Why Most Investors Fail at Trend Following | Systematic Investor | Ep.404

Episode Overview

• This episode explores the power of quantitative, systematic investing with a specific focus on combining trend-following strategies (managed futures) with equities to build highly resilient, all-weather portfolios.
• It demystifies the mechanics of systematic investing, revealing how simple, rules-based models outperform complex, over-engineered algorithms when facing unpredictable, real-world market regimes.
• The discussion highlights the modern evolution of alternative investments, tracking their transition from high-fee hedge funds and mutual funds into highly liquid, low-cost, and tax-efficient ETF structures.
• It addresses the critical behavioral hurdles of investing, explaining why investors struggle with "line-item risk" and tracking error, and how single-wrapper products can help investors stick to their long-term plans.

Key Concepts

• Rule-Based Systematic Investing: An approach to understanding global market trends through a quantitative, systematic lens rather than relying on human predictions, forecasts, or discretionary biases.
• The "Magic Combo" (Trend Following + Equities): The powerful diversification benefit of combining systematic trend-following with long equity exposure to reduce portfolio volatility and drawdowns while boosting long-term risk-adjusted returns.
• Risk Balancing and Equal Risk Contribution: Balancing the risk contribution of equities and trend strategies based on volatility rather than capital. This ensures that one asset class does not dominate the portfolio's risk profile when future performance is uncertain.
• The Behavioral Challenge of "Line-Item Risk": While the mathematical benefits of diversification are clear, investors struggle psychologically when a single line-item in their portfolio underperforms a simple equity benchmark, often leading them to abandon great long-term strategies.
• Simplicity vs. Complexity in Trend Following: Simple, blunt systematic models are far more robust than complex, over-engineered systems when facing out-of-sample data and unprecedented market regimes, whereas complex models often suffer from over-fitting.
• The Illusion of Correlation Optimization: Attempting to optimize portfolio diversification using complex, fluid correlation mathematics often fails during extreme market crises; true diversification comes from letting simple rules capture outlier trends when volatility spikes.
• Defining CTA as "Contrarian Tactical Alpha": Rethinking CTAs as providers of contrarian tactical alpha. Rather than just riding popular trends, they systematically take positions early in trend cycles—often when those positions are highly uncomfortable—offering genuine diversification to static portfolios.
• Structural Evolution of ETFs: The ongoing transition of complex alternative investment strategies into highly liquid, tax-efficient, and low-cost ETF structures, which helps democratize institutional-grade strategies for retail investors.

Quotes

• At 0:01:16 - "It is a fertile soil environment for finding trends... there's a lot of dislocation, a lot of uncertainty, and I think a lot of risk premiums to collect going forward." - Eric Crittenden on why market uncertainty and macro economic shifts create prime opportunities for trend-following strategies.
• At 0:09:33 - "I would love to have an ETF vehicle someday... but at the time, given the scope of our portfolio and what we were doing, it would not have worked very well because we have international markets... where the market makers in the ETF space weren't giving us positive feedback on being able to provide efficient liquidity." - Eric Crittenden on the historic structural challenges of executing complex managed futures strategies within an ETF structure.
• At 0:13:31 - "With an ETF, you have an NAV that fluctuates during the day... and the pricing when you buy and sell is the market... the more complicated the underlying is, the more illiquid the underlying is... they will take less risk to try to keep the price close to NAV." - Andrew Beer explaining the intraday pricing mechanics of alternative ETFs and the role of market makers.
• At 0:17:47 - "I strive for equal risk contribution from the equities and from the trend side... because I don't know which one is going to do better in the future." - Eric Crittenden explaining his philosophy of balancing equity beta with trend convexity.
• At 0:18:57 - "Whatever it is that you're going to bat for, and you have to stick with for decades, it better be a decent fit for your personality... because the accountability and the responsibility land on me." - Eric Crittenden emphasizing that the best investment strategy is the one you can behaviorally stick with during periods of underperformance.
• At 0:22:25 - "You want to hear from somebody building a product that they're thinking about it from an investor perspective... they have made a career bet that this will work over 5 or 10 years." - Andrew Beer on the importance of manager alignment and long-term design over asset-gathering marketing.
• At 0:29:49 - "I built the program that I am comfortable with... something that I'm happy to invest my money, or even my mom's money, in for a long period of time." - Eric Crittenden emphasizing the difference between institutional marketing products and family-and-founder-aligned products.
• At 0:31:28 - "Normal product development in the mutual fund and ETF business is marketing and distribution people who are saying, 'Look at how much money they're raising over there... How can we build something and stuff it in people's portfolios as fast as we can?'" - Andrew Beer exposing the sales-driven nature of the retail fund industry.
• At 0:35:50 - "When you shift over to the full portable alpha products... the driver there is that there is a subset within the allocator community who is very, very worried about capital efficiency. They don't want to sell anything to get exposure to it." - Andrew Beer explaining the structural demand driving the rise of return stacking and portable alpha.
• At 0:42:02 - "The simple ones are the ones that hold up on data they haven't already seen a lot better, and that's what matters—is real life." - Eric Crittenden underlining the superiority of simple systematic models in out-of-sample trading.
• At 0:45:41 - "In trend following, you make your money in market environments where the vol is going up, the correlation is going up, you-know-what is hitting the fan... and that's when you need to be pressing the gas." - Eric Crittenden explaining when trend-following strategies deliver their true diversifier value.
• At 0:48:14 - "No one has a Sharpe ratio over 0.4 if the horizon is long enough... However, if you combine strategies... you get something like 1.1 or 1.2." - Eric Crittenden illustrating the power of multi-strategy diversification over long time horizons.

Takeaways

• Overcome Line-Item Risk with Single Wrappers: Mitigate behavioral tracking-error pain by packaging equities and trend-following into a single fund wrapper (such as a mutual fund or ETF), which hides the individual "zigging" and "zagging" of assets on brokerage statements.
• Avoid Over-Engineered Models: Implement simple, robust systematic rules for trend following rather than complex mathematical formulas, as simpler models adapt much better to unprecedented market regimes.
• Target Equal Risk Contribution: When building a diversified portfolio, allocate capital based on equalizing the volatility contribution of each asset class rather than simply splitting dollar amounts.
• Look for Founder-Aligned Funds: Evaluate fund managers by checking if they have significant personal co-investment ("skin in the game") in their own strategies, ensuring their goals align with long-term investors rather than short-term asset gathering.
• Leverage Portable Alpha for Capital Efficiency: Utilize return stacking or portable alpha strategies to gain exposure to alternative risk premiums without having to liquidate core equity holdings.
• Embrace Systematic Discomfort: Trust rules-based systems to execute highly uncomfortable, contrarian trades (such as shorting equities during crashes or buying skyrocketing commodities) that discretionary human managers would reject out of fear.