Episode #439: Tim Pickering, Auspice – Commodities, CTAs & The LME Scandal
Guest: Tim Pickering is the Founder, President and CIO of Auspice. Tim leads strategic decision making and the vision for Auspice’s diverse suite of award winning rules-based quantitative investment strategies.
Date Recorded: 8/17/2022 | Run-Time: 1:19:18
Summary: In today’s episode, we talk all about trend-following and commodities. Tim shares why trend-following can serve as a great diversifier to stocks and bonds, and why it’s a great way to play the current commodity cycle. He ever shares his thoughts on the LME fiasco earlier this year and what his reaction was when he saw his trades were cancelled.
Comments or suggestions? Interested in sponsoring an episode? Email us Feedback@TheMebFaberShow.com
Links from the Episode:
- 1:34 – Intro
- 2:01 – Welcome to our guest, Tim Pickering
- 2:55 – How Tim became interested in commodities and not tech stocks before the 2000 bubble
- 16:02 – Tim’s philosophy on commodity strategies
- 25:52 – How often they rebalance their position sizes and what they hold
- 26:33 – Tim’s thoughts on the LME cancelling his trades this year
- 31:03 – How investors and allocations slot in their long flat commodity strategy
- 39:25 – Agnostic risk management
- 50:44 – Does trend following’s lack of adoption come down to bad branding?
- 57:07 – Why 2022 is a good indicator of why this strategy works; Annti Ilmanen; Episode #413: Anttii Ilmanen, AQR
- 1:01:14 – What does Tim do with the collateral for these funds?
- 1:03:44 – Why venture capitalists don’t use trend following or managed futures for risk management?
- 1:06:55 – What Tim’s happy hour view for 2022-2023 looks like
- 1:10:29 – Common misconceptions and false views he encounters around commodities
- 1:12:17 – Things they’re working on in the background and what he’s thinking about
- 1:14:12 – His most memorable investment or trade
- 1:15:46 – Episode #313: Rob Arnott, Research Affiliates
- 1:16:38 – Learn more about Tim; auspicecapital.com
Welcome Message: Welcome to “The Meb Faber Show” where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas, all to help you grow wealthier and wiser. Better investing starts here.
Disclaimer: Meb Faber is the co-founder and chief investment officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.
Meb: Today’s episode is sponsored by The Idea Farm, my own private curated research service that gives investors access to research reports often used by the world’s largest institutions, funds, and money managers. These reports come from some of the most respected shops in investing, many of them costing thousands of dollars. We also send our favorite investing podcasts from the past week, so you can be sure to only listen to the best of the best.
Also included in the subscription, we send out our quarterly valuation updates like the CAPE ratio, so you can see which countries appear to be the cheapest for new investment dollars in the stock markets all around the world. We also have the quant back tester, which allows you to evaluate very strategic and asset allocation strategies going back in time. So all this can be yours with a subscription to The Idea Farm and best of all, you can try it out for a free, no-risk 30-day trial. Are you ready for an investing edge? Visit theideafarm.com to learn more.
Meb: What is up my friends? We got an awesome show for you today. Our guest is Tim Pickering, founder, and CIO of Auspice Capital. In today’s show, we talk all about trend following in commodities. Tim shares why trend following can serve as a great diversifier to traditional stocks and bonds and why it’s also a great way to play the current commodities cycle. He even shares his thoughts on the LME fiasco earlier this year and what his reaction was when he saw his trades were cancelled. Ouch. Tim mentioned some charts during the episode, so if you want to follow along, click on the YouTube link in the show notes and subscribe while you’re on the page. Please enjoy this episode with Auspice Capital’s, Tim Pickering.
Meb: Tim, welcome to the show.
Tim: Thanks for having me.
Meb: Where do we find you today?
Tim: You find me in Calgary, Alberta, Canada, Western Canada, right along the Rockies.
Meb: Was the last time I saw you, you wearing a ski helmet? Is that right?
Tim: Yes. Yes. That’s right. Good memory. We skied at Lake Louise. It would’ve been November of 2019.
Meb: Right before it all went down, you know?
Tim: That’s right. In a way, it seems like yesterday, in another way it seems like a hell of a long time ago.
Meb: Yeah. Well, I’m lucky to have gotten those days in because I’ve gotten F all days in since then. I’m still convinced I got COVID from Jackson Hole into February, March 2020, even though the antibodies say otherwise. So you and I bonded over some nachos and we’ll get into a little bit of this here, Opry [SP] is really the best place to talk markets. Like, this is like, that’s supposed to be the vibe for this podcast is Opry. That should have been the name of it, “Investing Opry.” But you got your start in the ’90s if I recall.
Meb: You didn’t get seduced into the dotcom mania somehow as the rest of our world did, but somehow ended in the backwaters of the commodity world, which is a very Canadian thing, by the way. So, like, that’s probably a more normal path for you guys than it would’ve been for someone south of the border.
Tim: It’s funny. You’d think it would be, but, you know, still the financial ecosystem in Canada, you know, Wall Street, we got Bay Street in Toronto, that Toronto world is still very financially-focused. It’s stocks and bonds. And being in the commodity… you know, going down a commodity path isn’t as natural as you’d think in this sense. When most people think about commodities in Canada is our strong resource equity market. And that’s what the TSX, Toronto Stock Exchange, has been known for. We got obviously big oil companies, big mining companies. That’s kind of when people think about commodities.
But actually going into the trading of commodities is still, you know, very nascent, very a little bit out there in Canada. And that’s part of what we can talk about. It’s like, okay, how are you getting your commodity exposure? Well, I’ve got this resource equity stock or this ETF. It’s like, but that’s not commodities really, that’s resource equity. And there’s a difference. So it was still a bit of an abstraction, the path I went down with this conservative Canadian bank at the outset.
Meb: When you say commodities, obviously, it’s a very differentiated world. Did you have a focus? Did they stick you in the gold part of the office, which was probably nice or was it something else?
Tim: Yeah, the path was really in what I call the Bitcoin of the time and that was energy derivatives. And really, if you want to get specific, it was natural gas. Natural gas was now available NYMEX futures. There was liquidity there and it was volatile as heck. So that was really the proving ground for me stepping out as a proprietary trader, which was the team I joined at Toronto Dominion Bank. Really focused on energy derivatives. All commodities were in the sphere, but the sexiest of those were energy derivatives because of the volatility and the liquidity. Again, natural gas taught us lessons, taught me lessons from a risk management perspective, from a trend definition perspective of if you can dream it, it’ll happen. You know, it goes from $2 to $15. Things that shouldn’t happen, natural gas taught you those lessons.
Meb: Yeah. So you got your feet wet. At what point did you kind of begin this entrepreneur journey? We always love to say that the naive optimism that kind of led you to believing you could start a company and some ideas there.
Tim: It was a realization and a light bulb going on for myself and Ken Corner, my co-founder here at Auspice and trading partner of 22 years, was that the strategies we built to adapt to this heretic energy commodities, and specifically natural gas, that adaptation that we developed was really applicable across all assets. We didn’t build something and tune it for natural gas or energies or commodities. We just built a strategy that kind of adapted to these paradigm shifts in volatility and risk. Well, okay, so why are we just trading natural gas? Why don’t we trade currencies and why don’t we trade grains and other things?
And so once we started testing that we realized there was an opportunity. It just wasn’t at Shell. Shell was a box. We were focused on a certain thing and, you know, eventually, the itch had to be scratched. And we had our first kid when I was working in Texas with Shell in Houston and wanted to raise my kid back near family in Calgary and stayed another year and then said, “You know what, now’s a good time for us to part ways.” And I wanted to give it a shot before, you know, I got too established with my family and was scared to do it. So it was naive optimism.
Meb: Yeah. And so what year on the timeline, did you guys start your company?
