Podcast Transcript: Mike Philbrick on Bond Massacres, Better Diversification and Systematic Thinking

This is an edited transcript of our podcast episode with Mike Philbrick, published 13 May 2022. Mike Philbrick is the Chief Executive Officer of ReSolve Global Asset Management. He has over 29 years of experience in investment management and is responsible for investment decisions, coaching, and strategic leadership. He has co-authored the book Adaptive Asset Allocation: Dynamic Global Portfolios to Profit in Good Times – and Bad. In the podcast, we discuss how to invest in different stages of the business cycle, the benefits of machine learning, current views on macro, and much more. While we have tried to make the transcript as accurate as possible, if you do notice any errors, let me know by email.

Introduction

Bilal Hafeez (00:00):

Welcome to Macro Hive conversations with Bilal Hafeez. Macro Hive helps educate investors and provide investment insights in all markets from crypto to equities to bonds. For our latest views visit macrohive.com.

It’s relentless. Stocks are falling, emerging markets are teetering, and crypto is collapsing, and the latter is certainly taking all the headlines. In an echo of currency markets of the 1990s, crypto land has been hit by stablecoins depegging, most notably the Terra Stablecoin. We have a lot to say on this topic and we’ve summed it up in a new note, which we released earlier this week, called The Crypto Quake Has Started. It’s well worth a read. But there are other themes, too, running in parallel from inflation in the US, war in Europe, and COVID in China. We draw all of these themes together in another note called Markets Have Entered the Multiverse of Madness.

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Now onto this episode’s guest Mike Philbrick. Mike is the CEO of ReSolve Global Asset Management. He has over 29 years of experience in investment management and is responsible for investment decisions, coaching, and strategic leadership at ReSolve. He’s co-authored the book Adaptive Asset Allocation: Dynamic Global Portfolios to Profit in Good Times – and Bad. And before his investment career, Mike played professional football and for the benefit of our non-American audience, I should say that is American football, not football, which you play with your foot, soccer.

Now onto the podcast. So welcome, Mike, to the podcast. I’ve been looking forward to this conversation for a while.

Mike Philbrick (02:10):

As have I. As have I. It was great connecting with you on Riffs [Bilal’s interview on ReSolve Riffs], and it’s a real pleasure to be here to chat today.

Bilal Hafeez (02:20):

Yeah, I really enjoyed being on your show. And so, on my show I have a certain question I always ask all my guests, which is their origin story. And so, I’d like to pose that to you, in essence, what’s your origin story? What did you study at university? What did you do afterwards? Was it inevitable you’d end up in finance? And how have you got to where you are now?

Mike Philbrick (02:38):

Yeah, it’s such a good question. You were born. We’re here now. What happened in the middle? I love it. I love it.

Actually, I grew up in Canada. Was born in the Hamilton. Grew up in the Niagara region. Worked on a farm. I remember my first experience with the stock market. I was picking cherries piece mail and there’s two things I thought I wanted. I wanted a pellet gun. I think I was like 10 or 11 years old. And I wanted to buy some GM stock.

And in Niagara, GM was a big employer in that area. And so, I bought some GM stock. I mean it did okay. It wasn’t anything magic. And then Brights Wines was in the area. So, I bought some wine stock. And my grandfather was quite passionate on investing. And so, I went on to study economics at university, but I also was playing football. And I played professionally in Canada for about 12 years.

Bilal Hafeez (03:27):

American football.

Mike Philbrick (03:28):

Yeah, American football. Yeah, yeah, not the real football.

Bilal Hafeez (03:31):

Not the real football, yeah. I was waiting for you to say that. I didn’t want to-

Mike Philbrick (03:34):

The colonial football. The one that’s played in the colonies, for sure.

Mike Philbrick (03:38):

So, I studied economics and went to play football. And sort of halfway through my career, you always see the writing on the wall, and you want to start doing something else. And I was very fortunate to have a fellow by the name of Wally Gabler, who had played in the NFL and the CFL, and was also with a company called Nesbitt Thompson, part of the Bank of Montreal group of companies. And he said, ‘Yeah, while you’re playing, why don’t you get into the wealth business and start building a book’.

And so I started it there. Went to Scotia Bank, went to a smaller niche company called GMP Securities Partners, wound my way around to Macquarie doing the whole global gamut. And yeah, and then in 2015 we launched ReSolve Asset Management and exited the sort of the big firm mentality.

There are wonderful things at large firms, but there’s also a lot of limitations, as you know in your career path. Eventually you get to a level where you just want to get away from all the cross currents and the politics that sort of limit the opportunity to sort of express whatever your unique vision is for the world.

Bilal Hafeez (04:43):

And so you launched ReSolve along with some other people. I mean, what was that process like?

Mike Philbrick (04:48):

Well, it was funny. We were acquired at Macquarie. They came into Canada. They were sort of buying all of the ancillary business is to a banking business. And Macquarie wanted a Schedule I banking licence in Canada and applied for it but didn’t get it. And so, we were one of these acquisitions that was placed around the skyscraper, if you will. And the skyscraper was going to be obviously the Schedule I banking licence. So, when they didn’t get that, they basically sold everything else off.

And that’s where we had the opportunity to actually fully launch. So, with my partners Adam Butler and Rodrigo Gordillo launched ReSolve Asset Management, which is a global systematic macro shop. It’s grown from being more ETFs and into much more futures, just because of the way the futures market is so much more efficient.

