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What's the Alternative? | Episode 10 | Alternative Building Blocks featuring Michael Green
6 Plays7 months ago
Welcome to Banrion Capital Management’s What’s the Alternative Podcast! Join host Shana Orczyk Sissel, the “Queen of Alternatives” Founder & CEO of Banrion Capital Management, as she interviews leaders in the alternative investment space. Learn more about their firms, their passions and about the many different ways investors can use alternative investments to add value in their investment portfolios.
In this episode Shana sits down with Michael Green, Portfolio Manager & Chief Strategist at Simplify Asset Management, to discuss the best approach for advisors to start building portfolio allocation to the alternative space.
Michael has studied markets and market structures for nearly 30 years. He has presented his proprietary research to the Federal Reserve, the BIS, the IMF and numerous other industry groups and associations.
Michael joined Simplify in April 2021 after serving as Chief Strategist and Portfolio Manager for Logica Capital Advisers, LLC. Prior to Logica, Michael managed macro strategies at Thiel Macro, LLC. Prior to Thiel, he founded Ice Farm Capital, a discretionary global macro hedge fund. From 2006-2014, Michael founded and managed the New York office of Canyon Capital Advisors where he established their global macro strategies, managing in excess of $5B of exposure across equity, credit, FX, commodity and derivative markets.
Additionally, Michael has been noted for his work as a public speaker and financial media participant. He is a graduate of the Wharton School at the University of Pennsylvania and a CFA holder.
Learn More About Simplify Asset Management: Simplify Asset Management
Check out Simplify's Research: Simplify Investor Hub
Connect with Michael on LinkedIn: Michael Green
Learn More About Banrion: Banrion Capital Management
Connect with Banrion on 𝕏: @Banrion_Capital
Connect with Shana on LinkedIn: Shana Orczyk Sissel
Connect with Shana on 𝕏: @shanas621
If you are an advisor wanting to check out our platform, we want to hear your feedback!
Important Disclosures:
The opinions expressed on the “What’s the Alternative Podcast” are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security.
It is only intended to provide education about the financial industry. To determine which investments may be appropriate for you, consult your financial advisor prior to investing. Any past performance discussed during this program is no guarantee of future results.
The guests featured on this program are participants on Banrion Capital Management’s platform. As such Banrion may receive payment for their participation as a platform partner.
Any indices referenced for comparison are unmanaged and cannot be invested into directly. As always please remember investing involves risk and possible loss of principal capital; please seek advice from a licensed professional.
Investments are not FDIC-insured, nor are they deposits of or guaranteed by a bank or any other entity, so they may lose value.
Investors should carefully consider investment objectives, risks, charges and expenses. This and other important infor
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Transcript
Introduction to Alternative Investments Podcast
00:00:02
Speaker
Welcome to Bonnie and Capital Management's What's the Alternative podcast. Joining host Sheena Orsik-Sicil, the queen of alternatives and founder, CEO of Bonnie and Capital Management as she interviews leaders in the alternative investment space. Learn more about their firms, their passions, and about the many different ways investors can use alternative investments to add value in their investment portfolio.
Who is Michael Green?
00:00:30
Speaker
Hello, everyone. This is Shayna Orzak Sissel, CEO of Bonrion Capital Management. And this is another episode of What's the Alternative? Today, we have a very special guest. We have Michael Green, who is the Chief Strategist and Portfolio Manager at Simplify Asset Management. Simplify is a new partner to Bonrion and the
00:00:56
Speaker
core of what we're building in our model marketplace, which is a really important component of helping advisors scale alternative investment allocations by providing them with not only access to private funds, but also liquid alternative models that they can use with any client in their book of business, regardless of whether or not they meet the hurdle of accredited investor status, but also providing
00:01:22
Speaker
a number of different liquidity options for advisors based on their client's comfort level. Michael has joined Simplify in 2021. And prior to that, he has a myriad of experience running global macro strategies for hedge funds. And he started his own firm. And I'm trying to think on my thing. It says Icefarm Capital. And we're going to have to talk about where Icefarm came from. So welcome, Michael. Thank you for having me, Shannon. I really appreciate it.
00:01:53
Speaker
So let's just dive a little bit into your background. You know, I found it really interesting. You started your own global macro hedge fund and I need to understand the ice farm, like where that come from. And let's talk a little bit about how that experience kind of brought you to where you are with Simplified today.
Michael Green's Career Journey
00:02:10
Speaker
Sure. So let's actually go back even further and just make it straightforward and try and create something that looks like a harmonic career, even though it doesn't have those characteristics.
00:02:19
Speaker
I grew up in California on a farm and then ended up going to the East Coast to go to college.
00:02:26
Speaker
I went to the U.S. Pennsylvania's Wharton School of Business as an undergrad where I focused on valuation and the ideas behind valuation, the theoretical frameworks of thinking about discounted cash flows, cost of capital, all that sort of fun stuff. Transitioned into the investment world in the 1990s, initially going to work for consulting firms focused on mergers and acquisitions consulting, primarily around helping corporations restructure their business units
00:02:53
Speaker
thinking about how those businesses should be valued, etc. It's very hard for people to imagine the world that existed back then because computers were still relatively new in the corporate executive suite. And so the existence of things like Lotus 123 or VisiCalc before that or then Microsoft Excel and valuation techniques like discounted cash flows or residual income models
00:03:18
Speaker
really were not widespread. And so I was fortunate to be able to step into the industry at a point in which it became increasingly important for people to understand those dynamics, took a turn into entrepreneurship for the first time in the mid 1990s, co-founding a software company focused around those types of tools. That's how I became introduced into the investment management world. One of my former mentors or one of my mentors, I guess it's not a former mentor,
00:03:45
Speaker
Mitch Julis of Canyon Partners, which is a multi-strat hedge fund, discovered our work, asked us if we could link our valuation engines to the publicly traded databases so that we would have a tool for valuing publicly traded equities. We did that, that ultimately led to us pushing into the asset management industry and the sale of that business in 1999. At that point, I actually transitioned to active portfolio management, joining one of my clients,
00:04:15
Speaker
which is a small cap value manager, after having done a quick survey of the opportunities in front of me and recognizing that there was this incredible disconnect in valuation as it tied to domestic small cap value at a time period in which the markets were incredibly richly valued in the original.com dynamic. I was fortunate in being proven right, although in hindsight, I would suggest for the wrong reasons.