Tim: So I left Shell in January of 2005. I started the company late that year, got my registrations with our local regulator. And then the first fund launched midway through 2006. And the delay was I was trying to recruit my compadre from TDE and Shell to join me. And when Ken joined me in early 2006, we honed in on what we wanted to do and came up with a plan and started our first fund.
Meb: Thinking about commodities in general, you know, there’s a lot of investors, both retail, professional advisors, and institutions that listen to this podcast. And I think of all the assets, I think commodities are probably one of the biggest struggles. And there’s like a timeline for even the institutions. You know, there was a big adoption of commodities as an asset class, you know, particularly post-2000, 2003, and then that decade. And then it’s kind of been different periods and different ways to go about it. You know, you have everything from Jim Rogers and Barclays and Goldman, and there are others who are like, “You can’t index commodities at all.” So I’ll give you the mic, anywhere you want. Just the starting of how to even think about that world in general, and then we’ll get to some strategies and ideas too.
Tim: So, in general, my philosophy and the one that I sort of… some of it I can say I came up with and some of it was influences, but the way the bank that I started with, TD Bank, looked at it was commodity was this completely open territory. You know, there are equities and they’re all, you know, linked and they have correlation and there are bonds and they have some relationship, but commodities are a whole different territory. Cotton’s not like crude, is not like coffee, is not like canola.
Now, if anybody thinks they’re a fundamental, an expert in every single commodity, that becomes, like, you know, a little bit crazy, a little bit of a fallacy, right? So how do you go about, you know, investing in this area and why do you want to? Well, you want to because of these many unique opportunities. Maybe there’s something happening in energy. Forget petroleum energies, what about natural gas? That’s a whole different story. What about natural gas in Europe versus North America? What about wheat? What about soybeans? Well, they’re related, but they’re very different. How about canola? Well, Canada produces canola. Well, how does Russia affect that? So it goes on and on and on.
Meb: Yeah. Let me interrupt you real quick. Listeners, a good example of this is to go pick your favorite quote site. And as you were talking, just pulled up an example on finviz.com and they have a whole future section. And you can click and just kind of walk through these charts on a daily, weekly, monthly basis. I like monthly just to see a really long-term perspective. But you can click through nat gas, gold, palladium, hogs, oats, and canola, wheat, coffee, on and on and see how different and how crazy all these different markets are. Almost everyone we talk to, it’s just, particularly for us, U.S. stocks and bonds. And then you look at this entire world of other, and then it’s like, you know, opening a new door and being like, oh, wow, wait, it’s not just stocks month. Okay, keep going.
Tim: And so, you know, like, think of the perspective, I’m at this conservative Canadian bank that they make money lending money and being in the investment banking space and stocks and bonds, and currencies, that’s their world. And then you throw in commodities, but bear in mind, this is a conservative Canadian bank, right? They get that commodity exposure. They want the commodity exposure. They want the diversification. They want it done in a very disciplined way. And so the question became, how can I participate in these somewhat heretic commodities that have shifts in volatility, there’s always something going on. What way am I going to participate? Now, at this point, I’d never heard the term CTA in my life. In fact, really, it never meant much until I left Shell because I didn’t know… I didn’t really identify as a CTA. I don’t come from that background. I’m a trader who focuses on quantitative factors to participate in market trends.
That’s the background, TD then Shell. And so how am I goanna go about this in participating in all these different markets? So, of course, what does that lead you to? It leads you to trend following. At the end of the day, I don’t care what your driver is, fundamental or non-discretionary, it really doesn’t matter. We’re all trying to follow trends. You know, maybe your bottom-up, top-down, you want to buy the stock here, sell it there, or sell it there and buy it there. It doesn’t matter the asset, we’re trend followers. We follow it in real estate. We follow it in everything we do in life. So it all leads you to trend following.
But the question became what my opportunity was. The team that I was working with at TD, they had done trend following in the lower volatility financial markets, currencies, bonds, equities was kind of a little bit separate, but same idea. What? Can you do that in commodities? And they had tested their strategies in commodities and it didn’t work very well. And the reason it didn’t work very well is because commodities, in general, and let’s think of natural gas as the perfect example, natural gas will be trading at 30 volatility, then something happens and there’s this paradigm shift and it’s at 130 volatility. And those may as well be two different assets, right? They don’t behave the same. They don’t act the same. So what do you do to adapt to that paradigm shift?
So trend following, yes, but if you keep getting knocked outta your trends or stopped out or having extraordinary risk because the volatility changes, that was concerning to the organization I worked for. So could we create strategies that were a trend following, but adapted to the characteristic of that asset? So natural gas in this state, you got to do one thing, natural gas in another state, you’ve got to do something else.
So I’ll give you an example. So a breakout, my son actually was asking me about stocks today and he’s looking at this one stock and he says, “It’s breaking out.” Like, this is a 17-year-old kid. He’s figuring out breaking out means something. Okay. So a breakout, that’s one indication of momentum.
Meb: Usually that age they’re talking about, that’s acne. He’s like, “Man, breaking out. I need some Clearasil.” They even make that anymore, those pads? All right. Breakouts, he’s learning early.
Tim: So here’s the question, how far do you look back to qualify a breakout that’s significant, right? So you’ve got natural gas. Maybe that’s your asset. Do you look back two days, two weeks, two months, two years? The answer kind of depends. It depends on the characteristic of that asset. If that asset is say 20 vol, it’s bouncing around a little bit, well, maybe you don’t need to look as far back to qualify a significant breakout. But if that asset’s bouncing around massively, looking back two days is going to tell you nothing about a significant breakout. And so the immediate path with trend following is, well, I’m going to look back in history and figure out what the best breakout is in history. It’s 25 days. Well, of course, we know that’s pitfall. That’s not robust. That’s curve fitting.
So we approached it very different. It’s like I don’t know. I don’t know what’s a significant breakout. Let’s look at the data. Well, why just look at the data in natural gas? Let’s look at the universe and say, what’s a zone that makes sense? Well, it kind of is in this zone. It’s from here to here. You know, that’s kind of the zone and the way that I’m going to find myself to that breakout at that moment in time depends on the volatility of that asset. If natural gas is low-vol don’t look as far back, if it’s high-vol, you got to look further back, right?
So it’s these adaptations to the character of that market because that asset, natural gas in my case, would do these different things. It would have these paradigm shifts. So that’s what we built. We built a strategy that had a trend definition that adapts to volatility. And then it’s got these queues or these adders that qualify that trend, the upper probabilities that, again, aren’t tuned to natural gas of just kind of generic. And the way that the market finds itself between these goalposts, if you will, is depending on the characteristic at that moment in time. So that does a couple of things. It tunes it, but it also makes it robust. And then there’s the third thing.
The third thing is why I left Shell to start Auspice. It was the realization that what we built, this adaptive strategy, was as good in natural gas as it was in Swiss franc, as it was in an equity. We didn’t build a strategy for natural gas. We built a strategy for a heretic thing, which happened to be natural gas that we had to adapt to. It was the realization that this is robust. So, yes, I get pushed into the commodity camp because we do run 75% commodity risk. Commodities are the proving ground. Commodities are the opportunity. It doesn’t mean we don’t trade financial markets. They can be just as opportune.
Meb: Okay. And so why don’t we start with your ETF or the philosophy behind commodity strategies because that’s what I know you for? And at the time when we were having nachos, when did it get started 20-?
Tim: So a bit of the history. So we launched the underlying strategy or index and had it published by the NYSE since 2010. So we did that in the fall of 2010 to launch an ETF product with, if you remember a company called Claymore. They were in the U.S. and Canada. We launched that first in Canada, an ETF linked to our underlying index. We’ve had the direction products in ’40 Act since 2012 and then flipped it to a ’40 Act ETF in 2017. So the focus is the ETF since 2017 and it was just customer sentiment, they want ETFs.