We acquired a firm called Acorn Global Investments, which was run by Jason Russell, who’s still at ReSolve. CTA, That was established back in 2008. In fact, Jason’s been running mandates like that since 2005. And so, yeah, here we are.

Then the opportunity came to think about things through a global lens. Being in Canada is fine, but if you’re going to start a global operation, where might you locate? And so in 2019, we set up ReSolve Global based here in the Cayman Islands. And so that’s been the journey thus far there.

Bilal Hafeez (06:08):

And which year did you launch the institution?

Mike Philbrick (06:13):

2015.

Bilal Hafeez (06:15):

And so, you launched just as the Fed was raising rates and then we had the China deval that year as well, 2015. So, it was quite an interesting transition point. So, did the macro backdrop affect your launch in any way or were you kind of all guns blazing? You were going to do this anyway.

Mike Philbrick (06:32):

Oh no, we were going to do it anyway. Yeah, the ships had been burned. There was only one way to fight the war and that was through the natives and into the jungle. So it honestly feels like it’s been a decade of fighting that battle since we are purveyors of diversity, diversification, whether you want to think about whether risk parity as being a sort of basic tenet of how you might construct a portfolio to consider many of the outcomes and be prepared for inflation shocks and liquidity shocks and all these things.

So, diversification has just been an albatross around everybody’s neck, probably since 2009, not even ’15, where I think, the 60/40 portfolio pre-2022 had a sharpe ratio that was in the 99th percentile of historical sharpe ratios. And so, investors, allocators, whether they’re retailer institutional, start to issue those basic diversity tenets. And how can they not? I mean, it’s just been a drag. It’s been an Albatros to a portfolio to own international stocks, to own commodities. Oh my gosh, it’s been terrible.

So having allocations to these asset classes and being a CTA that also has things like seasonality and trend following. Well, there’s not very many CTAs left in the in the world. Now they’re coming back. Hey, we’re making a comeback.

Understanding true diversification

Bilal Hafeez (07:49):

And so, two things to take out there. One is on the diversification point. That essentially means that you were not just long bonds and long US equities, but before 2020 or 2022, I should say even, did that mean your performance was less than your peer group because you were diversifying? Or how did you deal with that?

Mike Philbrick (08:08):

Yeah, so our longest mandate goes back to 2015. It has a sharp ratio of 0.8 and returns of sort of in that 6% to 7% range. And the max drawdown was 6.7% something along those lines. And this is, this is an early man version. Used ETFs, not futures. So we were able to garner some returns. It’s just that they paled in comparison.

A sharpe ratio is a wonderful thing, unless it just means you got 6% and the world was making 20. No one really cares. And again, you’re set against a backdrop where the sharpe ratio of the balanced 60/40 portfolio in the US, which, by the way, is a very concentrated bet, right? You’re eschewing the rest of the world. You’re eschewing any kind of inflationary assets that are going to help keep you on an even footing in a year like 2022.

And so you have this wonderful equity line in that domain. And that’s where you’re being compared because kind of a balanced portfolio, but you’ve got more balance. You’re thinking about the fact that, hey, you shouldn’t have 60% of your portfolio in equities because that really means you have 90% exposure to equity risk, and you have 10% exposure to bond risk.

And we’ve been through this wonderful 40-year period where stocks and bonds have not been correlated. And even when their returns have been inversed, right? So in the 2000s it was bonds were the higher performing asset class and stocks were the shitty ones. So the efficient frontier sort of flips upside down, but there’s still a source of return and a source of diversity.

If you look at 1970, which is a very similar state of affairs that we might be heading into, and I’d argue, the forties might be a little bit more apropos, but that’s sort of between the jigs and the rails. But if you look at the efficient frontier in the ’70’s, it’s a straight-line stocks and bonds correlate, but bonds just go down a little less and go up a little less.

And so you have this, I feel like it’s been a decade of sort of an uphill slug where we’ve been espousing diversity, espousing appropriate balance throughout the portfolio. Don’t have too much in any one area. And it’s taken until sort of the last six months to manifest in an area where we can say, “Hey, well, we told you,” I guess. I don’t want to say it like that, but diversification is now an in thing, thinking about your portfolio through the lens of where are the sources of risk that I have in the portfolio and return, right?

So if you have been underexposed to those assets that are inflationary sensitive on the upside, you’ve done pretty poorly. But a simple risk parody portfolio, some of our simple SMA portfolios that are just run with ETFs, are maybe down 2% this year. It’s a yawner. It’s a total yawner. But that’s if you’ve taken the opportunity to be prepared, right? Just simply preparation an all-weather sense. You’ve weathered this storm pretty well.

How to invest in different stages of the business cycle

Bilal Hafeez (11:00):

And you mentioned a few terms that just for the better of our audience, risk parity, how do you define risk parity?

Mike Philbrick (11:05):

If you think about the dynamics of inflation and growth, right? And we show this sort of what we call a market target. But if you think about growth going across the horizontal axis and inflation on the vertical axis, what you end up with is four regimes. And when you have inflation surprising on the upside and accelerating growth, so global growth that can sort of attenuate the increase in commodity prices, you have an inflationary boom.

And then, if you move around that target, that chart, you get a disinflationary boom where you have inflation attenuating and growth continuing sort of like the last 10 years. US market does exceedingly well. And then you have the periods where you have slowing growth and rising inflation, stagflation in the ’70’s, slowing growth and slowing inflation ’08, and the Great Depression.