00:04:41
Speaker
And that managed to send me down a career path that ultimately led to me joining Mitch Julis at Canyon Partners in 2005 to launch the Canyon, 2006, I'm sorry, to launch the Canyon Partners New York office, which I built initially from a small allocation to a team of about 15 people running somewhere around $5 billion with a particular focus actually around derivative strategies, which is something I'd been involved with from the early 1990s.
00:05:12
Speaker
In 2014, the CEO, the CIO at Soros approached me about launching my own firm or more accurately originally about going to work for Soros. I turned them down and they said they picked up on my entrepreneurial urges and said, Would you like to start your own firm?
00:05:28
Speaker
So I started a firm called Ice Farm Advisors, Ice Farm Capital really, that was named after a vacation property that I owned at the time, which is a 19th century ice harvesting operation. Somewhat ironic name and that ice harvesting, which is a business that doesn't really exist today except in the boutique elements of bars in Prospect Hill and various parts of Brooklyn,
00:05:55
Speaker
That was the seventh largest business in the United States in 1900. And so this former property actually had train tracks that could take you directly to New York City or to Philadelphia where they would sell ice into ice boxes. It was a great illustration of how much things can change in a very short period of time because by 1935, basically every single ice harvesting operation was bankrupt having been driven out of business by electrification.
00:06:25
Speaker
So it was a fun experience, ran that for a couple of years, had some interesting adventures, and then was approached by Peter Thiel to manage his personal capital at his firm, Thiel Macro, relocated back to California after having spent 30 years on the East Coast in various iterations.
Michael Green at Simplify Asset Management
00:06:43
Speaker
Um, and did that until, uh, 2020. And then, uh, Harley Bassman, who was one of my partners at Simplify reached out and said, Hey, you should really take a look at what these guys are doing in the ETF space. Recognize that there was an opportunity to bring the hedge fund type strategies that I had been running for well over a decade at that point into the ETF world.
00:07:08
Speaker
tied to a regulatory change in September of 2020 called the derivative rule that set in place the regulations and guidance on how to introduce derivative strategies into ETFs. And so one of the key issues with derivative strategies is that they tend to be relatively tax inefficient.
00:07:30
Speaker
The ETF structure helps to solve a lot of that and suddenly makes available what my partner Harley calls institutional grade products to the retail investor. And so we've been very fortunate to have grown with, I was about, we were about $200 million in assets. When I entered the firm, we're now about 4.2 billion in assets. And we're running somewhere in the neighborhood of 25 strategies across different expressions of
00:07:57
Speaker
Everything from equity exposure to fixed income exposure to true alternatives, like managed futures and equity long short. Well, that is like pedigree. You have pedigree, man, pedigree. And I got serious pedigree and I got, I got lungs like nobody's business. Cause I'm not sure I even took a breath in that conversation, in that dialogue. So.
00:08:21
Speaker
Anyway, thank you. I appreciate that. And candidly, I'm thrilled to be at Simplify with a group of individuals. This is a byproduct of the pandemic. A lot of senior people that were looking for opportunities that allowed them to continue to build on their experience base and do so in a manner that is truly virtual. So as an organization, we don't really have a headquarters. We just have a bunch of talented individuals
00:08:47
Speaker
that like working together and are able to interact in a manner that candidly couldn't have been done 10 years ago. And so it's an exciting, you know, development on multiple fronts for me.
How Can Advisors Understand Alternatives Better?
00:08:57
Speaker
Yeah, it's really interesting that you talked about that derivatives rule change in 2020, you know,
00:09:03
Speaker
The first rule change that kind of made it possible to have a proliferation of like hedge fund type product and a 40 act rapper happened around the time of the financial crisis I think it was oh seven oh six oh seven, where you saw the first iteration of that was the 130 30 funds.
00:09:23
Speaker
That came and went because of changes and the rules on how much you could actually short within a 40 act product because prior to that there's been substantial limitations on shorting and You know the use of leverage and things of that nature and that that kind of loosened a little bit so you had all these mutual funds come to market but they had really high expense ratios and a lot of them failed because not just
00:09:52
Speaker
based on performance. I mean, they actually launched it a ton. That was pretty good for those types of products. Those types of products did well through the financial crisis. But, you know, a lot of hedge funds that had no experience doing distribution into the retail market. Nobody really knew how to categorize them. Morningstar only introduced like alternative categories, I want to say in like 2021.
00:10:15
Speaker
And so I think that's really interesting because until 2020 there were no real ETFs, there were some, but again there wasn't the proliferation you started to see after that things like you know buffer ETFs and things of that nature that use a lot of derivatives in those products. So I think that's really interesting in terms of like how you know
00:10:37
Speaker
Advisors can look now and find opportunities to add these diversifying products into the mix, which I think brings me to my next question, which is, you know, you have a lot of experience in global macro, which I think is really relevant to building portfolios because global macro is sort of a mishmash of a lot of stuff.
00:10:57
Speaker
It's, you know, currency and, you know, equities and fixed incomes and derivatives and futures, commodities and all these trend following things. So there's there's a lot you got to know about a lot of different areas of the market. So when you think about it, how
00:11:15
Speaker
Do we start talking to advisors about the appropriate way to build and use alternatives? Because my experience has been advisors think they can pick one fund. It's an alt fund. It's diversified. Throw it in a portfolio, get some diversification benefit. They usually pick the wrong one. It usually doesn't perform the way they thought it would.