Meb: Yeah, Claymore, that’s a blast from the past, listeners. We were supposed to actually start our ETF journey in 2008 with Claymore. Forbes was going to move into the ETF space and we were going to be the index provider for a fund. Then 2008 happened. I think our launch date was like December 2008. Good and bad it didn’t happen. Bad because Forbes probably would’ve scaled to be $100 billion ETF issuer with the might of their media empire, which I think they’re for sale by the way. I saw that the other day. Good because on partnering with that many partners, I think we would’ve gotten, like, five basis points or something, but who knows. It caused us to go start our own firm. But Claymore, I’m sad because I would’ve gotten a sword. They used to give all of their partners swords.
Tim: I wish I could flip the camera down the hallway. The Claymore’s in my hallway. When we launched the first ETF, which was February of 2008 and incidentally, the ticker was gas, G-A-S that was linked to Canadian natural gas, what we call ATCHO Gas. Launched on the TSX February of ’08 kind of pre-financial crisis, it was not quite hitting yet and went and rang the bell at the Toronto Stock Exchange and then proceeded to walk down Bay Street with a Claymore in my hand, a sword that’s like, you know, five feet long. Had some funny looks. You’d probably get in trouble now. But, yeah, it’s just part of the journey. Then we launched this product, what we call our long flatter, the Auspice broad commodity index strategy.
And what was it designed to do? Okay. So let’s backstep. Like, why were we doing this? Claymore and the leader there, a guy named Som Seif, great entrepreneur. Runs a company called Purpose ETFs now. Som felt that investors were looking for commodity exposure, but they wanted it in sort of a disciplined way as opposed to picking their own commodities, as opposed to just buying all commodities and burying your head in the sand, i.e., buying the Bloomberg commodity index or Rogers or GSCI maybe there was a better way. And so we were connected on that. And our view was there is a better way. I want to be long in the commodities going up and at very least I want to be out of the commodities going down. And so what does this sound like? Well, it sounds a lot like trend following in CTA. They didn’t want the short side of the equation and they just wanted commodities. And so they wanted commodity upside with a reduced downside.
So all we did was we looked at what we do as a core as a CTA and said, we’ve got robust definitions of trend that can define when commodities are going up, this isn’t rocket science, and we’re going to go long on those commodities on an individual basis. Not all at once, not all this in a sector like grains, but you get long crude because it’s going up. You get outta crude because it’s not going up anymore. That’s simple trend following philosophies. That’s step one, trend following.
Step two is volatility-based position sizing and resizing, the capital allocation. How big do you trade natural gas versus wheat. Well, we normalize those risks because we don’t know which is going to be the opportunity. That’s, again, borrowed from CTA. Then we have to look on an ongoing basis. Do we want to ride that risk when natural gas goes from 30 vol to 130 vol or do we adjust that risk depending on the situation? Well, we made the choice, as in our CTA, to adjust that risk, to sit in a volatility zone 10 to 12, that we feel is very palatable for investors, right?
So commodities are great and you kind of alluded to this, but the volatility of commodities can be crazy. So why not pick a zone that is comfortable for the investor so they can hold it for the opportunity? So now you’re adjusting that risk. And then the third thing, the icing on the cake, is when you make that decision to go long a commodity natural gas, how does that forward-term structure of futures contracts affect that experience? So you’re along the front and now you got to roll up to a higher price, i.e., can tango and there’s a negative roll of yield, right? So we’re getting technical here. But I think if you’ve looked at the commodity products, people have understood that basic concept.
So we look at that term structure and make a decision where should we belong. Right in the front or do we push it further back? And that’s, again, a quantitative decision. So those three steps. It’s a trend following way to get commodity upside, limit the downside, commodities are coming off, go to cash, even go right to cash. Grains start coming up, well, let’s peel those off. Natural gas is going up, well, let’s peel that off. Let’s take profits there, all quantitatively based. So that was the idea behind it. So we went as far as, why did we create an index? We wanted to create our own index, which is the underlying strategy so that the ETF would track our underlying strategy, have a third party, publish that index no different than S&P 500 or GSCI, but it has this active trend following, position weighting, term structure layers built into it.
Meb: I was thinking, as you were talking about launching a gas ETF, I was like, man, you should be… a European gas ETF would probably be a useful tradable here. How do you come up with the portfolio? You know, there’s sort of a unlimited breadth of choices in our world. And how do you kind of settle on the certain number? You know, I see it’s not 100. So how do you kind of come down to the ones that you think are the main muscle movements or the ones you think are the most important?
Tim: There are a few things to touch on there. One, we get asked all the time as a CTA, it’s like, “Okay, so how come you’re not trading 250 markets?” It’s like, “Well, why would we trade 250 markets?” If anything, that’s a capacity issue because you become so big. We don’t have that problem quite yet. We want to be in markets that represent the overall commodity landscape that are liquid enough to execute this strategy and scale this strategy. So we pick markets that we believe represent the market, that have the ability to take on the capacity that we believe the strategy has to grow to. In our case, our underlying strategy is used for the COM ETF, it’s used for institutional managed accounts, which are quite large. So there’s that capacity we have to consider. We want markets that are liquid and trend, but also give us the opportunity to manage that risk.
If they’re gappy markets, we don’t want that kind of a situation. And I’ll give you an example. It’s like commodities that don’t fit that criteria for this liquid ETF product and this underlying index are markets like, say, lumber, right? Because lumber will gap and we want to manage that risk so we can sit in that volatility zone. So, okay, so lumber’s gone on a great trade. How come you don’t have lumber in the portfolio? Well, it’s just one of the things that don’t hit our criteria in terms of scaling this strategy.
Now, there’s another factor and that is we’ve designed an underlying index to fit within the North American ETF world. These are North American traded futures on North American time so that the market makers can replicate that index and show markets in the ETF. And so if we, for example, added LME metals, then that complicates the market-making side of it significantly and the liquidity and the two ways that the North American ETF investor is going to get. So we really built a product that fit for that situation, that fit into the ETF world in our opinion.
Meb: So give us an example of what’s in there. How many you got?
Tim: There are 12 markets. There are the four energies. There are the major grains, soybean, corn, and wheat. And then we have cotton and sugar round out the eggs.
Meb: So what’s that portfolio look like today? There’s been a lot of all over the place with markets. Are you 100% invested?
Tim: We came into the year, you know, commodities screaming higher. Of course, that’s pre-Russia-Ukraine. Russia-Ukraine had us reduce some of the risk. There was a lot of volatility at that time. As commodities started to correct, as you got into Q2, we started to peel off that risk. By the time you got to the end of June, we were long I guess about 7 of the 12 component markets. We peeled off the rest of the eggs in July. And what we’re holding right now is the four energies, 4 NYMEX energy or CME NYMEX energies at a much reduced exposure that we had, say, at the end of February. So we’ve cut that risk as that volatility exploded when Russia-Ukraine hit and a few times since. So we’re holding a much reduced exposure, but still long the energy. So 4 of 12 components, much reduced exposure. Like, the VAR as an example, the value at risk now versus in February is about 25%.
Meb: How often do you guys update this? How often are you looking at it? Every day, 1000 times a day, once a month?
Tim: It’s daily. So that position, you know, we could get kicked out of a trend on any given day. We know where that point is that hits our criteria. We go to adjust those position sizes on a monthly basis. We’re looking on a monthly basis, has the risk in natural gas gone from here to here? There’s a threshold there that’s part of the special sauce. And if it’s moved up by a certain level, we’re going to cut that risk and bring natural gas back so that we’re normalizing those risks across the different assets. So positions can change any given day. The risk resizing happens on a monthly basis.
Meb: You briefly referenced the LME. LME was in the news this past year. You want to give the listeners a little overview or thoughts on that situation because that was a little bit odd?
Tim: Part of what I’ll say is I can’t say it as fact, so it’s going to be a bit of conjecture here. So what happened? The price of nickel exploded higher. And why did that occur? The street’s understanding, my understanding of what happened, in that case, is it was basically a short squeeze. It was a Chinese-based producer that’s along the commodity. They produce nickel and they sell futures to hedge part of that position. Nickel started to move up and against them for whatever reasons. Fundamental, technical, I’m not even going to guess. And that caused them to start covering their shorts in their hedge. And that started to accelerate. And so once that squeeze became sort of apparent, the price of nickel exploded.