You want to think of those four quadrants and then you want to balance the risk that you have exposed to the portfolio via the asset classes that are sensitive to those regimes. You want to make sure that you’ve balanced the risk so that it really doesn’t matter if you enter a stagflationary environment. You’re going to have some assets that are killing it and some assets that are killing you.

And that’s just going to be the way the target works, but you’re wrapping your arms around all of the risk premia that are out there. And risk parity technically states that return is a function of risk. So if we equalise the risk exposure, then the diversity of the returns and thinking about the quadrants, you come up with a bit of a four by four. It’s an all-seasons portfolio. You’re going to get to work no matter if it’s July or if it’s January.

Bilal Hafeez (12:38):

And in terms of the risk then that you look at, obviously people can look at different types of risks, but for you it seems like growth risk or sort of business cycle and inflation risk are two key ones to focus on.

Mike Philbrick (12:49):

So, the risk from the standpoint of the portfolio construction is often just a function of what is the volatility of the asset class and then how does that volatility, or that beta function, is it correlated to inflationary dynamics or is it correlated to growth dynamics? So emerging market stocks are a function of growth and inflation.

So, you want inflationary growth for emerging market stocks to do well, right? They’re going to be there’s demand in Chile for copper. There’s demand in Canada for oil and gas. And so those countries respond well, both because they have trade surpluses at that time money flowing in because they’re digging holes in the ground and selling it to China or if that’s Australia or whoever you might think of.

So, there’s these structural dynamics at play that drive these asset class prices in these various regimes. So, you want to measure that beta, but the implementations one might think about in risk parity are all weather, are infinite.

One of the bugga boos we have is stocks and bonds that are levered. That’s not a risk parody concept, right? You’re leaving out a third of the equation when thinking about inflationary protection from those assets that might protect you in that sense that are gold and commodity oriented or emerging market bond spreads or tips and that type of thing.

Bilal Hafeez (14:04):

And so actually on that, in terms of the range of assets then, then how do you work out your range of assets? Because, I mean, you can carry on… It can be frontier, EM. It could be different types of assets in the capital structure. It could be private markets. I mean, where do you draw the line?

Mike Philbrick (14:17):

Yeah. So we need liquidity and largely we’re in the future’s market. So we’re going to be trading the commodity markets, the exchanges, the stock exchanges from the various countries, the currencies, the sovereign bonds. So we don’t do any sort of junk or high grade, none of that, because those are all conflated beta, right? So you have, well, gold stocks. Well that’s stocks and gold. We would prefer just to have the pure beta from gold as an example, as a sort of an easy example. So it sits in highly liquid markets so that you can rebalance.

The other thing that you get is an amazing tailwind of, in the studies we’ve looked at, 2% to 4% compounded just from rebalancing the different sectors that you have. So first we have these regimes. Next, we have a slew of 85 to 100 different futures, contracts, and currencies that we can trade. But then we need to slot those into, well, where do they fit? How does their beta react with the beta of each of these quadrants? And so there’s a method to do that.

And then there’s a method on, okay, what do we think the return vector might be? So part of our twist on risk parity is not just to think about it through the risk lens, but also to think about it through the carry lens or the what’s the yield on these various asset classes? Because all things being equal higher yield means you’re going to make that return as you roll through time.

Whether valuations matter

Bilal Hafeez (15:35):

Would you also look at valuations as well?

Mike Philbrick (15:37):

Not really. Relative valuations a little bit, yeah. But valuations, no.

Bilal Hafeez (15:42):

That’s interesting. Why not?

Mike Philbrick (15:43):

We think that the valuations are a reflection of the assumptions that are baked in with inflation and growth and so far, be it from us to make assumptions that those would be wrong. We’ll let the market tell us when that happens.

And you’ll see these sort of phase transitions and asset classes. We’re seeing it now in equities, in the us, you’ve had this exceedingly calm 10 year period save 2020 and ’11 with the debt crisis. There’s been a few like scares along the way. But when volatility explodes, that automatically means that you’re going to be reducing position sizes. So you just wait for that expansion in volatility and you adjust the portfolio from there.

Remember in the risk parity concept, so right now we’re just thinking about preparation, not prediction, we do have advanced sort of alpha generation, which we hesitate to talk too much about because it is… It’s the secret sauce. And so there’s, there’s lots there.

So you can add to that, but the base should be, “Hey, where’s the do no harm portfolio?” Where’s the portfolio that we can kind of set it and have a lot of confidence that it’s going to navigate a lot of different timeframes. So part of the timeframes that are difficult for that are policy shocks. The 1994 bond massacre, which I think people are going to start reading about. Given the circumstances that we’ve been through in the last little while the parallels are quite interesting.

Anyway, I’m getting off topic. But generally it’s letting those understanding what regime they represent and then letting the volatility of the asset class and the carry on the asset classes determine the sizing of the portfolio.

Bilal Hafeez (17:12):

Okay, understood. And in terms of the beta you mentioned earlier, you kind of map growth risk to the betas to growth risk of each asset class and so on. But obviously the betas are unstable. The relationship between different asset markets and growth changes and fluctuates. And it’s not what you think it is exposed. I mean, how do you deal with all of that?

Mike Philbrick (17:32):

And assets will move over from one cluster to another. You manage that by doing this every day. Every day there are changes in the markets. Markets are open. Bunch of stuff happens. There’s a change in price. There’s a size and change of price. And then there’s the relationship of the changes in price to the other asset classes.