00:11:38
Speaker
And then they get burned, but we do a great job teaching advisors how to build equity portfolios. Great job teaching them how to build fixed income and you kind of have to approach alternatives in the same way. Well, I think, I think a couple of points that you raised there are absolutely spot on. First, I think it's funny that you brought up the 130-30 funds because that was part of the mutual fund answer to the emerging threat from hedge funds, right? So.
00:12:01
Speaker
In the aftermath of the dot com cycle, nobody wanted to have equity exposure. They all wanted to have exposure to genius asset managers. And so long, short hedge funds were the underlying mechanism. Now, a lot of my work is actually around how regulatory changes and how market structure changes with the dynamics of new market entrance.
00:12:25
Speaker
The 130-30s never really took off, but you're 100% correct that for the first time, we're now looking at ETFs, making accessible many of the types of products that would traditionally only have been available to either high net worth individuals through a JP Morgan or a Goldman Sachs or through hedge fund type strategies available to accredited investors. And as I indicated,
00:12:49
Speaker
make hedge funds in particular and a lot of structured products or a lot of things that use derivatives tend to be really tax inefficient, which tends to be one of the primary focus points for individual investors who don't have the tax advantages of tax deferred institutions, sovereign wealth funds, pension plans, et cetera.
00:13:08
Speaker
So I think there's a very important distinction between kind of just the market exposure and a market exposure that is optimized to make it useful and accessible to individuals, which is really where it begins to cross over into the RIA space.
00:13:23
Speaker
The 130-30 thing you mentioned, I think is interesting. I always felt like it was the reason they never took office because if you think about what a long short hedge fund does, right? It's like taking gross exposure up and down based on the market and providing you some downside protection. 130-30 funds are beta one.
00:13:42
Speaker
Yeah, they absolutely are. And so that dynamic of an equity long short, so simplify, for example, and I'm sure we'll talk about this as we go through this. We do offer a true equity long short fund. It is 200% long, 200% short with a focus purely on can we generate performance through security selection and industry selection or sector selection within that as well. There's no requirement that sector exposures be totally axed out.
00:14:11
Speaker
That is a very different animal than a 130-30, which, as you point out, is still a beta of one, at least theoretically. And what you're really doing is you're trying to isolate a degree of stock selection over and above, say, the S&P benchmark or a small cap benchmark, which I was more focused on. There's all sorts of challenges there, right? And part of my research around the dynamics
Understanding Payout Structures in Alternatives
00:14:35
Speaker
of how passive investing and the growth of passive investing has changed market structure
00:14:40
Speaker
has actually highlighted that that beta exposure is really the critical one, right? As more and more people pile into equities as a default choice and as their default choice simply by all equities in proportion to their market capitalization, excuse me, security selection becomes less effective as a tool and really becomes much more about catching the same ride that everybody else is piling into through that same strategy.
00:15:06
Speaker
So we've actually seen hedge funds to continue down this path. You know, equity long short as an asset class has shifted from market neutral to today. The exposure in the asset class is around 85 percent long. Right. They've recognized they've evolved in that manner.
00:15:23
Speaker
And one of the interesting opportunities that emerges is with the growth of the alternatives in the ETF space, we're starting to reintroduce strategies that may not have those same characteristics, right? That are true equity long shorts. And that is another key advantage that you have when looking at ETFs as compared to a hedge fund. An ETF is truly transparent. You can see its individual holdings. You can see its behavior on a day-to-day basis.
00:15:49
Speaker
There isn't an element of, is this doing what I want it to do? And you need to wait three years to find that out, right? You're going to find that out fairly quickly that it's giving you a predictable exposure. And I think that's one of the key benefits. It's one of the reasons why I generally think that the entire hedge fund industry is slowly going to migrate into ETFs. And again, you raise this point, and I think it's a very effective one,
00:16:15
Speaker
distributing those products, running the back office, building the capabilities of a firm to manage those processes across multiple strategies and multiple filings. That's really the key, right? I'm a firmly, you know, within the context of Simplify, I'd emphasize I'm a firmly ordinary talent in that there's thousands and thousands of portfolio managers that are out there.
00:16:39
Speaker
the back office is really actually the secret. The back office and the distribution and candidly hats off to the rest of my team for having done that. In some cases, I've been quite successful in portfolio management. In other cases, I've had mixed results like everybody else. But the long and short of it is that the organization and the ability to build the products that are designed to achieve certain objectives is increasingly really where the skill set is developed.
00:17:06
Speaker
With that said, I think that actually then feeds into how do you want to build a portfolio. And so when you start thinking about what we do on the equity or fixed income side, it becomes very straightforward because we know what we're supposed to get from equities. We know what we're supposed to get from fixed income. Right. Equities are supposed to deliver something that looks like an S&P 500 type return.
00:17:30
Speaker
which historically has been in the neighborhood of 10% with a certain degree of volatility. And we accept those underlying characteristics, fixed income, exact same thing, except tied to various components of either bond market or the credit market. But when we get into alternatives, it's really hard to figure out what people even mean by that, right? And that's where I would emphasize for people that what you wanna focus on is actually what's called the payout structure associated with it.