And so, for us, we were long nickel, as many CTAs I can imagine were. We were long nickel. And what happens with our core CTA strategy is that, as I was talking about earlier, when the volatility of that asset goes from here to now it’s bouncing around this much, what it tells us is the probability of keeping those mark-to-market gains is diminishing. Because it’s gotten so much more volatile, it could just bounce down. We could lose all those mark-to-market gains. So as that happens, we’re taking triggers from the market to say, you know what, too volatiles, move too far, cut some of that risk.
So on that fateful day or evening, for us it was evening, it hit our criteria. We put in sell orders to get out of the nickel market. We were executed on those. As far as we knew, we exited the nickel market and we come back in so to speak and I’m going to make, you know, operate 24/7, but, you know, the next morning you’re looking at your trade recaps and the trades were cancelled. And so the LME made a decision to cancel those trades where people were selling out of their positions.
Why did they do that? Well, because they had this big short player in this Chinese producer who was so far offside that they were worried about a default. They weren’t going to be able to pay it. The LME would be in trouble and they needed to interject into the market. And they have that right as the exchange. So what do I think about that? I think it’s fraudulent. I think it’s criminal. There are lawsuits against the LME currently by some very large players. I would be happy to join a class action. Again, why do we trade futures? Because there’s a buyer and a seller and I can get in and out no matter what the reason. And there’s an exchange in the middle, I don’t have to take credit risk. That’s the beauty of futures. When the LME made the decision to step in and kill these trades, I believe they went too far.
We’ve seen other cases where exchanges think of the flash crash in whatever year that was 2012, you know, the exchange said, “Well, it hit these stops and we’ve got to kill those trades.” That shouldn’t have happened. There are situations where I believe maybe that is the right decision. The LME’s decision to do that I don’t think was the right decision. And so what did it mean for us? Well, we tried to sell it way up here and then it went limit down because here’s the exchange helping out this one customer who’s short and at the cost of everybody else. And by the time we got outta that trade, we got out profitably, but, you know, we gave away 10 big figures of exposure. So it was an opportunity loss.
Meb: Yeah. That was weird times. With financial markets, the really only thing you ask is the fair game. You know, you go to Vegas, you expect the dealer’s not cheating you. You expect I’m going to play something and you’re not going to change the rules mid-game.
Tim: Well, bear in mind, in this situation, as we understand, I just think it’s documented now is that the group that was offside on the short side prices going higher, they’re getting squeezed from a short perspective, they’re long the underlying commodity, right? So they’re doing fine. They’re doing fine. Right? But they’re getting squeezed on their hedge. And then the question became, well, did they fully hedge? Did they hedge a percentage of that production or were they speculating? And, you know, again, I worked at a large producer, Shell, and I guarantee it wasn’t all hedging. There’s… I speculated.
Meb: Yeah. So as you think about this kind of, like, long-flat commodity strategy, how do most investors slot this in? Do they slot it in as, “Hey, I already have commodity exposure, I’m going to sub this in for part or all of it?” Do they say, “Ah, I’m just going to toss this in the alts bucket?” You know, I know you guys talk about crisis alpha this year. I think certainly is a painful year for many who are in traditional market cap-weighted U.S. stocks and bonds because they both went down. We’ll see what the final three months hold, four months. How do you think about it and then how do most of the allocators think about it for you guys?
Tim: There are kind of two paths at least, and one is an alt bucket. So it can be slotted in that regard because long-term commodities have a low correlation to other assets. And, you know, if you just look full cycle, adding in commodity exposure to a portfolio can be accretive. And if it’s done right, and we believe like with our product, you can lower your volatility. So accretive and lower the volatility, all good stuff. So that’s one slot.
Another slot, and it’s a bit more of an institutional line of thinking, we see this through large RIA groups, we see this through the institutions, they’ve got a slice in their asset allocation that is commodity. And the smart ones have separated resource equity and commodity and they’ve got commodity. The question is how do they get that exposure? So let’s back up. How in a second, but why do they want it? Well, they may have a view on the commodity cycle. So we can talk about what I believe the commodity cycle’s telling us in a second. That’s one thing. And then there’s inflation.
Well, three years ago, I think 2019, even the idea of me saying inflation got kind of scoffed by people. Well, we got no worry of that. We got lowest to no interest rates. We got zero inflation. You know, the stock market’s grinding higher. It’s 2019. Everything’s la-ti-da. We got VIX at single digits. Why do I need to worry about this? I think I even said stagflation and people thought I was losing my mind. But it comes in these surprising waves and you need a catalyst. And as we got towards 2019, we felt there were those catalysts.
And so I tell you all, this is certain institutional investors, certain sophisticated investors, not just those, but certain people kind of recognized this and said, “You know what, I think there is an inflation risk. I don’t know when it’s going to come. There may be a commodity cycle. I don’t know where it’s going to come. And I’ve got this little bucket that I want to put commodity exposure in. But what I don’t want is 25% volatility in a product that is known to pull back 50%. I want some downside protection. I want to participate in commodity upside, but I don’t want the same downside. I don’t want the same vol.” That’s where we fit in.
We can give you most of that upside. If it’s trending up, we’re going to be along those markets. When I start coming off, we’re going to peel off that risk and we’re going to cut that risk as I described earlier. It’s a better ride for the investor. And so we’re finding investors that either put it in that alt bucket or put it in a dedicated commodity bucket knowing that to get the right experience out of it, you’ve got to hold it. You can’t just try to time. It. It’s very difficult to do. You want to ride the cycle. You want to go full cycle on these things, whether it’s inflation or the commodity cycle.
So back to late 2019, and it started to happen in 2018, we saw some institutions stepping in. They felt that commodity had been in a downtrend for a long time and that the fundamental macro situation was changing. So what was changing? The amount of money being invested in commodities as a whole, whether it’s energies or mining or ag was declining. So CapEx has been in decline in the commodity market for a long time. Kind of peaked around 2010, 2012, and then it’s been in decline. So you’re structurally underinvesting in the market and slowly undersupplying the market. Well, that doesn’t matter if there’s not some catalyst or there’s not this big demand or something changes.
So what becomes that thing? We believe there’s two ingredients to a commodity supercycle, a long period of under-investment, CapEx dropping. We had that 2012 till you get to 2018, 2019. It’s been going a long time. That started to be recognized in 2018, 2019. But what’s going to start the party? There’s got to be some sort of catalyst, some sort of generational thing that occurs that kind of kicks it off and people can say, “Well, it was COVID.” Well, it kind of was COVID because COVID got us talking about build back better and investing in things, to build things we need commodities and, you know, got this whole thing going. But the underinvestment in the area had occurred for a long, long time. And this is kind of what we see as the potential for a commodity cycle. So these cycles are long. People say the last one was from 2000 to 2010, largely attributed to China.
If you actually go back and I’ll show you in a second, the real cycle was from like 1970 till then. And then we had this pullback, we all have recency bias. We said, “Commodities are going nowhere. We don’t need commodities. It’s all about ones and zeros and Bitcoin and all these other things.” But we believe those two basic ingredients are, again, that under-investment for a long period of time in supply and then some sort of generational demand shock. So what is the generational demand shock? It’s not really COVID, it’s the green transition and decarburization and ESG and stakeholder capitalism. Those become catalysts to say, okay, we need to do things, we need to build back better, but the first word is build. So we need commodities. COVID gave us the second piece, which is like supply chain complications. They’ll fix themselves over time.
We also have labor shortages, we have unionization, we have ageing demographics that affect the development and growth of the commodity space. We’ve got a war between two massive commodity powerhouses obviously. Let’s just put that as icing on the cake because that happened later. Then you’ve got investment in commodity products and inflation protection that was largely ignored for the better part of a decade. Nobody needed it. Pensions didn’t care. They weren’t worried about it. The average investor wasn’t caring about it or worried about it and maybe rightfully so. Okay?
