Talk Your Book: Trend Following with Eric Crittenden

0:00Today's Animal Spirits Talk Your Book is brought to you by Standpoint Funds. Go to StandpointFunds.com to learn more about their Standpoint Multi-Asset Fund, which we're going to talk about today. That's StandpointFunds.com.

0:33Clients of Ritholtz Wealth Management may maintain positions in the securities discussed in this podcast.

0:42Welcome to Animal Spirits with Michael and Ben. On today's show, we spoke with Eric Quinteton. Eric is the CIO of the Multi-Asset Fund at Standpoint Funds. This is a great conversation about trend following, systematic investing, why a lot of the alts have come and went. It's about survival. And one of the things about his strategy that I think has resonated, though the performance has been really solid, so that doesn't hurt, but he's developed a strategy that people can stick with. And that's the most important thing in this asset management business. There's a lot of strategies that might be optimized better or have the highest sharp ratio.

1:21Guess what? If somebody can't stick with it through thick or thin, it doesn't matter. I love how he said the word simple a dozen times in our talk, probably. And that to me is like, is like whatever the opposite of a red flag is a green flag. Like it's a good thing. With systematic investing, how many different indicators do you need to tell you that you should be long or short a market based on trend following? I don't know if it's three singles, but it's certainly not 175 per market. Right. And you and I have talked before about managed futures and how that was a difficult asset class to have in your portfolio in the 2010s.

1:58I think it's done better recently. But he was like, listen, we like managed futures, but we knew that that wasn't a strategy people could stick with and had to think of the behavioral. So we have a stock piece and a cash piece, and then the futures are on top of it. The trend stuff is on top of it. And that was really smart because you have to give people what they're going to invest in, not what you think they should invest in in an optimized world. If you could give somebody, I don't know, let's make it up, A 60-40 portfolio put 85 % of that in the 60-40, put 15 % of managed futures, but they can't see what's inside their actual portfolio.

2:33Would that smooth the ride over a 30-year period? Yeah, probably would. Would an investor be better off on that ride? Yeah, perhaps they would. But guess what? That's not how investors behave. They look at the line item. They say, hey, how come this thing is underperforming? Right? And so it just becomes a tricky thing to stick with. It's not a commentary on the asset class or the managers there. It's just from an investor behavior point of view, it's not easy. So I think what Eric has done over at Standpoint with the multi-asset fund so far has seemed to really resonate with its investors. It started from nothing and it's about to cross a billion dollars.

3:16And the fund went through a bear market already. So it's not just like a back test you can look at. Is this fund held up in the midst of a 25 % bear market? It started right before COVID. Oh, you're right. And then the 2022 bear market. So it's not a long period of time, but it's certainly been battle tested. So anyway, I think you're going to enjoy this conversation with Eric Quinteton. We'll see you on the other side.

3:43All right, Eric Quinteton, welcome back to the show. Thanks, glad to be here. So I was looking through your website and you have listed for your multi-asset fund. Your investment universe includes fixed income equities, industrial commodities, and agricultural commodities. And there's this huge line of currencies. There's a huge long list of assets under each of these. I don't know how many there are. Eyeballing it, 50 or 60? Am I in the ballpark? Yeah, 70. Okay. How do you come up with this list? What are your guidelines here? Is it all based on liquidity? How do you come up with all these different assets to track?

4:16So what I do once a year is I scan the globe. I have databases that connect to all the different futures exchanges and equity exchanges around the world. And like you mentioned, we rank and sort them based on liquidity. And then we try to pick the 70, 75 most liquid futures markets in the world. And then our ETFs follow a different methodology. We're just trying to get market cap weighted global equities on the equity side. But for the future side, we want the 70 to 75 most liquid futures markets. So Eric, I know that you're not a fundamental expert on all of these things, although I know you could talk the long guilt all day long, but that's not how you guys manage money.