And then that would give you some calculations around what needs to change in the portfolio. What asset classes might be migrating from one area to another, because there are asset classes that are known to cluster very differently. Gold is one of them, right? This kind of very different asset class that has a couple of different uses in a portfolio from everybody else’s perspective. So from the market’s perspective. So as the market changes the way it values a certain asset, you will see it shift through the different areas of cluster, if you will. And so you just, you continually monitor that.

Why systematic over discretionary

Bilal Hafeez (18:25):

And you earlier said you have a systematic approach. So does that mean it’s 100% systematic with no discretion or is it a hybrid approach?

Mike Philbrick (18:35):

It’s very largely systematic. So I don’t think anyone could really say they’re 100% systematic. You do have to, as the portfolio managers and CIOs, they do have to oversee the portfolio. There are things that you know that your models don’t know. Okay. So when you’re looking at all of these numbers, the machine only sees the numbers. It only sees the changes in one. It has no idea what’s going on outside of the fishbowl.

And so, you have to think about things. For example, the current situation with JGBs is an interesting one. They’ve said they’re going to buy an infinite amount of JGBs and that’s a challenge, right? So that’s something that our model doesn’t see. It doesn’t see the instability in that market.

And so we’ve sort of put that asset class on the sidelines for a little while, and just waiting for it to normalise a little bit, because you have some sort of jump risk there that the model is not going to see at all in the last 40 years of data. It’s blind to that. So very, very systematic, but in key situations you have to intervene and say, okay, the model, you can’t really even see this thing that’s happening. So we’re going to make a change here or we’re going to attenuate an exposure.

Bilal Hafeez (19:44):

And how’s the performance been so far this year? Obviously, we’ve had some wild moves in markets. How’s the portfolio performed?

Mike Philbrick (19:50):

Well, so we’ve got a number of different mandates. Let’s start with the sort of the most flexible, the one that has geared the highest. So it’s a 15 vol hedge fund. It has the widest sort of mandate flexibility in that it can have the largest concentrations in various asset classes and things like that. So it’s sort of showcasing the alpha side of the portfolio and that’s up about 32% for the year.

Bilal Hafeez (20:13):

That’s quite a big number, yeah.

Mike Philbrick (20:14):

It’s a 15 vol fund. So it’s not for the faint of heart, yeah. And so there’s another portfolio we have as well, lower vol, so targeted 10 vol, and this is just the alpha sleeve. So these have no sort of risk parity in them. And so that one’s up 17% for the year, but again, a 10 vol product and tighter constraints. So cannot get into as heavily a commitment let’s say in the energy area. We just don’t allow that. So it’s just a little bit more robust.

And then we have public products that trade in the US. We have a mutual fund, a ’40 Act mutual fund, there that’s up 10%. And that one has that. A third of that portfolio is that risk parity base. So that’s the beta that we would build in globally. If you think about, what is the most efficient way that someone can garner a beta to all markets? For us, it’s that all weather type risk parity, globally diversified balance approach.

And then we run an ETF with a similar mandate with a lower vol. So eight vol in Canada. That’s up about 7% for the year. And all have faired very well. But again, we’re no smarter than we were six months ago. What’s happened is that there’s been a return to dispersion in assets where you’re having these asset classes that are performing very differently.

For example, we need dispersion as active managers to differentiate our performance from everybody else. If you have 10 equity lines that you can choose from, and they’re all correlated 100%, no one can outperform anyone, right? It’s really, really tough to do.

Whereas if you have 10 asset classes or 10 return lines, but they’re like a fan and they’re vectoring out from one another and there’s varying correlations between them, now you have the opportunity for truly differentiated performance. And you can harness the simple things like this rebalancing premium. Putting together non-correlated streams of return and just rebalancing has a massive tailwind, which is something that we do within the feature sets.

So in the alpha sleaves there are different features that we’re using different factors that, whether that’s trends, seasonality, mean reversion. So you have these different feature sets that you can then draw out what you might think are ways to garner excess return. So where’s the sweet spot in the trend for any particular asset class? Where’s the sweet spot for seasonality? Seasonality is obviously very different across the futures markets.

And when you do sort of a PCA analysis on a future’s universe, what you find is there are a lot more unique bets than there is in let’s say the S&P 500 or even global stocks. So you just have the unique bets that might come from the lumber market and the unique bets that might come from what’s going on in the wheat market, and then the energy market, and whether that’s print or crude or the natural gas market. So you have these very different supply and demand dynamics that are going on in all these markets that give you a much more diverse set of opportunities and those diverse sets are paying off.

Bilal Hafeez (23:10):

Yeah. And in terms of the more alpha skewed portfolios, I mean, can you say what they’re allocated to at the moment? What their overall positioning is?

Mike Philbrick (23:18):

Yeah. So at the moment we are broadly speaking… Let’s just go with the highest vol one. So we’ll go with the evolution portfolio. But right now the risk exposures are moderately short bonds, moderately short currencies, quite long energies, medium long grains, stock indices, very, very incremental, slight short position.

We have some tail protection strategies as well that are involved in the portfolio, and we are seeing some of those be activated. So the tail protection strategy is something that’s not always on. Back during the Russian invasion we had like a max position on. Nothing happened. It attenuated. It was a small profit to the portfolio, but you have this disaster insurance kind of kicking in, which is interesting.