Now, where do we sit? Well, we’ve got potentially the reopening of an economic superpower, come back to rising interest rates in a second, but back to the under-investment in supply to go full circle in the red dots, we’ve got governments around the world that have made investing in resource development very difficult and very expensive. It’s a black sheep of the world. You know, you’re in the energy space or you’re a miner, all these things. So it’s harder. It’s more expensive. It’s got stigma.
Back to full circle, under-investment in the commodity side. So that’s where we sit. We believe there’s a catalyst and then there’s all these other factors. And in my opinion, most of these other factors did not exist in 2000 when we had this last sort of bull run that’s largely attributed to China. It was China building infrastructure. Now we’ve got all these other things.
Okay, so here’s what we’re going to do. Here’s the plan. The Fed and central banks around the world are going to raise interest rates to combat CPI and consumer-driven inflation. That’s what they’re going to do. They want to calm us down. We’re not going to spend as much. Tell me how that fixes the commodity problems. Per the bottom right, it may reduce demand for manufactured goods, but it sure as heck doesn’t increase commodity supply, right? It makes it more expensive and complicated to an already expensive and complicated thing. It doesn’t incentivize long-term commodity infrastructure investments. Doesn’t fix labor, ageing, doesn’t fix supply chain. Surely doesn’t resolve a war. So if anything, we believe the rising of interest rates exacerbates the problem. So that’s where we sit.
Meb: It’s crazy to see how the narrative changes. You have a couple of good pieces. We’ll link to them in the show notes, listeners, or you can go to the Auspice website. And one of them, you know, you timely say the coming 2020s bull market and commodities and wrote that in 2021. But if you look at the various periods, you know, we did a tweet the other day talking about everyone just assumes stocks outperform always. But we did a tweet looking at stocks, bonds, and gold, you know, and it was back to 2000, and obviously, that was the peak in the U.S., but, like, is, like, all three had similar performance over this century. Right?
And then if you would ask anyone, probably I think that they would’ve lost that bet that they all ended up in the same place, you know, stocks for the long run as a, cult’s the wrong word, as a belief system, you know, is pretty ingrained. But then you have something like 2022 where you get kind of smacked around and the days of the ’70s or perhaps the ’40’s or perhaps early even 2000s come back to the memory. I think that what’s so interesting about your fund and strategy is a lot of people struggle with the volatility. The commodity is there’s like, ah, they’re all over the place. And oil went negative and da, da, da.
Tim: But what you just said, this is the great part. So I 100% agree. That is the problem. People get scared of it because everybody’s got an Uncle Joe that lost his money trading hogs or something, or they got a friend who put it all in this ETF and it got crushed or whatever. But what you said was, they’re all crazy. They’re all heretic. They’re going up, they’re going down. Oil’s going to negative. What an incredible opportunity if you can manage risk.
I was taught to manage risk. What we do is manage risk. We’re agnostic. If you can take one word away from this call with Auspice is agnostic, I don’t care if commodities go up or down, I just care that they go up and down. Right? And in that period, when it was really tough, you know, for even a CTA, let alone a commodity-tilted CTA was we had low-vol, no interest rates, no inflation, commodity was oversupplied, volatility was really low. It was just tough to be in that space.
But when we look back over time, is that the norm or is that the anomaly? And if we look back and I’m going to share screen one more time, if you look back over time, I mean we believe that’s the anomaly. So chart on the left is logarithmic Goldman Sachs commodity index in the S&P. Long term, they’re in the same place, but we all remember this commodity pullback from 2010 to 2019, 2020. Right? I believe the trend tells you something overall and it’s going up. But forget the trend. There’s going to be volatility that you can participate in if you do it in a disciplined manner.
That’s how I make my living. I’m agnostic. I don’t care. And if you want that commodity upside and there’s reasons to have it, inflation cycle, whatever else, least going to give you that commodity upside in a more disciplined way, in a risk palatable way. I’m going to reduce the risk when it’s coming off as commodities inevitably will, as any asset will, I’m going to give you a better experience. Am I always going to keep up with the GSCI? No. But, you know, right now, I’ve got 4 out of 12 commodities and they’re all energies and I’m running a quarter of the risk that we had. If energies collapse here right now, we’re not losing too much, but the GSCI is dropping like a stone.
Meb: Yeah, the draw-down numbers, certainly, if you look back in history for the long-only versus long/flat on anything can be gut-wrenching, certainly 2008, 2009 global financial crisis in the long-only. You know, I think that scarred probably commodity investors forever, but it’s the same thing with any asset. Same thing with equities, same thing with bonds. Do you guys have a long/flat cryptocurrency trading fund yet? Because, like, it seems like the solution for that world, which is 10x more volatile and hard to hold, is there’s not enough tradeables?
Tim: Yeah. For a whole fund. I mean, for what we do, futures are the tool that we use. It fits our criteria. We definitely see some of the opportunity you’re describing and, you know, whether it’s long, short, or long/flat. I think both have a ton of merits. And, you know, I’ll make one thing clear, like, our long/flat commodity strategy, the broad commodity index, the COM ETF link to that, great ways to get commodity upside in a very disciplined way. But, you know, like, if you have to pick one thing you’re going to do, this is my own personal opinion, I think I can support it with the math is you want a commodity-tilted CTA that can go short and do that in a disciplined manner, right?
So why tie one arm behind your back? This is a great way to get commodity upside. And if that’s what you want, and you’re comparing that to long-only products, this is a way better way to get it. But if you can go that one step further and say, “Okay, I want commodity, but I want to trade it both ways. I want the commodity upside, but I’m recognising it’s going to flush. It’s going to go the other way. And I want to get short,” and you trust that there’s a risk management paradigm that can do that, that’s where you want a commodity-tilted CTA.
Meb: When are you guys putting out that ETF?
Tim: Well, it’s interesting. So we launched back, again, in 2012-ish or so. We launched a managed futures ETF in Canada. I mean, again, it was just the wrong time. The appetite wasn’t there. You’ve seen some launch here in the U.S. in recent times. For us, it’s not so much the… like, the delivery mechanism and the ETF’s great, but the product we’re able to put into an ETF as opposed to our flagship product is different. And so we have chose to focus with our flagship Auspice diversified.
Meb: And is that largely because of the ability to target a high enough sort of notional exposure, like, there’s just the limits of public products?
Tim: Absolutely. That is one of the restrictions in terms of the gross notional exposure, i.e., because we’re using futures contracts is definitely restrictive in certain structures, whether it’s ’40 Act, there’s a similar structure in Canada. You know, I think the point I would make, and it’s getting into the weeds, is that looking at gross notional exposures as a way to manage risk is ridiculous. Tells you nothing about risk. I’ll give you an example. And I’ve given this through a regulator. So let’s imagine crude oil. It’s March of 2020, COVID’s hitting, and crude oil at the beginning of the month’s $40. $40 times 1000 barrels in a contract is $40,000 of gross notional exposure. And let’s just pick a number. At that time, crude oil was trading at 40 vol, right? So it’s bouncing around this much 40,000 of gross notional exposure, $40 a barrel.
Now, crude oil goes to $10. Okay? So $10 times 1000 now 10,000 of gross notional exposure. Your gross notional exposure is one-quarter of what it was. And by the definition, it’s one-quarter of the risk. Well, think about it, at $10 crude oil, was it trading at 40 vol? No, it was trading about 140 vol. The risk in that trade was massive, you just had a lower gross notional. Gross notional tells you nothing about risk. It leads you astray in asset classes where there’s diversity like futures. Crude is not like canola, is not like coffee, is not like S&P futures, is not like interest rate futures. If you’re talking as a tool across one asset like equities or fixed income, you can use a tool like that. But when you cross assets, you can’t. And this is a mistake the regulators have made both sides of the border. And that’s why they’re switching now. You’ve seen this in the U.S. here. They’re switching now to VAR-based methodologies to measure risk. That’s going to happen in Canada as well because this idea of gross notional being the measure of risk is wrong.