00:17:58
Speaker
And so alternatives that simply give you a payout structure that looks like equity exposure are not particularly effective, right? If we were to offer an equity long short that was 85% net long, or as you point out a 13030 that is basically beta one,
00:18:15
Speaker
that's not really an alternative that does anything to diversify your portfolio. It allows you to isolate a skill for an individual manager, but not necessarily gives you a diversifying payout structure. Likewise, strategies that use derivatives to convert equities into income, right? What some people have talked about as synthetic yield, those can be super valuable
00:18:42
Speaker
but they're just bonds, right? So all you've done is rewritten bond contracts in a certain manner by capping the upside payout of equities and converting that into a yield, you've simply increased the bond exposure in your portfolio. And I think this is one of the most interesting things that's happening right now is that simultaneously we're hearing people say, I don't wanna own bonds in my portfolios because bonds are certificates of confiscation. I think that the interest rates are too low
00:19:10
Speaker
that the Federal Reserve is behind the curve, that inflation is running away, et cetera, all sorts of things, by the way, which I don't actually believe, but I understand that a lot of people do. And so they'll say, we don't want to actually want to have exposure to bonds. And then they'll engage in things like covered call strategies, which are turning equities into bond-like instruments.
What Tools Do Advisors Need for Alternatives?
00:19:28
Speaker
And so that to me is the primary thing that people need to always be thinking about is what do I expect the actual payout of this to look like? And it's one of the wonderful things about derivatives or strategies like an equity long short, it becomes very straightforward to figure out is that what you're actually obtaining.
00:19:46
Speaker
And I think what you just talked about is so important. So I was involved in writing a module and part of a group that wrote a couple of modules for the CHI Association's Fundamentals of Alternative Certificate Program. And one of the things we spent a lot of time on, and I've done an episode of You're Doing It All Wrong, our web series about this, is
00:20:12
Speaker
Alts are everything that's not public equity or public fixed income, but that doesn't mean they're diversifying. And you just touched on that. So like, if I look at private equity, it's still equity. So it still belongs in your equity exposure. It becomes more of a conversation about liquidity. And same thing with private credit and potential alpha opportunity that you can get by having less liquidity. But there are different alts that actually do diversify.
00:20:40
Speaker
And how can an advisor find them? Because I think our current resources, like most advisors use Morningstar, don't do a great job helping them differentiate across strategies. Let's talk options-based, right? Look at the options-based category of Morningstar. And you have covered call strategies, you have buffer ETFs, you have all sorts of,
00:21:06
Speaker
iterations of anything having to do with using options and they're all doing something completely different. So how do we help advisors like kind of figure that out?
00:21:16
Speaker
You know, it is a great question. And you highlight exactly the right issue, which is that the infrastructure has been built to this point that allows people to quickly and easily understand bond exposure or equity exposure. Am I buying risk-free? Am I buying sovereign? Am I buying foreign currency exposure? All those things are actually fairly straightforward.
00:21:38
Speaker
But ironically, when I look at tools like Morningstar and I think about exposure-based dynamics, right? So we'll talk about a derivative strategy. Well, a derivative strategy that is simply long the S&P and short, far out of the money covered calls is gonna behave exactly like the S&P, right? That exact same exposure expressed as near the money calls on the S&P, you know, so I'm shorter or a closer strike, it's gonna behave much, much, much more like a high yield bond
00:22:07
Speaker
than it is the S&P 500. And so I think as an industry, we need to do a better job of helping to explain these types of payouts and helping people understand exactly where these fit in. And unfortunately, or fortunately, as the case may be, I don't think there's an ability to separate that from the individual RA's understanding. And so a critical component is hopefully what we'll discuss is just the education process for your clients, making sure they understand
00:22:36
Speaker
how the product is expected to behave, giving them the tools to monitor those exposures, and making sure that they fully appreciate how that can benefit a portfolio structure. And I think we should go there because as you're talking and you're talking about like exposures and, you know,
00:22:54
Speaker
One of another big problem is if you look at an ETF or a mutual and that's doing any sort of alternative type of long short or derivative usage. They have collateral, which is usually in the form of treasuries. And so then when you use these X ray technologies to look at like the underlying holdings of the product.
00:23:12
Speaker
It looks like they hold like all cash or all bonds. And it's very confusing because the X-ray tools are not sophisticated enough to understand that. And so, you know, when you start to look at like, where are we in the style box? What are my exposures? Like it's really hard.
00:23:30
Speaker
So Simplify has great resources and at Bonrin, we have a lot of those resources are available on our platform because Simplify has made it available for our clients and we want advisors to understand. So let's talk about the resources Simplify has and how you kind of start that conversation.
00:23:50
Speaker
Sure, so the first process of that is education, exactly like what we're doing today. We put out deep dives on each of our individual portfolio constructions or strategies. We try to walk through those components. The reporting, as you point out, that we have on our website focuses on both easy transparency in terms of what the holdings are, and also a clear articulation of how we would expect the portfolio to behave under certain market conditions.
00:24:19
Speaker
Now, in a lot of situations, you're limited in your ability to put forward that type of information by disclosure rules and compliance rules, right? I can show how something behaves on a historic basis using a truly systematic strategy
00:24:37
Speaker
but one of the great ironies of the regulatory environment is if I build a truly non-discretionary strategy that may not actually attempt to optimize across individual environments, and I make it purely systematic and I put it into an index form, then I can theoretically show you what the performance would have been, but this actually creates its own challenges because if those strategies are not actively trading and they're merely existing in the theoretical framework in that time period,
00:25:08
Speaker
you have no idea how it's going to impact it. This actually was the source of one of my well-known trades, which was around the blow up of the XIV, the Volmageddon events of February 5th, 2018, where I actually had to castigate the founders of that strategy and say, you have no idea how this would have behaved in 1987 because the existence of it in 1987 would have caused markets to react differently.
00:25:36
Speaker
Right. Unfortunately, that ended up being prescient. The product that I predicted was going to go to zero went to zero, but that type of insight and that type of understanding, I think is really critical for firms that are engaged in building these types of strategies.
How Should Advisors Communicate Alternatives?