Bilal Hafeez (24:04):

And how does that work? You basically have some measure of market volatility? When a high-level market vol gets triggered, then you activate certain positions.

Mike Philbrick (24:11):

Yes, it has to do with the term structure of what’s going in vol, whether that’s increasing or decreasing, what other asset classes are doing as well. So there’s a few inputs that go into the tail hedge protection, and then it’s predominantly done through the VIX futures that are either European or American VIX future V stocks and VIX.

Bilal Hafeez (24:34):

Oh, in terms of that’s the instrument you’d use?

Mike Philbrick (24:34):

Yeah, that’s the instrument that’s used to express the view.

Bilal Hafeez (24:37):

Yeah. That makes sense.

Mike Philbrick (24:39):

And then short metals and short rates at the moment. So this changes a lot.

Bilal Hafeez (24:43):

I was going to ask that. I mean, how stable are these?

Mike Philbrick (24:46):

One-to-five-day prediction really is basically it. So tomorrow they’ll be totally different, which is something that’s really hard for individual investors to sort of compute. Because you would think that “Oh, I see this. Sort of here’s my long-term macro thesis. I think this is going to happen.”

We talk a little bit about don’t get involved in stories, because stories change and you want to be ground zero with price and the changing that’s going on there, not with the narrative necessarily. And so along the way that you might be seeing this envisioning some sort of long-term macro theme, there’s going to be lots of ebb and flow in that theme. And so, we want to take advantage of that ebb and flow through shorter timeframes. It also allows you to adapt a little bit more quickly when things start to go against you.

Bilal Hafeez (25:31):

What’s the advantage, would you say, to this systematic approach to a discretionary approach? Because obviously there’s other hedge funds who are purely discretionary. They have a global theme, inflation, China, slow down all, all those sorts of things. Then they put big bets on, and they try to make alpha that way. What’s wrong with that approach versus the systematic approach.

Mike Philbrick (25:49):

Oh, by the way, there’s nothing wrong with any approaches. I want to be clear. I absolutely applaud all those macro thinkers that think through the bets and think through the asymmetry of the bets. I’m sure a lot of your clients and a lot of your thinking is geared to how do we get exposure to these particular outcomes, but let’s do it cheaply or let’s figure out how we can get these exposures and be in more win-win scenarios. I love that.

For us it’s just a function of systematic thinking is more about really being consistent. So it doesn’t matter if I don’t sleep well tonight. It doesn’t matter if I saw some documentary on something that’s contrarian to my theme or my story. I don’t have to change my mind because my mind is something that is more attuned to what are the actual changes meaning and how are they manifesting? How are they manifesting across the portfolio?

The other thing is the multidimensionality of this. Think about 85 asset classes and you’re trying to do these calculations. There is no way for the human mind to comprehend that. It’s not possible. So it has to be assisted with the advent of some machine learning and some technology. And there’s a lot to be done there. That is a long conversation about how you avoid data fitting and all kinds of issues.

Benefits of machine learning

Bilal Hafeez (27:08):

And you mentioned machine learning. I mean, how important is machine learning to your process?

Mike Philbrick (27:13):

It’s the way you look at the data. Trying to not get leakage across areas, trying to make sure that you’re in a clean room setting when you’re doing testing, and things like that.

And the other thing that we’ve found from the perspective of where we see other CTAs make statements that don’t jive with us as an example of an interesting anecdote, is that many other CTA advisors will say that, “Oh, this pattern manifests and it manifests like this in wheat and so it’s usable in spoos or S&P 500.” We have not found that to be the case.

We have found that it’s possible that those, if you’re in the equity indices area, okay, maybe some of the things you’re seeing in S&P will be applicable, yeah, in NASDAQ, and maybe it’ll be applicable in other global markets, but it’s highly unlikely that it will be in any way applicable to the grain markets or the energy markets and those types of areas. So that’s something that we kind of tilt our head when we hear.

And maybe that’s just a little bit of marketing talk from those folks. So we don’t know exactly what their systems are and how they calculate things. But machine learning allows us to get some rigour around how we’re going to process the heat maps. The multidimensionality that spits out at you, it’s complex.

Bilal Hafeez (28:31):

Yeah. No, understood, yeah. And in terms of the CTAs, I mean, CTAs have a reputation of being essentially trend followers. It’s glorified, moving average crossovers and kind of lose money a lot of the time. And then periodically you make huge gains. And that’s kind of the risk of return characteristics of that. In contrast to say, carry, which is the opposite, where you make small amounts of money every day, and then you get wiped out periodically, but CTAs are certainly in that trend following camp. So how would you contrast your approach or returns to that type of CTL with the trend following, which is what people tend to associate with CTAs?

Mike Philbrick (29:04):

Yeah. So, there is a fair bit of trend following that makes it into our systems for sure, but we do what we would call ensembling. So, we want to make sure that we have a number of different ways to view the signal. So, it’s not just trend. There’s mean reversion. There’s seasonality there’s, as you talked about, yield or carry, relative value, and then volatility.

So, for example, let’s say we are in a situation where trend and seasonality are very strong in a particular asset class and, wow, it happens to have a good carry related to it as well. So what’s going to happen is our systems are going to say there’s more and more confidence which we have with that particular bet. And so there’s a lot of netting that goes on.

So let’s say seasonality is positive, but mean versions negative, trend following’s positive, volatility’s negative. You’re just getting kind of very mixed signals. Well, you’re going to net those positions out. It’s going to end up that you have a very weak position or a very small position because you don’t have a lot of confidence in it. Your various features that are feeding back to you are saying yes or no.