So to answer your question, yes, that is one of the reasons that it’s hard to replicate our flagship strategy in an ETF format. And we’ve decided as an organization to focus on our flagship strategy, instead of launching a version that fit again into that ETF paradigm and that gross notional and make sure that that flagship product is available to everyone, right? So not QEP, not accredited, but if you can get that product in the hands of everybody because the regulator understands the risk, that’s what we’re interested and that’s the path we’re going down.
Meb: Yeah. When you’re talking to institutions, you had a nice chart in one of your papers about public pensions adopting crisis risk and mitigation strategies. I want you to tell them they should allocate. What’s the bucket for these strategies and how should they think about slotting it in? Because I imagine a lot of listeners are like, “Okay, I like it. How much? Where does this go?”
Tim: Oh, I’d say I’m looking at that slide right now. And so first I’m going to, you know, be flippant about this, how much non-correlated crisis, alpha type return stream do you want in a portfolio? It’s kind of like exercising. Like, you know, exercising two, three, four times a year is not bad for you, it just does nothing for you. Maybe it’ll make you feel good, but at the end of the day, when the shit hits the fan, it ain’t going to help. So it has to be at a level that matters. Okay?
And so when we look at some of these large institutional organizations, and I’m looking at this slide that you’re referring to, and this could be like Hawaii pension, ERS very sophisticated organization, it could be Illinois, it could be CalSTRS, there’s a long list that use these products. And some call them crisis risk offset, some call them risk mitigating strategies or RMS, when we look at the percentage of the portfolio that some of these sophisticated organizations have gone to, it ranges from 10% to 25%. Some are even a little bit higher. So it’s got to be at a significant amount of level in these crises, risk offset, or risk mitigating strategies.
Now of those, what are the strategies they’re using in that area? It includes things like global macro, some sort of alternative return capture, treasury duration, that one’s a big debate right now, and then trend following. And of that mix of assets that give you this crisis risk offset, the fastest growing, and the sort of bulk of that is trend following. Now, we know trend following won’t work all the time, right? But we know that it typically helps at these critical times, whether it’s Q1 of 2020, or it’s the first half of 2022. When you need that special teams player to kick the ball through the uprights, it’s going to be there for you. And that’s what they’re looking for is that reliability at these critical times at a level that matters. So again, 10% to 25% for risk mitigating strategies, of that, we’re seeing a good quarter to a third to half of that in trend following.
Meb: We mentioned this a lot before on the podcast, but I think it bears repeating and curious to hear your thoughts. I say, you know, trend following and the whole umbrella of strategies still, despite, you know, decades of research and practitioner results still doesn’t have as much of a footprint in investor portfolios as one would expect. And I often tell people, I say, you do the blind taste test, the wine example where get an Excel sheet and look at various risk and return parameters and put them into an optimizer and spit it out. Well, you always, not almost always, always end up with a significant allocation to trend following. And the trend followers just got bad branding. Is it too complicated? Is the fact that they decided in many cases in the early days to use the word futures or managed futures? Like, what’s the problem there?
Tim: So, yes, yes. And yes. So here’s the knocks against it. CTA. What is that commodity trading advisor? We don’t only trade commodities. We happen to be commodity-tilted, not just commodities. Managed futures, this is another esoteric term. So this is bad branding. Those things suck. I’m going to get down to really what I think it is in a second, but what else is the knock against? Well, it goes through periods when it’s not adding value to the portfolio. And so we all have recency bias. So for this period of time, it’s most recent for getting the last three years, there’s a period where CTAs struggled. Now, if you go back the previous 40 years, CTAs did extraordinarily well, were the most accretive thing in a portfolio, not just accretive and negatively correlated, they put up killer returns. And so we’ve all got that recency bias. It’s human, right?
And so that’s the knock against it. I think there’s other knocks against it. I think CTAs as a whole, they’ve kind of lost the path. And what I mean by that is because vol dropped across all asset classes, but specifically in commodities, a lot of the big brand name CTAs, we know who they are, really tilted towards financial markets because those were the markets that people recognized. So it was a more familiar return stream. And also there was a capacity issue. They got so big. You can’t be as big in commodities, there’s position limits. So I think all those things kind of tilted things where when the opportunity came around, then some of these big brands didn’t perform the way that we thought they would. And so that was a knock against the industry. And if you stuck to the ethos of commodity-tilted, trend following, being that special teams player and never missing, you did pretty well.
I say, well, what’s the worst-case scenario for what we do at Auspice? It’s like 2019 lowest vol in history, no inflation, nothing’s moving, let alone commodities. My core fund was down just under 7%. “Tim, I mean, you’re down 7%. It’s terrible.” I said, “Well, at the end of the day, your own portfolio was up in 2019. I was some little paper cut. So if you took me off out of the portfolio at the end of 2019 because I didn’t perform, how’d you look in 2020 in Q1, right, when we popped the other way and did it a lot better than many of the CTAs in the CTA indexes because they were still financially tilted, but we had this commodity vol to play with, first up, then down, then up.” And so longwinded way to say, there’s lots of knocks against the area.
Another one is futures. I mean, people just don’t understand futures as a whole. As a financial society, we’re scared of futures. And I can’t imagine focusing trading any other instrument. It’s generally got the best liquidity I can… There’s a buyer and a seller, forgetting the LME situation. But there’s lots of those knocks.
But here’s the biggest one in my opinion. And I had struggled with this for probably a dozen years, risk-taking strategies, in my opinion, are of two types. They’re either convergent or divergent. Convergent return streams, equities, many alternatives, grind higher low-vol and every once in a while they correct. Right? That’s your negative skew. Big corrections from time to time grind higher, give you yield, pay you dividends. That’s a human return strategy, constant gratification. Yield dividend grinds higher, low-vol. We can justify the correction from time to time. That’s what I call a human investment strategy. We all want that constant gratification. “Meb, you look great today. I love your shirt. I love that you wore a hat.” We all want gratification. That’s human.
Now what we do and what I was taught is actually the opposite. It’s a divergent return stream. We grind along, grind along, grind along, grind along, pop, right? It’s like paper cut, paper cut, paper cut, pop, right? That pop generally comes at these critical times of opportunity. That’s that crisis alpha aspect of it. And when you put that convergence strategy together with that divergent strategy, that’s where the magic happens. That divergent strategy, very common, you know, that’s a CTA-like return stream is inhuman. It’s that paper-cut, paper-cut. “God, are you ever going to make any money? 2019 why didn’t you make any money? Everybody else is. You guys suck. Why do I need you?” Well, you need me here.
Okay. So that’s crisis alpha in a nutshell and why it’s inhuman and it’s hard for people to hold onto. I mean, you know, this is forgetting tail risk, that’s even crazier, right? That’s even harder for people to hold onto, in general. But here’s the shift, what if we are back in a regime like it was from say 1970 to 2010, where there’s just a little bit more volatility than 2019? There’s geopolitical drivers. There’s interest rates. There’s inflation to some degree. What if we’re in that paradigm we were from 1970 to 2010 and not the one from 2010 to 2019? What if we’re in that 40-year opportunity set and not that 7-year tough period of quiet? What if? I don’t just need commodities going up, I just need movement. And in my opinion, that’s where we are. I don’t know if commodities are going to continue to go up. It appears the fundamentals are there. But what I really care about is we’ve got a little more vol than 2019 and we’ll do just fine.