00:25:52
Speaker
It's not enough just to be able to show a back test, but also to understand the limitations around those types of back tests. And so again,
00:26:00
Speaker
Unfortunately, we're put right back into the camp of this just requires more work. It requires better understanding. It requires people to actually not only, you know, have access to the managers in terms of written materials, but also the opportunity to sit down and talk with them either directly or through an advisor in a manner that makes sure that they understand how this could affect their portfolio and where it makes sense.
00:26:27
Speaker
Right? And so, you know, we have products, for example, we'll give a really simple example. We have one called PFIX, right? Portfolio fix was the working title for it. And so PFIX is the catchy name that was put out. This is a very, very particular product that was designed for one purpose and one purpose only, to benefit from an increase in interest rates in a linear fashion or a nearly linear fashion.
00:26:56
Speaker
Almost every strategy that involved reducing exposure to fixed income as we were fearful of a rise in interest rates in 2020 and 2021 would have involved shorting bonds in one form or another. Ironically, things like shorting bonds are what's called negatively convex, right? Because as the interest rates- Also expensive, because you've got to pay the coupon.
00:27:17
Speaker
Exactly. That's exactly where it's going to go. So it's negatively convex on two fronts. One is as interest rates go up, the bonds eventually stop falling, right? Because they begin to represent capital appreciation as part of their yield. And so it tends to be a very poor strategy to outright short bonds, right? We chose a very particular product, but that product, while it did exactly what you would expect, has a volatility to it that it's important to understand how you size it appropriately in a portfolio, et cetera.
00:27:47
Speaker
Those who used it effectively, those who understood it, benefited tremendously. It was one of our first really successful products.
00:27:54
Speaker
those who attempted to use it as a standalone, right? To effectively YOLO into a massively negative bet on bonds could have done really well or if they timed it inappropriately could have done really poorly. So all of our tools, I just wanna emphasize this are meant to be used inside portfolios. They're not meant to be standalone products that you simply gain exposure to and say, wow, I found the secret to success.
00:28:20
Speaker
Right. That's just not how they're used. They're designed to be built into portfolios. And again, that communication component becomes really critical. Yeah, I think that with Alton General, that's true. You know, managed futures is a great example, right? Like managed futures work at very specific times in the market, exactly when you need them to work. But like,
00:28:43
Speaker
most of the time they don't. And so if you're an advisor and you have one-minute futures fund in your portfolio and you don't have a diversified mix of alt and you don't understand why it's there, you bought it because you wanted downside protection, but then the market goes up and up and up, it becomes the talking point your client like fixates on, right?
00:29:03
Speaker
every time they get their statement. And then you just get sick of talking about it, so you sell it. And then usually at the worst possible time, and you don't get the benefits of the diversification, but you also didn't set expectations. So because these are complex products and because they're all so different, how do you start that conversation with your clients to explain to them why we have these types of products in our portfolio so that they're not fixating constantly on how it's not
00:29:31
Speaker
aligned with equities or fixed income? And why do I even own this if like, it's not gonna give me those two things? Yeah, no, it's a perfect illustration. And I think the past couple of years have been a great example of that, right? Where people have been very focused on equity performance. We've seen more and more pressure to increase equity allocations. You've increasingly started to hear narratives around you should only have equity portfolios, 100% equity portfolios outperform over time.
00:30:00
Speaker
Well, you know, again, remember the disclaimer, past performance is no guarantee of future success or future investment results. That's super easy to dismiss, right? It's super easy to say, yeah, yeah, of course. But- I like to remind people that that was also what people said in 1999, right? And then everybody had a come to Jesus moment on fixed income after, you know, the tech bubble burst and realized, oh my God, if I had just had fixed income,
00:30:26
Speaker
you know, things would have been different. And I think that anytime equities are going straight up, you have that conversation. Now we're having that conversation, not just about fixed income, but now alts are accessible. Yeah. And I think that is really critical. And again, so like the first place we always start people with, with the core of our arts alt portfolio, which is our managed future strategy.
00:30:48
Speaker
It is our equity long short exposure. And we have another product called quantitative investment strategies. QIS is the ticker there. That is what's called portable alpha strategies. These are strategies that are run by investment banks. They're often used inside structured products. And we've assembled a grouping of about 15 of those out of a pool of about 7,000 potential options.
00:31:15
Speaker
that are designed to deliver an uncorrelated return. And so the most important thing that we always emphasize as we start introducing people to our alt portfolio is the degree of correlation that it has had relative to equity markets and bond markets. And to run products that have a positive expected return, but low to negative correlation with equities and bond portfolios,
00:31:41
Speaker
Is one of the primary components around the building blocks of portfolios right you're basically saying I'm going to add an additional component to my portfolio. In some periods, it's going to lower my returns, but as long as the portfolio or those components of my portfolio increase the diversification.
00:32:02
Speaker
and offer attractive returns on their own front, you can actually create a portfolio that is substantially more robust. You gave a great example of that. The 6040 portfolio has taken on various reasons. A lot of people will say, well, with bonds now positively correlated with equities because we're in an inflationary environment.
00:32:22
Speaker
The primary risk is that the Federal Reserve has to hike interest rates to fight inflation. That leads to equities and bonds behaving both with a positive correlation to each other and reduces the diversification benefits that you hit on that kicked in in the dot-com cycle.
Why Diversification Beyond 60-40 Matters
00:32:39
Speaker
That was near the peak of the diversification benefits. Alternatives, we've designed them in our portfolios to offer further diversification
00:32:50
Speaker
Now that those two strategies, bonds and equities are not demonstrably negatively correlated, the introduction of alts makes a ton of sense because it does give you that diversification that's missing otherwise in your portfolio. And I think that's really critical. You mentioned this idea, there are times when these strategies work, there's times when they're really valuable. I personally look at bond pricing at these levels and think, wow, this is actually a very attractive level of interest rates. And I
00:33:19
Speaker
In general, think that once we're through the uncertainty of inflation and is inflation truly persistent or has it been more transitory as people had initially anticipated.