The magic is trend with carry is something that is really, really good and shouldn’t be underestimated. So combining those two is great. And there’s lots of research in the public domain out there on trend in carry just having a really high, sharpe ratio, good value add to a portfolio, but that’s just one example.

If you look at seasonality and trend, often they will be correlated, obviously, right? So if you’re in a positive seasonal period, well, your trend is going to look good. What you don’t want to be in is you don’t want to be loading up on sunscreen in August, because your trend is saying, “Hey, we’ve never sold so much sunscreen,” and it’s August. It’s not a seasonal time to be loading up on sunscreen.

So some of those, the way the ensembles of the strategies work is you’re ensembling these different return factors. And then how you determine the feature sets is where a lot of the machine learning comes in. So how should we measure trend and what are the various ways that we might measure trend? And then within that, can we get more specificity that works out of sample, right? And all of that is a very arduous process.

Bilal Hafeez (31:24):

I can imagine. And how often do you generate signals? Is it every day you generate the signals? Is it intraday? Is it weekly?

Mike Philbrick (31:27):

It’s every day. And then, we will be moving to in intraday as we move through this year. Intra day has a whole bunch of challenges with it that are operational as well as research oriented. But at the moment it’s every day.

And then there’s you try to employ the best trading algorithms to make sure that you’re not getting front run or that you’re not getting seen in the markets. That you’re getting the best fills you can and best execution that you can based on what your model’s told you in the first place, right? So you’re going to want to measure against what you thought you were buying, if you will.

Current views on macro, the parallels to the 1970s and 1940s, the 1994 bond massacre, and inflation volatility

Bilal Hafeez (32:01):

And if we step back outside of the process, I mean, what’s your view of the world at the moment?

Mike Philbrick (32:07):

Let’s go back and look at the last 10 years. We’ve had global growth, benign inflation, and abundant liquidity, December 31st, 2021. I think it changed obviously in November, but I think everyone held their breath. They’re like, “We can’t sell anything. We have this massive tax problem, so we’re not going to sell anything.” And then January comes.

But if we look today and think about, well, where are we today? So that three-legged stool that’s been so kind, which is this global growth, benign inflation, abundant liquidity, is now contracting liquidity. We just had an eight-handle print on inflation. So that’s not benign. And the yield curve is inverted. This is a very different scenario.

And I kind of hearken back to that bond massacre in 1994, when the Greenspans, Fed tightens in a sort of surprising fashion and to control inflation at the time. And it really destroyed anything that had a sort of a discounted cash flow mechanism to it, bonds, stocks, et cetera. And to be fair, that’s one of the weaknesses of risk parity type portfolio.

When cash is the best performing asset class and all asset class are subject to a decline, then risk parity doesn’t do great. But that’s depending on how leveraged you are and the construction down two or three to down six or seven is where you’d be in that preparation phase.

But that’s truly one of the areas that policy risk is something that’s really hard to prepare for. And one of the reasons that we’ve continued to shorten the outlook on the alpha sleeve, because we want to be adaptive and able to assist the portfolio to adapt more quickly. And so that alpha sleeve is complimentary where the products are mixed. And then where it’s just alpha it just responds more quickly.

So, we have this changing of the guard and we’ve had a previous 10 to 15 years, whatever, 12 years. And it tends… My experience… I started in this business way back in 1990 and it tends to… We move in these decade long periods where there’s been a sea change. There’s been some change. And I don’t see this reverting to the old way, just because we also now have inflation volatility.

So you have an inflation metric, right? But then you have a mean expectation, but you have volatility around that mean, and since 1990, the volatility around that means has been 1.3%. And Man did a paper on this. I don’t know if you’ve seen it. But prior to 1990, it was 4.8%. So when you have higher vol around some inflation expectation, you have to discount asset prices back further in order to account for that uncertainty and that risk.

Since 1990 we’ve had a 1.3 inflation vol. So assets have become quite robust in their pricing because of that, right? You’ve had this certainty that inflation not only was going to be low, but there’s going to be no volatility around that lowness. And now that’s changed.

So even if we revert to a more normal inflationary number, the volatility around that is much like, as I mentioned, the ’40’s. The ’70’s were, “Hey, inflation’s rolling and the central banks are going to do something about it.” And so the cash rate went along with the inflation rate. In the ’40’s it did not. We had these massive spikes in inflation and it was… The US government could not afford to increase rates. So it was a bit of a confiscation type of rate regime, which feels a lot like we’re in today.

Bilal Hafeez (35:41):

And I mean, what do you think also about things like we have this Russia/Ukraine war going on, we have zero COVID in China, how do you factor that in? I guess that goes back to policy. I suppose that’s that’s policy in some ways.

Mike Philbrick (35:54):

My sense is if we think through the choices that central bankers have at the moment, we have high inflation, we have an election cycle, supply chains are extremely compromised, so it’s not like we can turn a switch to increase the supply of goods in order to attenuate the inflation. So what does that leave you with? That leaves you with the attenuation of demand, which is well let’s raise rates and slow the global economy while the supply chains heal.

I don’t know if it’s that nefarious or that thought through, but it certainly could be. I mean, if you were in the chair sitting there and looking at the circumstances, you’d probably say, “Okay, I’m faced with making the least bad of the bad choices.” Which is, okay, let’s engineer a recession that will reduce demand that will slow things down and allow the COVID situation in China to heal, maybe the Russian situation to resolve. Which by the way, may go in the opposite direction. Which this is a serious game of chicken, I guess, if you will. I’m not sure.