4:59Before we get into the strategy and where the rules come from and all that sort of good stuff, maybe just like a quick background on how you got to where you are today. Sure. I was one of those weirdos that was in college for a long time and kept changing my major. So my background is things like meteorology, geography, public health, and ultimately settled in on finance and computer science. My first job out of college or first paying job was working for a big family office in Kansas and helping them manage their money. So, and I was mostly research. So I, you know, eight, 10 hours a day, just banging away on data.

5:39I guess data scientists before it was a popular phrase, was kind of my job back then. So I learned a lot about investing and trading without being in the industry. I've never worked on the sell side. I didn't work on Wall Street. So I was kind of this peripheral player that had flexibility and freedom to do creative stuff. Ultimately got tired of the weather in Kansas, came out to Arizona, started a hedge fund, started a mutual fund company, left that company, started Standpoint, And now, you know, the goal is I want a product that is going to be how I would want my money managed personally. So the standpoint is my final job.

6:22This is where I'll retire. But I came up through the hedge fund industry, did a lot of work in long short equity, managed futures, spread trading, things of that nature. And then ultimately now I'm trying to pull together the best lessons I learned and my best ideas into one fund structure. And that's why I refer to it as kind of all weather. How would you summarize that in terms of like how you want your personal money to be managed? What are the top level things you're looking for? Well, at the highest level, what I'm trying to do is maximize the compounded return after fees, taxes and inflation.

6:54So what's left over after everyone gets paid? And I want to do that with the least amount of risk that I have to absorb possible. And we can get into how we do that, but that's really high level. I just want to maximize the geometric growth of my true wealth over time. Before we get into like the nuts and bolts of the strategy, this is kind of a in the weeds question for investing people. But you mentioned that you you look at the historical data and every year you update your your data on this stuff. What are your like rules for data sources and how you are willing to look at data and backtest data and all that stuff?

7:29Because there's plenty of different providers. And how do you how do you think about that? Because a lot of this has to come from backtested data, obviously. Yeah, right. So garbage in, garbage out. You really need to understand survivorship bias and how databases work and how, you know, one group of people can collect data and show you one version of history and another group can purportedly collect the same data and show you a completely different view of history. my job is to be impartial and reconstruct history as it actually unfolded and that's a lot more cumbersome than just the convenient data packages that are available for purchase for say five thousand dollars on the internet that could be a three-hour conversation my job is to collect the data clean it so that it looks or structure it so that it looks as if it would have looked in real time historically so you can't use the conveniently clean data after the fact because it's not what he would have been trading on.

8:24So it's pretty involved to do proper backtesting. That's why we have a rule that says 98 % of all backtests are garbage, just go in the trash. So it's a completely different discipline to accurately model historical financial time series data, and that's something that I take pretty seriously. It is funny you mention that. I worked with a guy who was a big quant back in 2008, and he had this whole earnings-driven model that looked amazing in the backtest. And then all the financial companies totally threw earnings out the window, right? In the 2008 crisis. And his whole model blew up because he didn't think of a world in which the earnings from AIG and Citi and whatever could go to zero or negative or whatever and totally skew the S &P 500.

9:08So you're so right that the garbage in scenario and garbage out is such a big part of it. Eric, Ben mentioned the GFC. After that period in time, global macro became the thing. the sexy thing that everybody wanted to become. And it was a lot of chin scratching and master of the universe, uber intellectual type mental masturbation, if you would forgive me for using that phrase, in terms of like, well, if this happens, that happens. And they were trying to solve a four-dimensional puzzle and just masters of the universe type nonsense. And a lot of those people have struggled to adapt to a new world because, as you know, better than anyone, the world of financial markets is so incredibly complex.

9:57It's a biological living thing. I forget who said this quote, but it's so true that once you think you've got the keys to the market, somebody changes the locks. And so what you do and the discipline that you come from is pretty antithetical to thinking. Not that you're not a smart person, But you're not thinking around corners. What does the next six to 12 months look like? What are the odds of a recession? How do I want to be positioned? What about the yen? What about the carry trade? What about this? What about that? What your thing is, and I'd love to hear you expound on this, is all of what we think, it's in the price.