Meb: 2022 is such a good microcosm of why this strategy makes sense is that, I mean, everything was down this year. I did a screen the other day where I… and this is better or worse depending on your opinion, but more extreme a month or two ago. But I screened all ETFs that weren’t leveraged or inverse, 90% plus were down on the year, right? Not like half, 90% plus. And that’s because most people were taking the same risks. Right? And so very few and everything else was littered with, it was either commodities or managed futures. Right? That was it. And that’s the only thing that was saving your bacon this year. We’ll see how the rest of the year plays out. But as a microcosm for longer periods, I think that’s useful because most people assume wrongfully that stocks and bonds will always be uncorrelated.
And there was a piece we’ll link to, one of my favorite charts of the year, looking at Antti Ilmanen from AQR, we did a podcast with, he has a great new book out, but he had a chart that showed stress periods with U.S. stocks and bonds, and a lot of the uncorrelated, you know, crisis periods that have lulled people into thinking bonds always help have occurred in the last 40, 50 years when… let’s see, what is that? Forty years when bonds have, you know, been in a different environment than the prior 140. So I don’t know if you have any thoughts there, but…
Tim: You’re bang on. I’m just going to, again, quickly share a screen. This is my colleague, Brennan Basnicki shared this today. Do you see that? Hedge fund performance H1 2022, look at all the different strategies, arbitrages, distressed, event, fixed income, obviously long/short equity, macro multi-strat relative value. What’s up? CTA. It’s the agnostic, right? And at the end of the day, that divergent versus convergent diatribe I went on that it’s not just equities that have that convergent effect, it’s most alternatives, especially at times of crisis. They behave very similarly. What is the one that doesn’t give a rat’s you know what? When the shit’s hitting the fan, it’s these crazy CTAs who are agnostic in terms of what the opportunity is. I don’t honestly care. Now, at the end of the day, I have a slight tilt. It’s not how I trade. It’s not how I allocate risk, but the commodity upside, I think, is potentially there. But if I’m going to get it, I’m going to do it in a disciplined manner. But the best thing you can do is add a CTA.
Meb: Yeah. And going back to your earlier comments, you know, in a meaningful way, we’ll have conversations with advisors sometime and they’ll talk about adding a certain number of our funds and say like, “All right, I’m going to, you know, 1% position.” And often I’m trying to be humorous but also convey a message where I’ll say, like, “Honestly, like, don’t bother.” Not meaning, like, I appreciate it. Like, I’m very gracious that you entrust us with your money, but, you know, you can run simulations and we’ll show them like, “Hey, adding something or subtracting something, it needs to be enough for it to make a difference and 1%’s not going to…” It may be a talking point, but other than that, it’s…
Tim: Well and there nailed it, the talking point. So, you know, we work with a particular group and they like to show clients how well we’ve done in the last few years. And they really wave that flag and say, “You know, these guys have done really well. We know these guys really well. You know, you should invest with us because we’ve got managers like this. They’ve done a really good job.” And I was doing the quick math and I’m like, wow, when you look at the level they have allocated to us, it’s just not moving the needle. Right? Like, yes, so you’re showing that we’ve done well and they should invest with this pool, but at the end of the day, it’s not enough to make a difference. And I said that to them. I was very candid. It’s like, that’s great. You know, I’d love to manage your money. But the reality is, you know, you’re kind of telling a story to the client, it’s not affecting their portfolio.
Meb: What do you guys do with the collateral typically on these funds? Is it hang out in T-bills? Are you putting it in GameStop? Where does the collateral sit?
Tim: It’s generally cash vehicles that have very little risk. You know, this is an ongoing debate. You might say ongoing like 16 years of, you know, what should we do? Should we take a little bit extra risk with that capital? And the answer is in those core funds, whether it’s the long flag, broad commodity strategy, the COM ETF or our flagship CTA, where we run up what’s called a margined equity of about 7%. Some of these we’re 90-plus percent cash to create those futures exposure fees less than 10% of the capital. It’s just disciplined investing in T-bills and cash instruments.
But this brings up an interesting point, and this kind of hit us. And, you know, this goes by various names and, you know, I’ll just open the can of worms is what about if we created a product where we had our full CTA exposure or we need 10 cents on the dollar to create that exposure, we took that at 90 cents and we created an upside equity, fixed income growth portfolio? Let’s do both. So for every dollar that comes into the portfolio, we’re going to give you one and one. We’re going to give you exposure to both, right?
So, you know, the boys that resolve call this return stacking in some flavor, portable alpha cash efficiency. This is nothing new. When we managed account for a institutional investor in our CTA, they fund the managed account, which cents on the dollar, they take the rest of that capital and they go do more capital-intensive things with it, infrastructure, real estate, private equity. That’s efficient use of capital. So we launched a fund in 2020 mimics, one, how we manage our money and, two, what we see the institutions doing. Let’s get that CTA exposure, full exposure, forget 50%, right? It’s every do… Well, I guess it is. It’s one in one. We’re really giving you 200% exposure, a dollar of CTA exposure of trend following and a dollar of that equity fixed income growth portfolio. Right?
And you could stop right there. You could buy the S&P and CTA, put those two things together, 100 to 100, stack those returns and the returns are great, right? Could we do a little better recognizing that I think we’re pretty good at identifying trend, so let’s be long equities when it’s going up and let’s cut some of that risk when it’s trending the other way? So on that traditional fixed income and equity portfolio, let’s have an active overlay there as well.
Meb: I was tweeting the other day. I said, you know, it’s interesting to me because there’s this whole universe of venture capitalists and angel investors that understand this concept of power laws and the big hits and a lot of little paper cuts like you mentioned earlier, but I don’t know any angel investors or VCs that also invest in managed futures and trend. And there’s probably no better crisis strategy to benefit and diversify traditional angel investing than trend. I think I know one. Excuse me. I know one VC who will remain nameless.
Tim: Do you mean a VC that invests in that as a strategy to offset their risk or do you mean that VC investing in, like, trend following manager?
Meb: Look, okay, let’s say you got a VC angel investor and that they put all the money in these angel investing stocks and they just have one giant exposure. I mean, granted, if you do enough vintages over time and enough stocks, like, it’s not a big deal, but you’re seeing it this year. You know, the biggest risk for that world is, and I put private equity in the same bucket, is that you go through a session, you go through a bear market, not only do valuations come down, multiples come down, prices come down, exits evaporate. You have just, all these things happen at once. And, you know, your portfolio goes down by half or whatever.
For such a similar long-vol philosophy, you rarely see an angel investor who’s like, you know what, I angel invest, but with my cash or with my other money, I put it in trend or managed futures. Like, I’ve never even met one who honestly even really knows what it is, you know? They buy more stocks and bonds. So I was saying the ultimate portfolio to me, I imagine, if you’re trying to maximize return, but also make it survivable would be half sort of that angel. I mean, if you’re looking for max compound CAGR would be half VC and angel with the assumption that you can generate those returns, which every angel and VC thinks they can, and then put the other half or all your cash in trend.
Tim: So the answer for me is I haven’t experienced much of that either. Say for a couple of examples, we have a family office we work with, they made the money in oil and gas and they are very tech-focused in their investing for decades plus now. Very aggressive in that space. And they got to know us and they did the smartest thing ever. Instead of putting money in our fund structure, fully funded, they did a managed account for a size that matters and funded the margin, right? So they came along and said, “Hey, we want this as an offset to everything else. And we’re going to do the same things an institution does is we’re going to run a managed account with you and fund it on margin.” It’s not the numbers, but say for a million or 2 million of margin, they put down, they’re getting 10-plus million of exposure to our CTA strategies. And that’s helping them at times when the proverbial stuff’s hitting the fan like it is here in 2022.
Meb: All right. Let’s take off your quant rules-based hat and put on your Opry Nacho, Labatts. What’s the…? Labatts. What’s Labatts? Labatts Blue.
Tim: Labatts. Well, there’s Molson [inaudible 01:07:11] Labatts Blue
Meb: Kokanee, that’s what I was thinking of.
Tim: Kokanee. Well, I mean, that’s, you know, like I’ve got a home in Southeastern British Columbia, that’s Kokanee territory.
Meb: Is that on the Powder Highway?