So what that means is have exposure to these asset classes that can profit that are non-correlated to the base rate. I mean, everyone has been lulled into a sense of 60/40 US stocks and bonds, and they’ve been caught absolutely flat footed here. Central banks have told them the inflation is transitory.

Policy has misguided the investment world. And those who could see through it and say, “Well, I don’t think it’s transitory,” have done certainly far better, have had positions on that have profited in this timeframe. Those who have sort of said, “It’s just going to be like every other decade,” and sort of this peak passive type of investing, which to me is someone who’s been around since 1990 and watched Japan go through a significant bear market, watched the US market go flat for 14 years and just have volatility.

And being Canadian, experience in the Canadian market where in the ’90’s Canada was terrible. I mean, it was terrible. The US market reigned supreme. And you see these decade long periods where we have these major changes in sort of structural returns or structural asset class returns. And part of it is initial conditions.

Right now, look at the initial conditions we’re starting with in the resource space. We’ve had a massive ESG push. No reinvestment in those businesses has been allowed to go on. So you’re now led to very tight supply dynamics for any kind of natural resource. So that’s tough. So maybe the global recession is engineered to help kind of attenuate that a bit or maybe it’s just it’s more likely it’s just a whole bunch of mistakes manifesting, and here’s what we have to do today.

Bilal Hafeez (38:33):

Yeah, it’s probably more that than anything else. But we haven’t talked about crypto. Any thoughts on crypto?

Mike Philbrick (38:39):

Yeah. I mean, we don’t trade crypto. We have the ability to start trading. It doesn’t have quite enough history yet for the learning to really be effective. But generally I would say this is a space that, notwithstanding what’s going on currently, by the way, which should be expected.

So I think this is a very much like a NASDAQ ’80’s and ’90’s and story. The NASDAQ peaked in 2000, but there was a lot of fits and starts around technology and technology investing and the evolution of the internet and all of the things that came along with that. And so if you look at that history, this is, this is not surprising.

If you look at the ecosystem and the number of very smart and intelligent people devoting their lives to it, like the career movement that’s gone in, it’s hard to think that it is a Ponzi scheme. And then you look at the finance and the type of people involved with backing it. These are some of the Vanguard of traditional finance. So, Fidelity’s involved. It’s hard to think that this is all a Ponzi scheme.

Is it going to go through what it’s going through right now with what’s going on with the stablecoins? Yes. And you should expect it, absolutely. Welcome to the world of frontier investing.

Bilal Hafeez (39:52):

Well put, those points. Now I did want to sort of pivot to some more kind of personal questions. I know you host or co-host your own podcast show. So, you’ve had numerous guests. Are there certain things that you’ve learned from those guests or certain things that made you think, huh, that’s interesting, I want to sort of incorporate that in some way?

Mike Philbrick (40:09):

Yeah, without a doubt, it has been one of the unforeseen gems. I’m sure you having done this for a while have found the same thing. You just will learn some things that are just things you’d never thought of.

I think some that stood out was having Annie Duke on [ReSolve’s interview with Annie Duke]. And it’s also interesting how myself and my partners will think an episode is absolutely mind blowingly awesome and the response from the world is, “Eh,” you know, “It’s fine,” right? So, Annie duke was one of those.

Gosh, we thought we were writing a thesis on decision making and really kind of had a great conversation with Annie Duke and thinking about resulting and probabilistic thinking and the exercises that you can do. Whether you are in investment management or any other decision-making process you’re going through, how you can improve your decision making, avoid resulting. I mean, just an amazing discussion with her. And was met with not quite crickets, but it was pretty quiet.

And then Chris Schindler was another great guest and his discussion on crowded trades [ReSolve’s interview with Chris Schindler]. The fact that when you allocate to a manager, you want them making the same probabilistic bet over and over again, whether it’s the end of the quarter, the end of the year, the beginning of the year. You get into Q4, and all these discretionary managers may start to back away knowing they’ve got a profit locked in, right?

As a systematic manager, we don’t do that. The bets are the bets. The probabilistic thinking is the probabilistic thinking. Because we’re going to crystallise a performance fee on December 31st, has no bearing. It’s just running machine. So, I think those are some of the advantages that you get coming back to our discussion on why systematic versus more discretionary.

We don’t have that kind of discretion to say, “Oh, we’re just going to pull the models back.” We’ve got some sort of profit locked in. And Chris was very effusive about that, managing the styles and the strategies of managers, the mistakes that allocators make. Because remember, if you’re paying performance fees, you have an asset. When a managers in a draw down, you get all of those returns without paying any fees.

So when you turn the managers over, there’s this huge drag on returns. So you have to be darn sure. Now is the manager experiencing a low series of returns or is the manager broken? And that’s a hard question to answer, but you got to think long and hard about that, especially when you’re in draw down and you have that asset there that is an opportunity for you to recover some of those returns.

And then a lot of the institutions will say, “Well, if you’re down 10% or 15%, you’re going to be out.” That also is absolutely flawed decision making. If you hire 10 managers and those managers are targeting 10 vol, you’re going to fire like a quarter of them every year, like mathematically. So a lot of his thinking was really thoughtful and I would suggest folks take a look at those.