00:33:31
Speaker
Once we work through that, we'll rediscover that these levels of bonds were actually quite attractive, but that doesn't change the underlying dynamics of portfolio construction and raises the importance of identifying these negatively or neutrally correlated zero correlation assets that can diversify and enrich your portfolio construction.
00:33:50
Speaker
And I think you touched upon this, you have managed futures, but you don't do it in a vacuum. You have the equity long short, which has some equity beta to it to kind of counteract, you know, that persistent negative beta that you get from managed futures in terms of comparison to equities. And then having these portable alpha strategies kind of compliments that and zigs when the others are zagging and kind of all work in tandem with each other, but all in
00:34:16
Speaker
And in that little bucket, also being sort of complimentary and uncorrelated in their access to each other. Absolutely. That's really the critical component. So we typically will recommend that people will do something like what had been a 60-40 portfolio. We broadly described should look more like a 50-30-20 type framework today, right? We think equities are generally less attractive than they've been historically.
00:34:43
Speaker
Those who want to tune into my various work around the dynamics of passive investing know that that comes with caveats, but the overall perspective is that equities are likely to deliver lower returns in the future. And there's a variety of reasons why we think that valuation though being the obvious one. On the flip side of that, if I look at bonds, again, I'm not a fan of taking bonds down to zero in your portfolio for the fairly obvious reason that for the first time you're actually getting paid to own them
00:35:11
Speaker
in many, many years. And while we may complain about a 4.7% treasury or a 5% two-year bond relative to observed inflation, which is in the twos to the mid threes, depending on how you want to define it, you're still realizing a very positive real return, which has been unusual in the bond space
00:35:31
Speaker
And candidly, the Federal Reserve has told us is unsustainable, right? So to not take advantage of that seems somewhat silly to me, although I understand why people worry about it today.
00:35:43
Speaker
The alt portfolio, that 20%, you hit the nail on the head, Shannon, but when you highlight that not only does it have to be diversifying to the rest of the portfolio, but within that 20%, it would make no sense to have the products there correlated with each other as compared to offering diversifying benefits. And so that's exactly what we're trying to do with the core of that portfolio.
00:36:05
Speaker
The managed futures strategy does not have a positive correlation with the equity long short strategy, which does not have a positive correlation with the QIS strategy. And so all of those provide diversifying benefits. Some of which, by the way, there's some components of those portfolios that are gonna behave very much like the long equity portions. QIS has about 20% of the assets tied into short equity volatility. That is a strategy that behaves an awful lot like the S&P 500.
00:36:35
Speaker
but it's offset by other long volatility strategies that neutralize that exposure within the overall portfolio as well, leaving us with zero to slightly negative correlation. So the underlying dynamic around all of this is super complicated. And I understand the resistance that people often have to introducing complicated concepts, but it really does boil down to this issue of diversification and lowering the aggregate internal correlation of your portfolio by identifying strategies
00:37:05
Speaker
that on a payout basis behave differently. Yeah, I always talk about their risk management tools in a lot of ways, right? Because your goal here is to have better risk adjusted returns. 100%.
00:37:17
Speaker
And you touched on the 20% number. I talk about the 20%. People are always like, what's the optimal mix of having alts in the portfolio? And 20% is like the number everybody talks about. And there's so many reasons why. Institutions will go higher. I've seen JP Morgan has their guide to alternatives, a quarterly guide that they do, which has like 35%, which I think is bordering a little heavy. But they're using hedge fund strategies, so they're getting
00:37:45
Speaker
things in there that are more correlated to the fixed income or equities in that. But I think the 20% is important. And can you talk about, you know, how that where that number comes from, why that's kind of the optimal number and and how that helps with risk adjusted returns? Well, it does it on two fronts. And one, I want to emphasize
00:38:07
Speaker
You know when we use the phrase past performance is no guarantee of future results, there is no noble optimum on any of these things right so part of what we're trying to do is come to a place that is a happy medium between.
00:38:20
Speaker
false precision, right? It should be 19.6% of your portfolio. That's absurd, right? We don't- I was actually listening to a podcast with Cliff Asness on it the other day and he was saying like, whenever I have an analyst come to me and say like the expected return is 9.6, he's like, I just need the number, I just need the sign. Is it positive or negative? Because everything else is literally just a guess. 100%. I actually just ran an analysis where the GDP report came out today
00:38:49
Speaker
And people were highlighting that the growth of final goods was inconsistent with a retreat in inflation. And I found it fascinating that the expected level of inflation given the rate of final purchases that was in the report today was a range of inflation anywhere from minus 2% to plus 8%, right?
00:39:12
Speaker
I cannot emphasize this enough. I use this language all the time for people. We have about 100,000 years as an anatomically modern species. We've got about 10,000 years of written history. If we are lucky, have about 100 years of financial services, stock market history, we don't know anything, right? So anyone who tells you the answer is 9.6 versus positive is engaged in false precision. I think Cliff is spot on on that.
00:39:40
Speaker
And I would say the same thing right so 20% is really just an attempt to come to something that in our analysis introduces an appropriate level of diversification in the portfolio. It does work on a historical basis, but more importantly from a theoretical framework.
00:40:00
Speaker
We can actually demonstrate how it lowers that correlation without necessarily canceling out the underlying exposures to equities or fixed income that you're seeking to obtain in your portfolio. So you hit the nail on your head when on the head when you said lower volatility higher returns is the goal.
Why Avoid Overprecision in Alternatives Allocation?
