SI421: Taking CTAs Mainstream ft. Andrew Beer

Andrew Beer · Dynamic Beta Investments

Stock-bond diversification has broken down; 60/40 was a historical accident of the 2000s bond bubble.

Andrew says the 60/40 portfolio rested on a short window when stocks and bonds were negatively correlated and bonds never fell. He calls it a historical accident fueled by a twenty-year bond bubble, when bonds were the statistically perfect diversifier. Allocators have had recency bias and keep resetting assumptions rather than admitting they were wrong. He gives an example from 2021: equities rose 28% while bonds were flat and earned about zero, and allocators who rebalanced into bonds at the peak of the bond bubble made one of the worst mistakes an allocator could make. In the GFC bonds neither rose nor fell much, and in 2022 the relationship broke down. He is critical of bonds over the past decade, though he still holds them for the coupon. He says the simple stock-bond construct is now challenged and allocators are either changing the 40 or moving some of it into alternatives.

“I think what you're seeing right now is an existential crisis in the asset allocation world.”at 19:06

Andrew Beer · Dynamic Beta Investments

Bonds currently offer little diversification value, so investors should consider dropping them for stocks.

Beer's core claim is that bonds have no value today as a diversifier. He says that over a reasonable period, bonds don't help a portfolio, so investors should forget bonds and just own stocks, which he says carries the same risk. He backs this with the correlation data: the US investment-grade market, where most people hold their money, has a correlation of about 0.36 to equities over the 27-year sample. The 2000–2020 period, when the Bloomberg aggregate's maximum drawdown was under 4%, was an anomaly driven by central bank policy and bubbles, and it created a false perception that bonds could never do wrong. He also describes the present as looking like 'the mother of all bond market tantrums' building, though he hedges that it may reverse tomorrow.

“the amazing thing about bonds right now is bonds have no value today... You should just forget about bonds and just own stocks.”at 55:10

Andrew Beer · Dynamic Beta Investments

AI sharply lowers the barrier to starting a business, enabling one-person firms and entrepreneurship.

Andrew argues AI will substantially cut the working capital and staffing needed to start a business. He contrasts a business that once needed about $500,000 to $1 million of working capital and four people in accounting and operations with one person working through an AI assistant. He cites a friend who runs a home-organising business without a CFO or accounting department, using AI to handle the work. He expects enormous disruption and sees a surge of entrepreneurial activity as the result. He compares this to the 1990s, when cheaper risk-taking changed how people viewed starting companies and helped US growth. He expects the disruption to be healthy for the economy.

“the business that used to require a million dollars of working capital, $500,000 of working capital, you had four people... It's now one person in Claude... It's unimaginably lowered the barriers to entry to starting new businesses.”at 5:03

Andrew Beer · Dynamic Beta Investments

Commodities' negative correlation to equities was a historical window that flipped positive in the mid-2000s.

Andrew describes the late-1990s futures-based commodity return series, which showed commodities delivering equity-like returns over decades with a negative correlation to equities. Allocators then rushed to add commodities. He says that held only until the mid-2000s, when the correlation flipped positive. He also notes that commodities, like REITs, fell about 50% in the GFC after the 2000s commodity super cycle, which shows how a diversifier can stop diversifying once it is crowded.

“[That negative correlation] was true until you got to kind of the mid two thousands and the correlation flipped positive.”at 18:58

Andrew Beer · Dynamic Beta Investments

Managed futures/CTAs are the strongest crisis hedge in a portfolio, rating three stars on crisis alpha.

Andrew argues crisis alpha is the strongest case for CTAs. He uses the SocGen CTA index (average of large managed-futures managers, about 27 years of daily data) and three equity bear markets: the dot-com crash, the GFC and 2022. In the dot-com period the S&P fell about 40% and the Nasdaq about 80%, while the CTA index rose about 26%. Bonds, REITs and gold also rose then, so the 'playbook' worked. It failed in the GFC, when stocks, REITs, commodities and high yield fell and bonds did not rise, and the CTA index rose about 11%. In 2022 oil drove the GSCI up and CTAs gained again. He says CTAs profit from big price moves away from consensus, so the strategy structurally should do well in crises. He calls this 'contrarian tactical alpha' and rates it three stars.

“So the argument on crisis alpha is the strongest argument for the space because... It's, you know, managed futures funds make money when there are big price moves away from consensus, basically.”at 33:57

Andrew Beer · Dynamic Beta Investments

A private credit fund's claimed Sharpe ratio of 8–10 is inflated because it doesn't mark holdings to market.

Beer uses a private credit fund as an example of how alpha and Sharpe ratios can be misused. He says the fund claims a Sharpe ratio of eight or 10 because it does not mark anything to market. Beer is wary of the way alpha is reported, and he says that in general it is worth checking how much of a fund's return is sneakily coming from equity exposure, because that affects results in a crisis. The example suggests that smoothed, unmarked valuations make private credit returns look far better than their risk warrants.

“There's a private credit fund that claims to have a Sharpe ratio of eight or 10 because it doesn't mark anything to market.”at 38:29

Andrew Beer · Dynamic Beta Investments

AI funding arrangements look like circular 'daisy chain' financing, which Beer compares to Enron.

In a discussion of AI funding sources and the 'daisy chain' arrangements behind them, Beer says he pithily remarked that 'we used to call that Enron.' He is highlighting how the circular financing between AI players raises red flags about the sustainability of AI-linked valuations. This is a brief remark rather than a developed argument, and he gives no detailed mechanism in this passage.

“AI funding sources and the daisy chain things. And I sort of pithily said, yeah, we used to call that Enron.”at 58:55