Why Trend Thrives When Inflation Returns | Systematic Investor | Ep.373

Episode Overview

• The episode begins with a detailed discussion on the state of mathematics education in the UK, focusing on the "leaky pipeline" that loses talented students and new initiatives designed to combat this issue.
• The conversation shifts to financial markets, analyzing the impact of central bank policies like Quantitative Easing (QE) on asset prices and risk-taking.
• The speakers explore the different dynamics of financial versus physical commodity markets and how trend-following strategies must adapt to these varying speeds of adjustment.
• The discussion culminates with insights from recent financial research, highlighting the significant gap between backtested and live performance and redefining where systematic managers truly generate alpha.

Key Concepts

• Mathematics Education Pipeline: The concept of a "leaky pipeline" in UK math education, where the number of students in the "excellence stream" dwindles at each educational stage, particularly affecting women and those from disadvantaged backgrounds.
• XTX-Backed Initiatives: The role of quantitative trading firm XTX in supporting educational improvements, including the specialized 1729 maths school and a Nottingham University report analyzing the pipeline.
• Portfolio Transmission Effect: The mechanism by which central bank policies like QE push investors from safe assets (bonds) into riskier assets (equities), influencing overall market dynamics.
• Market Adjustment Speeds: The contrast between fast-adjusting financial markets (like equities) and slow-moving physical commodity markets, where supply and demand inelasticity creates prolonged trends.
• Backtest Overfitting: A key finding from financial research indicating that backtested results are often highly inflated, with an average performance "haircut" of around 60% when a strategy goes live.
• The Alpha "Envelope": The idea that true alpha for systematic managers comes not just from a superior trading signal, but from the surrounding "envelope" of expert portfolio construction, risk management, and execution.

Quotes

• At 1:42 - "What has been on my radar is what is mathematics in high schools and primary schools in the UK." - Yoav introduces his primary topic of interest.
• At 3:08 - "You start with 25,000 schools in England and the UK, and then how at each stage, fewer and fewer people remain in what they call the 'excellence stream'." - Yoav summarizes the core problem of the diminishing pipeline for advanced math students as detailed in the Nottingham University report.
• At 5:15 - "I kind of refuse to get drawn on that because I'm always a pessimist. So I'll count my chickens at the end of the year, but certainly fixed income has been very difficult." - Yoav comments on the recent market performance, specifically noting the challenges within fixed income trend trading.
• At 25:31 - "That's the whole point of QE as well, or at least it's one of the rationales for QE, is that you get this portfolio transmission effect from safe bonds into riskier bonds and then ultimately into risky assets like equities." - Explaining the mechanism by which central bank policy influences the broader market.
• At 27:36 - "From a trend following perspective, you really need to understand the dynamics from the purpose of what is the delay for the market to find a new new equilibrium." - On the importance of understanding market structure for designing trend strategies.
• At 29:20 - "That delay between supply and demand basically means that price will have to do the work over an entire year... and that means that you are looking at a sort of a prolonged trend and that's how you should harvest it." - Explaining why the inelasticity of commodity markets creates long-term trends suitable for trend-following.
• At 35:18 - "The average haircut is around 60%. So you think your Sharpe is one, but actually the Sharpe you're getting is 0.4." - Highlighting a paper's stark finding on the average performance degradation from backtested results to live trading.
• At 38:16 - "It couldn't have got it more right, even if you tried to. It's very rare that quants get it right, but he just managed to do it." - Praising a 2021 research paper from Man Group for accurately predicting which strategies would perform well during the 2022 inflationary period.
• At 38:40 - "The alpha is not necessarily in 'Oh, I've got a better signal than you'... It's really in how you put together a portfolio of those... Portfolio construction is important, how do you manage the risk of that portfolio... execution... is really important." - Arguing that the true value-add for a systematic hedge fund comes from the implementation surrounding the signal, not just the signal itself.

Takeaways

• To build robust trend-following strategies, you must tailor your models to the unique speed and structure of each asset class, recognizing that commodities and equities behave differently.
• Be extremely skeptical of backtested performance; as a rule of thumb, discount expected returns by more than half to set realistic expectations for live trading.
• When evaluating systematic managers, focus on their process for portfolio construction, risk management, and execution, as this is where sustainable value is created, not just in a "secret" signal.
• Recognize that central bank interventions create market distortions and moral hazard, which systematically influence asset prices and require careful consideration in any investment framework.
• The physical constraints of commodity markets (supply/demand delays) are a primary driver of long-term trends, making them a structurally sound component of a trend-following portfolio.
• Supporting specialized educational initiatives is crucial for nurturing talent and fixing the "leaky pipeline" in critical fields like mathematics, which ultimately benefits industries like quantitative finance.