10:34And the price is going to tell me where I want to be long, where I want to be short. And my opinion, your opinion, who cares? It's all in the price. Can you talk about how you got there? I'm sure that you did some. thinking back in the day and said, okay, I can't outsmart everybody always. This is really hard. Yeah. Can we get you to join our marketing team? Yes, 100 % agree with everything you just said. And I'll give you an example. Let's say that you have some really good critical thinkers that are extremely knowledgeable and they're 90 % right on every prediction they make, but they still fail in this game.

11:16And normally when you see that, it's really simple. What's happening is the laws of joint probability kick in. So let's say that you calibrate a portfolio or a series of bets where you have to be right on four things and you have a 90 % chance of being right. Well, the cumulative probability is 0.9 times 0.9 times 0.9 times 0.9. It doesn't take long for that to fall below for the product of that to fall below 50%. Right. So it's the more the more variables, more moving parts, the more nuance, the more you're looking out like you can't win this chess game. You know, cumulative probability or the joint probability is simply not on your side.

11:58So whereas I would like to play chess, I would like to think eight, 10 steps ahead, but your winning percentage, you have to be right almost 100 % of the time for that fragile approach to work. So what works is just pure Darwinism, and that is protect yourself at all times and ruthlessly cut risk when it's not going in your favor and only think one or two steps ahead and just be prepared. I can't tell you, I mean, I'm 52. I've been in the business, I think 27 years now, how many people I've come across that are, they have a higher IQ than me. They're more educated than me. They're more networked than me, but they're not still in the business.

12:39And all they had to do was get it wrong once or twice to get taken out. So this is a game for the humble and the disciplined, this marathon. And you don't need to have an IQ of 150 to pull that off. Yeah. And then furthermore, and like, yeah, these are very intelligent people. You don't get to have that job without having a monster IQ. But there's also like the execution part of it. You could be right, but early or directionally right, but get stopped out or get scared or have the emotions, start second guessing yourself or digging your heels or whatever, whatever, whatever. Talk about the way that you actually implement certain systems and rules to help you before you get into a trade, how you manage a trade at a high level?

13:25How does all that work? Yeah. So full disclosure, I wouldn't have been a very effective discretionary trader because, you know, what people refer to me as pretty robotic and unemotional. I still, they're still human. And there are times where I think this can't possibly go any further, or this has to turn around. And I write those down and I check back, you know, six months later, one year later, three year later, and it's just, it goes so much further than you ever would have initially guessed and it drags on for so much longer. So, but what we do is systematic and we implement rules that we test historically on all kinds of different markets and stress test and implement rules that were good historically at keeping you on the right side of big trends and not allowing you to be on the, to stay on the wrong side of big trends and then calibrating your risk to where it needs to be based upon how diversified your portfolio is, your assets under management, so on and so forth.

14:20It's actually quite simple. The only real complexity is that we use multiple systems because any one system can be good over 50 years, but it can go out of favor for three, five, seven years. And then your investors lose confidence. You want other systems that tend not to go out of favor at the same time as your first system. And that way, you can diversify across systems, not just markets, not just asset classes. So when you say diversify across systems, you mean you're looking at different ways of defining trend, essentially? That's one way to do it. Yes. In our case, we're looking at different tranches.

14:54So short-term trends, medium-term trends, and long-term trends. How do you define those periods? What is considered long-term for you? I'm curious. Long-term is one year. Okay. Yeah. Medium-term is nine months. Short-term is six months. We tested everything from one day to 5 ,000 days. And you can look at all the results and you can plot them in a chart. And then you can look at their variance over time. Like how volatile are are they? There are some systems that are very short term that are lights out for five years, but they're just a license to lose money for three years after that. We're not interested.