00:40:19
Speaker
whether we achieve that or not candidly is unknowable until the future is observed. But from a best effort standpoint, that's absolutely where we come out. We also try to avoid that false precision by saying you should wait, you know, CTA the managed futures product two thirds more than something else, right? The simple reality is that because they are all expected to have a positive return component and they are all designed to run at a
00:40:47
Speaker
neutral correlation to each other. The diversification benefits outweigh the false precision around this strategy returns more than the other strategy. There's so much of it that we just have to acknowledge is a finger in the air. We think this is roughly correct. The false precision around trying to overemphasize this is the exact right weighting.
00:41:13
Speaker
simple answer is is that you know we only know that in hindsight and and the answer for the past decade was bitcoin we have no idea what it is for the next decade right so we're putting best efforts forward it's funny that there's a behavioral aspect of this we like nice round numbers yep uh as humans and so the 20 percent is a nice round number mathematically easy to do the calculation
00:41:40
Speaker
And who knows, I could run a Monte Carlo simulation, create some efficient frontiers and maybe tell me it's like 18.754. Who knows? 20 is just a nice round number. And then to your point, like what's inside there, I tend to stick with no more than four or five different underlying alt strategies because quite frankly, that's kind of the maximum that's out there that you can find that are not correlated with each other. And then I don't try to like time those. It's 5% nature.
00:42:10
Speaker
And that's actually exactly the strategy that we recommend, which is for people to treat them as diversifying to limit the exposures because remember if you overweight alts and you basically try to pick all the alts.
00:42:22
Speaker
you're gonna end up with something that just looks like the risk free rate, right? So you might as well just go buy a 10 year US bond and you're gonna get very similar exposures with far more risk is the quick answer. So you wanna identify managers that have some sense of what they're doing, who have articulated an individual strategy, who are able to articulate what the expected behavior of that is, and whose portfolios have largely maintained those exposures and behaved in the manner that you would expect them to.
00:42:49
Speaker
It's impossible to know if they're going to continue to do that future again, past performance, no guarantee of future success, but the transparency aspect of ETFs, et cetera, make it easier to understand that. And the tools are coming. You hit on exactly the right point, the X-ray type tools.
00:43:03
Speaker
they're really ineffective at analyzing these types of strategies. You'll often find, oh my gosh, it's got nothing but treasuries or cash. And what you're missing is the line item that says total return swap that actually accounts for the vast majority of the risk. But because it is a return swap, it actually shows up as a very small neutral value. It's what's called a difference contract that like a futures basically builds up your exposures as you gain profits, right?
00:43:30
Speaker
So all these things basically play through in complicated ways to portfolios, but the end result is actually very straightforward. Diversification, reduced volatility, and hopefully higher return over time.
00:43:44
Speaker
Yeah, derivatives, whether it be futures contracts or option contracts or any of those things, there's implied leverage in those, right? They're leverage vehicles. So the position size that shows up in these X-rays look tiny, but the actual exposure, which the X-rays never show you, could be very much magnified to that, multiple
Understanding Leverage in Derivatives
00:44:05
Speaker
of that. And there's really no
00:44:07
Speaker
easy way to figure that out, and I'm going to kind of to boundary and torn here. We built our analytical tools to be able to kind of look at those things and have that implied leverage and that shorting aspect of it, because our tools were built for hedge funds.
00:44:25
Speaker
to do this work. And now we're kind of taking it and applying it to more traditional spaces to help advisors. So it's not the kind of tools that advisors have had access to before. It does all the same stuff those tools do. But because it was built for and by hedge fund folks, it does a much better job kind of
00:44:45
Speaker
showing that, but I think advisors would be remiss to not understand that those line items of derivatives are magnified exposures to you know what they're investing in or attempting to replicate.
00:44:58
Speaker
Absolutely. And again, P fix would be a great illustration of that, right? This is a product that if you actually look at its underlying holdings, it's basically 75% US treasuries. But if you actually then, you know, short dated treasuries, but if you actually think about the behavior of the product, it behaves very much like a four times levered version of short 30 year bonds, right? It's not identical, but that's a simple way to think about it. And so those things can be very powerful.
00:45:23
Speaker
In very small packages as you highlight there is a degree of leverage that's contained in almost all of these strategies. And so it's really important I cannot emphasize this enough for advisors to actually take the time to understand them for individuals to feel comfortable that their advisors have built the tools for properly monitoring them.
00:45:41
Speaker
And again, one of the things we try to do at Simplify is to provide the tools that give that transparency, help people understand how the product should behave, whether those are deep dives on the individual portfolio, the individual portfolios themselves, or whether it is public speaking engagements, etc., where we try to share information around this sort of
00:46:01
Speaker
behavior. So I think all those are really critical and I applaud what you've done in terms of building those tools to understand this because this is kind of the next generation. This is where things are going, right? Portfolios are becoming more complex in the pursuit of better targeting outcomes, which is really what we care about. Nobody cares about the performance of the S&P 500. They care about, do they have a secure retirement? They care about, do they have enough money to spend, you know, to go out to eat at a restaurant?
00:46:32
Speaker
without thinking twice about it or to replace a car or to do an emergency repair or to pay for their kids to go to college. We need to recognize that we're in the solutions business trying to provide people with outcomes as compared to look at the performance of my fund.
Simplify's ETF Strategies for Diversified Returns
00:46:49
Speaker
Yeah, it's funny. I always joke and like, this is, you're so spot on with this. I always joke that no advisor gets bonus points because they beat the bogey. But they certainly, 100% will get fired if they miss it.
00:47:05
Speaker
And so the goal here is to not miss it. And understanding that point in time makes a difference, right? You know, if you are at a disadvantage and you happen to need these things at the exact worst time, you got to think about that, right? So how do I make sure that the ride's a little smoother, that the volatility is limited so that even in the worst case scenario, you know, you have a better chance of hitting that bogey.