Tim: That’s on the Powder Highway.
Meb: I got to go back. We got kind of skunked is the wrong word because Canada doesn’t ever really get skunked, but when I went there, we didn’t have the amazing snow that I fantasized about. So that’s going to be back on the to-do list. So we spent a lot more time probably drinking Kokanee than skiing bell to bell, but I would love to go back to Revelstoke, Kicking Horse, all those good spots.
Tim: Great spots. Yeah. Great for sure.
Meb: So we’re at Opry we’re chatting, we’ve had a weird year. Pandemic, war, Europe seems like it’s in a boatload of trouble mess with their energy markets. What does the rest of the year look like to you 2023? Give us your happy hour sort of view of what the future looks like, your crystal ball.
Tim: Well, I kind of already gave the punchline, so I’m not going to reinvent the wheel. And that is, I don’t know which way the markets are going to go. I think commodities are continue as a whole and that’s such a generic term that it’s almost foolish, but I think, as a whole, commodities are going to continue to move higher. We’re in a cycle. It’s going to last a long time. The biggest takeaway that I can, you know, give people is the likelihood of us going back to a low volatility scenario, no inflation, quantitative easing, no interest rates is slim to none. And so you need to look at strategies that can, or you should look at strategies that can take advantage of volatility, especially in an agnostic manner. You know, the only tilt is, you know, I think there is something to the commodity story. Obviously, I believe in that, you know, go about that in a risk-disciplined way.
I think volatility, not at chaos level, it doesn’t have to be Russia-Ukraine, and it doesn’t have to be Q1 at 2020 with COVID, but the overall level of volatility is going to be what I call normal. Like, we were in an environment. And I firmly believe this, by the way, that the environment we were in, say, pick a date, like, I don’t know, 2014, 2015 through 2019, that was the artificial environment, right? That’s not real because that was quantitative easing and all sorts of things.
What we’re back into is reality, controlling inflation, some commodity movement, volatility, interest rates. Not crazy interest rates, just some interest rates. That’s where we are. And with enough geopolitical drivers that, you know, there’s catalysts. That’s where we are. And I think we’re going to be there for the next 5 to 10 years. And I’ve never been more excited than I am in my career.
Early in my career, you know, dot-com like you said, you started with that, it was dot-com. And I was on this commodity desk. Didn’t kind of know what I was doing, trying to learn my way through it. And I didn’t understand the gravity of that opportunity that became that 2000 to 2010 with China. We’re in a much bigger opportunity. And I kind of know what I’m doing a little bit now. So I think I’ve never been more excited than I am right now.
Meb: Any misconceptions, any ideas that as you talk about this concept strategies that consistently percolate that are in conversations or things where you could just kind of slap your forehead and say, “Man, I’ve answered this question 1000 times, or this is something that someone believes that isn’t true?” Anything in that genre or we covered the basis?
Tim: There’s a couple. One is the risk definition, which I think is progressing, like the regulators. SEC just put something in place this month, I mean, you know, that movement forward to a VAR-based methodology. So the understanding of risk is progressing that one, like with gross notional, really, you know, talk about hitting myself in the head. That’s definitely one of them. You know, this whole black box idea, I mean, is just patently, you know, foolish, right? Like, you know, like, I didn’t go on Amazon and order a black box and it’s going to spit out buy and sell signals and futures. I built a strategy that I feel is robust that can participate in trends in a risk-disciplined way that we continue to improve upon. That’s no different than, you know, Henry Ford figuring out an assembly line process works a hell of a lot better than building cars one-off and ad hoc, right?
We want to be consistent in our application. And the way to do that is through systematic trend following. And if you want to call process-driven investing black box, what you’re doing is ignoring technology and you don’t do it in any other aspect of your life, so why would you do it in investing? So all we do is embrace technology. We’re scientists. I’ve got a team of people here. I’m the least educated person in my company point blank. PhDs, masters in mathematics, they’re scientists. We’re looking for scientific ways to extract value in a risk-disciplined way. And we’re agnostic about it. We’re passionate about it.
Meb: Anything you guys are working on, you have a lot of great content on your website? Anything we can look behind the curtains or that you’re thinking about as we look to the horizon and give us a sneak peek on?
Tim: The biggest efforts for us are kind of this list and that is expanding the reach of our broad commodity strategy, that long/flat strategy, making it available to more investors. Right now, we have a U.S.-based ETF. So making that more available, both to retail investors and institutional investors around the world. So that’s one core project. As I mentioned, working on making our core funds. So our flagship CTA is diversified and the one fund, the one where I talked about combining CTA in a growth portfolio, making those available to all investors, not just to credit investors. So that’s a big effort on our part. We launched our flagship program, it’s been around 16 years, but we didn’t have a U.S. vehicle. We launched that earlier this spring on the RCM platform in Chicago.
And then lastly is a big effort for us right now. And that’s what we call alternative markets and accessing some, a little bit more esoteric markets to trend following. So that includes less liquid commodities, things like the Canadian energy market that’s traded physically that Ken and I spent a lot of time of our career in giving trend following access to those markets, China, cryptos like you were describing, and just expanding that beyond the sort of most traditional. That’s a big effort for us because, at the end of the day, and we talked about this earlier, we all want trend following. You know, I want it in everything I can get and some of our best institutional clients, that’s what they’re looking for. We want trend-following returns in anything we can get our hands on because it works.
Meb: We will wrap a bow with that comment. What’s your most memorable trade lifetime good, bad, in between? Anything come to mind or most memorable investment?
Tim: The one that just came to mind is, I mean, there’s so many natural gas stories that it would be boring to even talk about, but I’ll never forget, and this ties back to you in a funny way, I was skiing big white outta Colonna, and I was on a chairlift with a client and I got a call from one of our brokers and they said the Swiss franc has just moved six big figures. The Swiss franc had been trending down for years and years, and that’s when the unpegging happened. And the Swiss franc popped six big figures. I knew we were short. Any trend follower would’ve been short for a long time in years. And all of a sudden, it exploded higher. And I get this call.
And I called back to, you know, our trade desk and, you know, my business partner, Ken Corner, and said, “You know, we’re short swissy into the day. You know, I heard it moved six big figures higher. How much did we give back? Did we get pretty hurt?” “Oh, no, we were out in seconds. We were out right near the beginning of that move.” And I’m like, “See, that’s the thing.” At Auspice, our philosophy is if the volatility starts to bounce around too much and it’s not explainable, the probability of keeping that trade, that mark-to-market gain is diminishing, walk away. Don’t ask questions. Don’t try to look for a fundamental answer. Don’t read the next news report. Don’t wait till the next day. The math tells you the risk is changing and the risk changes, walk away. And that one, you know, we’re really proud of, but there’s many examples of that.
Meb: Yeah. I was just thinking about, we’re talking about inflation earlier. We have a podcast with Rob Arnott and Cam Harvey that will be out by the time this one drops. So, listeners, you would’ve already heard it. But in that podcast, we were talking about inflation and thinking about, has it peaked yet? And we did a survey. So the commonly accepted consensus is it’s peaked. Like, we’ve already passed the top, but they were saying that they didn’t think it’s peaked yet. And we have potential higher coming forward. And I think it was like two-thirds of people said they thought it peaked already. So I’ll be curious to see what happens, but the nat gas situation, as you talk about it in Europe, which is already much, much, much higher than the U.S., hopefully, it comes down. But when you hear about Germans buying up wood for this coming winter, not a good sign. All right, Tim, this has been a blast. Where do people go if they want to find out more about you, your firm, and your ETFs? What’s the best spot?
Tim: Best spot is auspicecapital.com. There’s all of our research on that page.
Meb: Podcast listeners, we’ll post show notes to today’s conversation at mebfaber.com/podcast. If you love the show, if you hate it, shoot us feedback at email@example.com. We love to read the reviews. Please review us on iTunes and subscribe to the show anywhere good podcasts are found. Thanks for listening, friends, and good investing.