15:24We want durability and robustness. So we chose the three settings that were the most durable over the last 50 years that also are not redundant with one another. Have you noticed changes in the way you execute certain trades over your time in the market? Do markets function differently today? Is there less liquidity? Is there, I don't know, do things happen quicker? Any substantial changes that have forced you to change your strategy? Or is it the exact opposite? Okay. So this is an interesting topic that I need to be concise about because it's one of my favorite topics and I don't want to drone on for hours here.

16:02Markets are always evolving and changing. Generally, they're getting more liquid. They're getting more soggy and soppy. The signal to noise ratio generally gets worse over time as market becomes more liquid, pulling in more spread traders, more hedgers, more speculators, more government intervention, so on and so forth. That's intraday generally or intraweek. For long-term trends, things, statistically speaking, they haven't changed very much since the 1970s. Sure, it's a lot easier to execute now because there's liquidity. The depth in the markets is much larger. But for what's important to us, they're not meaningfully different.

16:38They're just a lot more liquid. This is certainly not the end, they'll be all, this is not a mic drop, but if you were to look at, say, something as simple as a 30-day rolling rate of return for the S &P 500 going back, as far back as it can go, or even further back than the index exists, it goes like this, up and down and up and down and up and down and up and down. There's not a period on that chart where you would say, this is where mutual funds went away, this is where indexes picked up, this is where whatever, whatever, whatever. But are there other things that you would say, well, actually, there are certain things that are just fundamentally different.

17:11The intraday liquidity is fundamentally different, but the signal to noise ratio hasn't changed as much as people imply with their comments about this topic. In fact, we run our operations the same way we would have run them in 1970. That's actually very important to me because you don't know what you're going to get in the future. And I don't trust a back test that looks good in the 1970s and 80s if I know that I couldn't have actually implemented it back then. And so it's not valid. So it was important for us that the methods that we use to execute the strategy in real life could have worked exactly as we're testing them on the historical data.

17:50So you wanted to make sure that these futures contracts have had a long enough history that you trust it, basically. Well, that too. Yes. But I mean, there's a lot of people will backtest something on micro cap stocks or, you know, some smaller market like the VIX and assume that they could get a fill at the tick price, the instant, you know, the signal was received. And that may be true today, but it wouldn't have been true in the 1980s. But still, they're looking at their test results from the 80s and thinking that would have been awesome. I was trading in the early 90s, and I can tell you that, you know, your slippage costs were five times higher.

18:27I was trading when there were fractions and there were fixed commissions of$60 a trade. And now it's a dollar a trade with a 0.01 bid-ask spread. So you have to factor that in. So for anybody that pines for the long days or the good old days of trading and less intervention and less index funds and more price discovery and more this, more that, what would you say? It's a trade-off, right? And if necessary, you need to evolve with the changing circumstances or you need to have a system that is outside the scope of all that madness, which is where I think we're at. Do you fall under the managed futures umbrella?

19:02Is that a category that you're in? We're not in that category. So what we're doing is we, so I have my history is managed futures and long, short equity and a little bit of spread trading. What we did in our pursuit of an all weather kind of absolute return fund is we took the attributes from managed futures that we wanted and implemented them in our own macro program. But no, we're not considered a managed futures fund and we're not in that category. So what's the what's the biggest difference there? The biggest difference between what we do, I'd say scalability. You know, a lot of these managed futures programs are going to be more specialized, shorter term.

19:40They're going to have more rules. They're a bit more fragile, in my opinion. There's some good ones out there. Don't get me wrong. Like those guys have been doing it for a long time. They know what they're doing. But we wanted a simplified version that was more durable. And again, it's a tradeoff, right? If you want higher returns, you want something that's more focused on certain markets, well, there's a cost to that. There's a little bit more fragility. We wanted to minimize fragility, maximize durability. I guess a good contrast would be managed futures did unbelievably well during the 2008 crisis and one of the few strategies that worked.

20:15And then for almost the whole 2010s, managed futures funds basically sucked, right? A lot of them did, if you look at the track records. And now it seems it's come back a little bit. So your strategy started in, what, 2019? So we don't know how you did it in the 2010s, but is it true that just trend following itself is working better this decade? It is, yeah. I mean, we've segued into a macro environment that's conducive to trend following, for sure. That was a tough period of time from, I think, 2011 to about 2018. That was a below average period of time for managed futures. But every asset class has its lost decade.

