarian approach to that, the opposite in terms of emotional reaction. So you’re looking for the folks who have underperformed. I’m assuming this is all – I mean, it has to be contingent on a long track record of very strong performance. But address you’re looking to buy the dip, buy into a strategy once it is underperformed? Doesn’t that by its very nature contradict the rules of you know, just letting your winners run. If it’s if it’s expensive now, it’ll probably double from here, right?
Andreas Clenow 1:10:31
Sure. Okay. You’re mistaking me for dogmatists here. Strict rules I have, I have no more religious views about the buck trading. For me, that’s different thing. If I like the manager, you can look at the stock the same way. Right, you can really have a strong opinion about a stock, you really believe that the stock, but he just doubled, maybe you waited x, I think, you know, if you have some discretionary fundamental opinion about it, you think it’s gonna be great stock, but you know, just moved up too fast. You might wait a little bit, right. Same thing to do. If you look in discretionary trading, you don’t just jump into it. You know, like the crazy trend followers thing, really, I mean, if you don’t do due diligence on a manager, you like to manager, you love to shop, the strategy, everything is right, all the boxes tick, you checked everything, but they just doubled them last year. You don’t really want to go in after that. And you can always long time the past 20 years they’ve been compounding it’s they are 22%. But the last year they did 45%. You want to wait after that. Oh, wait a little bit.
Dave Lundgren 1:11:33
I guess my answer to that interesting question, Tyler, it would be that I have zero confidence in any stock that I buy. But I have a lot of confidence in the strategy over time. So that’s to me is what allows me to think about buying a strategy in drawdown versus buying a stock in drawdown.
Tyler Wood 1:11:49
Well said, yeah, important distinction.
Andreas Clenow 1:11:51
There’s different things. I mean, they take something like last year, I will find you mixing stocks on the on the tips. That’s not a systematic strategy. I just thought that this is gonna work out this is gonna be some some great stocks. I mean, Dow now, for instance, did pretty well. Yeah, I’m applying it after a big run up, because it’s going to be, you know, hysteria for a while, because everybody just heard about, it’s just in the news, right? There’s some content coming out studies coming out, it moves up. I want to wait until it dips down and I buy it. Maybe I buy more on the next day. But that’s a whole different thing. That’s this discretionary trading approach, which is which is totally different from the start on walk autobahn. Yeah. You should of course, your mind two different methods.
Tyler Wood 1:12:32
We’ve noticed this about you, Andreas. No one can put Andreas in a box because he didn’t break the boundaries. And nobody puts Andreas in the corner.
Dave Lundgren 1:12:42
Nobody wants [unintelligible] his own podcast to dirty dancing.
Dave Lundgren 1:12:49
Well done. Exactly.
Tyler Wood 1:12:51
Andreas, there are two things that David and I wanted to ask you about as we’re coming to the end of this interview. One, your thoughts about the emerging merchant banking industry, which I understand you’re exploring? And then the second is the new novel you have coming out, a little crime novel perhaps about Swiss bankers? I can’t wait to read it. Talk about out of the box, answer whichever one you want to touch on first, right?
Andreas Clenow 1:13:13
Merchant banking I know very little about, but we have some interest in some dodgy credit ventures in the states basically lending money to the American companies, which we securitize and raise money institutionally in Europe for. It’s a little bit different from our own books about but it’s been an interesting trading model for a while. And obvious little issues. We got a recent shutdown a year ago, and so on, but still doing quite okay, good. Now, I wasn’t actually planning to mention this. But since we did the novices, we are recording and all of this, I do have any planned book coming out. But I haven’t decided how I want to proceed with it yet. So I don’t know if it’s going to be two months or half a year or something in terms of publication and so on. But yeah, I did make an attempt to actually write a novel, financial thriller, if you like, just make an attempt to become a real author. I think 20 books doesn’t really count, right? So I’m making attempts to write a proper book. The proper way, which is a whole different type of scary than writing books. I just take it I wrote three books already this all quite well, it was pretty easy to do another one. But the challenge is called with the latest book I wrote, I tried to find a new challenge by revenue, much more technical book. And I was very surprised that that actually outsold the previous books. It’s such such a technical book. So I’m not the one.
Dave Lundgren 1:14:32
You’re building. You’re built. You’re building momentum as an author.
Andreas Clenow 1:14:35
Oh, okay. Yeah, gotcha. Gotcha. All right. So I think it let’s let’s give it an attempt to write the book and see if I can compete with actual authors. And whether or not that succeeds you should all know, but in the next half year, I suppose the book is actually finished. It’s a novel taking place in international city of Zurich in a very similar environment that I live and breathe every day, which say launch part of things that happen are real metaphor should happen or less real, but enough is real powerful to hopefully give you a realistic and real feeling on what is like over here and how things work and how things can work out. If things go really bad. I will come back with much more information on that as it goes along.
Tyler Wood 1:15:19
The fourth book tanks, then we’ll be buying out of the money call options on your fifth book, because we believe in the management, don’t worry. What a what a fascinating variety of disciplines. You know, you seem to be a person who just always loves a new challenge, can’t wait to, you know, reconnect with you year after year and see what you’re up to.
Andreas Clenow 1:15:43
Other people say, I just have a short attention span.
Tyler Wood 1:15:47
Yes, the benefits of being ADD, right. Well, Dave and Andreas, I really really appreciate getting to be a part of this conversation, what a fascinating treat for all of our listeners, Dave, any questions as we wrap up?
Dave Lundgren 1:16:00
Not to me, I think we you know, we’ve kept them on the on the line for quite a while. They’re way more than he probably anticipated by probably not long enough for us. But we’ll call it a draw on that. And just say thank you very much, Andreas for your time, both what you’ve dedicated to the community in the past and your time here in this conversation. It’s been fantastic and lived up to my expectations. So this is fantastic. Thank you so much.
Andreas Clenow 1:16:20
Thank you for having me on. It was a pleasure.
Tyler Wood 1:16:22
Thank you, Andreas. We look forward to seeing you either back in Singapore or here in New York sometime real soon. Excellent. Thank you. Have a great day.
Andreas Clenow 1:16:31
Tyler Wood 1:16:32
Bye bye. Thank you all so much for listening to today’s interview with Andreas Clenow. I wanted to update you on a few things from the CMT Association. For those of you who are looking for that mid year market update, we just concluded two incredible days at the CMT European Summit. Fortunately for all of you, those sessions were recorded with expert money managers, analysts, institutional traders and researchers about how they’re approaching markets currently both across you know, Pan-European equities as well as the global allocation space. So please find that at CMTassociation.org and take a look. The other update we wanted to share is that exam registration for the CMT program, the global standard in technical analysis education, is now open. The next administration of CMT exams will be held from December 2 through December 12. Right now, the early registration period is your chance to sign up at the lowest possible price. So please visit us at CMTassociation.org or email us at admin@CMTassociation.org. Fill the Gap is brought to you with support from Optuma. In addition to candidate study of the official CMT curriculum, Optuma provides a full video course on all of the material that candidates need to know for each level of the CMT exams. Each course is broken up into modules, ranging from 15 to 45 minutes, depending on the complexity and length of the topics being covered. Learn more at optuma.com.
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