00:47:34
Speaker
I think that's right. And I think, you know, again, it's hard for people going back to my observation of, you know, 10,000 years of recorded history and basically 100 years of financial history. It's just really hard for people to appreciate that we've we have lived through a unique period in time. We're fumbling our way to understanding these products and the implications that they have for financing retirements.
00:47:59
Speaker
of length and magnitude that our ancestors could never have imagined, right? The idea that you would have a 30 plus year retirement, candidly never occurred to the vast majority of human beings who ever lived. The fact that we've made as much progress towards that as we have is encouraging, but there's a lot more work to be done. And I think the innovation that's occurring within the ETF space and simplify candidly, we're thrilled to be part of it, is part of that process.
00:48:26
Speaker
So let's sell advisors the three white paper pieces that Simplify has that are must reads. And we'll add some links in our show notes so that they know where to find them. And then advisors that are part of Bonery and these things are available in Bonery Room. But what three do you think are must reads for advisors that Simplify has put together?
00:48:50
Speaker
So on our Simplify information pages, we will have links to deep dives. And so for each of the alternative products, and I would include in that
00:49:02
Speaker
our hedged high yield credit fund, which is one that I run that I think is actually quite interesting at this juncture, where we were faced with an interesting situation of either the economy is going into a recession, in which case a credit hedge becomes really important, or we're not going into a recession, in which case you actually want to be positioned for higher yielding instruments to perform
00:49:25
Speaker
It kind of is one of these weird put up or shut up moments, right? And so taking a hedged approach there is something I would recommend. But if you go in, you'll see deep dives on our core alternatives products. Those would be QIS, which I mentioned, CTA, which is our our trend commodity trading advisor is what that stands for. But that's our trend following strategy. It kills me that that ticker wasn't taken when you guys launched it.
00:49:53
Speaker
How did somebody not like bookmark that? That seems like a ticker that should have been taken. I gotta be honest with you. I think that there's a lot of tickers out there that have multiple meanings to people, but you talk about the individual geniuses. One of our primary founder, Paul Kim, I would just say is a ticker symbol genius. He manages to find stuff that I think is absolutely fantastic.
00:50:22
Speaker
But each of those products, the QIS, CTA, EQLS, which is that equity long short, again, another ticker that should have been taken but wasn't taken, those all have deep dives available on our website that I would encourage people to check out. And so those are not white papers. Those are a combination of written materials and video presentations. CDX is the hedged high yield product. I speak on that extensively. We have deep dives as well on that.
00:50:52
Speaker
From a theoretical standpoint, if people want to understand how we think of how the world is behaving right now and a lot of the confusing dynamics that we're seeing, things like meta dropping as sharply as it did today, I would encourage people to search for a podcast I did called Lunch at the Club, which is a review of my work around passive investing and how that is influencing market behavior and structure.
00:51:18
Speaker
And then I'm trying to think if there's a, the third piece is, you know, again, I would encourage people to look at our model portfolio construction, same general principles and ideas that you would have in your portfolio constructions. We've got reviews of those and explanations for why we've taken different approaches to how to build those portfolios. I would encourage people to check that out to get a sense of our thought process there.
00:51:44
Speaker
Awesome. We will put links to a lot of those things in our notes as well as just a link to simplify site. I can't stress enough, you guys have awesome materials, probably some of the best in the industry in my opinion. Your whole framework and your educational resource data bank is
00:52:04
Speaker
phenomenal and we're so excited to have Simplify partnered with Bonrion helping advisors in this and really working to help with the educational component because that as you pointed out earlier is the key to all of this because at the end of the day an advisor might listen to this podcast and be more intimidated not less because you know it is complicated but
00:52:29
Speaker
we won't, we, I believe anyways, and I know simplified believes this, this is the thing you have to do. And sometimes you have to do the hard thing. And sometimes educating yourself is difficult, especially in this area. Um, but it's the right thing to do. Uh, cause the world's evolving and the world's changing and you want to be able to compete for business and, and, and help your clients meet their goals. So education is part of that. And I would argue that that's why I love our business.
00:52:58
Speaker
It is a constant source of education. Every day you learn something new.
Making Complex Strategies Accessible
00:53:04
Speaker
As I like to remind people, it is what I think of as the greatest game. It is both humiliating and enriching and candidly humbling in a lot of ways because the world looks different every single time, even if it bears resemblance to episodes that have happened in the past. The proverbial history doesn't repeat, but it rhymes type framework.
00:53:24
Speaker
We're in an interesting period and a lot of people look at our products and Shannon, it means a lot for you to say how good the materials we put forward is. That's feedback for our team that means an incredible amount to us. But people will look at our products, they're like, you've misnamed your firm, it's simplify. Everything you do is really complex. And the answer is it is, right? But what we're actually trying to do is simplify the access to these types of strategies that we think are increasingly important
00:53:54
Speaker
as components of portfolios in a world that candidly is a lot more complex than a 60-40 world. Yep. I like to say the 60-40 isn't dead. It's just evolving. I like that usage. That makes sense to me as well.
00:54:09
Speaker
Well, thank you so much for joining us today. I hope our audience found this helpful, although I'm sure maybe a little overwhelming. But the point is that we're here for you, both the team at Simplify and the team at Bonrion. That's why we exist, and that's what we're really passionate about. So feel free to reach out and ask questions. We're here to help.
00:54:33
Speaker
So if you like what you heard, please make sure you like this video and subscribe to our YouTube channel and to our podcasts. And until next time, have a great day.
00:54:48
Speaker
The opinions expressed on the What's the Alternative podcast are for general informational purposes only, and are not intended to provide specific advice or recommendations for any individuals or in any specific security. This is only intended to provide education about the finance industry. If the terminals and documents may be appropriate for you, consult with someone
Podcast Disclaimer and Investment Risks
00:55:13
Speaker
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00:55:43
Speaker
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00:56:00
Speaker
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00:56:16
Speaker
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