20:52Yeah, no, it's true. And how much of that at play is just cash rates are higher? Because if you're going shorting and longing and the cash involved, does that increase in the baseline rate increase your return as well? Yeah, because a macro program or a managed futures program generally has 80 % to 90 % of its money sitting in cash that you can just roll into T-bills. And if you're getting$5.50 on your T-bills, that's a nice tailwind. But one thing people don't realize is that risk-free rate of return also gets priced into the futures curve, so into the term structure of the futures curve. So for medium and long-term trend followers that are collecting either backwardation or contango, depending on whether they're long or short, those risk-free rates inflate those numbers.

21:33So that's another potential kind of indirect source of return for those strategies. So it's twofold. You're getting the T-bills. But also, if you're long-term enough, you're probably getting the term structure as well. Eric, I'm not going to lie. I still can't explain backredation and contango. I get them mixed up every time. You have a 50-50 shot. That's true. There's no such thing as an easy lost decade for any asset class. I really don't care if it's corner stocks. However, because investors will bail, very understandably so. But I think that at least on a go-forward basis, I think that investors generally ascribe to the idea that stocks go up over time because the earnings power of companies goes up over time.

22:20And of course, that is a general statement. There will be a loss ticket at some point in the future. Investors will get frustrated and bail and sell at the bottom, et cetera, et cetera. But with something like – with a strategy like what you're running, I know you're very in tune with the behavioral side of it. If there's a lost decade for managed futures, people get really uncomfortable. Why am I short natural gas? Why am I long sugar? How does that help me at all? So from a behavioral standpoint, how do you position – or I guess this is not a managed future strategy. Maybe it's not a fair question.

22:52But how would you talk to investors about a category where it's more trading and less a fundamental belief that managed futures goes up over time? Well, you don't. I got out of that industry because there's simply no way to win. The cognitive psychology makes it almost impossible to – I mean, there are some people, you can just show them the math and they'll go, yeah, they'll look at it as a trade-off and they'll say, yeah, that belongs in the portfolio. But generally speaking, you got to get through multiple layers of bureaucracy. You've got compliance, you've got marketing, you've got advisors, you've got their clients.

23:29It's just a losing proposition. And that's why the Dow bar in alternatives is so bad that people buy the high and sell the low over and over and over again. So, I mean, our strategy is to pick the best alts that we believe in, do them in-house so we're not paying fees on them and integrate them into an equity and T-Bell portfolio in order to provide an all-weather experience. And then we're making the bet that people will like that all-weather experience and they'll view that as their alternative investment or a core investment and they'll bring it in. So we gave up on the managed futures industry simply because, and it's not fair to the managed futures industry.

24:05Managed futures has been the best diversifier for many, many decades, but people just won't stick with it. So what about your strategy allows investors to stick with it then? Well, the fact that we're actually delivering the diversification benefit encapsulated in one fund. So let me say it this way. If I took my fund and I broke it into its three pieces, the equity piece, the cash piece, the T-bill piece, and then the macro piece, and I offered them as three separate vehicles, we might have$100 million under management. But because we merge all three of them together, we end up with a much higher Sharpe ratio, much higher risk-adjusted returns, a stress-free equity curve, and we have a billion dollars under management.

24:43So that's the difference. It's kind of like the Reese's peanut butter cup. You could sell the chocolate, you could sell the peanut butter. If you mix the two together, you have much higher margins and people are happy. So you have a static allocation to each of those pieces. What is it? Is it static? What's the allocation there? So we start with a 50 % allocation to global equities, market cap way to global equities. And we leave that alone for the most part, because we don't want to generate taxes. And we allow that to fluctuate. And that's just the strategy. It can go as high as 67 % and it can go as low as 33%, but we won't let it get beyond those numbers.