Lehman’s Legacy, ETF Performance & What Investors Still Get Wrong | Systematic Investor | Ep.366

Episode Overview

• The hosts reflect on the 17th anniversary of the Lehman Brothers collapse, discussing the fallibility of expert predictions and the irony of mainstream institutions now launching trend-following products.
• The discussion explores the "behavior gap," where investors often underperform the very funds they invest in due to poor timing, chasing high returns and selling during drawdowns.
• The conversation addresses the core dilemma for systematic traders: whether a period of underperformance means a strategy is broken or if it's a temporary downturn that should be weathered.
• A strong case is made against recency bias in system design, emphasizing the importance of trusting long-term data over short-term market noise when building and maintaining trading models.

Key Concepts

• Lehman Brothers Anniversary: A reflection on the Global Financial Crisis, highlighting an ironically timed bullish analyst report on Lehman just before its collapse, underscoring the unreliability of narrative-based market predictions.
• Mainstreaming of Trend Following: An analysis of why large asset managers like Fidelity and BlackRock are launching trend-following products now, questioning the timing and suggesting it could be a contrarian signal that the strategy is currently out of favor.
• The Behavior Gap: The significant difference between a fund's reported time-weighted returns and the actual dollar-weighted returns achieved by its investors, caused by investors chasing past performance by buying high and selling low.
• The Systematic Trader's Dilemma: The critical question systematic traders face during a drawdown: "Has the market regime changed, or is this just temporary underperformance?"
• Dangers of Recency Bias: A warning against shortening data lookback periods or optimizing trading systems based on recent poor performance, as this is a form of look-ahead bias that almost always degrades future results.
• Trading Foreign Assets: The advice to avoid converting asset prices into a different base currency before applying trading rules, as this combines two separate trends (the asset and the FX rate) and destroys valuable diversification benefits.

Quotes

• At 4:07 - "[The analyst] joined the Congressional Oversight Panel for market monitoring, regulation, and TARP management... I mean, you can't make this up." - Niels Kaastrup-Larsen highlights the ironic career turn of the analyst who recommended Lehman, moving into a government oversight role after the crisis.
• At 8:36 - "It's interesting to me is why now? Why are these huge institutions coming out with their products now? Because, as they say in this article, this is not new." - Niels Kaastrup-Larsen questions the timing of major asset managers like Fidelity launching trend-following products, given the strategy's long history.
• At 33:53 - "An ETF gains 42% a year and its investors still lose money." - Citing an article headline, Rob Carver introduces the concept of the "behavior gap," where poor market timing by investors leads to collective losses despite a fund's strong official performance.
• At 48:08 - "Has everything changed, or is this just a temporary period of poor performance?" - Rob Carver frames the classic dilemma faced by systematic traders and allocators during drawdowns, questioning whether to abandon a model or trust its long-term efficacy.
• At 51:25 - "If I use, say, the last two or three years of data because you think that something has changed... you'll find that it's not going to do anywhere near as well as just sticking to your guns and essentially assuming you can use all the data that you can." - Rob Carver explains why shortening the lookback window for system design in reaction to recent performance is a flawed approach that typically degrades future results.

Takeaways

• An investor's own behavior is often the biggest detractor from returns; chasing performance frequently leads to buying high and selling low, even in a winning fund.
• Resist the urge to tweak trading systems based on short-term underperformance. Sticking with a strategy grounded in long-term data is almost always more robust than reacting to recent events.
• To preserve diversification, treat different sources of return separately. Do not combine an asset's price trend with currency fluctuations before applying a trading rule.
• The entry of large, mainstream players into a niche strategy like trend following may serve as a valuable contrarian indicator, potentially signaling that the strategy is undervalued.