Bilal Hafeez (43:07):

Yeah. That’s great. And more generally over your career, what’s the best investment advice you’ve ever received?

Mike Philbrick (43:13):

Well, I think that’s pretty simple. It was marry once, spent spend less than you earn, and then take the time required to get the skills and mindset to be successful in investing. It takes time. It takes a lot of time to get where you are. And it’s hard.

I don’t even know. How do you handle that when some young person comes and says, “I’m keen about investing. What should I read or what should I do?” And your mind is like, “There’s an ocean. And I don’t know where to tell you to start.” So it’s such a… Anyway.

Bilal Hafeez (43:43):

And speaking of youngsters, any advice to young people leaving university now and entering their careers?

Mike Philbrick (43:51):

Oh, absolutely. Absolutely. I actually have a passion for this. I’m an alumni of Carlton university and they have a fantastic mentorship programme that I participate in there. And I think one of the books that I would say is a guide, “The Way of the Champion.” And complete this sentence for me. In my life I am on a mission to… What? Right? And so, when you’re young and you’re coming out of university, in my life I’m on a mission to… Please complete the sentence for me.

For me, it’s to realise potential, both my own and those around me. So it’s a pretty wide open thing. But you need to have passion for something that you’re going into. That doesn’t mean… And there’s been lots of ink spilled on this, too, about passion and, “Ah, that’s BS. You can’t follow a passion,” blah, blah, blah. Well, you have to create that passion. Somehow some way you need to create the passion, right?

Bilal, you have a massive passion for markets. I do too. Why we have it? I don’t know. But somehow over the years we’ve manifested a passion for this particular thing that we do.

You have to be passionate about what you do because you’re going to be competing with others who are, and if you’re not passionate and they are passionate, you lose. You have no edge, right? And so if you don’t have passion, figure out how to create it in some way, shape, or form so that you can compete or change the game.

And then, generally kind of look at growing industries. Going into a dying industry is a tough one. A friend of mine was an architect coming out in the ’90’s in Canada. There was no work. He had to go to Japan to get work. That was a big leap back then. But when he went to Japan, they were building like crazy still. And it was baptism by fire. And he was just absolutely accelerated up the chain of command because they had to. There was no option otherwise.

So try and get into industries that are growing that, which is not an easy thing to figure out either. I mean, that’s not super easy. But that’s what I would say.

And try and clarify the goals and get some urgency. That’s something that we didn’t talk about playing football really does. When you start the year, you have one goal. That’s to win the championship. And you’ll have 18 games between now and then. You know where every game is. You know what you’re doing every moment in the time. You know what the goal is. And you know the means to get to the goal.

People don’t run their lives like that generally, but the younger, you can start thinking about the world through that lens, bringing some urgency to it and clarifying your goals around what you’re on a mission to do, I think the better you’ll do.

Books that influenced Mike

Way of Champions (Lynch), Manias, Panics, and Crashes (Kindleberger), Zen and the Art of Motorcycle Maintenance (Pirsig), Flow (Csikszentmihalyi), Lessons of History (Durant), Behavioural Investing (Montier), Liar’s Poker (Lewis), Market Wizards (Schwager), and Fortune’s Formula (Poundstone)

Bilal Hafeez (46:21):

And you mentioned the Lynch book just now. Are there any other books that influenced you over your life?

Mike Philbrick (46:27):

Oh gosh, yeah, tonnes. Tonnes. Anything written by Kindleberger [we suggest Manias, Panics, and Crashes] has been awesome. Zen and the Art of Motorcycle Maintenance, that’s one that I really enjoyed. Mihaly Csikszentmihali, anything there with Flow. It was awesome. Will and Ariel Durant, Lessons of History, those are amazing.

But more specifically on the investment side Montier in Behavioural Investing. You should have some really great opus on behavioural investing because you’re looking at yourself for that book. It applies to you. Just because you read about it and now you know about it doesn’t mean you’re not subject to it. You absolutely are.

Stuff by Mike Lewis is always awesome [Liar’s Poker is a classic]. Market Wizards. Fortunes formula, another one for those who sort of more systematic thinking. That Fortunes Formula is very influential. Anyway, lots of a reading list there.

Bilal Hafeez (47:14):

Yeah. No, that’s a big reading list there. That’s great. So, with that, I mean we’ve covered a lot of ground. A lot to digest. And what’s the best way for people to reach out or connect or follow you in some way?

Mike Philbrick (47:24):

Mike Philbrick on LinkedIn. On Twitter it’s @MikePhilbrick99. investresolve.com is the website. And ReSolve Riffs is the YouTube channel.

Bilal Hafeez (47:33):

Great. Okay. I’ll make sure to include the links to that in the show notes. So, with that, thanks a lot for being such an excellent guest. And good luck trading for the rest of this year.

Mike Philbrick (47:41):

Yeah, thank you very much. And great seeing you.

Bilal Hafeez (47:44):

Thanks for listening to the episode. Please subscribe to the podcast show on Apple, Spotify, or wherever you listen to podcasts. Leave a five-star rating, a nice comment, and let other people know about the show. We’d be super grateful. Sign up to become a member of Macro Hive at macrohive.com. We’ll be back soon. So, tune in then.

Bilal Hafeez is the CEO and Editor of Macro Hive. He spent over twenty years doing research at big banks – JPMorgan, Deutsche Bank, and Nomura, where he had various “Global Head” roles and did FX, rates and cross-markets research.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)